-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, INCF1NpaN6eYXrUvvuRi1JXppVbklZ0spildjWcwsMSIfOlTR3uQnfjS2xjJDPbh M8ajkQ8O6ceeVQwWpgLgIw== 0000950135-06-000377.txt : 20060130 0000950135-06-000377.hdr.sgml : 20060130 20060130170310 ACCESSION NUMBER: 0000950135-06-000377 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 20051031 FILED AS OF DATE: 20060130 DATE AS OF CHANGE: 20060130 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VERMONT PURE HOLDINGS LTD/DE CENTRAL INDEX KEY: 0001123316 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-GROCERIES & RELATED PRODUCTS [5140] IRS NUMBER: 030366218 STATE OF INCORPORATION: DE FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-31797 FILM NUMBER: 06562713 BUSINESS ADDRESS: STREET 1: 44 KRUPP DRIVE STREET 2: PO BOX 536 CITY: WILLISTON STATE: VT ZIP: 05495 BUSINESS PHONE: 8028601126 MAIL ADDRESS: STREET 1: 44 KRUPP DRIVE STREET 2: PO BOX 536 CITY: WILLISTON STATE: VT ZIP: 05495 FORMER COMPANY: FORMER CONFORMED NAME: VP MERGER PARENT INC DATE OF NAME CHANGE: 20000905 10-K 1 b58814vpe10vk.txt VERMONT PURE HOLDINGS, LTD. UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) [X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended October 31, 2005 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from ________ to ________ Commission File Number 000-31797 VERMONT PURE HOLDINGS, LTD. (Exact name of business issuer in its charter) DELAWARE 03-0366218 (State or other jurisdiction of I.R.S. Employer Identification Number incorporation or organization)
1050 Buckingham St., Watertown, CT 06795 (Address of principal executive offices and zip code) Formerly: 45 Krupp Drive, Williston VT 05495 Issuer's telephone number, including area code: (860) 945-0661 Securities registered pursuant to Section 12(g) of the Act: None Securities registered pursuant to Section 12(b) of the Act: Common Stock, par value $.001 per share (Title of Class) Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [ ] No [X] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X] 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 requirement for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [ ] No [X] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] The aggregate market value of the registrant's voting and non-voting common equity held by non-affiliates of the registrant, computed by reference to the last sale price per share of common stock on April 30, 2005, the last day of the registrant's most recently completed second fiscal quarter, as reported on the American Stock Exchange, was $21,932,821. The number of shares outstanding of the Issuer's Common Stock, $.001 par value, was 21,655,646 on January 17, 2006. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive proxy statement, which is expected to be filed not later than 120 days after the registrant's fiscal year ended October 31, 2005, to be delivered in connection with the registrant's annual meeting of stockholders, are incorporated by reference to Part III into this Form 10-K. TABLE OF CONTENTS
PAGE ---- PART I Item 1. Business 3 Item 1A. Risk Factors 10 Item 1B. Unresolved Staff Comments 15 Item 2. Properties 15 Item 3. Legal Proceedings 16 Item 4. Submission of Matters to a Vote of Security Holders 16 PART II Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 17 Item 6. Selected Financial Data 18 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 18 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 29 Item 8. Financial Statements and Supplementary Data 30 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 30 Item 9A. Controls and Procedures 30 Item 9B. Other Information 30 PART III Item 10. Directors and Executive Officers of the Registrant 31 Item 11. Executive Compensation 31 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 31 Item 13. Certain Relationships and Related Transactions 31 Item 14. Principal Accountant Fees and Services 31 ITEM IV Item 15. Exhibits and Financial Statement Schedules 32 Signatures
In this annual report on Form 10-K, "Vermont Pure," the "Company," "we," "us" and "our" refer to Vermont Pure Holdings, Ltd. and its subsidiary, taken as a whole, unless the context otherwise requires. This Annual Report on Form 10-K contains references to trade names, label design, trademarks and registered marks of Vermont Pure Holdings, Ltd. and its subsidiary and other companies, as indicated. Unless otherwise provided in this Annual Report on Form 10-K, trademarks identified by (R) are registered trademarks or trademarks, respectively, of Vermont Pure Holdings, Ltd. or its subsidiary. All other trademarks are the properties of their respective owners. Except for historical facts, the statements in this annual report are forward-looking statements. Forward-looking statements are merely our current predictions of future events. These statements are inherently uncertain, and actual events could differ materially from our predictions. Important factors that could cause actual events to vary from our predictions include those discussed in this annual report under the heading "Risk Factors." We assume no obligation to update our forward-looking statements to reflect new information or developments. We urge readers to review carefully the risk factors described in this annual report and in the other documents that we file with the Securities and Exchange Commission. You can read these documents at www.sec.gov. 2 PART I ITEM 1. BUSINESS. INTRODUCTION AND INDUSTRY TRENDS Vermont Pure Holdings, Ltd. is engaged in the production, marketing and distribution of bottled water and the distribution of coffee, ancillary products, and other office refreshment products. Through February 2004, when we divested the retail segments of our business, our products were sold predominantly in the Northeast, as well as in the Mid-Atlantic and Mid-Western United States. Since March 2004, we have operated exclusively as a Home and Office delivery business, using our own trucks for distribution throughout New England, New York, and New Jersey. All of our water products are still (non-sparkling) waters. We believe that consumers perceive bottled water to be a healthy and refreshing beverage alternative to beer, liquor, wine, soft drinks, coffee and tea and sales of bottled water will continue to grow as consumers focus on health and fitness, alcohol moderation and the avoidance of both caffeine and sodium. Bottled water has become a mainstream beverage as the centerpiece of many consumers' healthy living lifestyles. In addition, we believe that the development and continued growth of the bottled water industry reflects growing public awareness of the potential contamination and unreliability of municipal water supplies. In recent years, the bottled water industry has experienced periods of significant consolidation and aggressive price competition. Large multi-national companies such as Nestle, Groupe Danone and Suntory Water Group have been active acquirers of small and medium sized regional bottled water companies. In 2003, Danone and Suntory pooled their respective United States assets in the industry into a joint venture to create the largest Home and Office water delivery company in the country. In 2005, this joint venture was sold to a private equity firm. In general, the primary drivers of this consolidation are the incremental growth realized by acquiring the target company's customer base, and synergies resulting from integrating existing operations. Moreover, the entrance of major soft drink bottlers, notably Coca-Cola (with Dasani) and Pepsi Cola (with Aquafina), into the bottling and distribution segment of the industry has had a major impact on the bottled water industry. COMPANY BACKGROUND Incorporated in Delaware in 1990, we originally developed Vermont Pure(R) Natural Spring Water as our flagship brand in the still, non-carbonated retail consumer category. Over the next decade, we grew aggressively both internally and through acquisitions, primarily in the Home and Office market. In addition to marketing the Vermont Pure(R) brand, in 1995 we renewed marketing efforts with respect to our original trademark, Hidden Spring(R). We expanded our product lines to include more sizes and features, such as sports caps on selected bottle sizes for convenient single serve, and multi-packs for the grocery and convenience store channels. By 1996, we began to pursue a strategy of diversifying our product offerings. Most notably, we began to utilize an acquisition strategy in 1996 to minimize our reliance on the retail consumer side of the business and to increase growth in other categories. Prior to 1996, our retail business represented 90% of our total sales revenues. By way of contrast, in 2003, our last full year in the 3 retail business, our Home and Office delivery category represented 65% of our total sales. Additional benefits of increasing the Home and Office channel have included higher gross margins and reduced seasonality of our sales. In October 2000, we merged with the Crystal Rock Spring Water Company, Inc. of Watertown, Connecticut. Crystal Rock had historically focused its manufacturing resources on the still, non-carbonated segment of the bottled water industry. Although its primary business had been the marketing and distribution of the Crystal Rock(R) brand of purified and mineralized drinking water to the Home and Office delivery markets, it also distributed coffee, other refreshment type products, and vending services in Connecticut, New York and Massachusetts. We continued our acquisition strategy in fiscal 2002 and 2003 with smaller acquisitions in our established Home and Office markets. We closed acquisitions in fiscal year 2004 with $5 million in annual sales in our core market areas. The activity for the year culminated at the end of the year with the acquisition of Mayer Brothers Home and Office division in Buffalo, NY, making us the largest distributor in that market. Previously in the year, we had acquired Mayer Brothers smaller Rochester operations. These acquisitions solidified our presence in the western New York region. In 2004, we sold the retail segments (which we traditionally have referred to separately as "PET" and "Gallon") of our business, while retaining our Home and Office distribution business. The segments sold included our retail consumer business under our own brands, as well as the private label business that we packed for others. The sale included the springs, manufacturing facility, inventory, and the related machinery and equipment located in Randolph Center, Vermont. We retained the Vermont Pure(R) trademark and continue to distribute water under that brand throughout our Home and Office distribution area, while licensing it to the buyer, for a period of 30 years, for use in the bottling and distribution of retail products. The buyer acquired our Hidden Spring(R) trademark and licenses it back to us for Home and Office distribution. We relocated our five-gallon Home and Office bottling operations from Randolph to White River Junction, Vermont, and source our spring water from a Vermont location under an existing water supply agreement. Also in conjunction with the sale, we relocated our corporate headquarters to our Williston, Vermont facility. Subsequently, we moved our headquarters to Watertown, CT where most of our administrative operations are now located. Although we are proud of the business and brands we built in the retail consumer market, the goal of the transaction was to enable us to concentrate on our higher margin, and more profitable, Home and Office business, which distributes the Crystal Rock(R) brand of water, as well as our Vermont Pure(R) water, coffee and other products. It is the culmination of a strategy that we began pursuing in 1996, when we originally diversified into the Home and Office segment. Over time, the retail segments became unprofitable, as margins had been squeezed by intense competition in this segment of the market. Management's decision to concentrate the business in the Home and Office market has been driven by, among other things, attractive margins and good cash flows from equipment rentals, as well as by the advantages of product diversification. OTHER SIGNIFICANT PRODUCT LINES Coffee, a product that is counter seasonal to water, is the second leading product in the distribution channel, now accounting for 18% of our total sales in fiscal year 2005. We generally buy coffee under contracts that set prices for up to eighteen months, in order to maintain price and supply 4 stability. Please refer to "Commodity Price Risks -- Coffee" on page 29 of this report for additional information on our coffee supply agreements. Because coffee is a commodity, we cannot ensure that future supplies and pricing will not be subject to volatility in the world commodity markets. Any interruption in supply or dramatic increase in pricing may have an adverse effect on our business. The increase in coffee sales in 2004 and 2005 has been driven by the market growth of single serve coffee products. This development has revolutionized the marketplace and, while we expect the growth of these products to continue, innovation and changes in distribution will play a significant role in the profitability of the products. WATER SOURCES, TREATMENT, AND BOTTLING OPERATIONS Water from the local municipalities is the primary raw source for the Crystal Rock(R) brand. The raw water is purified through a number of processes beginning with filtration. Utilizing carbon and ion exchange filtration systems, we remove chlorine and other volatile compounds and dissolved solids. After the filtration process, impurities are removed by reverse osmosis and/or distillation. We ozonate our purified water (by injecting ozone into the water as an agent to prohibit the formation of bacteria) prior to storage. Prior to bottling, we add pharmaceutical grade minerals to the water, including calcium and potassium, for taste. The water is again ozonated and bottled in a fully enclosed clean room with a high efficiency particulate air, or HEPA, filtering system designed to prevent any airborne contaminants from entering the bottling area, in order to create a sanitary filling environment. If for any reason this municipal source for Crystal Rock(R) water were curtailed or eliminated, we could, though probably at greater expense, purchase water from other sources and have it shipped to our manufacturing facilities. In conjunction with our acquisition of their Home and Office distribution assets, we entered into a contract with Mayer Brothers of Buffalo, New York to bottle our Crystal Rock(R) brand in that market. The primary source of our natural spring water is a spring owned by a third party in Stockbridge, Vermont that is subject to a water supply contract. We also obtain water, under similar agreements with third parties, from springs in Bennington and Tinmouth, Vermont. All of the springs we use are approved by the State of Vermont as sources for natural spring water. We have for several years bought spring water from a source in Stockbridge, Vermont. Until late 1999, we had no contract with respect to this source. Commencing in November 1999, we obtained a 50-year water supply contract to purchase, on a first priority basis, up to 5,000,000 gallons per month from the spring owner. Because this amount is well in excess of our current needs and within the apparent capacity of the spring, we believe that we can readily meet our bulk water supply needs for the foreseeable future. In 2002, we signed a 20-year agreement with the Town of Bennington, Vermont to purchase water from a spring owned by the town. Under that agreement, we can use up to 100,000 gallons a day from this site. We plan to use this water primarily in our Halfmoon, New York bottling facility. We started using water from this site in November 2004. 5 Percolation through the earth's surface is nature's best filter of water. We believe that the exceptionally long percolation period of natural spring water assures a high level of purity. Moreover, the long percolation period permits the water to become mineralized and pH balanced. We believe that the age and extended percolation period of our natural spring water provides the natural spring water with certain distinct attributes: a purer water, noteworthy mineral characteristics (including the fact that the water is sodium free and has a naturally balanced pH), and a light, refreshing taste. An interruption or contamination of any of our spring sites would materially affect our business. We believe that we could find adequate supplies of bulk spring water from other sources, but that we might suffer inventory shortages or inefficiencies, such as increased purchase or transportation costs, in obtaining such supplies. We are highly dependent on the integrity of the sources and processes by which we derive our products. Natural occurrences beyond our control, such as drought, earthquake or other geological changes, a change in the chemical or mineral content or purity of the water, or environmental pollution may affect the amount and quality of the water emanating from the springs or municipal sources that we use. There is a possibility that characteristics of the product could be changed either inadvertently or by tampering before consumption. Even if such an event were not attributable to us, the product's reputation could be irreparably harmed. Consequently, we would experience economic hardship. Occurrence of any of these events could have an adverse impact on our business. We are also dependent on the continued functioning of our bottling processes. An interruption may result in an inability to meet market demand and/or negatively impact the cost to bottle the products. Additionally, the distribution of the product is dependent on other businesses. PRODUCTS We sell our three major brands in three and five gallon bottles to homes and offices throughout New England, New York, and New Jersey. In general, Crystal Rock(R) is distributed in southern New England and upstate and western New York, while Vermont Pure(R) and Hidden Spring(R) are distributed throughout New England. We rent water coolers to customers to dispense bottled water. Our coolers are available in various consumer preferences such as cold, or hot and cold, dispensing units. In conjunction with our Home and Office accounts, we also distribute a variety of coffee, tea and other hot beverage products and related supplies, as well as other consumable products used around the office. We offer vending services in some locations. We rent multi-burner and sell single serve coffee machines to customers. In addition, we supply whole beans and coffee grinders for fresh ground coffee and cappuccino machines to restaurants. We are the exclusive office coffee distributor of Baronet Coffee in New England, New York and New Jersey. In addition to Baronet Coffee, we sell other national brands, most notably, Green Mountain Coffee Roasters. MARKETING AND SALES OF BRANDED PRODUCTS Our water products are marketed and distributed in five and three-gallon bottles as "premium" bottled water. We seek brand differentiation by offering a choice of high quality spring and purified water along with a wide range of coffee and office refreshment products, and value-added service. Home and Office sales are generated and serviced using our own facilities, employees and vehicles. Telemarketers and outside/cold-call sales personnel are used to market our Home and Office 6 delivery. We support this sales effort through promotional giveaways and Yellow Pages advertising, as well as radio, television and billboard advertising campaigns. We also sponsor local area sporting events, participate in trade shows, and endeavor to be highly visible in community and charitable events. We market our Home and Office delivery service throughout most of New England and New York and parts of New Jersey. Advertising and Promotion We advertise our products primarily through Yellow Pages and other print media and secondarily through print, television and radio media. We have also actively promoted our products through sponsorship of various organizations and sporting events. In recent years, we have sponsored professional golf and tennis events and various charitable and cultural organizations, such as Special Olympics, the National Association of Breast Cancer Organizations, the Multiple Sclerosis Society, and the Vermont Symphony Orchestra. Sales and Distribution We sell and deliver products directly to our customers using our own employees and route delivery trucks. We make deliveries to customers on a regularly scheduled basis. We bottle our water at our facilities in Watertown, Connecticut, White River Junction, Vermont, and Halfmoon, New York. We maintain numerous distribution locations throughout our market area. From these locations we also distribute dispensing equipment, a variety of coffee, tea and other refreshment products, and related supplies. We ship between our production and distribution sites using both our own and contracted carriers. We use outside distributors in areas where we currently do not distribute our products. Distributor sales represented less than 2% of total revenue in fiscal year 2005. SUPPLIES We currently source all of our raw materials from outside vendors. As one of the largest Home and Office distributors in the country, we are able to capitalize on volume to continue to reduce costs. We are a member of the Quality Bottlers Cooperative, or QBC, a purchasing cooperative comprised of some of the largest independent Home and Office water companies in the United States. QBC acts as a purchasing and negotiating agent to acquire national pricing for the cooperative on common materials such as bottles, water coolers, cups, and other supplies. QBC believes that due to its size it can effectively purchase equipment and supplies at levels competitive to larger national entities. We rely on trucking to receive raw materials and transport and deliver our finished products. Consequently, the price of fuel significantly impacts the cost of our products. We purchase our own fuel for our Home and Office delivery and use third parties for transportation of raw materials and finished goods between our warehouses. While volume purchases can help control erratic fuel pricing, market conditions ultimately determine the price. In 2005 we experienced substantial increases in fuel prices as a result of international events and natural disasters. Continued increases in fuel prices would likely affect our profitability if we are not able to adjust our pricing accordingly without losing sales volume. 7 No assurance can be given that we will be able to obtain the supplies we require on a timely basis or that we will be able to obtain them at prices that allow us to maintain the profit margins we have had in the past. We believe that we will be able to either renegotiate contracts with these suppliers when they expire or, alternatively, if we are unable to renegotiate contracts with our key suppliers, we believe that we could replace them. Any raw material disruption or price increase may result in an adverse impact on our financial condition and prospects. For instance, we could incur higher costs in renegotiating contracts with existing suppliers or replacing those suppliers, or we could experience temporary dislocations in its ability to deliver products to our customers, either of which could have a material adverse effect on our results of operations. SEASONALITY Our business is seasonal. The period from June to September, when we have our highest water sales, represents the peak period for sales and revenues due to increased consumption of cold beverages during the summer months in our core Northeastern United States market. Conversely coffee, which represented 18% of our sales in 2005, has a peak sales period from November to March. COMPETITION We believe that bottled water historically has been a regional business in the United States. However, the Home and Office market includes several large regional brands such as Poland Spring, Deer Park, Belmont Springs and Culligan that are all owned by larger companies with national or multinational distribution. Additionally, we compete with smaller, locally-owned, regional bottlers such as Monadnock in the Boston area and Leisure Time in the Hudson Valley of New York. With our Vermont Pure(R) brand, we compete on the basis of pricing, customer service, and quality of our products, the image of the State of Vermont, attractive packaging, and brand recognition. With the Crystal Rock(R) brand, we compete on the basis of taste, service, and the purity of the distilled product with minerals added back. We consider our trademarks, trade names and brand identities to be very important to our competitive position and defend our brands vigorously. We feel that installation of filtration units in the home or commercial setting poses a competitive threat to our business. To address this, we make available plumbed-in filtration units and servicing contracts on a limited basis. Competition from non-traditional sources is changing the marketplace. The two most notable examples are water filtration as a substitute for purchasing water and cheaper coolers from offshore sources, making customer purchasing a more viable alternative to leasing. We are reacting to these changes by integrating this type of equipment into our business. If we are not able to successfully integrate them into our business, our sales and profits could decrease. There has also a been a trend developing in the marketplace for consumers to own their own water coolers, thereby foregoing rental charges on the unit. If this trend continues, it could have a negative impact on our sales as a result of the reduced rental income. 