Primo Water Corporation
Q3 2018 Earnings Call Transcript

Published: 11 Nov 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to the Primo Water Third Quarter 2018 Financial Results Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call may be recorded. I would now like to turn the conference over to Madeleine Kettle [ph]. You may begin.

[Unidentified Company Representative:]

Good afternoon, and welcome to Primo Water's third quarter 2018 earnings conference call. On the call with me today are Matt Sheehan, Chief Executive Officer; and David Mills, Chief Financial Officer. By now, everyone should have accessed the release that went out this afternoon at approximately 4

[Matthew Sheehan:]

Thanks, Madeleine. Good afternoon, everyone, and thank you for joining us to review our quarterly results and an update on our business. For our call today, I will give a summary of the quarter; provide a detailed explanation of what we believe is a short-term operational Refill matter, which what we believe will be -- with long-term upside, which impacted adjusted EBITDA; update you on some of our exciting growth initiatives. And finally, provide an update on the continued tap water issues across the U.S. and Canada. David will then provide more detail on the financial results of the quarter as well as an update to our guidance. Let's begin with a brief overview of our quarterly results. First, we were in line with our sales expectations at $81.8 million led by better-than-expected results in both Exchange and Dispensers, offset by what we believe is a temporary decline in Refill. Secondly, sales were led by yet another strong quarter in U.S. Exchange, as same-store unit growth accelerated once again to 10.4% compared to 6.2% in the prior year and 9.6% for the first half of 2018. July and August actually posted same-store unit growth of 12%, marking yet another inflection in the business based on our successful marketing efforts, such as the activation of an everyday promotion that will drive greater household creation and connection. September's growth rate was less but still impressive when facing a tough comp due to the significant hurricanes that occurred in the prior year in the heavy-volume states of Florida and Texas. The third quarter marked the 26th consecutive quarter of 6% plus same-store unit growth. Third, dispenser sales increased over 13% led by sell-through unit growth of 10% to 187,000 units compared to the prior year despite the headwinds created by the recent tariff environment. Lastly, adjusted EBITDA was $16.2 million, which was below our expectations, primarily the results of the revenue decrease in Refill, as well as additional marketing investments we made in the business to accelerate household penetration, connectivity and future growth. With that high-level summary in mind, let me dive directly into the Q3 Refill revenue decrease of approximately $3 million when compared to the prior year. The decline is a result of an uptime issue, mostly related to our outdoor coin units. We believe the solution to this issue is well within our control and ironically has given us insight and confidence into future growth in Refill. Let's get into the details. As you know, in the second quarter, we increased Refill pricing at a majority of our 17,000 outdoor coin U.S. locations based on the testing we had done for over a year, along with analysis of prior Glacier pricing changes. The pricing test at a $0.05 increase, showed solid accretion to our business. At that time, we believed and we still believe that the price increase will be a significant positive to the business, specifically as we look at the value proposition we offer consumers versus other alternatives. As we analyze the Q2 and Q3 data, with a higher volume drop than expected we uncovered what we believe was the primary cause of the decline

[David Mills:]