8 As discussed above, coffee is another significant component of our overall sales. The growth of this product line has been driven by single serve packages. Since these packages are relatively new, distribution channels are not yet fully developed. Increased competition for sales most likely will develop from other food and beverage distributors, retailers, and the internet. In addition, machines to brew these packages are different from traditional machines and packages ideally need to be brewed in machines that accommodate the specific package. It is conceivable that the popularity of a certain machine or brand may dictate what products are successful in the marketplace. Consequently, our success, both from a sales and profitability perspective, may be affected by our access to distribution rights for certain products and machines and our decisions concerning which equipment to invest in. TRADEMARKS We sell our bottled water products under the trade names Vermont Pure Natural Spring Water(R), Crystal Rock(R), and Stoneridge(R). We have rights to other trade names, including Hidden Spring(R), Pequot Natural Spring Water(R), Excelsior Spring Water(R), Happy Spring Water(R), Manitock Spring Water(R), and Vermont Naturals(R). Our trademarks as well as label design are registered with the United States Patent and Trademark Office. GOVERNMENT REGULATION The Federal Food and Drug Administration (FDA), regulates bottled water as a "food." Accordingly, our bottled water must meet FDA requirements of safety for human consumption, of processing and distribution under sanitary conditions and of production in accordance with the FDA "good manufacturing practices." To assure the safety of bottled water, the FDA has established quality standards that address the substances that may be present in water which may be harmful to human health as well as substances that affect the smell, color and taste of water. These quality standards also require public notification whenever the microbiological, physical, chemical or radiological quality of bottled water falls below standard. The labels affixed to bottles and other packaging of the water are subject to FDA restrictions on health and nutritional claims for foods under the Fair Packaging and Labeling Act. In addition, all drinking water must meet Environmental Protection Agency standards established under the Safe Drinking Water Act for mineral and chemical concentration and drinking water quality and treatment that are enforced by the FDA. We are subject to the food labeling regulations required by the Nutritional Labeling and Education Act of 1990. We believe we are in compliance with these regulations. We are subject to periodic, unannounced inspections by the FDA. Upon inspection, we must be in compliance with all aspects of the quality standards and good manufacturing practices for bottled water, the Fair Packaging and Labeling Act, and all other applicable regulations that are incorporated in the FDA quality standards. In May 1996, new FDA regulations became effective that redefined the standards for the identification and quality of bottled water. We believe that we meet the current regulations of the FDA, including the classification as spring water. We also must meet state regulations in a variety of areas. The Department of Health of the State of Vermont regulates water products for purity, safety and labeling claims. Bottled water sold in 9 Vermont must originate from an "approved source." The water source must be inspected and the water sampled, analyzed and found to be of safe and wholesome quality. The water and the source of the water are subject to an annual "compliance monitoring test" by the State of Vermont. In addition, our bottling facilities are inspected by the Department of Health of the State of Vermont. Our product labels are subject to state regulation (in addition to the federal requirements) in each state where the water products are sold. These regulations set standards for the information that must be provided and the basis on which any therapeutic claims for water may be made. The bottled water industry has a comprehensive program of self-regulation. We are a member of the International Bottled Water Association, or IBWA. As a member, our facilities are inspected annually by an independent laboratory, the National Sanitation Foundation, or NSF. By means of unannounced NSF inspections, IBWA members are evaluated on their compliance with the FDA regulations and the association's performance requirements, which in certain respects are more stringent than those of the federal and various state regulations. The laws that regulate our activities and properties are subject to change. As a result, there can be no assurance that additional or more stringent requirements will not be imposed on the our operations in the future. Although we believes that our water supply, products and bottling facilities are in substantial compliance with all applicable governmental regulations, failure to comply with such laws and regulations could have a material adverse effect on our business. EMPLOYEES As of January 17, 2006, we had 328 full-time employees and 30 part-time employees. None of the employees belong to a labor union. We believe that our relations with our employees are good. ADDITIONAL AVAILABLE INFORMATION Our principal website is www.vermontpure.com. We make our annual, quarterly and current reports, and amendments to those reports, available free of charge on www.vermontpure.com, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. Reports of beneficial ownership of our common stock, and changes in that ownership, by directors and officers on Forms 3, 4 and 5 are likewise available free of charge on our website. The information on our website is not incorporated by reference in this annual report on Form 10-K or in any other report, schedule, notice or registration statement filed with or submitted to the SEC. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically at www.sec.gov. You may also read and copy the materials we file with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW., Washington, DC 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. ITEM 1A RISK FACTORS We operate in a competitive business environment that is influenced by conditions that are both controllable and beyond our control. These conditions include, but are not limited to, the regional 10 economy, monetary policy, and the political and regulatory environment. The following summarizes important risks and uncertainties that may materially affect our business in the future. OVER A PERIOD OF YEARS, WE HAVE BORROWED SUBSTANTIAL AMOUNTS OF MONEY TO FINANCE ACQUISITIONS. IF WE ARE UNABLE TO MEET OUR DEBT SERVICE OBLIGATIONS TO OUR SENIOR AND SUBORDINATED LENDERS, WE WOULD BE IN DEFAULT UNDER THOSE OBLIGATIONS, AND THAT COULD HURT OUR BUSINESS OR EVEN RESULT IN FORECLOSURE, REORGANIZATION OR BANKRUPTCY. The underlying loans are secured by substantially all of our assets. If we do not repay our indebtedness in a timely fashion, our secured creditors could declare a default and foreclose upon our assets, which would likely result in harmful disruption to our business, the sale of assets for less than their fully realizable value, and possible bankruptcy. We must generate enough cash flow to service this indebtedness until maturity. Fluctuations in interest rates could significantly increase our expenses. We will have significant interest expense for the foreseeable future, which in turn may increase or decrease due to interest rate fluctuations. To partially mitigate this risk, we have established fixed interest rates on approximately 75% of our outstanding debt. As a result of our large amount of debt, we may be perceived by banks and other lenders to be highly leveraged and close to our borrowing ceiling. Until we repay some of our debt, our ability to access additional capital may be limited. In turn, that may limit our ability to finance transactions and to grow our business. In addition, our senior credit agreement limits our ability to incur incremental debt without our lender's permission. Our senior credit agreement contains numerous covenants and restrictions that affect how we conduct our business. THE BAKER FAMILY CURRENTLY OWNS A MAJORITY OF OUR VOTING STOCK AND CONTROLS THE COMPANY. SUCH CONTROL AFFECTS OUR CORPORATE GOVERNANCE, AND COULD ALSO HAVE THE EFFECT OF DELAYING OR PREVENTING A CHANGE OF CONTROL OF THE COMPANY. The Baker family group, consisting of the four current directors Henry Baker (Chairman Emeritus), Peter Baker (CEO), John Baker (Executive Vice President) and Ross Rapaport (Chairman), as trustee, together own a majority of our common stock. Accordingly, these stockholders, acting together, can exert a controlling influence over the outcome of matters requiring stockholder approval, such as the election of directors, amendments to our certificate of incorporation, mergers and various other matters. The concentration of ownership could also have the effect of delaying or preventing a change of control of the company. As permitted under the corporate governance rules of the American Stock Exchange (AMEX), we have, at the direction of the Baker family group, elected "controlled company" status under those rules. A controlled company is exempted from these AMEX corporate governance rules: (1) the requirement that a listed company have a majority of independent directors, (2) the requirement that nominations to the company's board of directors be either selected or recommended by a nominating committee consisting solely of independent directors, and (3) the requirement that officers' compensation be either determined or recommended by a compensation committee consisting solely 11 of independent directors. We do not currently utilize exemption (3) as we have a compensation committee consisting solely of three independent directors. OUR SUCCESS DEPENDS ON THE CONTINUED SERVICES OF KEY PERSONNEL. Our continued success will depend in large part upon the expertise of our senior management. Peter Baker, our Chief Executive Officer and President, John Baker, our Executive Vice President, and Bruce MacDonald, our Chief Financial Officer, Treasurer and Secretary, have entered into employment agreements with Vermont Pure Holdings, Ltd. These "at will" employment agreements do not prevent these employees from resigning. The departure or loss of any of these executives individually could have an adverse effect on our business and operations. THE PERSONAL INTERESTS OF OUR DIRECTORS AND OFFICERS CREATE A CONFLICT. As mentioned above, the Baker family group owns a majority of our common stock. In addition, in connection with the acquisition of Crystal Rock Spring Water Company in 2000, we issued members of the Baker family group (including Joan Baker, the wife of Henry Baker) 12% subordinated promissory notes secured by all of our assets. The current balance on these notes is approximately $14,000,000. We also lease important facilities in Watertown and Stamford, Connecticut from Baker family interests. These interests of the Baker family create various conflicts of interest. THE MARKET FOR BOTTLED WATER IS SUBJECT TO RAPID MARKET CHANGE, INTRODUCTION OF COMPETING PRODUCTS, AND CHANGING INDUSTRY STANDARDS. We operate in highly competitive markets. The principal methods of competition in the markets in which we compete are distribution capabilities, brand recognition, quality, reputation, and price. We have a significant number of competitors, some of which have far greater resources than us. Among our principal competitors are the Nestle Waters North America, large regional brands owned by private groups, and local competitors in the markets that we serve. Price reductions and the introduction of new products by our competitors can adversely affect our revenues, gross margins, and profits. In addition, the industry has been affected by the increasing availability of water coolers in discount retail outlets. This has negatively impacted our rental revenue stream in recent years as more customers choose to purchase coolers rather than rent them. The reduction of rental revenue has been somewhat offset by the increase in coolers that we sell but not to the extent that rentals have declined. We do not expect retail sales to replace rentals completely because we believe that the purchase option does not provide the quality and service that many customers want. However, third party retail cooler sales may continue to negatively impact our rental revenues in the future. THE BOTTLED WATER INDUSTRY IS REGULATED AT BOTH THE STATE AND FEDERAL LEVEL. IF WE ARE UNABLE TO CONTINUE TO COMPLY WITH APPLICABLE REGULATIONS AND STANDARDS IN ANY JURISDICTION, WE MIGHT NOT BE ABLE TO SELL OUR PRODUCTS IN THAT JURISDICTION, AND OUR BUSINESS COULD BE SERIOUSLY HARMED. The Federal Food and Drug Administration regulates bottled water as a food. Our bottled water must meet FDA requirements of safety for human consumption, labeling, processing and distribution under sanitary conditions and production in accordance with FDA "good manufacturing practices." In addition, all drinking water must meet Environmental Protection Agency standards established under the Safe Drinking Water Act for mineral and chemical concentration and drinking water 12 quality and treatment, which are enforced by the FDA. We also must meet state regulations in a variety of areas. These regulations set standards for approved water sources and the information that must be provided and the basis on which any therapeutic claims for water may be made. We have received approval for our drinking water in Connecticut, Massachusetts, New Hampshire, New Jersey, New York, Rhode Island and Vermont. However, we can give no assurance that we will receive such approvals in the future. WE DEPEND UPON MAINTAINING THE INTEGRITY OF OUR WATER RESOURCES AND MANUFACTURING PROCESS. IF OUR WATER SOURCES OR BOTTLING PROCESSES WERE CONTAMINATED FOR ANY REASON, OUR BUSINESS WOULD BE SERIOUSLY HARMED. Our ability to retain customers and the goodwill associated with our brands is dependent upon our ability to maintain the integrity of our water resources and to guard against defects in, or tampering with, our manufacturing process. The loss of integrity in our water resources or manufacturing process could lead to product recalls and/or customer illnesses that could significantly reduce our goodwill, market share and revenues. Because we rely upon natural spring sites for sourcing some of our water supply, acts of God, such as earthquakes, could alter the geologic formation of the spring sites, constricting water flow. In addition, we do not own any of our water sources. Although we feel the long term rights to our spring and municipal sources are well secured, any dispute over these rights that resulted in prolonged disruption in supply could cause an increase in cost of our product or shortages that would not allow us to meet the market demand for our product. FLUCTUATIONS IN THE COST OF ESSENTIAL RAW MATERIALS AND COMMODITIES, INCLUDING FUEL COSTS, FOR THE MANUFACTURE AND DELIVERY OF OUR PRODUCTS COULD SIGNIFICANTLY IMPACT OUR BUSINESS. We rely upon the raw material of polycarbonate, a commodity that is subject to fluctuations in price and supply, for manufacturing our bottles. Bottle manufacture also uses petroleum-based products. Increases in the cost of petroleum will likely have an impact on our bottle costs. Our transportation costs increase as the price of fuel rises. Because trucks are used extensively in the delivery of our products, the rising cost of fuel has impacted and can be expected to continue to impact the profitability of our operations unless we are able to pass along those costs to our customers. Further, limitations on the supply or availability of fuel could inhibit our ability to get raw materials and distribute our products, which in turn could have an adverse affect on our business. A significant portion of our sales, 18% in fiscal year 2005, is derived from coffee. The supply and price of coffee may be limited by climate, by international political and economic conditions, and by access to transportation, combined with consumer demand. An increase in the price of coffee could result in a reduction in our profitability. If our ability to purchase coffee were impaired by a market shortage, our sales might decrease, which would also result in a reduction of profitability. WE HAVE A LIMITED AMOUNT OF BOTTLING CAPACITY. SIGNIFICANT INTERRUPTIONS ON OUR BOTTLING FACILITIES COULD ADVERSELY AFFECT OUR BUSINESS. 13 We own three bottling facilities, and also contract with a third party, to bottle our water. If any of these facilities were incapacitated for an extended period of time, we would likely have to relocate production to an alternative facility. The relocation and additional transportation could increase the cost of our products or result in product shortages that would reduce sales. Higher costs and lower sales would reduce profitability. WE RELY UPON A SINGLE SOFTWARE VENDOR THAT SUPPLIES THE SOFTWARE FOR OUR ROUTE ACCOUNTING SYSTEM. Our route accounting system is essential to our overall administrative function and success. An extended interruption in servicing the system could result in the inability to access information. Limited or no access to this information would likely inhibit the distribution of our products and the availability of management information, and could even affect our compliance with public reporting requirements. Our supplier is Computer Design Systems, or CDS, of which we own approximately 24%. CDS has a limited number of staff that has proprietary information pertaining to the operation of the software. Changes in personnel might result in disruption of service. Any of these consequences could have a material adverse impact on our operations and financial condition. OUR CUSTOMER BASE IS LOCATED IN NEW ENGLAND, NEW YORK AND NEW JERSEY. IF THERE WERE TO BE A MATERIAL DECLINE IN THE ECONOMY IN THESE REGIONS, OUR BUSINESS WOULD BE LIKELY BE ADVERSELY AFFECTED. Essentially all of our sales are derived from New England, New York and New Jersey. A significant negative change in the economy of any of these regions, changes in consumer spending in these regions, or the entry of new competitors into these regional markets, among other factors, could result in a decrease in our sales and, as a result, reduced profitability. OUR BUSINESS IS SEASONAL, WHICH MAY CAUSE FLUCTUATIONS IN OUR STOCK PRICE. The period from June to September represents the peak period for sales and revenues due to increased consumption of beverages during the summer months in our core Northeastern United States markets. Warmer weather in our geographic markets tends to increase sales, and cooler weather tends to decrease sales. To the extent that our quarterly results are affected by these patterns, our stock price may fluctuate to reflect them. ACQUISITIONS MAY DISRUPT OUR OPERATIONS OR ADVERSELY AFFECT OUR RESULTS We regularly evaluate opportunities to acquire other businesses. The expenses we incur evaluating and pursuing acquisitions could have a material adverse effect on our results of operations. If we acquire a business, we may be unable to manage it profitably or successfully integrate its operations with our own. Moreover, we may be unable to realize the financial, operational, and other benefits we anticipate from these acquisitions. Competition for future acquisition opportunities in our markets could increase the price we pay for businesses we acquire and could reduce the number of potential acquisition targets. Further, acquisitions may involve a number of special financial and business risks, such as: - charges related to any potential acquisition from which we may withdraw; - diversion of our management's time, attention, and resources; 14 - decreased utilization during the integration process; - loss of key acquired personnel; - increased costs to improve or coordinate managerial, operational, financial, and administrative systems including compliance with the Sarbanes-Oxley Act of 2002; - dilutive issuances of equity securities, including convertible debt securities; - the assumption of legal liabilities; - amortization of acquired intangible assets; - potential write-offs related to the impairment of goodwill; - difficulties in integrating diverse corporate cultures; and - additional conflicts of interests. WE ARE REQUIRED TO BE IN COMPLIANCE WITH SECTION 404 OF THE SARBANES-OXLEY ACT AS OF OUR FISCAL YEAR ENDING OCTOBER 31, 2007. UNDER CURRENT REGULATIONS, THE FINANCIAL COST OF COMPLIANCE WITH SECTION 404 IS SIGNIFICANT. FAILURE TO ACHIEVE AND MAINTAIN EFFECTIVE INTERNAL CONTROL IN ACCORDANCE WITH SECTION 404 COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS AND OUR STOCK PRICE. We are in the process of implementing the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, which requires management to assess the effectiveness of our internal controls over financial reporting and include an assertion in our annual report as to the effectiveness of its controls. The cost to comply with this law will affect our net income adversely during the compliance period. In addition, management's effort and cost are no assurance that our independent auditors will attest to the effectiveness of our internal controls in its report required by the law. If that is the case, the resulting report from our auditors may have a negative impact on our stock price. ITEM 1B. UNRESOLVED STAFF COMMENTS None. ITEM 2. PROPERTIES. As part of our Home and Office delivery operations, we have entered into or assumed various lease agreements for properties used as distribution points and office space. The following table summarizes these arrangements: 15
Location Lease expiration Sq. Ft. Annual Rent - -------- ---------------- ------- ----------- Williston, VT June 2009 10,000 $ 69,556 Waltham, MA December 2008 11,760 $108,780 Bow, NH June 2010 9,600 $ 48,360 Rochester, NY January 2007 15,000 $ 89,400 Buffalo, NY Month-to-month 10,000 $ 60,000 Syracuse, NY December 2010 10,000 $ 38,070 Halfmoon, NY October 2011 22,500 $165,825 Plattsburgh, NY May 2010 5,000 $ 24,000 Watertown, CT October 2010 67,000 $360,000 Stamford, CT October 2010 22,000 $216,000 White River Junction, VT June 2009 12,000 $ 69,100 Waterbury, CT June 2007 5,000 $ 24,200 Groton, CT October 2009 7,500 $ 56,375
All locations are used primarily for warehousing and distribution and have limited office space for location managers and support staff. The exception is the Watertown, CT location that has a substantial amount of office space for sales, accounting, information systems, customer service, and general administrative staff. In conjunction with the Crystal Rock merger, we entered into ten-year lease agreements to lease the buildings that are utilized for operations in Watertown and Stamford, Connecticut. The landlord for the buildings is a trust with which Henry, John, and Peter Baker, and Ross Rapaport are affiliated. We believe that the rent charged under these leases approximate fair market rental value. We expect that these facilities will meet our needs for the next several years. For the lease that is currently under a month to month arrangement, we plan to negotiate a renewal or enter into a lease at another facility that better meets our needs on a long term basis. ITEM 3. LEGAL PROCEEDINGS. Please refer to Item 3, "Legal Proceedings," in our Annual Report on Form 10-K/A for the fiscal year ended October 31, 2004 for a description of our August 2003 lawsuit in federal district court in Massachusetts against Nestle Waters North America, Inc. and its parent company, Nestle S.A. That description is incorporated by this reference. In March 2004, we voluntarily dismissed our case against Nestle S.A. Since January 31, 2005, the date of last year's disclosure, Nestle has made a number of motions on which the Court has yet to rule. The case continues to proceed in its discovery phase. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matter was submitted to a vote of security holders during the quarter ended October 31, 2005. 16 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Our Common Stock is traded on the American Stock Exchange, or AMEX, under the symbol VPS. The table below indicates the range of the high and low daily closing prices per share of Common Stock as reported by AMEX. Fiscal Year Ended October 31, 2005
High Low ----- ----- First Quarter $2.53 $1.71 Second Quarter $2.86 $1.80 Third Quarter $2.16 $1.68 Fourth Quarter $2.26 $1.71
Fiscal Year Ended October 31, 2004 First Quarter $3.45 $3.00 Second Quarter $3.50 $2.75 Third Quarter $3.10 $2.05 Fourth Quarter $2.24 $1.79
The last reported sale price of our Common Stock on AMEX on January 17, 2006 was $1.82 per share. As of that date, we had 443 record owners and believe that there were approximately 3,200 beneficial holders of our Common Stock. No dividends have been declared or paid to date on our Common Stock. Our senior credit agreement prohibits us from paying dividends without the prior consent of the lender. It is unlikely that we will pay dividends in the foreseeable future. SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS. The following table sets forth additional information as of October 31, 2005, about shares of our Common Stock that may be issued upon the exercise of options and other rights under our existing equity compensation plans and arrangements, divided between plans approved by our stockholders and plans or arrangements that were not required to be and were not submitted to our stockholders for approval. 17
(c) Number of Securities (a) (b) remaining available for Number of Securities to be Weighted-average exercise future issuance under issued upon exercise of price of outstanding equity compensation plans outstanding options, options, warrants and (excluding securities Plan Category warrants and rights rights reflected in column (a)). - ------------- -------------------------- ------------------------- ------------------------- Equity compensation plans approved by security holders (1) 2,470,490 $2.99 61,197 Equity compensation plans not approved by security holders (2) 156,000 $2.50 -0- ------------- ----- ------ Total 2,626,490 $2.96 61,697 ============= ===== ======
(1) Includes options to purchase 1,479,200 shares of our common stock issued to the former chief executive officer and several directors. These options expired in December 2005 in connection with the resignation of such officer and directors from our company. (2) Represents options to purchase 156,000 shares of our common stock issued to several former directors. These options expired in December 2005 in connection with the resignation of such directors from our company. ITEM 6. SELECTED FINANCIAL DATA. The selected consolidated financial data set forth below should be read in conjunction with our financial statements and footnotes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing elsewhere in this report. The historical results are not necessarily indicative of the operating results to be expected in the future.
Fiscal Years Ended ------------------------------------------------------------------- October 31, October 31, October 31, October 31, October 30, (000's except per share) 2005 2004 2003 2002 2001 ----------- ----------- ----------- ----------- ----------- Net sales $ 59,835 $ 52,473 $ 49,854 $ 49,068 $ 47,551 Income from continuing operations $ 871 $ 500 $ 941 $ 2,079 $ 775 Income per share from continuing operations $ .04 $ .02 $ .04 $ .09 $ .04 Total assets $102,889 $103,781 $111,123 $109,143 $106,138 Long term debt, less current portion $ 37,975 $ 37,854 $ 48,274 $ 46,540 $ 47,851
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following Management's Discussion and Analysis (MD&A) is intended to help the reader understand our company. The MD&A should be read in conjunction with our consolidated financial statements and the accompanying notes. This overview provides our perspective on the individual 18 sections of the MD&A, as well as a few helpful hints for reading these pages. The MD&A includes the following sections: - Business Overview - a brief description of fiscal year 2005. - Results of Operations -- an analysis of our consolidated results of operations for the three years presented in our consolidated financial statements. - Liquidity and Capital Resources -- an analysis of cash flows, sources and uses of cash, and contractual obligations and a discussion of factors affecting our future cash flow. - Critical Accounting Policies -- a discussion of accounting policies that require critical judgments and estimates. Our significant accounting policies, including the critical accounting policies discussed in this section, are summarized in the notes to the accompanying consolidated financial statements. BUSINESS OVERVIEW The improvement in our operating results in fiscal year 2005 was indicative of the sales growth that we experienced from higher pricing and volume increases which also resulted in increased gross profit. The increase in gross profit was eroded by higher selling, general, and administrative costs and other costs. The increase in operating costs was driven by market prices for fuel and insurance as well as administrative costs for regulatory compliance, corporate reorganization, refinancing, and severance. In addition, we incurred costs related to the settlement of legal suits. Much of the increase in administrative costs, specifically corporate reorganization, refinancing, severance, and legal settlements, we do not expect to incur in future years. RESULTS OF OPERATIONS Fiscal Year Ended October 31, 2005 Compared to Fiscal Year Ended October 31, 2004 Sales Sales for fiscal year 2005 were $59,835,000 compared to $52,473,000 for 2004, an increase of $7,362,000 or 14%. Sales attributable to acquisitions in fiscal year 2005 were $3,731,000. Net of the acquisitions, sales increased 7%. The comparative breakdown of sales is as follows:
Product Line 2005 2004 Difference % Diff. - ------------ ------------ ------------ ------------ ------- (in 000's $) (in 000's $) (in 000's $) Water $28,869 $25,043 $3,826 15% Coffee and Other Products 21,629 18,524 3,105 17% Equipment Rental 9,337 8,906 431 5% ------- ------- ------ --- Total $59,835 $52,473 $7,362 14% ======= ======= ====== ===
Water - The increase in water sales was primarily attributable to acquisitions. Net of acquisitions, water sales increased 6%. The increase, net of acquisition, was evenly split between the effect of price and volume. The increase in price was attributable to general increases in list prices. Increases in volume were a result of an increase in demand in our core markets which, in part, was favorably 19 impacted by substantially warmer weather than a year ago. Sales to distributors, which account for about 4% of water sales, were up 15%. Coffee and Other Products - Sales of coffee and other products increased 4% from sales volume related to acquisitions. Net of acquisitions, sales in this category increased 13%. The increase in sales was attributable to increased volume of all products in this category but primarily to the growth of single serve coffee, which grew 43% to $5,045,000 in fiscal year 2005 compared to $3,532,000 in fiscal year 2004. The margin on single serve coffee products is lower than that for traditional products. Other revenue increases were generated by increased sales of coolers and single serve brewers and fees charged to customers to offset increased fuel costs. These represented a total revenue increase of $426,000. We expect cooler sales to grow at a similar rate next year as customers choose to purchase coolers rather than rent them. Equipment Rental - Equipment rental revenue was up in fiscal year 2005 compared to fiscal year 2004 as a result of more cooler placements and additional coffee machine rentals from the sale of single serve coffee. Net of acquisitions, equipment rental revenue was down 2% for the year compared to last year. Total equipment rental and water cooler placements in the fiscal year 2005, net of acquisitions, were down 1% compared to fiscal year 2004 as a result of sales competition in the retail market. We expect water cooler rental placements to stay level or decrease slightly in the coming year as customers purchase their own coolers. Average rental price was down 1%. Brewer rentals increased slightly as a result of demand for single serve units. Gross Profit/Cost of Goods Sold Gross profit increased $5,296,000, or 18% in fiscal year 2005 compared to 2004, to $34,992,000 from $29,696,000. As a percentage of sales, gross profit increased to 59% of sales from 57% for the respective period. The increase in gross profit, in dollars and as a percentage of sales, was attributable to higher pricing and lower cost of goods sold. Lower costs were primarily a result of bottling efficiencies in our plants. In addition, production and transportation costs decreased as a result of our outsourced water bottling in western New York, which commenced in November 2004 in conjunction with our acquisition of Mayer Brothers in Buffalo, NY. Cost of goods sold includes all costs to bottle water, costs of purchasing and receiving products for resale, including freight, as well as costs associated with product quality, warehousing and handling costs, internal transfers, and the repair and service of rental equipment, but does not include the costs of distributing our product to our customers. We include distribution costs in selling, general, and administrative expense, and the amount is reported below. Other companies may include distribution costs in their cost of goods sold, in which case, on a comparative basis, such other companies may have a lower gross margin as a result. Income from Operations/Operating Expenses Income from operations increased to $5,221,000 in 2005 from $4,505,000 in 2004, an increase of $716,000, or 16%. The increase was attributable to higher sales and gross profit that more than offset higher operating costs. Total operating expenses increased to $29,771,000 for the year, up from $25,191,000 the prior year, an increase of $4,580,000, or 18%. Selling, general and administrative (SG&A) expenses were $27,791,000 in fiscal year 2005 and $23,748,000 in 2004, an increase of $4,043,000, or 17%. Of total SG&A expenses, route sales costs, significantly influenced by labor, fuel, vehicle, 20 and insurance costs, increased 14%, or $1,584,000 to $13,182,000 in fiscal year 2005 from $11,598,000 in fiscal year 2004, primarily related to labor for commission-based sales from increased product volume, fuel due to market prices, vehicle lease and repair costs, and insurance costs due to market rates and loss experience. Included in SG&A expenses, total direct distribution related costs increased to $12,563,000 in fiscal year 2005 from $10,940,000 in fiscal year 2004. In addition, selling costs increased 14%, or $345,000 to $2,849,000 in fiscal year 2005 from $2,504,000 in fiscal year 2004, as a result of a increase in sales staffing. Administrative costs increased 22%, or $2,113,000 to $11,760,000 in fiscal year 2005 from $9,646,000 in fiscal year 2004, as a result of legal, accounting, and consulting costs attributed to regulatory compliance, corporate reorganization, bank refinancing, and severance costs. Advertising expenses were $1,194,000 in fiscal year 2005 compared to $1,034,000 in 2004, an increase of $160,000, or 15%. The increase in advertising costs is primarily related to television and print advertising campaigns run during the year. Amortization increased to $787,000 in fiscal year 2005 from $409,000 in 2004. This increase is attributable to intangible assets that were acquired as part of several acquisitions in fiscal year 2004. Other Income and Expense, Income Taxes, and Income from Continuing Operations Interest expense was $3,365,000 for fiscal year 2005 compared to $3,507,000 for fiscal year 2004, a decrease of $142,000. Lower interest costs were primarily a result of reduced amounts of senior and subordinated debt. Lower loan balances, and conversion of $3,600,000 of subordinated debt to senior debt, were partially offset by higher market interest rates and fixing new senior debt at a higher rate than market rates at the time. In fiscal year 2005, we incurred $250,000 related to the settlement of legal matters with former employees. These expenses comprise most of the $261,000 of total miscellaneous expense in 2005. In 2004, we recognized an impairment charge related to our investment in a software provider as we determined it was likely that the investment was not recoverable. The amount of the charge was $153,000. We expect to continue to receive reliable products and service from the provider. Income from continuing operations before income tax expense was $1,610,000 in fiscal year 2005 compared to $855,000 in fiscal year 2004. The tax expense for fiscal year 2005 was $740,000 compared to $355,000 for fiscal year 2004 and was based on an effective tax rate of 46% in 2005 and 41% in 2004. The increase in the tax rate is a result of a shift in earnings in states with higher effective rates and permanent differences primarily, non-deductible meals and entertainment and other items. Our total effective tax rate is a combination of federal and state rates for the states in which we operate. Income from continuing operations was $871,000 in 2005, $371,000 more than income from continuing operations of $500,000 in 2004. Discontinued Operations There were no discontinued operations in 2005. The loss from operations for discontinued retail segments in fiscal year 2004 was $79,000. This related to the four months of operations of those segments. The gain on the sale of assets of the discontinued operations was $353,000. The 21 corresponding tax expense of loss from discontinued operations combined with the gain on the sale of $114,000 was calculated at 42%. Net Income Net income of $871,000 in fiscal year 2005 was derived from continuing operations and exceeded fiscal year 2004 by $211,000. Net income of $660,000 in fiscal year 2004 was attributable to income from continuing operations and loss from discontinued operations combined with a gain on the sale of a portion of the retail business. Based on the weighted average number of shares of Common Stock outstanding of 21,620,000 (basic) and 21,626,000 (diluted) during 2005, net income was $.04 per share - basic and diluted. All earnings per share were derived from continuing operations. Based on the weighted average number of shares of common stock outstanding of 21,497,000 (basic) and 21,575,000 (diluted) during 2004, net income was $.03 per share - basic and diluted. Of the $.03 earnings per share, $.02 was attributable to continuing operations while $.01 was from discontinued operations, basic and diluted. Fiscal year 2005 earnings per share exceeded those for 2004 by $.01 per share, in total, and $.02 per share for continuing operations. The fair value of our swaps increased $107,000 during the year, resulting in an unrealized gain of $65,000, net of taxes for the fiscal year ended October 31, 2005. The increase during the year has been recognized as an adjustment to net income to arrive at comprehensive income as defined by the applicable accounting standards. Further, it has been recorded as a current asset and an increase in accumulated other comprehensive income on our consolidated balance sheet. Fiscal Year Ended October 31, 2004 Compared to Fiscal Year Ended October 31, 2003 Sales Sales for fiscal year 2004 were $52,473,000 compared to $49,854,000 for 2003, an increase of $2,619,000, or 5%. Sales attributable to acquisitions in fiscal year 2004 were $3,022,000. Net of the acquisitions, sales decreased 1%. The comparative breakdown of sales is as follows:
Product Line 2004 2003 Difference % Diff. - ------------ ------------ ------------ ------------ ------- (in 000's $) (in 000's $) (in 000's $) Water $25,043 $24,030 $1,013 4% Coffee and Other Products 18,524 17,284 1,240 7% Equipment Rental 8,906 8,540 366 4% ------- ------- ------ --- Total $52,473 $49,854 $2,619 5% ======= ======= ====== ===
Water - Net of acquisitions, water sales decreased 2%. The decrease was primarily a result of a decrease in distributor volume. This was a result of the loss of a major distributor and lower volume from remaining distributors. Sales to distributors are the least profitable part of our business and account for about 4% of water sales. The volume of water from our own distribution system was flat while the average selling price per delivered bottle increased 1%, reflecting competitive pressures in our core market. The increase in selling price was not enough to offset the decrease in distributor volume. 22 Coffee and Other Products - The acquisition of a large office coffee distributor during the second half of fiscal year 2003 and in the last quarter of fiscal year 2004 accounted for 6% of the increase in sales. Net of acquisitions, the category increased 1%. Sales of Keurig single-serve coffee packages more than offset a decrease in conventional coffee sales to account for the growth. However, the margin on single serve distribution is lower than traditional coffee products. In addition, a non-recurring favorable adjustment in 2003 related to deposits for bottles not returned resulted in a 2% decrease in sales for this category. Equipment Rental - Growth from acquisitions resulted in a 5% increase in cooler rental placements. Average rental price was down 1%. Brewer rentals increased slightly as a result of demand for single serve units. Net of acquisitions, rental income was down 1%. Gross Profit/Cost of Goods Sold Gross profit increased $642,000, or 2% in fiscal year 2004 compared to 2003 to $29,696,000 from $29,054,000. The increase in gross profit was attributable to higher sales. As a percentage of sales, gross profit decreased to 57% of sales from 58% for the respective period. The decrease in gross profit, as a percentage of sales, was attributable to higher costs of sales and a higher percentage of sales of non-water related products. The increase in cost of sales is attributable to higher costs of production as a result of higher costs of materials for bottles and labor, and higher service costs as a result of lower sales volume per customer. Cost of goods sold includes all costs to bottle water, costs of purchasing and receiving products for resale, including freight, as well as costs associated with product quality, warehousing and handling costs, internal transfers, and the repair and service of rental equipment, but does not include the costs of distributing our product to our customers. We include distribution costs in selling, general, and administrative expense, and the amount is reported below. Other companies may include distribution costs in their cost of goods sold, in which case, on a comparative basis, such other companies may have a lower gross margin as a result. Income from Operations/Operating Expenses Income from operations decreased to $4,505,000 in 2004 from $5,807,000 in 2003, a decrease of $1,302,000, or 22%. The decrease was related to a higher sales mix of lower margin products, higher production and service costs and higher operating costs. Total operating expenses increased to $25,191,000 for the year, up from $23,248,000 the prior year, an increase of $1,943,000, or 8%. Selling, general and administrative (SG&A) expenses were $23,748,000 in fiscal year 2004 and $22,229,000 in 2003, an increase of $1,519,000, or 7%. Of total SG&A expenses, route distribution costs, significantly influenced by labor, fuel, vehicle, and insurance costs, increased 11%. Included in SG&A expenses, total distribution related costs increased to $10,940,000 in fiscal year 2004 from $9,821,000 in fiscal year 2003. In addition, selling costs decreased 8% as a result of vacancies in our sales staffing and administration costs increased 5% as a result of the costs of serving more customers and increasing regulatory requirements. Advertising expenses were $1,034,000 in fiscal year 2004 compared to $832,000 in 2003, an increase of $202,000, or 24%. The increase in advertising costs is related to additional yellow page advertising in 2004. 23 Amortization increased to $409,000 in fiscal year 2004 from $186,000 in 2003. This increase is attributable to intangible assets that were acquired as part of several acquisitions in fiscal years 2003 and 2004. Other Income and Expense, Income Taxes, and Income from Continuing Operations Interest expense was $3,507,000 for fiscal year 2004 compared to $4,269,000 in 2003, a decrease of $762,000. Lower interest costs were primarily a result of reduced amounts of senior and subordinated debt combined with lower fixed rate commitments compared to a year ago. The gain on sale of equipment was $10,000 in fiscal year 2004 compared to a loss of $2,000 in 2003 primarily related to the sale of bottling equipment when new equipment was purchased in 2004 for relocation of a bottling line from Randolph to White River Junction Vermont. We also recognized an impairment charge related to our investment in a software provider as we determined it was likely that the investment was not recoverable. The amount of the charge was $153,000. We expect to continue to receive reliable products and service from the provider. Income from continuing operations before income tax expense was $855,000 in fiscal year 2004 compared to income from continuing operations before taxes of $1,536,000 in 2003. The tax expense for fiscal year 2004 was $355,000 compared to tax expense of $595,000 in 2003 and was based on an effective tax rate of 41% in 2004 and 39% in 2003. The increase in the tax rate is a result of a shift in earnings to states with higher effective rates and federal permanent differences. Our total effective tax rate is a combination of federal and state rates for the states in which we operate. Income from continuing operations was $500,000 in 2004, $441,000 less than income from continuing operations of $941,000 in 2003. Discontinued Operations The loss from operations for discontinued retail segments in fiscal year 2004 was $79,000. This related to the four months of operations of those segments. The gain on the sale of assets of the discontinued operations was $353,000. The corresponding tax expense of loss from discontinued operations combined with the gain on the sale of $114,000 was calculated at 42%. Income from discontinued operations in fiscal year 2003 was $637,000. Tax expense, calculated at an effective rate of 40%, was $246,000. Total income from discontinued operations was $160,000 in 2004 compared to $391,000 in 2003. Net Income Net income of $660,000 in fiscal year 2004 was attributable to income from continuing operations and loss from discontinued operations combined with a gain on the sale of a portion of the retail business. This was a decrease in net income of $672,000 from net income of $1,332,000 in 2003. Based on the weighted average number of shares of Common Stock outstanding of 21,497,000 (basic) and 21,575,000 (diluted) during 2004, net income was $.03 per share - basic and diluted. Of the $.03 earnings per share, $.02 was attributable to continuing operations while $.01 was from discontinued operations, basic and diluted. This compares to $.06 per share, $.04 continuing and $.02 discontinued, basic and diluted, in 2003. 24 The fair value of our swaps increased $139,000 during the year ended October 31, 2004, resulting in an unrealized gain of $103,000, net of taxes. This increase has been recognized as an adjustment to net income to arrive at comprehensive income as defined by the applicable accounting standards. Further, it has been recorded as a current asset and an increase in accumulated other comprehensive income on our consolidated balance sheet. LIQUIDITY AND CAPITAL RESOURCES As of October 31, 2005, we had working capital of $3,372,000 compared to $350,000 as of October 31, 2004, an increase of $3,022,000. The increase in working capital was primarily the result of refinancing our senior debt facility in 2005, an increase in cash and receivables generated from operations, and reclassification of a note receivable from a long term to a current asset based on its date of maturity. These were partially offset by the decrease in current portion of the deferred tax asset. On April 6, 2005, we refinanced our senior credit facility with Bank of America. Webster Bank is a participant in the new loan. The new facility refinanced $28 million of existing senior debt in the form of a seven year term loan, provides a revolving credit facility of $6 million for working capital and letters of credit for a term of three years, and makes available up to $7.5 million to be used for acquisitions for a period of three years. The term loan may also provide funds for future principal payment of our subordinated debt if certain financial covenants are met after the first two years of the loan. With the $28 million of term debt, we repaid our borrowings under our former senior credit facility with Webster Bank, including $17.5 million under the old term loan and $5.4 million under the old acquisition line of credit as well as $3.6 million of our subordinated debt. The balance of the new term loan as well as $2 million of the new line of credit was used to pay a balance of $3.5 million on the old revolving line of credit with Webster Bank. At October 31, 2005, we had no outstanding balance on our line of credit with Bank of America. There was $1.4 million of letters of credit outstanding, leaving $4.6 million of availability. As of October 31, 2005, there were outstanding balances of $26,500,000 on the term loan and $600,000 on the acquisition line. The term loan amortizes over seven years and the new acquisition debt amortizes as a term loan for five years after the first three years. During the first three years of the acquisition debt, interest only is paid on a monthly basis for amounts outstanding. Interest on the term loan is tied to our performance based on the 30-day LIBOR plus a 250 basis point margin, while the acquisition and revolving lines have a 225 basis point margin over the 30-day LIBOR. For the respective loans, the margin may vary from 125 to 225 basis points and 150 to 250 basis points based on the level of senior debt to earnings before interest, taxes, depreciation, and amortization (EBITDA). The applicable margins as of October 31, 2005 was 2.50% for the term note and 2.25% for the acquisition line, resulting in total variable interest rates of 6.59% and 6.34%, respectively, as of that date. The facility is secured by substantially all of the Company's assets. As a result of our refinancing, less of our debt has been classed as a current liability. At the end of fiscal 2004, the outstanding amount of our operating line of credit was $1,500,000 which was, along with $200,000 of the acquisition line of credit, classified as current debt. As of October 31, 2005, this had been paid down in full with funds from the new term loan as well as cash from 25 operations. In addition, the payment schedule of the new term loan reduced the payments over the next 12 months. Our credit facility requires that we be in compliance with certain financial covenants at the end of each fiscal quarter. The covenants include senior fixed charge coverage of greater than 1.25 to 1, total fixed charge coverage of greater than 1 to 1, and senior debt to EBITDA of greater than 3 to 1. As of October 31, 2005, we were in compliance with all of the financial covenants of our new credit facility and we expect to be in compliance in the foreseeable future. As of October 31, 2005, we had two separate interest rate swap agreements outstanding. We had $10 million of debt fixed at 2.74% plus the current margin of 2.5% in an agreement with Webster Bank that expires in June 2006. On May 3, 2005, we entered into an additional interest rate swap agreement with Bank of America in conjunction with our new senior financing. The credit agreement requires that we fix 75% of the interest rate of the term debt for the life of the loan. The swap with Bank of America fixes the interest rate at 4.66%, plus the applicable margin, 2.50% as of October 31, 2005, and amortizes concurrently with the loan principal to fix the interest rate with respect to 75% of the outstanding principal. The swaps constituting 75% of fixed rate principal include our existing swap. For a further explanation of our fixed debt instruments, see Item 7A. As of October 31, 2005, we had $1,390,000 committed to letters of credit secured by our operating line of credit. In fiscal year 2005, we reduced our deferred tax asset by $738,000 to reflect usage of federal net operating loss carryforwards and other deferred tax assets. This reflects our utilization of our deferred tax assets to offset taxes that would have been payable in cash for the period. We have increased the current portion and decreased the long-term portion of the deferred tax asset to reflect current estimates of future utilization. There is a total deferred tax asset of $1,451,000 as of October 31, 2005. During fiscal year 2005, we used cash for capital expenditures, acquisitions, and repayment of debt. Cash used for capital expenditures of $3,126,000 was used for the purchase of bottling equipment, and coolers, brewers, bottles, and racks related to Home and Office distribution. In addition to our senior and subordinated debt commitments, we have significant future cash commitments, primarily in the form of operating leases that are not reported on the balance sheet. The following table sets forth our contractual commitments as of October 31, 2005:
PAYMENT DUE BY PERIOD ------------------------------------------------------------------- LESS THAN 1 MORE THAN 5 CONTRACTUAL OBLIGATIONS TOTAL YEAR 1-3 YEARS 3-5 YEARS YEARS - ----------------------- ----------- ----------- ----------- ----------- ----------- Debt (1) $41,242,000 $3,268,000 $ 7,374,000 $ 9,056,000 $21,544,000 Interest on Debt (1) 18,938,000 3,550,000 6,363,000 5,175,000 3,850,000 Operating Leases 8,615,000 2,289,000 3,915,000 2,262,000 149,000 Coffee Purchase Commitments 719,000 616,000 103,000 -- -- ----------- ---------- ----------- ----------- ----------- Total $69,514,000 $9,723,000 $17,755,000 $16,493,000 $25,543,000 =========== ========== =========== =========== ===========
(1) Interest based on 75% of outstanding senior debt at the hedged interest rate discussed above, 25% of outstanding senior debt at a variable rate of 5.95%, and subordinated debt at a rate of 12%. 26 As of the date of Form 10-K, we have no other material contractual obligations or commitments. Factors Affecting Future Cash Flow In 2005, we generated sufficient cash to fund operations, capital expenditures, scheduled loan payments and pay down the operating line of credit with the bank. We anticipate that we will continue to be profitable and generate cash for these and other purposes. If we continue to generate cash in excess of these activities we will explore opportunities to best use it. We will continue to evaluate potential acquisitions in our existing core market areas and may borrow more money to finance such transactions if we close them. However, we have a large amount of debt and would like to pay down debt if we do not find acquisitions that are accretive. If the business does not perform to our expectations we would have to borrow from our line of credit to fund some expenditures and our debt level would not decrease as much as anticipated or may increase. Moreover, interest rates have been increasing and we continue to be exposed to market rates. We expect capital spending of $3,126,000 in fiscal year 2005 to remain relatively unchanged in 2006. Inflation has had no material impact on our performance. CRITICAL ACCOUNTING POLICIES Our financial statements are prepared in accordance with generally accepted accounting principles. Preparation of the statements in accordance with these principles requires that we make estimates, using available data and our judgment for such things as valuing assets, accruing liabilities, and estimating expenses. The following is a list of what we feel are the most critical estimations that we make when preparing our financial statements. Accounts Receivable - Allowance for Doubtful Accounts We routinely review our accounts receivable, by customer account aging, to determine the collectibility of the amounts due based on information we receive from the customer, past history, and economic conditions. In doing so, we adjust our allowance accordingly to reflect the cumulative amount that we feel is uncollectible. This estimate may vary from the proceeds that we actually collect. If the estimate is too low we may incur higher bad debt expenses in the future resulting in lower net income. If the estimate is too high, we may experience lower bad debt expense in the future resulting in higher net income. Fixed Assets - Depreciation We maintain buildings, machinery and equipment, and furniture and fixtures to operate our business. We estimate the life of individual assets to spread the cost over the expected life. The basis for such estimates is use, technology, required maintenance, and obsolescence. We periodically review these estimates and adjust them if necessary. Nonetheless, if we overestimate the life of an asset or assets, at a point in the future, we would have to incur higher depreciation costs and consequently, lower net income. If we underestimate the life of an asset or assets, we would absorb too much depreciation in the early years resulting in higher net income in the later years when the asset is still in service. Goodwill - Intangible Asset Impairment We have acquired a significant number of companies. The difference between the value of the assets and liabilities acquired, including transaction costs, and the purchase price is recorded as goodwill. 27 If goodwill is not impaired, it would remain as an asset on our balance sheet at the value acquired. If it is impaired, we would be required to write down the asset to an amount that accurately reflects its carrying value. We have had an independent valuation of the Company performed as of October 31, 2005. By comparing the fair value to the carrying value of the Company, we have determined that goodwill is not impaired. In providing the valuation, the independent valuation firm has relied, in part, on projections of future cash flows of the assets that we provided. If these projections change in the future, there may be a material impact on the valuation of the Company, which may result in an impairment of goodwill. Deferred Tax Asset We have recognized a deferred tax asset on our balance sheet to reflect cumulative current benefit of future tax loss carryforwards and other deferred income taxes. We expect this asset to be realized over the next two years and therefore have not provided a valuation allowance related to this asset. We have relied on our estimated financial results for future years. If we have overestimated earnings in future years, we may have, in turn, overestimated the deferred tax asset and may have to provide a valuation allowance, decreasing net income. Conversely, it may take us longer than two years to realize the value of the asset. Stock Based Compensation In following the accounting treatment prescribed by APB Opinion No. 25, we have recognized no compensation expense for our stock option awards because the exercise price of our stock options equals the market price of the underlying stock on the date of option grant. If our compensation committee chose to award options at lower than market prices, we would be required to recognize compensation expense. There are currently no plans to issue options at prices lower than the market value. The compensation committee has issued restricted shares of our stock and recorded compensation expense as a result of the issuance. We provide pro forma disclosure in the footnotes to our financial statements to enable the reader to assess the impact on the financial statements if we had used the fair value method using SFAS 123. In doing so, we make certain assumptions related to interest rates and the volatility of its stock price. The accuracy of these assumptions affects the eventual outcome of the amount of stock based compensation reported in the footnote. We estimate a risk free rate of return based on current (at the time of option issuance) U. S. Treasury bonds and calculates the volatility of its stock price over the past twelve months from the option issuance date. The fluctuations in the volatility assumption used in the calculation over the years reported is a direct result of the increases and decrease in the stock price over that time. All other factors being equal, a 10% increase in the volatility percentage results in approximately a 12% increase in the fair value of the options, net of tax. SFAS 123(R) will be effective for us starting with its fiscal year ending October 31, 2006. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (SAB 107) which provides additional guidance regarding the pronouncement. We are currently assessing the impact that SFAS 123(R) will have on our results of operations and financial position. 28 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK INTEREST RATE RISKS At October 31, 2005, we had approximately $7,225,000 of long-term debt subject to variable interest rates. Under the credit agreement with Bank of America, we pay interest at a rate of LIBOR plus a margin of 2.50%, or 6.59% at October 31, 2005. A hypothetical 100 basis point increase in the LIBOR rate would result in an additional $72,000 of interest expense on an annualized basis. Conversely, a decrease would result in a proportionate interest cost savings. We have fixed the interest rate on $10 million of debt at 5.24% with a swap agreement until June 2006 and an amount amortizing with our term note equal to 75% of the principal at 7.16%. On May 3, 2005, the Company entered into an interest rate hedge ("swap") agreement in conjunction with its new senior financing. The new credit agreement requires that the Company fix the interest rate on its term debt for the life of the loan. The swap fixes the interest rate at 4.66%, plus the applicable margin, 2.50% at October 31, 2005, and amortizes concurrently with the loan principal to fix the interest rate with respect to 75% of the outstanding principal. The swap arrangement constituting 75% of fixed rate principal include the $10 million swap until June 2006. When that swap matures in June 2006 the balance of the aforementioned swap will increase to hedge 75% of the term loan on an amortizing basis. As of October 31, 2005, the total notional amount committed to swap agreements was $19.9 million. As of October 31, 2005, these were rates favorable to the market. We will continue to evaluate swap rates as the market dictates. They serve to stabilize our cash flow and expense 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. To date we have fixed rates as required by our credit agreement with the bank. Future low rates may compel us to fix a higher portion to further stabilize cash flow and expenses as we monitor short and long term rates and debt balances. COMMODITY PRICE RISKS Coffee The cost of our coffee purchases are dictated by commodity prices. As of October 31, 2005, we purchased green coffee on the spot market and fixed price contracts with our vendors. We enter into contracts to mitigate market fluctuation of these costs by fixing the price for certain periods. As of October 31, 2005, we had fixed the price of our anticipated supply through December 2006 at a "green" price of $.98 -$1.07 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 $75,000 annually. In this case, competitors that had fixed pricing might have a competitive advantage. Diesel Fuel We own and operate vehicles to deliver product to customers. The cost of fuel to operate these vehicles fluctuates over time. During fiscal year 2005, fuel prices increased significantly. We estimate that a $0.10 increase per gallon in fuel cost would result in an increase to operating costs of approximately $60,000 on an annual basis. In aggregate, we have spent approximately an additional $402,000 on fuel as a result of higher prices in fiscal year 2005 compared to 2004. We 29 have offset some of this cost by adjusting our price to our customers on a monthly basis while fuel prices are higher. ITEM 8. FINANCIAL STATEMENTS Our Consolidated Financial statements and their footnotes are set forth on pages F-1 through F-24. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES Our Chief Executive Officer and our Chief Financial Officer, and other members of our senior management team have evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures, as of the end of the period covered by this report, were adequate and effective to provide reasonable assurance that information required to be disclosed by us, including our consolidated subsidiary, in reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported, within the time periods specified in the 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. CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING During the fourth quarter of fiscal 2005, there were no changes in our internal control over financial reporting that materially affected or are reasonably likely to materially affect internal control over financial reporting. ITEM 9B. OTHER INFORMATION None. 30 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item is incorporated by reference from the Proxy Statement for our Annual Meeting of Stockholders scheduled to be held April 26, 2006. ITEM 11. EXECUTIVE COMPENSATION. The information required by this Item is incorporated by reference from the Proxy Statement for our Annual Meeting of Stockholders scheduled to be held April 26, 2006. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. Information required by this Item is incorporated by reference from the Proxy Statement for our Annual Meeting of Stockholders scheduled to be held April 26, 2006. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by this Item is incorporated by reference from the Proxy Statement for our Annual Meeting of Stockholders scheduled to be held April 26, 2006. ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES. The information required by this Item is incorporated by reference from the Proxy Statement for our Annual Meeting of Stockholders scheduled to be held April 26, 2006. 31 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES. a) The following documents are filed as part of this report: Financial Statements Reference is made to the Financial Statements included in Item 8 of Part II hereof. Schedules None b) Exhibits:
FILED WITH INCORPORATED BY REFERENCE EXHIBIT THIS FORM ---------------------------------------- NO. DESCRIPTION 10-K FORM FILING DATE EXHIBIT NO. - ------- --------------------------------------------- ---------- ---- ------------------ ------------ 3.1 Certificate of Incorporation S-4 September 6, 2000 Exhibit B to Appendix A 3.2 Certificate of Amendment to Certificate of 8-K October 19, 2000 4.2 Incorporation 3.3 By-laws 10-Q September 14, 2001 3.3 4.1 Registration Rights Agreement with Peter 8-K October 19, 2000 4.6 K. Baker, Henry E. Baker, John B. Baker and Ross Rapaport 10.1* 1993 Performance Equity Plan S-8 August 25, 1995 10.1 10.2* 1998 Incentive and Non-Statutory Stock 14A March 10, 2003 A Option Plan, as amended 10.3* 1999 Employee Stock Purchase Plan 14A March 15, 1999 A 10.4* 2004 Stock Incentive Plan 14A March 9, 2004 B 10.5* Instrument of Amendment dated September 8-K September 28, 2005 10.1 22, 2005 amending the 1999 Employee Stock Purchase Plan 10.6* Employment Agreement dated January 1, 2005 10-K January 31, 2005 10.4 with Timothy G. Fallon 10.7* Employment Agreement dated January 1, 2005 10-K January 31, 2005 10.6 with Peter K. Baker 10.8* Employment Agreement dated March 24, 2005 10-Q July 8, 2005 10.7 with Bruce S. MacDonald 10.9* Employment Agreement dated January 1, 2005 10-K January 31, 2005 10.7 with John B. Baker 10.10* Employment Agreement dated January 1, 2005 8-K June 29, 2005 10.1 with Henry E. Baker 10.11* Severance Agreement dated December 5, 2005 with Timothy Fallon X 10.12 Lease of Grounds in Stamford, Connecticut S-4 September 6, 2000 10.24 from Henry E. Baker 10.13 Lease of Buildings and Grounds in Watertown, S-4 September 6, 2000 10.22
32 Connecticut from the Baker's Grandchildren Trust 10.14 Lease of Building in Stamford, Connecticut S-4 September 6, 2000 10.23 from Henry E. Baker 10.15 Credit Agreement dated April 5, 2005 with 10-Q July 8, 2005 10.1 Bank of America and Webster Bank 10.16 Form of Term Note dated April 5, 2005 10-Q July 8, 2005 10.2 issued to Bank of America and Webster Bank 10.17 Form of Subordination and Pledge Agreement 10-Q July 8, 2005 10.3 dated April 5, 2005 between Henry E. Baker, Joan Baker, John B. Baker, Peter K. Baker and Bank of America 10.18 Form of Second Amended and Restated 10-Q July 8, 2005 10.4 Promissory Note dated April 5, 2005 issued to Henry E. Baker, Joan Baker, John B. Baker and Peter K. Baker 10.19 Form of Acquisition Note dated April 5, 10-Q July 8, 2005 10.5 2005 issued to Bank of America and Webster Bank 10.20 Form of Revolving Credit Note dated April 10-Q July 8, 2005 10.6 5, 2005 issued to Bank of America and Webster Bank 10.21 Form of Indemnification Agreement dated November 2, 2005 with each of Henry E. Baker, John B. Baker, Peter K. Baker, Phillip Davidowitz, Martin A. Dytrych, David Jurasek, John M. Lapides, Bruce S. MacDonald and Ross S. Rapaport X 10.22 Form of Indemnification Agreement dated November 2, 2005 with each of John M. Lapides and Martin A. Dytrych X 10.23 Purchase and Sale Agreement dated March 1, 10-Q March 16, 2004 10.27 2004 with MicroPack Corporation 10.24 Trademark License Agreement dated March 1, 10-Q March 16, 2004 10.28 2004 with MicroPack Corporation 10.25 Supply and License Agreement dated March 10-Q March 16, 2004 10.29 1, 2004 with MicroPack Corporation 22.1 Subsidiary X 23.1 Consent of Deloitte & Touche LLP X 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 X 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 X 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 X 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 X
* Management contract or compensatory plan. 33 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Vermont Pure Holdings, Ltd. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. VERMONT PURE HOLDINGS, LTD. By: /s/ Peter K. Baker ---------------------------------- Dated: January 30, 2006 Peter K. Baker, Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Name Title Date - ---- ----- ---- /s/ Ross S. Rapaport Chairman of the Board of Directors January 30, 2006 - ------------------------------------- Ross S. Rapaport /s/ Henry E. Baker Director, Chairman Emeritis January 30, 2006 - ------------------------------------- Henry E. Baker /s/ John B. Baker Executive Vice President and Director January 30, 2006 - ------------------------------------- John B. Baker /s/ Peter K. Baker Chief Executive Officer and Director January 30, 2006 - ------------------------------------- Peter K. Baker /s/ Phillip Davidowitz Director January 30, 2006 - ------------------------------------- Phillip Davidowitz /s/ Martin A. Dytrych Director January 30, 2006 - ------------------------------------- Martin A. Dytrych /s/ John M. Lapides Director January 30, 2006 - ------------------------------------- John M. Lapides /s/ Bruce S. MacDonald Chief Financial Officer and Chief January 30, 2006 - ------------------------------------- Accounting Officer and Secretary Bruce S. MacDonald
34 EXHIBITS TO VERMONT PURE HOLDINGS, LTD. ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED OCTOBER 31, 2005 EXHIBITS FILED HEREWITH
Exhibit Number Description - ------- ----------- 10.11 Severance Agreement dated December 5, 2005 with Timothy Fallon 10.21** Form of Amendment of Indemnification Agreements, dated November 2, 2005, between the Company and the following Directors and Officers: Henry E. Baker John B. Baker Peter K. Baker Phillip Davidowitz David Jurasek Bruce S. Macdonald Ross S. Rapaport 10.22** Form of Indemnification Agreements, dated November 2, 2005, between the Company and John M. Lapides and Martin A. Dytrych 22.1 Subsidiary 23.1 Consent of Deloitte & Touche LLP 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.
35 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---------- Report of the Independent Registered Public Accounting Firm F-1 Financial Statements: Consolidated Balance Sheets, October 31, 2005 and 2004 F-2 Consolidated Statements of Operations, Fiscal Years Ended October 31, 2005, 2004, and 2003 F-3 Consolidated Statements of Stockholders' Equity and Comprehensive Income Fiscal Years Ended October 31, 2005, 2004, and 2003 F-4 Consolidated Statements of Cash Flows, Fiscal Years Ended October 31, 2005, 2004, and 2003 F-5 Notes to Consolidated Financial Statements F-6 - F-24
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Vermont Pure Holdings, Ltd. Watertown, Connecticut We have audited the accompanying consolidated balance sheets of Vermont Pure Holdings, Ltd. and subsidiary (the "Company") as of October 31, 2005 and 2004, and the related consolidated statements of operations, changes in stockholders' equity and comprehensive income and cash flows for each of the three years in the period ended October 31, 2005. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Vermont Pure Holdings, Ltd. and subsidiary as of October 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended October 31, 2005, in conformity with accounting principles generally accepted in the United States of America. /s/ DELOITTE & TOUCHE LLP January 26, 2006 F-1 VERMONT PURE HOLDINGS, LTD. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS
October 31, October 31, 2005 2004 ------------ ------------ ASSETS CURRENT ASSETS: Cash and cash equivalents $ 1,895,810 $ 783,445 Accounts receivable - net of reserve of $289,837 and $303,304 7,249,801 7,065,530 for 2005 and 2004, respectively Inventories 1,133,315 1,069,834 Current portion of deferred tax asset 796,662 1,439,446 Other current assets 1,699,370 1,379,104 Unrealized gain on derivatives 168,582 103,100 ------------ ------------ TOTAL CURRENT ASSETS 12,943,540 11,840,459 ------------ ------------ PROPERTY AND EQUIPMENT - net of accumulated depreciation 10,890,376 12,147,200 ------------ ------------ OTHER ASSETS: Goodwill 74,755,851 74,772,591 Other intangible assets - net of accumulated amortization 3,569,818 3,734,899 Deferred tax asset 654,729 749,713 Other assets 75,000 536,000 ------------ ------------ TOTAL OTHER ASSETS 79,055,398 79,793,203 ------------ ------------ TOTAL ASSETS $102,889,314 $103,780,862 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current portion of long term debt $ 3,266,750 $ 6,140,635 Accounts payable 2,582,105 2,828,789 Accrued expenses 2,990,129 2,318,486 Current portion of customer deposits 732,835 202,244 ------------ ------------ TOTAL CURRENT LIABILITIES 9,571,819 11,490,154 ------------ ------------ Long term debt, less current portion 37,975,000 37,853,696 Customer deposits 2,933,732 3,168,483 ------------ ------------ TOTAL LIABILITIES 50,480,551 52,512,333 ------------ ------------ COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Common stock - $.001 par value, 50,000,000 authorized shares, 21,744,817 issued and 21,673,267 outstanding shares as of October 31, 2005 and 21,569,711 issued and 21,498,161 outstanding as of October 31, 2004 21,744 21,569 Additional paid in capital 58,207,645 57,869,411 Treasury stock, at cost, 71,550 shares as of October 31, 2005 and October 31, 2004 (264,735) (264,735) Unearned compensation (134,250) -- Accumulated deficit (5,590,223) (6,460,816) Accumulated other comprehensive income 168,582 103,100 ------------ ------------ TOTAL STOCKHOLDERS' EQUITY 52,408,763 51,268,529 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $102,889,314 $103,780,862 ============ ============
See the accompanying notes to the consolidated financial statements. F-2 VERMONT PURE HOLDINGS, LTD. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS
Fiscal Year Ended October 31 --------------------------------------- 2005 2004 2003 ----------- ----------- ----------- NET SALES $59,834,575 $52,473,401 $49,854,313 COST OF GOODS SOLD 24,842,247 22,777,542 20,799,833 ----------- ----------- ----------- GROSS PROFIT 34,992,328 29,695,859 29,054,480 ----------- ----------- ----------- OPERATING EXPENSES: Selling, general and administrative expenses 27,790,539 23,748,088 22,229,135 Advertising expenses 1,193,905 1,033,601 832,443 Amortization 787,043 409,380 186,060 ----------- ----------- ----------- TOTAL OPERATING EXPENSES 29,771,487 25,191,069 23,247,638 ----------- ----------- ----------- INCOME FROM OPERATIONS 5,220,841 4,504,790 5,806,842 ----------- ----------- ----------- OTHER EXPENSE: Interest (3,364,902) (3,506,769) (4,268,958) Miscellaneous expense (245,580) (143,189) (1,523) ----------- ----------- ----------- TOTAL OTHER EXPENSE (3,610,482) (3,649,958) (4,270,481) ----------- ----------- ----------- INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES 1,610,359 854,832 1,536,361 INCOME TAX EXPENSE 739,766 354,708 594,974 ----------- ----------- ----------- INCOME FROM CONTINUING OPERATIONS 870,593 500,124 941,387 DISCONTINUED OPERATIONS: (Loss) income from discontinued operations -- (78,555) 637,044 Gain on disposal of segments of business -- 352,535 -- Income tax expense from discontinued operations -- (113,759) (246,022) ----------- ----------- ----------- INCOME FROM DISCONTINUED OPERATIONS -- 160,221 391,022 ----------- ----------- ----------- NET INCOME $ 870,593 $ 660,345 $ 1,332,409 =========== =========== =========== NET INCOME PER SHARE - BASIC: Continuing Operations $ 0.04 0.02 $ 0.04 Discontinued Operations -- 0.01 0.02 ----------- ----------- ----------- NET INCOME $ 0.04 $ 0.03 $ 0.06 =========== =========== =========== NET INCOME PER SHARE - DILUTED: Continuing Operations $ 0.04 0.02 $ 0.04 Discontinued Operations -- 0.01 0.02 =========== =========== =========== NET INCOME $ 0.04 $ 0.03 $ 0.06 =========== =========== =========== WEIGHTED AVERAGE SHARES USED IN COMPUTATION - BASIC 21,619,863 21,497,251 21,282,294 =========== =========== =========== WEIGHTED AVERAGE SHARES USED IN COMPUTATION - DILUTED 21,625,683 21,574,515 21,764,698 =========== =========== ===========
See the accompanying notes to the consolidated financial statements. F-3 VERMONT PURE HOLDINGS, LTD. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
Additional Common Stock Paid in Unearned Treasury Shares Par Value Capital Compensation Shares ---------- ----------- ------------ ------------- ---------- Balance, October 31, 2002 21,235,927 $21,236 $57,023,093 -- Stock compensation 9,285 9 38,988 Exercise of stock options 125,000 125 281,124 Treasury stock purchase (71,550) 71,550 Shares purchased under employee stock plan 60,775 61 191,864 Net income Unrealized gain on derivatives ---------- ------- ----------- ------ Balance, October 31, 2003 21,359,437 21,431 57,535,069 71,550 Stock compensation 7,484 7 56,350 Exercise of stock options 33,200 33 82,967 Restricted stock grants 26,000 26 57,174 Shares purchased under employee stock plan 72,040 72 179,777 Officer share purchases 5,741 Deferred compensation (47,667) Net income Unrealized gain on derivatives ---------- ------- ----------- ------ Balance, October 31, 2004 21,498,161 21,569 57,869,411 71,550 Shares purchased under employee stock plan 97,047 97 150,646 Restricted stock grants 75,000 76 134,174 $(134,250) Stock compensation 3,059 2 5,747 Deferred compensation 47,667 Net income Unrealized gain on derivatives ---------- ------- ----------- ---------- ------ Balance, October 31, 2005 21,673,267 $21,744 $58,207,645 $(134,250) 71,550 ========== ======= =========== ========== ====== Accumulated Other Stock Accumulated Comprehensive Comprehensive Amount Deficit Gain (Loss) Total Income --------- ----------- ------------- ----------- ------------- Balance, October 31, 2002 $ -- $(8,453,570) $(842,898) $47,747,861 Stock compensation 38,997 Exercise of stock options 281,249 Treasury stock purchase $(264,735) (264,735) Shares purchased under employee stock plan 191,925 Net income 1,332,409 1,332,409 $1,332,409 Unrealized gain on derivatives 807,394 807,394 807,394 --------- ----------- --------- ----------- ---------- Balance, October 31, 2003 (264,735) (7,121,161) (35,504) 50,135,100 $2,139,803 ========== Stock compensation 56,357 Exercise of stock options 83,000 Restricted stock grants 57,200 Shares purchased under employee stock plan 179,849 Officer share purchases 5,741 Deferred compensation (47,667) Net income 660,345 660,345 $ 660,345 Unrealized gain on derivatives 138,604 138,604 138,604 --------- ----------- --------- ----------- ---------- Balance, October 31, 2004 (264,735) (6,460,816) 103,100 51,268,529 $ 798,949 ========== Shares purchased under employee stock plan $ 150,743 Restricted stock grants $ -- Stock compensation $ 5,749 Deferred compensation $ 47,667 Net income $ 870,593 $ 870,593 $ 870,593 Unrealized gain on derivatives $ 65,482 $ 65,482 65,482 --------- ----------- --------- ----------- ---------- Balance, October 31, 2005 $(264,735) $(5,590,223) $ 168,582 $52,408,763 $ 936,075 ========= =========== ========= =========== ==========