Thanks, Matt, and good afternoon, everyone. Today, I'll review our financial results for the third quarter and then discuss our outlook for the remainder of the year. Following my review, I will turn the call back over to Matt for closing remarks. To assist investors in understanding our operating results, we do provide adjusted EBITDA and adjusted net income, both of which are non-GAAP financial measures. A reconciliation of each is included in our earnings press release issued this afternoon and available on our website. Turning to our results for the quarter. As Matt mentioned, we continue to see the positive impact of our marketing efforts on our business, specifically Exchange. For sales, our results were in line with our expectations, while the decline in Refill that Matt discussed impacted adjusted EBITDA. Sales for the third quarter were $81.8 million, led by another quarter of accelerated same-store unit growth in U.S. Exchange and better-than-expected dispenser sales. Looking at the segments. Dispenser sales for the quarter were up 13.8% to $11.9 million, significantly ahead of our expectations due to continued strong demand and despite the fact that we experienced a positive shift in timing of sales in 2017. Consumer demand of our dispensers continued the strong trend, with sell-through of 187,000 units, up over 10% from 2017. This demand continues to drive the overall increase in dispenser sales, which are up over 20% year-to-date. We believe that dispenser sales are leading to new water households and driving the growth in Exchange. Turning to Exchange. We continued to see the strong growth as sales increased 5.3% to $21.5 million for the quarter, driven by U.S. Exchange same-store unit growth of 10.4%. This is the third consecutive quarter of accelerated same-store unit growth. Overall, the Exchange results are more impressive considering the impact of the two hurricanes in 2017, which were much more impactful than the hurricanes in 2018. The 2017 hurricanes drove significant volume of initial-purchase transactions, which are at a higher price per unit than the Exchange transaction. Lastly, Refill sales were down 5.8% to $48.3 million for the quarter, driven primarily by the decrease in volume we experienced in the quarter that was related to the service downtime issue, as Matt outlined in detail. Turning to gross margin. The overall gross margin percentage was 28.7% for the quarter compared to 30.3% in the prior year. The decrease is primarily the result of the sales mix as dispensers made up a larger portion of the overall sales. Drilling into the details, dispenser gross margin for the quarter was 5.2%, as we saw a shift in customer and product mix and the impact of the tariffs implemented during the quarter. Exchange gross margin for the quarter was 31.1% compared to 31.7% in the prior year. Exchange margin was impacted by the acceleration of promotional activities, primarily the everyday IRCs that we put in place at Wal-Mart during the quarter. Gross margin for the quarter in Refill was 33.4% compared to 33.5% in the prior year. As Matt discussed, we believe in the future we will see volume return and the resulting gross margin improvements. Next, SG&A costs for the quarter decreased to $7.4 million from $7.9 million, primarily due to a decrease in stock-based compensation, partially offset by an increase in marketing and promotional investments. Overall, as a percent of sales SG&A was 9% for the quarter, demonstrating the continued leverage in our business model. Moving down the income statement. Interest expense for the quarter was $2.5 million compared to $5.2 million in the prior year, demonstrating the full quarter of savings as a result of the debt refinancing in June of 2018 that came with significantly lower interest rates. As Matt mentioned on our last quarterly call, we decided to discontinue the Glacier brand in Refill. This resulted in non-cash charges totaling $63.1 million to reduce the book value to the estimated fair value. While we will incur future costs associated with the rebranding, primarily capital costs, we plan to manage them so they are covered through operating cash flows and seasonal usage of our revolving line of credit. In addition, as Matt mentioned, we will be selling the ice operation and related assets, which have annual sales between $9 million and $10 million and EBITDA margins of approximately 10%. In connection with a potential sale, we have recorded a non-cash charge of $4.6 million to reduce the book value of the assets to their estimated fair value. For the quarter, we had a net loss of $58.2 million or $1.45 per diluted share compared to net income of $4.9 million or $0.14 per diluted share in the prior year. On a comparable basis, adjusted net income was $7.5 million compared to $6.4 million in the third quarter of 2017 or an increase of over 16%. Adjusted EBITDA was $16.2 million compared to $18 million in the prior year. Adjusted EBITDA was primarily impacted by the decrease in Refill volume and sales as mentioned earlier. Also in the quarter, we made proactive growth investments, such as the IRC and dispenser pricing that we believe will have long-term benefits. Now let's turn to the balance sheet. We ended the quarter with $5.6 million in cash, total outstanding debt of $189.3 million, which is down from $273.3 million at the end of 2017. At the end of the quarter, our leverage ratio improved to 3.37 times, which is down from over 4.9 times at year-end and 3.43 times at June 30th. Looking at the statement of cash flows for the first nine months of the year. Cash flow from operations more than doubled to $22.8 million compared to $10.7 million, while cash flow used in investing activities decreased to $10.3 million from $15.5 million. The decrease in cash flow from investing activities is primarily due to the redemption of the Glacier trust preferred securities in connection with the second quarter debt refinancing. Free cash flow, which excludes the impact of the refinancing as well as intangible and other additions increased significantly to $7.2 million from negative free cash flow in the prior year. Turning to our outlook for the remainder of the year. We now expect sales in the range of $304 million to $308 million as we believe the growth in Exchange and Dispensers will continue to drive the business. For adjusted EBITDA, we now expect the full year to be in the range of $54 million to $58 million. range takes into account the third quarter shortfall of $2 million largely associated to Refill, a similar estimated shortfall in the fourth quarter and investments of approximately $1 million to reduce Refill downtime with labor and technology as well as the acceleration of marketing initiatives that we believe will continue to drive long-term top-line growth through dispenser sell-through and water connectivity. With that, I will turn the call over to Matt for closing remarks.