See the accompanying notes to the consolidated financial statements. F-4 VERMONT PURE HOLDINGS, LTD. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal Year Ended October 31, ----------------------------------------- 2005 2004 2003 ------------ ------------ ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 870,593 $ 660,345 $ 1,332,409 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 4,802,387 5,091,470 5,074,159 Provision for bad debts 316,667 366,844 598,142 Amortization 787,043 409,380 186,060 Non cash interest expense 31,862 -- -- Deferred tax expense 737,768 150,283 575,776 Gain (loss) on disposal of property and equipment (15,067) (9,649) 42,137 Gain on the sale of segments of business -- (352,535) -- Non cash compensation 53,416 34,234 38,997 Loss on investment in CDS -- 152,838 -- Changes in assets and liabilities: Accounts receivable (500,938) (154,303) (1,011,285) Inventories (63,481) (594,561) 1,102,285 Other current assets (203,693) 30,402 (529,008) Other assets (39,000) (136,027) 603,765 Accounts payable (246,683) 178,516 446,557 Accrued expenses 671,643 (477,290) (58,536) Customer deposits 295,840 235,867 (157,212) ------------ ----------- ----------- NET CASH PROVIDED BY OPERATING ACTIVITIES 7,498,357 5,585,814 8,244,246 ------------ ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property, plant and equipment (3,126,397) (3,231,338) (4,171,835) Proceeds from the sale of segments of business - net of transaction costs -- 8,921,693 -- Proceeds from sale of property plant and equipment 83,433 584,565 106,526 Cash used for acquisitions - net of cash acquired (414,440) (4,448,477) (3,953,692) Other investing activities -- -- (116,236) ------------ ----------- ----------- NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (3,457,404) 1,826,443 (8,135,237) ------------ ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from line of credit borrowings 2,000,000 6,689,248 1,866,433 Proceeds from debt 28,513,852 -- 3,746,653 Payments on line of credit (3,500,000) (1,443,248) (1,866,433) Principal payments on debt (29,908,183) (13,313,723) (3,545,984) Payments of debt issuance costs (185,000) -- -- Exercise of common stock options -- 83,000 281,249 Purchase of treasury stock -- -- (264,735) Proceeds from sale of common stock 150,743 185,590 191,925 ------------ ----------- ----------- NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (2,928,588) (7,799,133) 409,108 ------------ ----------- ----------- NET INCREASE (DECREASE) IN CASH 1,112,365 (386,876) 518,117 CASH AND CASH EQUIVALENTS - beginning of year 783,445 1,170,321 652,204 ------------ ----------- ----------- CASH AND CASH EQUIVALENTS - end of year $ 1,895,810 $ 783,445 $ 1,170,321 ============ =========== =========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION, EXCLUDING NON-CASH FINANCING AND INVESTING ACTIVITIES Cash paid for interest $ 2,565,763 $ 3,715,739 $ 4,398,114 ============ =========== =========== Cash paid for taxes $ 246,109 $ 72,079 $ 360,238 ============ =========== =========== NON-CASH FINANCING AND INVESTING ACTIVITIES: Notes payable issued in acquisitions $ 141,750 $ 640,000 $ 200,000 ============ =========== =========== Note receivable on sale of segment of business $ -- $ (500,000) $ -- ============ =========== ===========
See the accompanying notes to the consolidated financial statements. F-5 VERMONT PURE HOLDINGS, LTD. AND SUBSIDIARY NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 1. BUSINESS OF THE COMPANY Vermont Pure Holdings, Ltd. and Subsidiary (collectively, the "Company") is engaged in the production, marketing and distribution of bottled water and distribution of coffee, ancillary products, and other office refreshment products. Through February, 2004, when the Company divested the retail segments of its business, the Company's products were sold, predominantly in the Northeast, as well as in the Mid-Atlantic and Mid-Western United States. Distribution was accomplished through a network of independent beverage distributors and with the Company's own trucks and employees. Commencing March 2004, the Company operated exclusively as a home and office delivery business, using its own trucks to distribute throughout New England, New York, and New Jersey. 2. SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation - For 2003, the consolidated financial statements include the accounts of Vermont Pure Holdings, Ltd. and its wholly-owned subsidiaries, Vermont Pure Springs, Inc., Crystal Rock Spring Water Company ("Crystal Rock"), Excelsior Spring Water Company Inc. and Adirondack Coffee Services. In 2004, the Company merged the subsidiaries mentioned above into Vermont Pure Holdings, Ltd. In December 2004, the Company organized a new wholly owned subsidiary, Crystal Rock, LLC, and assigned all of its material operating assets, leases and other contracts to the new subsidiary. As of and for the years ended October 31, 2005 and 2004 the consolidated financial statements of the Company include the accounts of Vermont Pure Holdings, Ltd. and its wholly-owned subsidiary, Crystal Rock, LLC. All material inter-company profits, transactions, and balances have been eliminated in consolidation. A. Cash Equivalents - The Company considers all highly liquid temporary cash investments with an original maturity of three months or less to be cash equivalents. B. Inventories - Inventories primarily consist of products that are purchased for resale and are stated at the lower of cost or market on a first in, first out basis. C. Property and Equipment - Property and equipment are stated at cost net of accumulated depreciation. Depreciation is calculated on the straight-line method over the estimated useful lives of the assets, which range from three to ten years for equipment, and from ten to forty years for buildings and improvements. D. Goodwill and Other - Intangible assets with lives restricted by contractual, legal, or other means are amortized over their useful lives (defined by sfas no. 142 As the period over which the asset is expected to contribute to the future cash flows of the entity). Goodwill and other intangible assets not subject to amortization are tested for impairment annually or more frequently F-6 if events or changes in circumstances indicate that the asset might be impaired. The amount of impairment for goodwill and other intangible assets is measured as the excess of their carrying values over their implied fair values. The Company conducted assessments of the carrying value of its goodwill as required by sfas no. 142 And concluded that there was no impairment of goodwill as of October 31, 2005 and 2004. Other than goodwill, intangible assets consist primarily of customer lists and covenants not to compete, with estimated lives ranging from 3 to 10 years. E. Securities Issued for Services - Through October 31, 2005, the Company recorded stock option awards in accordance with the provisions of accounting principles board (apb) opinion 25, "accounting for stock issued to employees." The Company estimated the fair value of stock option awards in accordance with sfas no. 123, "Accounting for stock-based compensation," as amended by sfas no. 148, "Accounting for stock-based compensation - transition and disclosure, an amendment of financial accounting standards board (fasb) statement no. 123," And disclosed the resulting estimated compensation effect on net income on a pro forma basis. The Company has several stock-based compensation plans under which incentive and non-qualified stock options and restricted shares are granted, and an Employee Stock Purchase Plan (ESPP). The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to employees, and related Interpretations." No compensation cost is reflected in net income for incentive and non-qualified stock options or ESPP shares. Forfeitures of employee awards are provided in the following table as pro forma effects as they occur. Option awards with multiple vest dates are treated as separate awards, resulting in pro forma expense reported on an accelerated basis. All incentive and non-qualified stock option grants had an exercise price equal to the market value of the underlying common stock on the date of grant. The ESPP shares are granted at 85% of the lower of the fair market value at the commencement of the offering or the last day of the payroll payment period. As of January 1, 2006 the plan has been modified to allow employees to purchase shares of the Company's common stock at a purchase price equal to 95% of the lower of the fair market value on the commencement date of the offering and the last day of the payroll payment period. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, "Accounting for Stock-Based Compensation," to stock-based employee compensation: F-7
Years Ended October 31, 2005 2004 2003 --------- ----------- ---------- Net Income - As Reported $ 870,593 $ 660,345 $1,332,409 Add: stock based employee compensation expense included in net income, net of related tax effects 28,123 5,577 -- Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (336,444) (353,203) (249,656) Pro Forma Net Income $ 562,272 $ 312,719 $1,082,753 ========= ========= ========== Basic - As Reported $ .04 $ .03 $ .06 ========= ========= ========== Basic - Pro Forma $ .03 $ .01 $ .05 ========= ========= ========== Diluted - As Reported $ .04 $ .03 $ .06 ========= ========= ========== Diluted - Pro Forma $ .03 $ .01 $ .05 ========= ========= ==========
The weighted average fair values of the options granted for the respective fiscal years, using the Black-Scholes option pricing model, were $.86, $1.15, and $1.70, respectively. Assumptions used for estimating the fair value of the options on the date of grant under the Black-Scholes option pricing model are as follows for the fiscal years ended october 31, 2005, 2004, and 2003:
2005 2004 2003 ------- ------- ------- Expected Dividend Yield 0% 0% 0% Expected Life 5 Years 5 Years 5 Years Risk Free Interest Rate 3.0% 3.0% 5.7% Volatility 36% 39% 36%
Effective November 1, 2005, the Company adopted the provisions of SFAS No. 123, "Share-Based Payments (revised 2004)," (SFAS No. 123R). This statement supercedes the intrinsic value measurement provisions of APB Opinion No. 25 and requires companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. That cost will be recognized over the period during which an employee is required to provide services in exchange for the award, the requisite service period (usually the vesting period). SFAS No. 123R will also require companies to measure the cost of employee services received in exchange for ESPP awards and the Company will be required to expense the grant date fair value of the Company's ESPP awards. Through October 31, 2005 the Company reported in the above table on a pro forma basis the forfeitures of employee awards as they occurred. Under SFAS No. 123R this accounting method is no longer permitted, and beginning November 1, 2005 the Company provides an estimate of forfeitures at initial grant date. F-8 SFAS No 123R became effective for the Company on November 1, 2005, and the Company is currently evaluating the impact that SFAS No. 123R will have on its consolidated financial statements. No existing award vesting dates were accelerated prior to adoption. F. Net Income Per Share - Net income per share is based on the weighted average number of common shares outstanding during each period. Potential common shares are included in the computation of diluted per share amounts outstanding during each period that income is reported. In periods in which the company reports a loss, potential common shares are not included in the diluted earnings per share calculation since the inclusion of those shares in the calculation would be anti-dilutive. As required by SFAS No. 128, Earnings per share, 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. G. Advertising Expenses - The Company expenses advertising costs at the commencement of the advertising campaign. H. Customer Deposits - Customers receiving home or office delivery of water pay the Company a deposit for the water bottle that is refunded when the bottle is returned. Based on historical experience, the Company uses an estimate of the deposits it expects to refund over the next twelve months to determine the current portion of the liability, and classifies the remainder of the deposit obligation as a long term liability. I. INCOME TAXES - The Company uses SFAS No. 109, Accounting for income taxes, when calculating its tax expense and the value of tax related assets and liabilities. This requires that the tax impact future events be considered when determining the value of assets and liabilities in its financial statements and tax returns. The Company accounts for income taxes under the liability method. Under the liability method, a deferred tax asset or liability is determined based upon the tax effect of the differences between the financial statement and tax basis of assets and liabilities as measured by the enacted rates that will be in effect when these differences reverse. A valuation allowance is recorded if realization of the deferred tax assets is not likely. J. Use of Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the united states of america requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. K. Fair Value of Financial Instruments - The carrying amounts reported in the consolidated balance sheet for cash, trade receivables, accounts payable and F-9 accrued expenses approximate fair value based on the short-term maturity of these instruments. L. Impairment for Long-lived and Intangible Assets - The Company reviews long-lived assets and certain identifiable intangible assets for impairment whenever circumstances and situations change such that there is an indication that the carrying amounts may not be recovered. Recoverability is assessed based on estimated undiscounted future cash flows. At October 31, 2005 and 2004, the Company believes that there has been no impairment of its long-lived and intangible assets. M. Revenue Recognition - Revenue is recognized when products are delivered to customers. A certain amount of the Company's revenue is derived from leasing water coolers and coffee brewers. These leases are generally for the first 12 months of service. The Company recognizes the income ratably over the life of the lease. N. Shipping and Handling Costs - The Company distributes its home and office products directly to its customers on its own trucks. The delivery costs related to the Company's route system, which are reported under selling, general, and administrative expenses, were $12,563,000, $10,940,000, and $9,821,000 for fiscal years 2005, 2004, and 2003, respectively. 3. RECENT ACCOUNTING PRONOUNCEMENTS In March 2005, FASB issued FIN 47, "Accounting for Conditional Asset Retirement Obligations", offering further guidance on SFAS No. 143, "Accounting for Asset Retirement Obligations". The pronouncement details certain requirements related the asset retirement if it is conditional on future event(s). FIN 47 is effective for fiscal years ending after December 15, 2005. The Company does not believe that FIN 47 will have a material impact on its financial position or results from operations. 4. MERGERS AND ACQUISITIONS During fiscal years 2005, 2004 and 2003, Vermont Pure Holdings, Ltd. made four, seven, and five acquisitions, respectively. The purchase price paid for the acquisitions for the respective years is as follows:
2005 2004 2003 -------- ---------- ---------- Cash $478,770 $4,331,351 $3,888,764 Notes Payable 141,750 640,000 200,000 Acquisition Costs 32,800 552,125 64,928 -------- ---------- ---------- $653,320 $5,523,476 $4,153,692 ======== ========== ==========
The allocation of purchase price related to these acquisitions for the respective years is as follows: F-10
2005 2004 2003 -------- ---------- ---------- Accounts Receivable $ -- $ 296,189 $ 895,620 Inventories 70,532 1,048,320 116,875 Identifiable Intangible Assets 546,398 2,613,500 785,965 Goodwill 36,390 1,875,263 2,355,232 Bottle Deposits -- (309,796) -- -------- ---------- ---------- Purchase Price $653,320 $5,523,476 $4,153,692 ======== ========== ==========
The following table summarizes the pro forma consolidated condensed results of operations (unaudited) of the Company for the fiscal years ended October 31, 2005, 2004, and 2003 as though the acquisitions had been consummated at the beginning of fiscal year 2003:
2005 2004 2003 ----------- ----------- ----------- Net Sales $60,372,549 $58,539,910 $59,515,489 =========== =========== =========== Net Income $ 871,833 $ 905,348 $ 2,013,269 =========== =========== =========== Net Income Per Share-Diluted $ .04 $ .04 $ .09 =========== =========== =========== Weighted Average Common Shares Outstanding-Diluted 21,625,683 21,574,515 21,764,698 =========== =========== ===========
The operating results of the acquired entities have been included in the accompanying statements of operations since their respective dates of acquisition. 5. LEASES To open an account that includes the rental of equipment, a customer is required to sign a contract that recognizes the receipt of the equipment, outlines the Company's ownership rights, the customer's responsibilities concerning the equipment, and the rental charge for twelve months. In general, the customer does not renew the agreement after twelve months and is free to terminate the agreement with the return of the equipment in good condition. We expect to have revenue of $785,000 from the rental of such equipment over the next twelve months. The carrying cost of the equipment, which is included in property and equipment in the consolidated balance sheets, used to generate this revenue is calculated as follows: Original Cost $2,563,420 Accumulated Depreciation 1,130,910 ---------- Carrying Cost $1,432,510 ==========
6. ACCOUNTS RECEIVABLE The Company reduces its receivables by an allowance for future uncollectible amounts. The activity in the allowance for continuing operations for the years ended October 31, 2005, 2004, and 2003 is as follows: F-11
2005 2004 2003 --------- --------- --------- Balance, beginning of year $ 303,304 $ 335,321 $ 248,880 Provision 316,667 366,844 598,142 Write-offs (330,134) (398,861) (511,701) --------- --------- --------- Balance, end of year $ 289,837 $ 303,304 $ 335,321 ========= ========= =========
7. INVENTORIES Inventories at October 31 consisted of:
2005 2004 ---------- ---------- Finished Goods $ 994,240 $ 900,917 Raw Materials 139,075 168,917 ---------- ---------- Total Inventories $1,133,315 $1,069,834 ========== ==========
8. PROPERTY AND EQUIPMENT Property and equipment at October 31 consisted of:
Useful Life 2005 2004 ------------ ----------- ----------- Buildings and improvements 10 - 40 yrs. $ 386,960 $ 332,518 Machinery and equipment 3 -10 yrs. 27,977,298 26,504,296 ----------- ----------- 28,364,258 26,836,814 Less accumulated depreciation 17,473,882 14,689,614 ----------- ----------- $10,890,376 $12,147,200 =========== ===========
Depreciation expense for the fiscal years ended October 31, 2005, 2004 and 2003 was 4,802,387, $5,091,470, and $5,074,159 respectively. 9. GOODWILL AND OTHER INTANGIBLE ASSETS Components of other intangible assets at October 31 consisted of:
October 31, ------------------------------------------------------------- 2005 2004 ----------------------------- ----------------------------- Gross Carrying Accumulated Gross Carrying Accumulated Amount Amortization Amount Amortization -------------- ------------ -------------- ------------ Amortized Intangible Assets: Customer Lists and Covenants Not to Compete $4,655,238 $1,527,060 $4,152,840 $759,591 Other Identifiable Intangibles 633,168 191,528 513,604 171,954 ---------- ---------- ---------- -------- Total $5,288,406 $1,718,588 $4,666,444 $931,545 ========== ========== ========== ========
Amortization expense for fiscal years 2005, 2004, and 2003 was $787,043, $409,380, and $186,060 respectively. F-12 Estimated Amortization Expense:
Fiscal Year Ending Amount - ------------------ -------- October 31, 2006 $831,476 October 31, 2007 694,101 October 31, 2008 652,409 October 31, 2009 474,019 October 31, 2010 199,036
The changes in the carrying amount of goodwill for the fiscal years ended October 31, 2005 and 2004 are as follows:
2005 2004 ----------- ----------- Beginning Balance $74,772,591 $72,899,355 Goodwill acquired during the year 36,390 1,875,263 Goodwill disposed of during the year (53,130) (2,027) ----------- ----------- Balance as of October 31 $74,755,851 $74,772,591 =========== ===========
10. ACCRUED EXPENSES Accrued expenses as of October 31, 2005 and 2004 were as follows:
2005 2004 ---------- ---------- Payroll and Vacation $1,501,402 $ 959,633 Interest 524,545 607,203 Severance 250,000 -- Accounting and Legal 211,501 176,257 Legal Settlements 100,000 -- Miscellaneous 402,681 575,393 ---------- ---------- Total $2,990,129 $2,318,486 ========== ==========
11. DEBT a) Senior Debt On April 6, 2005, the Company refinanced its senior credit facility with Bank of America. Webster Bank is a participant in the new loan. The new facility refinanced $28 million of existing senior debt in the form of a seven year term loan, provides a revolving credit facility of $6 million for working capital and letters of credit for a term of three years, and makes available up to $7.5 million to be used for acquisitions for a period of three years. The term loan may also provide funds for future principal payment of the Company's subordinated debt if certain financial covenants are met after the first two years of the loan. With the $28 million of term debt, the Company repaid its borrowings under its former senior credit facility with Webster Bank, including $17.5 million under the old term loan and $5.4 million under the old acquisition line of credit as well as $3.6 million of its F-13 subordinated debt. The balance of the new term loan as well as $2 million of the new line of credit was used to pay a balance of $3.5 million on the old revolving line of credit with Webster Bank. At October 31, 2005, the Company had no outstanding balance on its line of credit with Bank of America. However, there was $1.4 million of letters of credit outstanding, leaving $4.6 million of availability. As of October 31, 2005, there were outstanding balances of $26,500,000 on the term loan and $600,000 on the acquisition line. The term loan amortizes over seven years and the new acquisition debt amortizes as a term loan for five years after the first three years. During the first three years of the acquisition debt, interest only is paid on a monthly basis for amounts outstanding. Interest on the term loan is tied to the Company's performance based on the 30-day LIBOR plus a 250 basis point margin, while the acquisition and revolving lines have a 225 basis point margin over the 30-day LIBOR. For the respective loans, the margin may vary from 125 to 225 basis points and 150 to 250 basis points based on the level of senior debt to earnings before interest, taxes, depreciation, and amortization (EBITDA). The applicable margins as of October 31, 2005 was 2.50% from the term note and 2.25% for the acquisition line, resulting in total variable interest rates of 6.59% and 6.34%, respectively. The facility is secured by substantially all of the Company's assets. The credit agreement with Bank of America requires that the Company be in compliance with certain financial covenants at the end of each fiscal quarter. The covenants include senior fixed charge coverage of greater than 1.25 to 1, total fixed charge coverage of greater than 1 to 1, and senior debt to EBITDA of greater than 3.00 to 1. From the inception of the credit agreement through October 31, 2005, the Company was in compliance with all of the financial covenants of its new senior credit facility. b) Subordinated Debt As part of the acquisition agreement in 2000 with the former shareholders of Crystal Rock Spring Water Company, the Company issued subordinated notes in the amount of $22,600,000. The notes have an effective date of October 5, 2000, were for an original term of seven years (subsequently extended to 2012 as part of the senior refinancing described above) and bear interest at 12% per year. Scheduled repayments are made quarterly and are interest only for the life of the note unless specified financial targets are met. In April 2004, the Company repaid $5,000,000 of the outstanding principal. In April, 2005, the Company repaid an additional $3,600,000 of this principal. As of October 31, 2005, payments of interest only of $420,000 are due quarterly with a principal payment of $14,000,000 due at maturity. The notes are secured by all of the assets of the Company but specifically subordinated, with a separate agreement between the debt holders, to the senior debt described in Note 11(a) above. c) Annual maturities of debt as of October 31, 2005 are summarized as follows: F-14
Senior Credit Lines Subordinated Other Totals ----------- ------------ ------------ -------- ----------- Fiscal year ending October 31, 2006 3,125,000 -- 141,750 3,266,750 2007 3,499,000 -- -- 3,499,000 2008 3,876,000 -- -- 3,876,000 2009 4,250,000 60,000 -- -- 4,310,000 2010 and after 11,750,000 540,000 14,000,000 -- 26,290,000 ----------- -------- ----------- -------- ----------- Total Debt $26,500,000 $600,000 $14,000,000 $141,750 $41,241,750 =========== ======== =========== ======== ===========
12. INTEREST RATE SWAP AGREEMENTS The Company uses interest rate swaps to fix certain long term interest rates. The swap rates are based on the floating 30-day LIBOR rate and are structured such that if the loan rate for the period exceeds the fixed rate of the swap, then the bank pays the Company to lower the effective interest rate. Conversely, if the rate is lower than the fixed rate, the Company pays the bank additional interest. On May 3, 2005, the Company entered into an interest rate hedge ("swap") agreement in conjunction with its new senior financing. The new credit agreement requires that the Company fix the interest rate on its term debt for the life of the loan. The swap fixes the interest rate at 4.66%, plus the applicable margin, 2.50% at October 31, 2005, and amortizes concurrently with the loan principal to fix the interest rate with respect to 75% of the outstanding principal. The swaps constituting 75% of fixed rate principal include another swap which is in the notional amount of $10 million and a fixed rate of $5.24%, including the applicable margin. When that swap matures in June 2006 the balance of the aforementioned swap will increase to hedge 75% of the term loan on an amortizing basis. As of October 31, 2005, the total notional amount committed to swap agreements was $19.9 million. As of October 31, 2004, the Company had one swap agreement for a total notional amount of $10 million. Based on the floating rate for years ended October 31, 2005 and 2004, the Company paid $44,000 less and $304,000 more in interest, respectively, than it would have without the swaps. These swaps are considered hedges under SFAS Nos. 133 and 137. Since the instruments are intended to hedge against variable cash flows, they are considered a cash flow hedge. As a result, the changes in the fair values of the derivatives are recognized as comprehensive income or loss until the hedged item is recognized in earnings. The net unrealized realized gain, net of income taxes, for the years ended October 31, 2005, 2004 and 2003 was $65,482, $138,604, and 807,394, respectively. The accumulated other comprehensive gain as of October 31, 2005 and 2004 was $168,582 and $103,100, respectively. F-15 13. STOCK BASED COMPENSATION a) Stock Option Plan In November 1993, the Company adopted the 1993 Performance Equity Plan (the "1993 Plan"). The 1993 Plan authorizes the granting of awards for up to 1,000,000 shares of common stock to key employees, officers, directors and consultants until November 2003. Grants can take the form of stock options (both qualified and non-qualified), restricted stock awards, deferred stock awards, stock appreciation rights and other stock based awards. During fiscal 2004 and 2003 there were no options issued under this plan. The plan prohibits issuances of options after November 2004. In April 1998, the Company's shareholders approved the 1998 Incentive and Non Statutory Stock Option Plan. In April 2003, the Company's shareholders approved an increase in the authorized number of shares to be issued under its 1998 Incentive and Non-Statutory Stock Option Plan from 1,500,000 to 2,000,000. This plan provides for issuances of up to 2,000,000 options to purchase the Company's common stock under the administration of the compensation committee of the Board of Directors. The intent of the plan is to reward options to officers, employees, directors, and other individuals providing services to the Company. The following table summarizes the activity related to stock options and outstanding stock option balances during the last three fiscal years:
Outstanding Options Weighted Average (Shares) Exercise Price ------------------- ---------------- Balance at October 31, 2002 2,583,821 2.93 Granted 65,000 4.09 Exercised (125,000) 2.25 Expired (45,000) 3.64 --------- Balance at October 31, 2003 2,478,821 2.98 Granted 265,000 2.96 Exercised (33,200) 2.50 Expired (47,831) 2.77 --------- Balance at October 31, 2004 2,662,790 2.96 Granted 414,500 2.28 Expired (450,800) 2.50 --------- Balance at October 31, 2005 2,626,490 $2.96 =========
The following table summarizes information pertaining to outstanding stock options as of October 31, 2005:
Weighted Average Weighted Weighted Exercise Outstanding Remaining Average Exercisable Average Price Options Contractual Exercise Options Exercise Range (Shares) Life Price (Shares) Price - ------------- ----------- ----------- -------- ----------- -------- $1.80 - $2.60 981,500 4.78 $2.41 916,500 $2.45 $2.81 - $3.38 1,404,990 5.28 3.15 1,404,990 3.15 $3.50 - $4.25 185,000 5.71 3.89 185,000 3.89 $4.28 - $4.98 55,000 5.03 4.82 55,000 4.82 --------- --------- 2,626,490 5.12 $2.96 2,561,490 $2.99 ========= =========
F-16 Outstanding options and warrants include options issued under the 1993 Plan, the 1998 Plan, the 2003 Plan and non-plan options and warrants. There were 2,457,790 exercisable options at a weighted average price of $2.96 per share as of October 31, 2004. Outstanding options have lives ranging from 5-10 years, vesting from 0-5 years, and have exercise prices ranging from $1.80-$4.98 per share. b) Employee Stock Purchase Plan The Company maintains an ESPP, under which 500,000 shares of common stock were reserved for issuance. The ESPP enables eligible employees to subscribe, through payroll deductions, to purchase shares of the Company's common stock at a purchase price equal to 85% of the lower of the fair market value on the commencement date of the offering and the last day of the payroll payment period. At October 31, 2005, 355,017 shares had been issued and up to 144,533 shares are subject to outstanding subscriptions under the ESPP. As of January 1, 2006 the plan has been modified to allow employees to purchase shares of the Company's common stock at a purchase price equal to 95% of the lower of the fair market value on the commencement date of the offering and the last day of the payroll payment period. c) 2004 Stock Incentive Plan In April 2004, the Company's shareholders approved the 2004 Stock Incentive Plan. The plan provides for issuances of awards of up to 250,000 restricted or unrestricted shares, or incentive or non-statutory stock options, of the Company's common stock. On September 17, 2004, the Company issued 26,000 restricted shares for two awards to employees under this plan. These awards vest one year from the anniversary date. The total value of the awards was $57,200. The Company recognizes compensation over the vesting period resulting in expenses of $47,667 and $9,533 in fiscal years 2005 and 2004, respectively. On January 1, 2005, the Company issued 75,000 restricted shares as an award to an employee under this plan. The total value of the award was $133,500. The Company did not recognize compensation related to this award in fiscal year 2005 since, during the period, it was not probable that the shares would vest. Effective November 2, 2005, these shares were forfeited in connection with the resignation of the employee (see Note 22). 14. RETIREMENT PLAN The Company has a defined contribution plan which meets the requirements of Section 401(k) of the Internal Revenue Code. All employees of the Company who are at least twenty-one years of age are eligible to participate in the plan. The plan allows employees to defer a portion of their salary on a pre-tax basis and the Company contributes 25% of amounts contributed by employees up to 6% of their salary. Company contributions to the plan amounted to $116,000, $107,000, and $102,000, for the fiscal years ended October 31, 2005, 2004, and 2003, respectively F-17 15. COMMITMENTS AND CONTINGENCIES 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: Fiscal Year Ending October 31, 2006 $2,289,130 2007 2,098,033 2008 1,816,756 2009 1,298,477 2010 964,307 Thereafter 148,500 ---------- Total $8,615,203 ==========
Rent expense was $2,701,332, $2,502,739, and $2,136,596 for the fiscal years ended October 31, 2005, 2004, and 2003, respectively. CONTINGENCIES 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, and 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. In fiscal year 2005, the Company accrued $100,000 related to a judgment regarding a claim asserted by a former employee of a business that the Company acquired. The claim was made prior to the acquisition and the amount of the expected settlement was recorded as a miscellaneous expense in the accompanying statement of operations for the fiscal year ended October 31, 2005. 16. RELATED PARTY TRANSACTIONS a) Directors and Officers Three of the Company's major shareholders (former Crystal Rock shareholders) have employment contracts with the Company through October 5, 2005. They are also directors. One contract entitles the shareholder to annual compensation of $47,000 as well as a leased Company vehicle. The other two contracts entitle the respective shareholders to annual compensation of $200,000 each and other bonuses and prerequisites. F-18 The Company leases a 67,000 square foot facility in Watertown, CT and a 22,000 square foot facility in Stamford, CT from a family trust controlled by a related party. The lease expires in October 2010. Future minimum rental payments under these leases are as follows:
Fiscal year ending October 31, Stamford Watertown Total - ------------------ ---------- ---------- ---------- 2006 248,400 414,000 662,400 2007 248,400 414,000 662,400 2008 248,400 414,000 662,400 2009 248,400 414,000 662,400 2010 248,400 414,000 662,400 ---------- ---------- ---------- Totals $1,242,000 $2,070,000 $3,312,000 ========== ========== ==========
The Company's Chairman of the Board, Ross S. Rapaport, who also acts as Trustee in various Baker family trusts is employed by Pepe & Hazard LLP a business law firm that the Company uses from time to time. During fiscal 2005, 2004, and 2003, the Company paid $117,506, $147,467, and $83,043 respectively, for services provided by Pepe & Hazard LLP. b) Investment in Voyageur The Company has an equity position in a software company named Computer Design Systems, Inc. (CDS), d/b/a Voyageur Software. One of the Company's directors is a member of the board of directors of CDS. The Company uses software designed, sold and serviced by CDS in its Home and Office delivery system to manage customer service, deliveries, inventory, billing and accounts receivable. During fiscal 2005, 2004, and 2003, the Company paid $217,871, $582,277, and $113,193, respectively, for service, software, and hardware. As of October 31, 2003, the Company held a note receivable from CDS dated August 1, 1998 for the principal amount of $120,000 with accrued interest of $43,650 and an original maturity date of August 15, 2003. At October 31, 2003, interest accrued on the note was equal to $50,150. In October 2003, the Company exercised the option to convert the principal amount of the note into additional common shares of CDS during 2003. At October 31, 2003, the Company's share of CDS losses resulted in a net equity investment in CDS of $100,988, representing approximately 24% of the common stock of CDS. In July 2004, the Company exercised the option to convert the interest amount into additional common shares of CDS. In 2004, the Company determined that it's investment in CDS was impaired and wrote off the remaining balance of $152,838 which is reflected as a charge to operations as a miscellaneous expense in the accompanying statement of operations for the fiscal year ended October 31, 2004. Since the Company has written off its entire interest in CDS as of that date, it did not recognize its share of the loss for CDS in fiscal year 2005. The loss not reflected by the Company in fiscal year 2005 was $8,000. F-19 17. INCOME TAXES The Company has approximately $5.8 million of available net operating loss carryforwards at October 31, 2005 expiring from 2005 through 2018. Deferred tax assets (liabilities) at October 31, 2005 and October 31, 2004, are as follows:
October 31, ------------------------- 2005 2004 ----------- ----------- Accounts receivable allowance $ 110,138 $ 115,256 Amortization (67,518) 159,587 Payroll 350,945 228,270 Tax effect of operating loss carryforwards 2,185,374 2,414,924 Sale of Business Segment 962,515 807,564 Other 448,126 384,302 ----------- ----------- Total deferred tax asset 3,989,580 4,109,903 ----------- ----------- Depreciation (818,814) (838,519) Returnable Containers (1,719,375) (1,082,225) ----------- ----------- Total deferred tax liability (2,538,189) (1,920,744) ----------- ----------- Deferred tax asset, net $ 1,451,391 $ 2,189,159 =========== ===========
Income tax expense differs from the amount computed by applying the statutory tax rate to net income before income tax expense as follows:
Fiscal Year Ended October 31, ------------------------------ 2005 2004 2003 -------- -------- -------- Income tax expense computed at the statutory rate $547,522 $384,071 $739,350 Effect of permanent differences 120,959 22,661 28,881 State income taxes 71,285 61,735 72,765 -------- -------- -------- Income tax expense $739,766 $468,467 $840,996 ======== ======== ========
F-20 The following is the composition of income tax expense (benefit):
Fiscal Year Ended October 31, ------------------------------ 2005 2004 2003 -------- -------- -------- Current: Federal $ 208 $199,184 $ 54,230 State 1,790 119,000 211,000 -------- -------- -------- Total current 1,998 318,184 265,230 -------- -------- -------- Deferred: Federal 667,664 111,283 575,766 State 70,104 39,000 -- -------- -------- -------- Total deferred 737,768 150,283 575,766 -------- -------- -------- Total income tax expense $739,766 $468,467 $840,996 ======== ======== ========
On September 3, 2003 the Company reached 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 the Company's income taxes of $136,000. This amount has been included in income tax expense for 2003. In calculating its effective tax rate, the Company has considered the effect of certain contingent factors involving state and local income taxes. Although it believes that the tax returns filed accurately reflect operations and financial results, the Company has accrued liability as of October 31, 2005 and 2004 of approximately $284,000 and $160,000, respectively, for the purpose of settling disputes in the event that certain jurisdictions viewed particular tax laws differently than the Company did when the returns were filed. 18. NET INCOME PER SHARE The following calculation provides the reconciliation of the denominators used in the calculation of basic and fully diluted earnings per share: F-21
Fiscal Year Ended October 31, --------------------------------------- 2005 2004 2003 ----------- ----------- ----------- Income from Continuing Operations $ 870,593 $ 500,124 $ 941,387 Income from Discontinued Operations -- 160,221 391,022 ----------- ----------- ----------- Net Income $ 870,593 $ 660,345 $ 1,332,409 =========== =========== =========== Denominator: Basic Weighted Average Shares Outstanding 21,619,863 21,497,251 21,282,294 Effect of Stock Options 5,820 77,264 482,404 ----------- ----------- ----------- Diluted Weighted Average Shares Outstanding 21,625,683 21,574,515 21,764,698 =========== =========== =========== Basic Net Income Per Share: Income from Continuing Operations $ .04 $ .02 $ .04 Income from Discontinued Operations $ .00 $ .01 $ .02 ----------- ----------- ----------- Net Income $ .04 $ .03 $ .06 =========== =========== =========== Diluted Net Income Per Share: Income from Continuing Operations $ .04 $ .02 $ .04 Income from Discontinued Operations $ .00 $ .01 $ .02 ----------- ----------- ----------- Net Income $ .04 $ .03 $ .06 =========== =========== ===========
In addition to the options used to calculate the effect of dilution, there were 2,561,490 and 1,645,000 options outstanding for the years ended October 31, 2005 and 2004, respectively, that were not included in the dilution calculation because the options' exercise price exceeded the market price of the underlying common shares. 19. SALE OF BUSINESS SEGMENTS On March 2, 2004, the Company completed the sale of substantially all of the assets related to its Retail and Retail - Gallons segments. These segments have been accounted for as discontinued operations. The sale resulted in a gain before income taxes, reported in discontinued operations, of $352,535. The gain was calculated by deducting the net carrying value of the assets and liabilities and transaction costs from the net proceeds as follows: Selling Price $10,567,998 Accounts Receivable (1,147,229) Inventory (2,490,181) Property, Plant, and Equipment (7,093,641) Accounts Payable 1,739,347 Transaction Costs (1,223,759) ----------- Gain $ 352,535 ===========
In addition to cash proceeds of $10,067,998, the Company received a $500,000, 5% subordinated note from the buyer as consideration for the sale. Interest is payable by the seller on a quarterly basis and the total principal is due on the second anniversary of the F-22 sale. Substantially all of the proceeds of the sale were used to reduce debt. $5,000,000 was used to pay down the Company's senior term debt with Webster Bank and $5,000,000 was used to pay down its subordinated debt. Revenues, expenses, and costs have been excluded from the respective captions in the related financial statements and reported as (loss) income from discontinued operations, net of income taxes, for fiscal years 2004 and 2003. For the years ended October 31, 2004 and 2003, net sales from discontinued operations were $6,434,000 and $26,341,000, respectively. The loss from discontinued operations was $79,000 for fiscal year 2004 and income from discontinued operations was $637,000 for fiscal year 2003. The respective losses and income do not include any allocation of corporate costs that were previously allocated to the discontinued operations. Those costs are expected to continue in the future and have been allocated to the only remaining line of business in continuing operations. 20. UNAUDITED QUARTERLY FINANCIAL DATA The Company's unaudited quarterly financial data for the last two fiscal years is as follows:
For the quarter ended: Fiscal 2005 ------------------------------------------------ (000's of $ except January 31, April 30, July 31, October 31, net income per share) 2005 2005 2005 2005 - --------------------- ----------- --------- -------- ----------- Net Sales $13,964 $14,756 $15,306 $15,809 Gross Profit $ 8,032 $ 8,588 $ 9,048 $ 9,324 Income from Continuing Operations $ 7 $ 205 $ 382 $ 277 Net Income $ 7 $ 205 $ 382 $ 277 Earnings per Share: ------- ------- ------- ------- Net Income - Basic and Diluted $ -- $ .01 $ .02 $ .01 ======= ======= ======= =======
For the quarter ended: Fiscal 2004 ------------------------------------------------ (000's of $ except January 31, April 30, July 31, October 31, net income per share) 2004 2004 2004 2004 --------------------- ----------- --------- -------- ----------- Net Sales $11,998 $13,182 $13,555 $13,738 Gross Profit $ 5,360 $ 5,960 $ 5,745 $ 5,713 (Loss) income from Continuing Operations $ (320) $ 187 $ 390 $ 243 Income from Discontinued Operations $ 64 $ 96 -- -- ------- ------- ------- ------- Net (Loss) Income $ (256) $ 283 $ 390 $ 243 ======= ======= ======= ======= (Loss) Earnings per Share: Continuing Operations - Basic and Diluted $ (.01) $ .01 $ .02 -- Discontinued Operations - Basic and Diluted -- $ .01 -- -- ------- ------- ------- ------- Net Income - Basic and Diluted $ (.01) $ .02 $ .02 -- ======= ======= ======= =======
F-23 21. CONCENTRATION OF CREDIT RISK The Company maintains its cash accounts at various financial institutions. The balances at times may exceed federally insured limits. At October 31, 2005, the Company had cash in deposits exceeding the insured limit by approximately $1,754,000. 22. SUBSEQUENT EVENTS Effective November 2, 2005, the Company's Chief Executive Officer ("CEO") resigned from that office as well as director. In addition, five other directors resigned. Also on that date the Board of Directors named a new CEO and two new directors and the Board voted to become a "controlled company" under the Corporate Governance Rules of the American Stock Exchange. A controlled company is exempted from certain rules otherwise applicable to companies whose securities are listed on AMEX, including (1) the requirement that a the company have a majority of independent directors; (2) the requirement that nominations to the company's Board of Directors be either selected or recommended by a nominating committee consisting solely of independent directors; and (3) the requirement that officers' compensation be either determined or recommended by a compensation committee consisting solely of independent directors. As a result of the resignation of the CEO and directors, 1,479,200 stock options, issued under various plans, outstanding as of October 31, 2005 expired on December 1, 2005. In conjunction with the resignation of the CEO the Company entered into a severance agreement with him. The severance agreement provides for payments totaling $250,000 over a period from May, 2006 to October 2007. It also includes customary provisions regarding the confidentiality of Company information and clarifies or modifies several provisions of Mr. Fallon's Employment Agreement with the Company dated as of January 1, 2005. F-24 EX-10.11 2 b58814vpexv10w11.txt SEVERANCE AGREEMENT DATED DECEMBER 5, 2005 Exhibit 10.11 SEVERANCE AGREEMENT THIS SEVERANCE AGREEMENT ("Agreement") is dated as of December 5, 2005 and is by and between Vermont Pure Holdings, Ltd., a Delaware corporation having an office located at 1050 Buckingham Street, Watertown, Connecticut 06795 ("Company"), and Timothy G. Fallon, an individual, with an address at 411 Sarles Street, Mt. Kisco, New York 10549 ("Fallon"). RECITALS Effective November 1, 2005, Fallon voluntarily resigned from the Company after serving for many years as its Chief Executive Officer, among other positions. In recognition of his significant contributions to the Company, and in return for his promises and agreements in this Agreement, the Company desires to compensate Fallon as set forth below. In return for such compensation, Fallon desires to carry out such promises and agreements. ACCORDINGLY, in consideration of the foregoing and of the mutual agreements and undertakings set forth herein, the Company and Fallon agree as follows: SECTION 1. SEVERANCE. 1.1. Provided that Fallon is not in breach of this Agreement, the Company shall pay to Fallon the following severance payments: (i) a payment of $50,000.00 on May 1, 2006, (ii) seventeen (17) monthly payments of $8,333.33 commencing June 1, 2006 and ending October 1, 2007, and (ii) a final payment of $8,333.39 on November 1, 2007, for a total of $200,000.00. SECTION 2. CONSULTING AND LITIGATION SERVICES. 2.1. "Consulting Services" shall mean such advice, consultation and other assistance and services respecting the general business of the Company as the Company may reasonably request from Fallon from time to time. 2.2.1. "Litigation Services" shall mean such assistance with respect to the prosecution and defense of the litigation known as Vermont Pure Holdings, Ltd. v. Nestle Waters North America, Inc., United States District Court (D. Mass.), Civil Action No. 03-11465-DPW (the "Nestle Litigation"), as further provided in Section 4 of this Agreement, as the Company and/or its counsel may reasonably request from Fallon from time to time. SECTION 3. ENGAGEMENT TO PROVIDE CONSULTING SERVICES. 3.1. The Company hereby retains Fallon to render Consulting Services to it, and Fallon hereby agrees to render Consulting Services to the Company, for a period of two years, all in accordance with and subject to the terms and provisions of this Agreement. Fallon agrees to use commercially reasonable efforts to complete and achieve all such services, in a time and manner consistent with the need for those services. Nothing in this Agreement shall prevent, limit or restrict Fallon from entering into employment or consulting agreements with, or otherwise providing services as an employee or providing consulting services to, any other person or entity; provided, however, that Fallon shall not provide services as an employee or consulting services, in any form, to a third party in violation of Section 4.4 of the Employment Agreement dated as of January 1, 2005 by and between the Company and Fallon (the "Fallon Employment Agreement"), as amended by Section 8 of this Agreement or as may be further amended from time to time. 3.2. Fallon shall render Consulting Services at such times and places as the Company may reasonably request. Recognizing that Fallon intends to be engaged in full-time employment with another company, Company personnel will endeavor to utilize telephone, e-mail and internet services to communicate with Fallon when that is practicable. SECTION 4. ENGAGEMENT TO PROVIDE LITIGATION SERVICES. 4.1. The Company hereby retains Fallon to render Litigation Services to it, and Fallon agrees to render Litigation Services to the Company, until the Litigation Termination Date (as hereinafter defined), all in accordance with and subject to the terms and provisions of this Agreement. Until the entry of a final, non-appealable order or judgment in the Nestle Litigation (including any court proceedings related to the Nestle Litigation that may be filed subsequently) (the "Litigation Termination Date"), Fallon will cooperate fully with the Company and/or its counsel in the prosecution or defense of the Nestle Litigation and in any such related court proceedings. Fallon's full cooperation in connection with such matters will include, but not be limited to, meeting and consulting with counsel to assist with the development of the case and to prepare for discovery or trial, and acting as a witness on behalf of the Company. Until the Litigation Termination Date, Fallon will also cooperate fully with the Company and/or its counsel in connection with any investigation or review of any federal, state or local regulatory authority respecting the Nestle Litigation. 4.2. Fallon shall render Litigation Services at such times and places as the Company may reasonably request. Recognizing that Fallon intends to be engaged in full-time employment with another company, Company personnel and counsel will endeavor to utilize telephone, e-mail and internet services to communicate with Fallon when that is practicable. Fallon understands and agrees that his compensation under this Agreement is the only payment he will receive for time (but not out-of-pocket expenses, which will be reimbursed to him as provided in this Agreement) he may spend in connection with the activities referred to in Section 4.1, regardless of the duration of the Nestle Litigation. SECTION 5. CONFIDENTIAL INFORMATION; RETURN OF PROPERTY; ENFORCEMENT. 5.1 Fallon acknowledges that: (a) Fallon has obtained, and during his services as provided in this Agreement will obtain, secret and confidential information concerning the business of the Company and its affiliates, including, without limitation, customer lists and sources of supply, their needs and requirements, the nature and extent of contracts with them, and related cost, price and sales information. (b) The Company and its affiliates will suffer substantial and irreparable damage which will be difficult to compute if, during his services as provided herein or thereafter, Fallon should divulge secret and confidential information relating to the business of the Company and its affiliates heretofore or hereafter acquired by him. (c) The provisions of this Agreement are reasonable and necessary for the protection of the business of the Company and its affiliates. 