[Matthew Sheehan:]

The third quarter was a busy and important quarter for us. We continued to show the power of a more connected model through the strong sell-through of Dispensers and a very impressive Exchange same-store unit growth. This also shows just the beginning impact of our everyday IRC program that we believe will drive long-term growth to our Exchange water. We also learned a lot about the Refill business from a service and technology perspective, and I'm excited to get us into a technology-driven Refill business. We have a track record of improving our operations, and we plan to do the very same thing here. Overall, I'm excited to capture and drive incremental growth and expand the bright lights across our entire business. Lastly, we have a very loyal and investable consumer, a healthy core business and significant industry tailwinds at our backs. I remain confident in our ability to drive value for consumers, employees, clients and shareholders. I'd like to thank our team, our retailers and our partners for their continued loyalty and support of our purpose. With that, I'd like to open the line for questions. Operator?

[Operator:]

[Operator Instructions] Our first question comes from the line of Amit Sharma of BMO Capital Markets. Your line is now open.

[Amit Sharma:]

Hi. Good afternoon, everyone.

[Matthew Sheehan:]

Hey, Amit.

[David Mills:]

Hi, Amit.

[Amit Sharma:]

Matt, in hindsight, do you think some of the difficulties in the Refill business perhaps, could have been looked at before you implemented the price increases? Or is that something that just too difficult to see from how the business was being operated?

[Matthew Sheehan:]

I think we could have sequenced our price -- our initiatives better, Amit. Frankly though, we did not see this underlying downtime issue. So I can't say that we could have re-sequenced them because of the visibility because frankly, we didn't see that. In hindsight though, if we had resequenced, we would've done technology before pricing, and we wouldn't have had the blip at all. So that's hindsight talking though.

[Amit Sharma:]

All right. And from a technology perspective, nice to know the time line for rolling out of credit card machines as Refill. I want to make sure that I heard this right. So when you implement the credit card machines in those outdoor locations, do you expect to take additional pricing to offset the additional costs of those machines?

[Matthew Sheehan:]

No, no. No, the upside with -- so Amit, let me step back. So there's two pieces of benefit for the cashless payment. There's the consumer upside in just a more e-payment method. We have seen that drive low-digit growth, single serve -- single-digit growth. That's just a benefit to consumer. That's with the same pricing strategy we have today. In addition, we have telemetry benefit, which is more supply chain and reduction of downtime. None of that assumes an increased pricing increase though.

[Amit Sharma:]

Got it. And the last one from me. From a gross margin perspective relatively flat on the Refill side of the business. Can you help us maybe get a sense for how much of that is volume deleverage? How much of the benefit of the pricing actually showed up in the quarter?

[David Mills:]

Yes, Amit, this is David. So a good question. Yes, the margins in Refill, obviously impacted by the volume dramatically. As we've talked in the past, we have a fairly fixed infrastructure in that business. So as volume declines, we obviously have the impact on margins. Pricing is included in there, obviously masked significantly by the expansion of downtime that we experienced during the quarter. Going forward, as we look at it, as we fix this downtime issue and bring more volume to -- volume comes back to the machines, and we will see margins come back to the levels that we would expect in the future, significantly better.