5.2 Fallon agrees that he will not at any time, either during his services hereunder or at any time thereafter, divulge to any person, firm or corporation any information obtained or learned by him during the course of providing services to the Company, with regard to the operational, financial, business or other affairs of the Company and its affiliates, and their respective officers and directors, including, without limitation, trade secrets, customer lists, sources of supply, pricing policies, operational methods or technical processes, except (i) with the express written consent of the Company; (ii) to the extent that any such information is lawfully in the public domain other than as a result of Fallon's breach of any of his obligations hereunder; or (iii) where required to be disclosed by court order, subpoena or other government process. In the event that Fallon shall be required to make any disclosure pursuant to the provisions of clause (iii) of the preceding sentence, Fallon promptly, but in no event more than 48 hours after learning of such subpoena, court order, or other government process, shall notify the Company, by personal delivery or by fax, confirmed by mail, to the Company and, if the Company so elects and at the Company's expense, Fallon shall (x) take all reasonably necessary steps requested by the Company to defend against the enforcement of such subpoena, court order or other government process, and (y) permit the Company to intervene and participate with counsel of its choice in any proceeding relating to the enforcement thereof. 5.3 At any time the Company may so request, Fallon will promptly deliver to the Company all memoranda, notes, records, reports, manuals, drawings, blueprints and other documents (and all copies thereof) relating to the business of the Company and its affiliates and all property associated therewith, which he may then possess or have under this control. 5.4 If Fallon commits a breach, or threatens to commit a breach, of any of the provisions of this Section 5, the Company shall have the right and remedy to have the provisions of this Agreement specifically enforced by any court having jurisdiction over the matter, it being acknowledged and agreed by Fallon that the services being rendered hereunder to the Company are of a special, unique and extraordinary character and that any such breach or threatened breach will cause irreparable injury to the Company and that money damages will not provide an adequate remedy to the Company. Such right and remedy shall be in addition to, and not in lieu of, any other rights and remedies available to the Company under law or equity. 5.5 If any provision of this Section 5 is held to be unenforceable because of the scope, duration or area of its applicability, the tribunal making such determination shall have the power to modify such scope, duration or area, or all of them, and such provision or provisions shall then be applicable in such modified form. SECTION 6. COMPENSATION AND REIMBURSEMENT. 6.1. As full compensation for providing Consulting Services and Litigation Services to the Company, provided that Fallon is not in breach of this Agreement, the Company shall pay Fallon a total of $50,000.00 on May 1, 2006. 6.2. The Company shall reimburse Fallon for his reasonable out-of-pocket expenses for travel, lodging and meals, approved in advance by the Company and incurred by Fallon incident to his providing Consulting Services and Litigation Services hereunder. Within ten (10) days following the date on which he incurs any reimbursable expense in accordance with this Section, Fallon will furnish the Company with a written statement and all receipts and vouchers documenting such expenses incurred, in a form, and accompanied by such documentation, as may be reasonably satisfactory to the Company. The Company shall promptly reimburse Fallon after receipt of any such statement of expenses. 6.3 Anything in this Agreement to the contrary notwithstanding, if the Company requests Consulting Services prior to the second anniversary of this Agreement or Litigation Services prior to the Litigation Termination Date, and Fallon willfully or intentionally fails or refuses to provide such Consulting or Litigation Services, then (i) Fallon shall be liable to the Company for the return of all amounts paid to Fallon under Section 6.1 of this Agreement and (ii) Fallon shall have no right to any amounts that are not yet due and payable to him under Section 1.1 of this Agreement at the time of such failure or refusal, which unpaid amounts shall be forfeited. The parties agree that the remedy in the first sentence of this Section 6.3 shall constitute liquidated damages to the Company for the failure or refusal described in that sentence and shall not constitute a penalty. The recovery of such amounts by the Company shall not affect the liability of Fallon to legal process in connection with the Nestle Litigation or otherwise, nor shall it affect any other claim the Company may have against Fallon for breach of this Agreement or any other agreement. SECTION 7. INDEPENDENT CONTRACTOR; NO CONFLICTS. 7.1 Fallon shall be deemed to be, and function as, an independent contractor, and not an employee of the Company, under this Agreement. The Company will not provide Fallon with any employee benefits or make any unemployment contributions on his behalf, nor will Fallon be entitled to any unemployment benefits or workers compensation insurance coverage. Fallon shall have no authority to act on the Company's behalf or to commit the Company to any course of conduct, and shall make no representation to the contrary to any person or entity not a party hereto. 7.2 Fallon represents and warrants to the Company that he is not a party to any agreement or understanding, oral or written, effective on the date first written above or applicable during the term of this Agreement, restricting or limiting his ability to observe and perform the terms and provisions hereof on his part to be observed and performed; and he will not become a party to any such agreement or understanding during while this Agreement is in effect without the Company's prior written consent. SECTION 8. CONFIRMATION OF CERTAIN UNDERSTANDINGS REGARDING THE FALLON EMPLOYMENT AGREEMENT. 8.1 The Company and Fallon hereby confirm the following understandings and agreements regarding the Fallon Employment Agreement: (a) The determination of Fallon's bonus for fiscal year 2005, as provided in Section 3.2.2(i) of the Fallon Employment Agreement, is based upon the ratio of actual earnings before interest, taxes, depreciation and amortization ("EBITDA") to target annual EBITDA approved in the budget for fiscal year 2005 by the Company's Board of Directors. In determining EBITDA, the Company will determine "earnings" as "net income," in accordance with United States generally accepted accounting principles, consistently applied, without adjustments. For the avoidance of doubt, the Company intends to expense in fiscal year 2005 the aggregate amounts payable under Sections 1.1 and 6.1 of this Agreement. The bonus payable to Fallon pursuant to Section 3.2.2(i) of the Fallon Employment Agreement will not be less than $110,000.00. Fallon has earned the bonus set forth in Section 3.2.2(ii) of the Fallon Employment Agreement (which deals with compliance by the Company with the financial covenants set forth in its loan agreement with its principal lender), and the unpaid amount of such bonus will be paid in accordance with the Company's customary practices. (b) The terms of the restricted stock award described in Section 3.3 of the Fallon Employment Agreement are set forth in that certain Restricted Stock Award Agreement - 2004 Stock Incentive Plan (the "Award Agreement") between the Company and Fallon which relates to a grant of 75,000 restricted shares (the "Award Shares") of the Company's Common Stock. Pursuant to Sections 3(c) and 3(f) of the Award Agreement, all of the Award Shares failed to vest and are forfeited to the Company at no cost. In furtherance of the foregoing, Fallon irrevocably appoints either of Bruce MacDonald or American Stock Transfer & Trust Company, each acting singly and each with full power of substitution in the premises, as attorney to effect the transfer of the Award Shares to the treasury of the Company, and agrees to execute such other documents (including without limitation signature guarantees) in connection with the aforesaid transfer as either of them shall request. (c) The provisions and obligations set forth in Section 4.4 of the Fallon Employment Agreement, dealing with non-competition, survive Fallon's resignation. Said Section 4.4 is hereby amended to extend the period of non-competition from 12 months to 24 months and, as so amended, shall read in its entirety as follows: 4.4 Non-Competition. During the Employment Term and for a period of 24 months thereafter, the Executive shall not, without the prior written permission of the Company, in the United States, its territories and possessions, directly or indirectly, (i) enter into the employ of or render any services to any person, firm or corporation engaged in any Competitive Business (as defined below); (ii) engage in any Competitive Business for his own account; (iii) become associated with or interested in any Competitive Business as an individual, partner, shareholder, creditor, director, officer, principal, agent, employee, trustee, consultant, advisor or in any other relationship or capacity; (iv) employ or retain, or have or cause any other person or entity to employ or retain, any person who was employed or retained by the Company or its affiliates while the Executive was employed by the Company; or (v) solicit, interfere with, or endeavor to entice away from the Company or its affiliates any of their customers or sources of supply. However, nothing in this Agreement shall preclude the Executive from investing his personal assets in the securities of any Competitive Business if such securities are traded on a national stock exchange or in the over-the-counter market and if such investment does not result in his beneficially owning, at any time, more than 4.9% of the publicly-traded equity securities of such competitor. "Competitive Business" shall mean any business or enterprise which (a) designs, sells, manufactures, markets and/or distributes spring or purified water products or still spring or purified water beverages in the home and office market, or (b) engages in any other business in which Company or its affiliates is involved at any time during the 12-month period immediately prior to the termination of the Executive's employment. SECTION 9. RELEASE OF CLAIMS. 9.1 Reference is made to the voluntary termination by Fallon of his employment with the Company, effective at the close of business on November 1, 2005. In connection with such termination, and as a condition to the Company's obligation to pay or provide severance and other payments or benefits under this Agreement, Fallon irrevocably and unconditionally releases, acquits and forever discharges the Company, its affiliated and related corporations and entities, and each of their predecessors and successors, and each of their agents, directors, officers, trustees, attorneys, present and former employees, representatives, and related entities (collectively referred to as the "Released Entities") from any and all charges, complaints, claims, liabilities, obligations, promises, agreements, controversies, damages, actions, causes of action, suits, rights, demands, costs, losses, damages and expenses (including attorneys' fees and costs actually incurred) arising out of or in connection with his employment with or termination of employment from the Company, which Fallon now has, owns or holds, or claims to have, own or hold, or which at any time heretofore, had owned or held, or claimed to have owned or held, or which Fallon at any time hereafter may have, own or hold, or claim to have owned or held against the Released Entities, based upon, arising out of or in connection with his employment with or termination of employment from the Company up to the date of this Release, including but not limited to, claims or rights under any federal, state, or local statutory and/or common law in any way regulating or affecting the employment relationship, including but not limited to Title VII of the Civil Rights Act of 1964, the Americans with Disabilities Act, the Age Discrimination in Employment Act and any other federal, state, local statutory and/or common law regulating or affecting the employment relationship. Fallon acknowledges and understands that he is waiving all of his possible claims arising out of or in connection with his employment with or termination of employment from the Company. 9.2 Fallon acknowledges that he has been provided at least twenty-one (21) days to consider whether to sign this Release, that he has been advised to consult with an attorney of his choosing concerning this Release, and that he has executed and delivered this release and waived any claims knowingly and willingly. Fallon may revoke this Release within seven (7) days after it is signed, and it shall not become effective or enforceable until such seven (7) day revocation period has expired. Such revocation shall not affect the enforceability by the Company against Fallon of any other provision of this Agreement. SECTION 10. TERM. 10.1 Unless sooner terminated, the obligations of Fallon to provide Consulting Services shall terminate on the second anniversary of the date of this Agreement; the obligations of Fallon to provide Litigation Services shall terminate on the Litigation Termination Date; and the obligations of Fallon under Section 5 shall terminate on the later of (i) the fifth anniversary of the date of this Agreement or (ii) two years after the Litigation Termination Date. This Agreement shall terminate at the option of the Company if, pursuant to Section 9.2, Fallon revokes the Release set forth in Section 9. SECTION 11. CONSTRUCTION OF AGREEMENT. 11.1. No waiver of any breach or default hereunder will be valid unless in a writing signed by the waiving party. No failure or other delay by any party exercising any right, power, or privilege hereunder will be or operate as a waiver thereof, nor will any single or partial exercise thereof preclude any other or further exercise thereof or the exercise of any other right, power, or privilege. No amendment or modification of this Agreement will be valid or binding unless in a writing signed by both Fallon and the Company. 11.2. All of Fallon's representations and warranties made in this Agreement and all terms and provisions hereof which by their terms are expressly required to be observed and performed by the Company or Fallon after the termination of this Agreement shall continue thereafter in full force and effect. 11.3. All notices provided for in this Agreement shall be in writing and shall be deemed to be given when delivered personally to the party to receive the same, when transmitted by electronic means or when mailed first class, postage prepaid by certified mail, return receipt requested, addressed to the party to receive the same at the applicable addresses set forth below or such other address as the party to receive the same shall have specified by written notice give in the manner provided for in this Section. All notices shall be deemed to have been given as of the date of personal delivery, transmittal or mailing thereof. (a) If to Fallon: Mr. Timothy Fallon, 411 Sarles Street, Mount Kisco, New York 10549. (b) If to the Company: Vermont Pure Holdings, Ltd., 1050 Buckingham Street, Watertown, Connecticut 06795, Attention: CEO, with a copy to: Dean F. Hanley, Esq., Foley Hoag LLP, 155 Seaport Boulevard, Boston, Massachusetts 02210. 11.4. This Agreement shall be binding upon and inure to the benefit of the Company's successors and assigns. If, prior to November 1, 2007, there is a transaction in which a majority of the voting stock of the Company, or all or substantially all of the Company's assets, are transferred to a third party that is not an affiliate of the Company, then all amounts payable to Fallon pursuant to Sections 1.1 and 6.1 of this Agreement ($250,000.00 in the aggregate) that have not been paid to Fallon shall be and become due and payable to him by the Company upon the closing of such transaction; provided, however, that in case such closing would occur prior to May 1, 2006, then, prior to such closing, the Company and Fallon will establish an escrow or similar arrangement pursuant to which Fallon will be paid the amounts due to him by reason of this Section 11.4 on or after May 1, 2006. The acceleration of such payments shall not affect Fallon's agreements hereunder. For the avoidance of doubt, severance payments accelerated as provided in this Section shall no longer be subject to Section 6.3(ii). 11.5. This Agreement is to be construed pursuant to the laws of the State of Delaware, without regard to the laws affecting choice of law. 11.6. Should any provision of this Agreement become legally unenforceable, no other provision of this Agreement shall be affected, and this Agreement shall continue as if the Agreement had been executed absent the unenforceable provision. 11.7. This Agreement represents the full agreement between the Company and Fallon with respect to the subject matter hereof and the Company and Fallon have made no agreements, representations or warranties relating to the subject matter of this Agreement that are not set forth herein except for provisions of the Fallon Employment Agreement that survive the termination of Fallon's employment with the Company. Except for provisions of the Fallon Employment Agreement that survive the termination of Fallon's employment with the Company, this Agreement supersedes any and all other agreements, oral or written, that may define the relationship between Fallon and the Company or any affiliate of the Company, and all of such other agreements are hereby terminated, without liability to any party thereto. Nothing in this Agreement confers any rights or remedies on any person or entity or than the parties hereto. 11.8. This Agreement may be executed by the parties in separate counterparts, each of which when so executed and delivered will be an original, but all of which together will constitute one and the same agreement. In pleading or proving this Agreement, it will not be necessary to produce or account for more than one such counterpart. IN WITNESS WHEREOF, the Company has caused this Agreement to be executed by its duly authorized officer and Fallon has set his hand both as of the date and year first above mentioned. VERMONT PURE HOLDINGS, LTD. BY: /s/ PETER K. BAKER ------------------------------------ PETER BAKER /s/ TIMOTHY G. FALLON ------------------------------------ TIMOTHY G. FALLON EX-10.21 3 b58814vpexv10w21.txt FORM OF AMENDMENT OF IMDEMNIFICATION AGREEMENT Exhibit 10.21 VERMONT PURE HOLDINGS, LTD. CRYSTAL ROCK/VERMONT PURE 1050 BUCKINGHAM STREET WATERTOWN, CONNECTICUT 06795 November 2, 2005 Name and Title _________________________ Address ________________________________ Address ________________________________ Re: Amendment to Indemnification Agreement Dear ________: Reference is made to the Indemnification Agreement dated as of November 1, 2002 (the "Agreement") by and between you and Vermont Pure Holdings, Ltd. The parties to the Agreement desire to amend Sections 19 and 22 of the Agreement to update information about notice, venue and jurisdiction. Accordingly, in consideration of the mutual promises hereinafter set forth and other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereby agree as follows: 1. Section 19 of the Agreement is hereby deleted in its entirety and the following text is inserted in lieu thereof: 19. NOTICES. All notices, requests, demands and other communications under this Agreement shall be in writing and shall be deemed duly given if delivered by hand, sent by facsimile transmission with confirmation of receipt, sent via a reputable overnight courier service with confirmation of receipt requested, or mailed by domestic certified or registered mail with postage prepaid and return receipt requested, to the Indemnified Party at the address on the first page of this Agreement and to VPUR at the address below (or at such other address for a party as shall be specified by like notice), and shall be deemed given on the date on which delivered by hand or otherwise on the date of receipt as confirmed: Crystal Rock/Vermont Pure 1050 Buckingham Street Watertown, Connecticut 06795 Attention: Peter Baker, Chief Executive Officer + Bruce MacDonald, Chief Financial Officer Phone: 860-945-0661 x 3008 Fax: 860-945-6246 With a copy to: Dean F. Hanley, Esq. Foley Hoag LLP 155 Seaport Boulevard Boston, Massachusetts 02210 Phone: 617-832-1000 Fax: 617-832-7000 2. Section 22 of the Agreement is hereby deleted in its entirety and the following text is inserted in lieu thereof: 22. CONSENT TO JURISDICTION; CHOICE OF VENUE. VPUR and the Indemnified Party each by this Agreement irrevocably consents to the jurisdiction of the courts of Connecticut and the federal courts within Connecticut for all purposes in connection with any action or proceeding which arises out of or relates to this Agreement, and agrees that any such action or proceeding shall be brought only in Hartford Superior Court, State of Connecticut, or in United States District Court, District of Connecticut, sitting in Hartford. 3. Except as expressly modified hereby, the Agreement is hereby ratified and confirmed in all respects. If the foregoing correctly sets forth our understanding, we would appreciate your executing the enclosed counterpart of this letter and returning it to us. VERMONT PURE HOLDINGS, LTD. By: ------------------------------------ Name: ---------------------------------- Title: --------------------------------- Accepted and agreed to: - -------------------------------------- INDEMNIFIED PARTY IDENTIFIED ON PAGE 1 EX-10.22 4 b58814vpexv10w22.txt FORM OF IMDEMNIFICATION AGREEMENT, DATED NOVEMBER 2, 2005 Exhibit 10.22 VERMONT PURE HOLDINGS, LTD. CRYSTAL ROCK/VERMONT PURE 1050 BUCKINGHAM STREET WATERTOWN, CONNECTICUT 06795 November 2, 2005 Name and Title _________________________ Address _______________________________ Address _______________________________ Dear _____: From time to time we have discussed with the officers and directors of Vermont Pure Holdings, Ltd. ("VPUR") the substantial increase in corporate litigation, which can subject officers and directors to expensive litigation risks and large claims for damages. We have also discussed the uncertainties involved in obtaining and maintaining directors' and officers' liability insurance on a reasonable basis as well as the potentially limited scope (and risk of non-renewal) of such insurance as can be obtained. You have informed us that you are concerned about the level of protection available to you as an officer or director of VPUR in the present legal climate, and we understand that your willingness to serve or to continue to serve as an officer or director of VPUR depends upon, among other things, assurance of adequate protection on a long-term basis. You have also informed us that you know of no pending or threatened claim against you relating to VPUR. The certificate of incorporation of VPUR (the "Charter") provides that VPUR will indemnify its corporate officers and directors to the full extent permitted by the applicable statute, which is Section 145 of the Delaware General Corporation Law. The statute, in turn, authorizes a Delaware corporation to provide indemnification against expenses and certain other losses incurred by a director or officer in any proceeding in which he or she is involved as a result of serving, or having served, as a director, officer, or employee of VPUR or, at VPUR's request, as a director, officer or employee of another corporation or entity. In addition, VPUR has the power under Delaware law to enter into arrangements for indemnification on any terms not prohibited by law that the Board of Directors deems to be appropriate. In order to attract and retain your services as an officer or director of VPUR, VPUR has agreed to indemnify you to the fullest extent of its authority to do so, subject to the limitations set forth herein. This letter agreement ("Agreement") is intended to supplement and confirm the indemnification provisions contained in the Charter of VPUR. VPUR and you (the "Indemnified Party") by this Agreement agree as follows: Indemnification. VPUR shall indemnify and hold harmless the Indemnified Party if the Indemnified Party is or was a party or is threatened to be made a party to, or is otherwise involved with, any Proceeding (as such term is defined in Section 0): by reason of the fact that the Indemnified Party is or was a director, officer, employee or agent of VPUR or any subsidiary of VPUR, by reason of any action or inaction on the part of the Indemnified Party while a director, officer, employee or agent of VPUR or any subsidiary of VPUR, by reason of the fact that the Indemnified Party is or was serving at the request of VPUR as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, or by reason of the fact that the Indemnified Party is or was serving at the request of VPUR in any capacity with respect to any employee benefit plan, against expenses (including reasonable attorneys' fees), judgments, penalties, fines and amounts paid in settlement (if such settlement is approved in writing in advance by VPUR, which approval shall not be unreasonably withheld or delayed) actually and reasonably incurred by the Indemnified Party in connection with such Proceeding unless VPUR shall establish, in accordance with the procedures and standards described in Section 0 and Section 0 of this Agreement, that the Indemnified Party was not entitled to indemnification, as described in Section 0. Limitation on Indemnification. Notwithstanding any other provision of this Agreement, no indemnification shall be paid under this Agreement with respect to claims involving acts or omissions as to which the Indemnified Party is finally adjudicated (by court order or judgment from which no right of appeal exists) not to have acted in good faith in the reasonable belief that the Indemnified Party's action was in