[Matthew Sheehan:]

I mean, I'll just add. I think we can in that business, when you think about where we'll be in the relatively near future, we can scratch at 34 point -- close to 35% margins in that business. A lot of fixed-cost volume plays a big part. So we feel very good about gross margins in that business.

[Amit Sharma:]

And last one. Matt, you did say that majority of the outdoor 17,000 machines have taken pricing, right?

[Matthew Sheehan:]

Yes.

[Amit Sharma:]

Off the machines that you have taken, is $0.05 a gallon still the right average for the ones where you have taken pricing?

[Matthew Sheehan:]

Yes, we only moved it $0.05.

[Amit Sharma:]

Right. But my point is that is that 17,000 still the right number? Or as you're harmonizing pricing either with indoor machines or your competitors, is the subset of machines where you will take that 5% still the right number across that 17,000 locations?

[Matthew Sheehan:]

Right, so the first approach at this is in the majority of those 17,000 units, we're moving up $0.05. Again, that's only outdoor locations. As we said and obviously as you know, we're going to optimize that over time, which we're about to start doing. And that's small market by small market. Secondly, but separately we have here in Q4 increased pricing in our indoor -- in the majority of our indoor locations. And so those are separate issues. But to your question, the $0.05 on outdoor, yes, it can go to the majority of 17,000. Yet, we will be resetting small percentages of that as we think about optimizing markets. Make sure I'm clear on that. You got that, Amit?

[Amit Sharma:]

Yes, no, I just wanted to make sure that there is no change in your view that the number of machines average that you were going to take pricing what happen in the quarter didn't change your view on the opportunities set for those -- for this price increase.

[Matthew Sheehan:]

No, frankly, Amit, my perspective here is pricing just got more attractive to us. As we came out of Q2, we didn't -- as we looked at volume, we did see a volume decline. Without knowing this downtime issue, we thought that might have been pricing. I don't think that anymore, given all the analysis we've done. So I'm more positive that pricing will be accretive to the business.

[Amit Sharma:]

Got it, thank you so much.

[Matthew Sheehan:]

Thanks, Amit.

[Operator:]

Our next question comes from the line of Mike Petusky of Barrington Research. Your line is now open.

[Michael Petusky:]

Hey, guys. A couple of questions. So on the -- and I may have missed this when you were explaining the everyday strategy at Wal-Mart, but are you going to still do -- I know you had a really successful Black Friday promotion with them last year. Are you still going to do something for Black Friday with Wal-Mart? Or is that now not really on the table?

[Matthew Sheehan:]

Yes, Mike, when we looked at the success of Black Friday last year, one of the insights we had is let's, frankly, not wait till Black Friday to do it. So we've pulled that into an everyday strategy in -- across Wal-Mart. And so that was -- the real insight was don't wait for the three day promotion to do IRCs, which clearly had benefit. We'd rather start that engine much earlier in the year, which we had this year. And so we don't -- we are not planning on a Black Friday event at Wal-Mart this year. We do have plans with other retailers that I can't share publicly. But again from our perspective, we didn't want to wait. We don't believe that that call it free water or IRC should be a promotional tactic. That should be an everyday connectivity tactic that helps drive the value proposition of the connected solution to a consumer when they are deciding of -- what water solution to get. Does that help?

[Michael Petusky:]

Yes, absolutely. So it does sound like you're going to do Black Friday, an event or events with other retailers, but just Wal-Mart's a different animal as you move forward. Is that fair?

[Matthew Sheehan:]

Yes, just for modeling purposes. That was a really big event with a lot of awareness at a lot of stores so I want to be a little careful on just how -- make sure I understand the magnitude. We don't believe that the Black Friday this year will have that kind of an impact, but we are leaning into Black Friday again. Frankly though, we are much more excited about what we learn -- taking what we've learned from Black Friday and drilling that into our everyday business.

[David Mills:]

Yes, and Mike, just to add one additional fact. As we analyze the results of the IRC program at Wal-Mart, our connectivity is actually in excess of what we experienced during Black Friday. So huge success beyond either what we had Black Friday as far as connectivity of the Water and the Dispenser together.

[Michael Petusky:]

Okay. All right, great. And then I just wonder if you guys can comment on the news out of Lowe’s where they are closing some underperforming locations. Have you guys looked at the impact? Or do you have thoughts that you can share on that revelation in the last few days?

[Matthew Sheehan:]

It was expected and not meaningful at all. The majority of those stores are in Canada that we did not have any presence in yet, and any stores in the U.S. are, to your point low performing. We don't expect it to have an impact in any major way.

[Michael Petusky:]

Okay. And then, I assume that the cashless technology you're going to bring to the outdoor Refill locations sort of opens you up then if you wanted to price not on the $0.05 or the $0.10, but $0.38 or $0.34. I mean, wouldn't that potentially open you up to really fine-tuning this?

[Matthew Sheehan:]

Our -- we might have more flexibility in the future with price, but that's not our plan, frankly, right now, Mike. We are planning on stick to our pricing strategy and use this to welcome more people into the franchise, if you will, from a payment technology perspective. It does allow you some more flexibility, but frankly, that's not our plan right now. If we get there in the future, that would be something we would communicate.

[David Mills:]

Yes. And, Mike, one other thing as long as there is cash being taken at the machine, it will have to be in $0.05 increments versus trying to price the credit card separately in a different model at this point.

[Michael Petusky:]

Just thinking out loud, and I'll finish with this thought. You could avoid the coin jams if you just essentially priced the $0.02 discount or something on the credit card and you might get more people using the card and less people using cash, and essentially incent less coin jams, but that's just me thinking out loud.

[Matthew Sheehan:]

Mike, keep thinking out loud. It's a good idea something we've talked about for sure. So there is a lot of benefit to have an e-payment for us, not just for the consumer but from a cash handling perspective, so great, great idea. Keep it coming.

[Michael Petusky:]

All right, thanks.

[Operator:]

Our next question comes from Mike Grondahl of Northland Securities. Your line is now open.

[Michael Grondahl:]

Yes, guys. When do you think you're going to have, kind of your arms fully around Refill and, kind of these kinks worked out?

[Matthew Sheehan:]

Mike, we're pretty sure that we understand the issue sitting here today. The revelation was near the late -- near the end of Q3 and certainly over the last few weeks coming into Q4, a lot of analysis went into it. So I would say that from a knowledge perspective, our arms are around it. It will take us some time to fix it. As we walked through the technology rollout this does not happen overnight. We're going to be aggressive, but we're going to do it smart, and we believe that we will be fully installed by the end of Q2 of next year. That said, every day we're installing the cashless technology, we are gaining ground on downtime. It's really early innings for us, but today we already have 1,400 of these installed in those machines. We're already getting better. And we are going to learn our way through this frankly, and make sure that the service tech model and formula we have today can respond to this increased visibility better. So we have some work to do, for sure, but we're pretty confident that we know the issue, which is step one, and two is that we'll get really good at optimizing our service to use this technology. But I would say that fully rolled out, it's going to take through Q2, but every single day, we're getting better and better at it.

[Michael Grondahl:]

And you said something about you'll have 6,000 cashless readers in by year-end, and that covered, I don't know if you said, a majority of the revenue or a chunk of the revenue. Can you just clarify that?

[Matthew Sheehan:]

You heard it right. It's a majority of the revenue will be covered by the 6,000 locations in which we put our telemetry readers.

[Michael Grondahl:]

Got it. And then kind of following up to that, you also talked about some automated service alerts and the consumer kind of testing consumer notifications. Just explain, do you basically mean that somehow a consumer can notify you when a machine is down and then the tech gets that alert and he can go to a machine quicker, respond quicker? I guess, just walk us through that.