the best interests of VPUR or, to the extent that such matter relates to service with respect to an employee benefit plan, in the best interests of the participants or beneficiaries of such employee benefit plan; and no indemnification shall be paid under this Agreement with respect to any criminal matter in which the Indemnified Party is finally adjudicated (by court order or judgment from which no right of appeal exists) to have had reasonable cause to believe that the Indemnified Party's action was unlawful. Notice of Resignation; No Employment Agreement. In consideration of the protection afforded by this Agreement, the Indemnified Party agrees not to resign voluntarily from the position now held by him with VPUR without first giving to VPUR not less than three weeks' written notice of his intention to resign. Nothing contained in this Agreement is intended to create or shall create in the Indemnified Party any right to employment (in the case of a director) or continued employment (in the case of an employee). Expenses; Indemnification Procedure. Advancement of Expenses. VPUR shall advance all reasonable expenses incurred by the Indemnified Party in connection with the investigation, defense, settlement or appeal of any Proceeding (but not amounts actually paid in settlement of any such Proceeding, which amounts shall be paid under Section 0). The advances to be made hereunder shall be paid by VPUR to the Indemnified Party within sixty (60) days following delivery of a written request therefor by the Indemnified Party to VPUR. Failure to Advance Expenses. If the Indemnified Party shall have requested an advancement of expenses pursuant to Section 0 and if such request shall not have been not paid in full by VPUR within sixty (60) days after a written request by the Indemnified Party for payment thereof was first received by VPUR, the Indemnified Party may, but need not, at any time thereafter bring an action against VPUR to recover the unpaid amount of the claim for advancement of expenses and, subject to Section 0 of this Agreement, the Indemnified Party shall also be entitled to be reimbursed for the expense (including reasonable attorneys' fees) of bringing such action. Reimbursement to VPUR. The Indemnified Party by this Agreement undertakes to repay such amounts advanced only if, and to the extent that, it shall ultimately be determined that the Indemnified Party is not entitled to be indemnified by VPUR as authorized by this Agreement. Notice; Cooperation by the Indemnified Party. The Indemnified Party shall give VPUR prompt notice of the commencement of any Proceeding, or the threat thereof against the Indemnified Party, for which indemnification will or could be sought under this Agreement. In addition, the Indemnified Party shall give VPUR such information and cooperation as it may reasonably require and as shall be within the Indemnified Party's power. If for any reason the Indemnified Party is not an employee of VPUR at the time of any activities performed by the Indemnified Party in connection with the defense of any Proceeding, VPUR shall compensate the Indemnified Party on the basis of $350.00 per day (or portion thereof) spent by the Indemnified Party on behalf of such activities at the request of VPUR, and reimburse the Indemnified Party for all related and reasonable out-of-pocket expenses, such compensation and expense reimbursement to be advanced in the manner set forth in Section 0. Procedure for Indemnification. Any amounts payable by VPUR pursuant to Section 0 shall be paid no later than sixty (60) days after the resolution (by judgment, settlement, dismissal or otherwise) of the claim to which indemnification is sought. If a claim is brought by the Indemnified Party under this Agreement, under any statute, or under any provision of VPUR's Charter or By-Laws, as amended or restated from time to time, which provision provides for indemnification, and if such claim is not paid in full by VPUR within such time period, the Indemnified Party may, but need not, at any time thereafter bring an action against VPUR to recover the unpaid amount of the claim and, subject to Section 0 of this Agreement, the Indemnified Party shall also be entitled to be reimbursed for the expense (including reasonable attorneys' fees) of bringing such action. It shall be a defense to any such action that the Indemnified Party has not met the standards of conduct which make it permissible under applicable law for VPUR to indemnify the Indemnified Party for the amount claimed. Section 0 shall apply to any such determination and the burden of proving such defense shall be on VPUR. In addition, the Indemnified Party shall be entitled to receive interim payments of expenses pursuant to Section 0 unless and until such defense shall be finally adjudicated by court order or judgment from which no further right of appeal exists. VPUR shall not be liable to indemnify the Indemnified Party under this Agreement for any amounts paid in settlement of any action or claim effected without its written consent, which consent shall not be unreasonably withheld or delayed. It is the parties' intention (which intention reflects applicable law) that if VPUR contests the Indemnified Party's right to indemnification, the question of the Indemnified Party's right to indemnification shall be for the court to decide. The termination of any action or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not create a presumption that the Indemnified Party was not entitled to indemnification under this Agreement. In addition, neither the failure of VPUR to have made a determination that indemnification of the Indemnified Party is proper under the circumstances, nor any determination by VPUR that the Indemnified Party has not met such applicable standard of conduct, shall create a presumption that the Indemnified Party has or has not met the applicable standard of conduct. Notice to Insurers. If, at the time of the receipt of a notice of a claim pursuant to Section 0 of this Agreement, VPUR has in effect any insurance, including, without limitation, directors' and officers' liability insurance, which may provide for payment of or reimbursement for such claim, VPUR shall give prompt notice of the assertion of such claim to each issuer of such insurance in accordance with the procedures set forth in the respective policies. VPUR shall thereafter (if it is appropriate to do so pursuant to the terms of the applicable insurance policy) take all necessary or desirable action to cause such insurers to pay, on behalf of the Indemnified Party, all amounts payable as a result of such Proceeding in accordance with the terms of such policies. Other Sources of Indemnification. The Indemnified Party shall not be required to exercise any rights against any other parties (for example, under any insurance policy purchased by VPUR, the Indemnified Party or any other person or entity) before the Indemnified Party enforces this Agreement. However, to the extent VPUR actually indemnifies the Indemnified Party or advances expenses, VPUR shall be subrogated to (and shall be entitled to enforce) any such rights which the Indemnified Party may have against third parties. Notwithstanding the foregoing, VPUR shall have no right to seek reimbursement under insurance policies maintained by the Indemnified Party personally or by the employer of an Indemnified Party who is a non-employee director of VPUR. The Indemnified Party shall assist VPUR in enforcing rights against third parties if VPUR pays the Indemnified Party's reasonable costs and expenses of doing so. Selection of Counsel. In the event VPUR shall be obligated under Section 0 of this Agreement to pay the expenses of any Proceeding involving the Indemnified Party, VPUR shall be entitled to participate in such Proceeding and, to the extent it shall wish, to assume the defense of such Proceeding, with counsel chosen by VPUR and approved by the Indemnified Party, which approval shall not be unreasonably withheld or delayed. Upon the delivery to the Indemnified Party of written notice of its election to assume such defense, approval of such counsel by the Indemnified Party and retention of such counsel by VPUR, VPUR will not be liable to the Indemnified Party under this Agreement for any fees of counsel or other expenses subsequently incurred by the Indemnified Party in connection with the defense of the same Proceeding, except for fees and expenses incurred by the Indemnified Party as a consequence of the Indemnified Party's obligation to cooperate with VPUR in the defense of such matters (as set forth in Section 0 of this Agreement). Notwithstanding the foregoing, the reasonable fees and expenses of the Indemnified Party's counsel shall be paid by VPUR only if (i) the employment of counsel by the Indemnified Party has been previously authorized by VPUR, (ii) the Indemnified Party shall have reasonably concluded that, under applicable standards of professional responsibility applicable to attorneys, there may be a material conflict of interest between VPUR and the Indemnified Party in the conduct of such defense or that such counsel and the Indemnified Party have fundamental and material disagreements as to the proper method of managing the litigation, or (iii) VPUR shall not, in fact, have employed counsel to assume the defense of such Proceeding. The Indemnified Party shall have the right to employ his own counsel in any such Proceeding at the Indemnified Party's expense. Additional Indemnification Rights; Nonexclusivity. Scope. In the event of any change, after the date of this Agreement, in any applicable law, statute or rule which expands the right of a Delaware corporation such as VPUR to indemnify a member of its board of directors or an officer, such changes shall, without any further action by VPUR, be included within the scope of the indemnification provided to the Indemnified Party by, and VPUR's obligations under, this Agreement. In the event of any change in any applicable law, statute or rule that limits or restricts the right of VPUR to indemnify a member of its Board of Directors or an officer, such changes shall have no effect on this Agreement or the parties' rights and obligations hereunder, except to the extent specifically required by such law, statute or rule to be applied to this Agreement. Nonexclusivity. The indemnification provided by this Agreement shall not be deemed exclusive of any rights to which the Indemnified Party may be entitled under VPUR's Charter or By-Laws, any agreement, any vote of disinterested directors, Delaware law, or otherwise, both as to action in the Indemnified Party's official capacity and as to action or inaction in another capacity while holding such office. The indemnification provided under this Agreement shall continue as to the Indemnified Party for any action taken or not taken while serving in an indemnified capacity even though he may have ceased to serve in such capacity at the time any covered Proceeding is commenced. Partial Indemnification. If the Indemnified Party is entitled under any provision of this Agreement to indemnification by VPUR for some or a portion of the expenses, judgments, fines or penalties actually or reasonably incurred by him in the investigation, defense, appeal or settlement of any Proceeding, but not, however, for the total amount thereof, VPUR shall nevertheless indemnify the Indemnified Party for the portion of such expenses, judgments, fines or penalties to which the Indemnified Party is entitled. Mutual Acknowledgment. Both VPUR and the Indemnified Party acknowledge that in certain instances, applicable law or applicable public policy could be construed to prohibit VPUR from indemnifying its directors and officers under this Agreement or otherwise. Nothing in this Agreement is intended to require or shall be construed as requiring VPUR to do or fail to do any act in violation of any applicable law. VPUR's inability, as a result of a binding order of any court of competent jurisdiction, to perform its obligations under this Agreement shall not constitute a breach of this Agreement and VPUR's compliance with any such order shall constitute compliance with this Agreement. Directors' and Officers' Liability Insurance. VPUR shall, from time to time, make the good faith determination whether or not it is practicable for VPUR to obtain and maintain a policy or policies of insurance with reputable insurance companies providing the officers and directors of VPUR with coverage for losses from wrongful acts, or to ensure VPUR's performance of its indemnification obligations under this Agreement. Among other matters, VPUR may consider the costs of obtaining such insurance coverage, the protection afforded by such coverage and the restrictions or other terms required by such insurance. In all policies of directors' and officers' liability insurance, the Indemnified Party shall be named as an insured in such a manner as to provide the Indemnified Party the same rights and benefits as are accorded to the most favorably insured of VPUR's directors, if the Indemnified Party is a director, or of VPUR's officers, if the Indemnified Party is not a director of VPUR but is an officer, or of VPUR's key employees, if the Indemnified Party is not an officer or director but is a key employee. Notwithstanding the foregoing, VPUR shall have no obligation to obtain or maintain such insurance if VPUR determines in good faith that such insurance is not reasonably available, if the premium costs for such insurance are disproportionate to the amount of coverage provided, if the coverage provided by such insurance is limited by exclusions so as to provide an insufficient benefit, or if the Indemnified Party is covered by similar insurance maintained by a subsidiary or parent of VPUR. Severability. Nothing in this Agreement is intended to require or shall be construed as requiring VPUR to do or fail to do any act in violation of applicable law. The provisions of this Agreement shall be severable as provided in this Section 0. If this Agreement or any portion of this Agreement shall be invalidated on any ground by any court of competent jurisdiction, then VPUR shall nevertheless indemnify the Indemnified Party to the greatest extent permitted by any applicable law or any applicable portion of this Agreement that shall not have been invalidated, and the balance of this Agreement not so invalidated shall be enforceable in accordance with its terms. Exceptions. Any other provision herein to the contrary notwithstanding, VPUR shall not be obligated pursuant to the terms of this Agreement: Excluded Acts. To indemnify the Indemnified Party for any acts or omissions or transactions from which a director, officer, employee or agent may not be relieved of liability under applicable Delaware law; or Claims Initiated by the Indemnified Party. To indemnify or advance expenses to the Indemnified Party with respect to proceedings or claims initiated or brought voluntarily by the Indemnified Party and not by way of defense, except (i) with respect to proceedings brought to establish or enforce a right to advancement of expenses or indemnification under this Agreement or any other statute or law and (ii) declaratory judgment or similar proceedings brought to obtain a judicial interpretation of an applicable statute or regulation, provided that such indemnification or advancement of expenses may be provided by VPUR in specific cases if the Board of Directors has approved the initiation or bringing of such suit; or Lack of Good Faith. To indemnify the Indemnified Party for any expenses incurred by the Indemnified Party with respect to any proceeding instituted by the Indemnified Party to enforce or interpret this Agreement, if a court of competent jurisdiction determines that each of the material assertions made by the Indemnified Party in such proceeding was not made in good faith or was frivolous; or Insured or Other Reimbursed Claims. To indemnify the Indemnified Party for expenses or liabilities of any type whatsoever (including, but not limited to, judgments, fines, ERISA excise taxes or penalties, and amounts paid in settlement) which have been reimbursed directly to the Indemnified Party, by an insurance carrier under a policy of directors' and officers' liability insurance maintained by VPUR, or otherwise by VPUR. (e) Claims under Section 16(b). To indemnify the Indemnified Party for expenses and the payment of profits arising from the purchase and sale by the Indemnified Party of securities in violation of Section 16(b) of the Securities Exchange Act of 1934, as amended ("Exchange Act"), or any similar successor statute. Sale of Assets. In case of (i) the sale or other disposition (excluding mortgage or pledge) of all or substantially all of the assets of VPUR to another corporation or entity, or (ii) the merger or other business combination of VPUR with or into another corporation or entity pursuant to which VPUR will not survive or will survive only as a subsidiary of another corporation or entity, in either case with the stockholders of VPUR prior to the merger or other business combination holding less than 50% of the voting shares of the merged or combined companies or entities after such merger or other business combination, or in the event of any other similar reorganization involving VPUR, VPUR shall to the extent possible cause the acquiring corporation or entity to assume the obligations of VPUR under this Agreement with respect to the Indemnified Party. Duration of Agreement. This Agreement shall be effective as of the date set forth on the first page and shall apply to acts or omissions of the Indemnified Party which occurred prior to such date if the Indemnified Party was an officer, director, employee or other agent of VPUR or any subsidiary, or was serving at the request of VPUR or any subsidiary as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, at the time such act or omission occurred. This Agreement shall be effective for an initial term of two years from and after the date of this Agreement ("Initial Term"). Thereafter, for so long as the Indemnified Party remains an officer or director of VPUR, this Agreement shall automatically renew for an additional period ("Renewal Term") of two years unless VPUR shall have given written notice of non-renewal to the Indemnified Party not later than six months before the end of the then current Term (either the Initial Term or a Renewal Term, as applicable). VPUR's obligations under this Agreement shall continuously, irrevocably and perpetually cover any and all of the Indemnified Party's covered acts and omissions that occur during the Initial Term or any Renewal Term. Such coverage shall apply to Proceedings relating to acts or omissions occurring during the Term even if such Proceeding is not initiated until after (or continues beyond) the Term. VPUR's obligations under this Agreement shall continue perpetually with regard to covered acts and omissions occurring during the period covered by this Agreement (including the Initial Term and any Renewal Term, as applicable), notwithstanding the giving of any such notice of termination or any other circumstance whatsoever. The indemnification provided under this Agreement shall continue as to the Indemnified Party even though he may have ceased to be a director, officer, employee or agent of VPUR. Counterparts. This Agreement may be executed in one or more counterparts, each of which shall constitute an original. Successors and Assigns. This Agreement shall be binding upon VPUR and its successors and assigns, and shall inure to the benefit of the Indemnified Party and the Indemnified Party's spouse, estate, heirs and legal representatives. Attorneys' Fees. In the event that any action is instituted by the Indemnified Party under this Agreement to enforce or interpret any of the terms of this Agreement, the Indemnified Party shall be entitled to be paid all court costs and expenses, including reasonable attorneys' fees, incurred by the Indemnified Party with respect to such action, unless as a part of such action, a court of competent jurisdiction determines that each of the material assertions made by the Indemnified Party as a basis for such action was not made in good faith or was frivolous. In the event of an action instituted by or in the name of VPUR under this Agreement or to enforce or interpret any of the terms of this Agreement, the Indemnified Party shall be entitled to be paid all court costs and expenses, including attorneys' fees incurred by the Indemnified Party in defense of such action (including with respect to the Indemnified Party's counterclaims and cross-claims made in such action), unless as a part of such action the court determines that each of the Indemnified Party's material defenses to such was made in bad faith or was frivolous. Notices. All notices, requests, demands and other communications under this Agreement shall be in writing and shall be deemed duly given if delivered by hand, sent by facsimile transmission with confirmation of receipt, sent via a reputable overnight courier service with confirmation of receipt requested, or mailed by domestic certified or registered mail with postage prepaid and return receipt requested, to the Indemnified Party at the address on the first page of this Agreement and to VPUR at the address below (or at such other address for a party as shall be specified by like notice), and shall be deemed given on the date on which delivered by hand or otherwise on the date of receipt as confirmed: Crystal Rock/Vermont Pure 1050 Buckingham Street Watertown, Connecticut 06795 Attention: Peter Baker, Chief Executive Officer + Bruce MacDonald, Chief Financial Officer Phone: 860-945-0661 x 3008 Fax: 860-945-6246 With a copy to: Dean F. Hanley, Esq. Foley Hoag LLP 155 Seaport Boulevard Boston, Massachusetts 02210 Phone: 617-832-1000 Fax: 617-832-7000 Construction Of Certain Words and Phrases. The term "expense" shall include all attorneys' fees, retainers, court costs, transcript costs, fees of experts, travel expenses, duplicating costs, printing and binding costs, telephone charges, postage, delivery service fees, and all other disbursements or expenses of the types customarily incurred in connection with prosecuting, defending, preparing to prosecute or defend or investigating a Proceeding. "Proceeding" shall include any threatened, pending or completed action, suit, arbitration, alternate dispute resolution mechanism, investigation, administrative hearing or any other proceeding whether civil, criminal, administrative or investigative, except one initiated by the Indemnified Party. The "Term" of this Agreement shall include both the Initial Term and any Renewal Term or Terms (as such terms are defined in Section 0). Choice of Law. This Agreement shall be governed by and its provisions construed in accordance with the laws of the State of Delaware without regard to its conflicts of law rules. Consent To Jurisdiction; Choice Of Venue. VPUR and the Indemnified Party each by this Agreement irrevocably consents to the jurisdiction of the courts of Connecticut and the federal courts within Connecticut for all purposes in connection with any action or proceeding which arises out of or relates to this Agreement and agree that any such action or proceeding shall be brought only in Hartford Superior Court, State of Connecticut, or in United States District Court, District of Connecticut, sitting in Hartford. If the foregoing correctly sets forth our understanding, I would appreciate your executing the enclosed counterpart of this Agreement and returning it to me. Upon your signature this letter agreement shall constitute a binding agreement. VERMONT PURE HOLDINGS, LTD. By: ------------------------------------ Name: ---------------------------------- Title: --------------------------------- Accepted and agreed to: - -------------------------------------- INDEMNIFIED PARTY IDENTIFIED ON PAGE 1 EX-22.1 5 b58814vpexv22w1.txt SUBSIDIARIES OF THE REGISTRANT EXHIBIT 22.1 SUBSIDIARY OF THE REGISTRANT Crystal Rock, LLC, organized in the State of Delaware. EX-23.1 6 b58814vpexv23w1.txt CONSENT OF DELOITTE & TOUCHE LLP EXHIBIT 23.1 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Vermont Pure Holdings, Ltd. Watertown, Connecticut We consent to the incorporation by reference in Registration Statements No. 333-95908, 333-64044, 333-100310, 333-109882 and 333-118228 on Form S-8 of our report dated January 26, 2006, appearing in this Annual Report on Form 10-K of Vermont Pure Holdings, Ltd. For the year ended October 31, 2005. /s/ DELOITTE & TOUCHE LLP Hartford, Connecticut January 27, 2006 EX-31.1 7 b58814vpexv31w1.txt SECTION 302 CERTIFICATION OF CEO EXHIBIT 31.1 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Peter K. Baker, certify that: 1. I have reviewed this annual report on Form 10-K of Vermont Pure Holdings, Ltd.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: January 30, 2006 /s/ Peter K. Baker - ------------------------------------- Peter K. Baker Chief Executive Officer EX-31.2 8 b58814vpexv31w2.txt SECTION 302 CERTIFICATION OF CFO EXHIBIT 31.2 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Bruce S. MacDonald, certify that: 1. I have reviewed this annual report on Form 10-K of Vermont Pure Holdings, Ltd.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: January 30, 2006 /s/ Bruce S. MacDonald - ------------------------------------- Bruce S. MacDonald Chief Financial Officer EX-32.1 9 b58814vpexv32w1.txt SECTION 906 CERTIFICATION OF CEO EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. Section 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report on Form 10-K of Vermont Pure Holdings, Ltd. (the "Company") for the year ended October 31, 2005, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned Chief Executive Officer of the Company, certifies, to the best knowledge and belief of the signatory, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Peter K. Baker - ------------------------------------- Peter K. Baker Chief Executive Officer Date: January 30, 2006 EX-32.2 10 b58814vpexv32w2.txt SECTION 906 CERTIFICATION OF CFO EXHIBIT 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. Section 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report on Form 10-K of Vermont Pure Holdings, Ltd. (the "Company") for the year ended October 31, 2005, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned Chief Financial Officer of the Company, certifies, to the best knowledge and belief of the signatory, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Bruce S. MacDonald - ------------------------------------- Bruce S. MacDonald Chief Financial Officer Date: January 30, 2005 -----END PRIVACY-ENHANCED MESSAGE-----