[Matthew Sheehan:]

Yes, yes. So let me paint the picture -- I'm going to do a little pre and post here, Mike, for a second. So in yesterday's model, we had no visibility into a down machine. The only time we found out is when a consumer or retailer would call us or we showed up at the machine. And 60% of the time, we did not know until we showed up. Hence why you saw a historic 7 to 10 days of downtime anytime it went down. That's been historic in this business for years. We spiked it in Q2 and Q3. What's happening now though is when you have cashless technology with telemetry it knows, I'll say the minute something goes down, an error is posted in that machine and it doesn't take any human any time to send a technician an alert on that machine. Frankly, that is a drastic difference from where we are today, and that's why we're so excited about this. And so that if a machine, I'll just call it, gets triggered or something occurs, whether it's a coin jam or malfunction we are working on the sensitivity of alerts to make sure that that tech knows about it as fast as possible. That is going to take days out of this cycle. I mean days. And so that is a big deal for us. Let me pause and I'll get to consumer technology, but does that help you understand, frankly, how impactful and why we are so positive about this?

[Michael Grondahl:]

Yes, it does. And then as a follow-up to that is the optimal number of days do you think going to end up being two, three, four? Like where do you -- realistically, where can you go?

[Matthew Sheehan:]

The formula is two things. One is, you want to make sure that you have preventative maintenance to drive the overall down occurrences, so you have two pieces of formula. How many times this machine will go down and then how long it stays down. So our two point strategy is, let's make sure that our ropes are really, really good. We're talking world-class preventative maintenance. That's where we're going to get to. That will reduce the amount of times on average a machine will go down. And then the second part of the formula is, when it does go down, let's jump really, really quick. So we have to do both sides of that formula. If you break it down and the average machine, as we said, two to four times it will go down, it will stay down for 7 to 10 days, we think we can get that, for a second let's assume it still goes down two to four times, we think we can get that down to on average three to four days when it happens. That's a -- that's a half a month of revenue per machine. And so, when we look at this, we don't like to -- frankly we don't like to miss like this, we don't like to have hiccups, but that's all this is. And this is a little blip and we are actually excited about the upside that we see. So short answer is, we think we can take that 7 to 10 days that has always been in the business and bring that to three to four days, and that's all upside that we frankly didn't even see in the business, nor did we ever give you in our projections.

[Michael Grondahl:]

Got it, that's helpful. And one more, Matt. On the Exchange, the same-store sales number 10.4%, obviously really, really strong and accelerating. But overall sales at 5.3%. When do those numbers converge? You're closing less, whether it's Kmarts or Office Depots. When do we see more of a convergence there?

[Matthew Sheehan:]

I would like to be able to predict retail, Mike, but I'm not sure I can. We still continue to believe there's going to be some compression in retail. I mean, you're even seeing it at Lowe's, and they are generally doing good in a lot of different ways. So I think there's going to be a gap for a while between those two. Most importantly, as we've always said, in a retail compression environment we believe we can continue to grow this business because of all of our efforts on same-store sales. It's why about a year ago, we said same-store is our target not number of locations. We think there's going to be a gap for a while from a location perspective.

[David Mills:]

Yes, Mike, and just to add on to that. So if you look at Q3, it was a tough comp in the Exchange business. As in 2017, the two hurricanes in Texas and Florida are really strong, high-volume states for us. And through the hurricanes, we saw significant growth in what we call initial purchase transactions, which are at almost double the price of an Exchange. So that was -- that made the third quarter of 2018 really difficult to comp and made -- why your units are up significantly but the dollars are at the 5%. We think over time and as you saw with the Black Friday event, that when you go into Q1 and Q2 of this year in Exchange, we saw those kind of come back in line after a quarter. But with the everyday RC driving strong growth in the business, we may see a little delta going forward for a little while, but I think Q3 was, I guess, exaggerated or significantly higher just because of the 2017 impact of the initial purchase transactions.

[Michael Grondahl:]

Got it. Okay, thank you, guys.

[Matthew Sheehan:]

Thanks, Mike.

[Operator:]

Our next question comes from the line of Mark Argento with Lake Street Capital. Your line is now open.

[Mark Argento:]

Hey, guys. Thanks for taking my question. Just wanted to drill down a little bit more on the kind of breakdown between incremental investments, the marketing spend and the downtime. I think you quantified, I believe the downtime in the script, but maybe you could just help us better understand the impact relative to, let's call it, the $5 million EBITDA delta for the full year?

[Matthew Sheehan:]

So let me, again, let me just break down some of the downtime here and Dave can sort of wrap some overall financials around it. So keep in mind, historically, downtime two to four day occurrence, 7 to 10 days when it's down. That's effectively a month's worth of revenue. That's been consistent throughout the business. If you looked at Q1 over Q1 this year, we were pretty much flat without knowing the kind of downtime. When we rerouted, we saw a spike in that, which frankly, on a run rate got us more than a month's worth of downtime in the last couple of quarters. So that breaks down just the logistics and probably sort of micro math of how that does. Dave, do you want to give us some color about the overall financials?

[David Mills:]

Yes, sure. And I think you're referring to kind of the bridge between the year-end EBITDA guidance. And as we look at it and the result of the third quarter obviously revenue significantly impacted from the Refill miss but made up significantly by Dispenser sales, which you know come with no EBITDA. As we looked at the full year, obviously, we had the $2 million miss EBITDA shortage in Q3. That's flowing through our numbers but we're also taking a pretty conservative view on Q4 and seeing a similar kind of $2 million, I would say, overall cost of businesses view. In addition, as Matt talked about, we're making investments in the Refill business to really drive downtime and reduce it to bring back that volume. The combination of those investments, which could include manpower and labor costs, technology, rolling out the credit cards and accelerating that, there are some costs associated with that, that will hit in Q4. In addition, we are accelerating -- continue to accelerate marketing initiatives that obviously we've seen in Q3 what they can do. We see we're going to continue to do those investments that will drive long-term top-line growth in the business. So that combination of the Refill and the marketing investments is about another $1 million.

[Matthew Sheehan:]

And, Mark, let me just add one thing to David's comment. I think what we could do here is really shut the spigot off on investment in growth, and we are not going to do it at all. We are seeing way too many bright lights in this business, even in Refill, but certainly in Dispensers and Exchange. We want to lean into that even more. We're going to fix the issue in Refill; we are on it. What we want to do is when we fix that through Q1 and Q2 of next year, we want Exchange and Dispensers to be rock rocket, so that's our approach. We believe too much in the growth of this business to slow down.

[Mark Argento:]

Great, that’s helpful. Good luck, guys.

[Matthew Sheehan:]

Thanks, Mark.

[Operator:]

Our next question comes from the line of Kara Anderson with B. Riley. Your line is now open.

[Kara Anderson:]

Hi, good afternoon.

[Matthew Sheehan:]

Hi, Kara.

[Kara Anderson:]

So most of my questions have been answered at this point, but I did actually want to jump back to what you were just talking about. Can you quantify the EBITDA impact from Refill in the quarter?

[David Mills:]

Of the $2 million, it was probably a majority of that $2 million. The other impact, obviously Dispensers was significantly ahead of our guidance. What we anticipated in innov stack, that does not come with EBITDA. So that and the combination of the IRCs, pushing the IRCs, the opportunity to accelerate that at Wal-Mart makes up the other half.

[Kara Anderson:]

Okay. And then when I think about the, I think you called it out as $1 million in investment on the Refill side in the fourth quarter, should we look at that as being a more one-time in nature investment or is that going to be a part of your ongoing cost structure from here?

[Matthew Sheehan:]

Kara, I think there's a little bit of a blend there. What we're trying to do, frankly is develop the visibility that telemetry is going to give us. We're trying to get people in the market as fast as we can. So some of that is more, I'll call it, one-time short-term that will, sort of -- that they will get into the business right away. We don't see that -- we don't see us hurting the long-term efficiency of that model. In fact, we believe that telemetry will help us reach the gross margins, even improve the gross margins that we have done in the past. So I think this is more short-term. I'm not sure we'd call it one-time, but we're going to invest in people, technology, reporting to make sure in the next couple of quarters that we're on track.

[David Mills:]

Yes, and I'd just -- I'd follow up on the technology side, the cashless payment readers in all of our testing, they -- ROI shows positive, and when you factor in bringing back and reducing downtime from 7 to 10, to three to four days, it only increases that, so.

[Kara Anderson:]

Got it, thank you.

[Operator:]

And our next question comes from the line of Jon Andersen of William Blair. Your line is now open.

[Jon Andersen:]

Hey. Good afternoon, everybody.

[Matthew Sheehan:]

Hey, Jon.

[David Mills:]

Hi, Jon.

[Jon Andersen:]

I wanted to ask about if you could talk a little bit about the shift to an IRC, everyday IRC with Wal-Mart. Was that a decision that was kind of jointly made? Were you pushing them in that direction? And I think somebody made a comment earlier that the return that you're seeing or the lift that you're seeing from that program is actually better than what you saw with Black Friday a year ago. So if you could talk a little more about that I would appreciate it.

[Matthew Sheehan:]

Yes, Jon. We were really excited by the overall results of Black Friday. Again the model that I think we did a couple of quarters ago when we walked everyone through it was, we called three part formula. One is our reduced pricing in Dispensers, increased awareness and then increased connectivity. When we analyzed Black Friday, we were just really excited about what that coupon could do on the outside of the box every day. Keep in mind, for years, we've been growing this Exchange business and the coupon to a razor-razorblade business was inside the box, which people wouldn't get until they get home. So that was a revelation for us given the Black Friday. So we, frankly, just decided to add a coupon on the outside and make it every day. We don't believe that we should wait for a Thanksgiving promotion to drive connectivity. Frankly, from my perspective, everyday connectivity through IRC is better than a Black Friday model because now we are getting water throughout the year. Last year, we did not get any real water benefit from our huge promotion at Wal-Mart. I mean, because that water came really in Q1 so we just said, let's not wait let's bring that all forward and get that done. So that's the shift in thinking. And frankly, we're going to lean into that as much as we can. The value of this consumer, 35 bottles four to five years, and that number just keeps on running up when we ask consumers about how long they stick with us, has a lot of investability. We're going to continue to lean into that promotion, which makes a lot of sense when you have a razor-razorblade. The second point is about connectivity. What we said was, we judged the percentage of people that redeemed the IRC coupon at Black Friday, period. We've compared that to the redemption and connectivity that we have seen since we have done it in every day, and as good as it was at Black Friday, it's even better when you do it every day. So on every single level, while that will pressure our gross margins just a wee bit, in the short-term this is a home run for us as it relates to making sure that we sell the value proposition to a consumer because we want them walking out with a dispenser and water. We know that they don't wait -- they don't walk backwards. Once they get that in the home and they realize that they drank 25% to 30% more, they realize how really convenient and good it is for their entire family. We don't see a lot of consumers going backwards. We want to invest and make sure they walk away with water. So let me pause there if that helped answer the question.

[Jon Andersen:]

Yes, no, that's really helpful. Coming back to Refill for a minute. As you look out through the middle of 2019, I guess, should we be thinking about the ongoing impact of the downtime issue, kind of, $2 million a quarter, obviously, in the fourth quarter, and $2 million a quarter in Q1 and Q2, until you get cashless up, until you have addressed some of the technology issues? And then we start to see that kind of normalize in the second half of 2019? I'm just trying to understand again the extent, the magnitude and the duration of the kind of headwind here we are experiencing within Refill.

[Matthew Sheehan:]

Let me give you my strategic view. David, feel free to jump in on the numbers. I think that we are putting in action today, Jon, that we'll begin to improve or reduce that downtime. We want to be conservative in Q4 and put a number out there as we are learning. I believe, though, that we're going to consistently, with every telemetry piece we put out there, we're going to get better along with the learnings we have on the people front. So I think we will quickly diminish the impact that will have through Q1 and for Q2, we're going to be the majority of our revenue is already covered in by Q4. We're going to trim that impact down fairly well. We're just trying to be, frankly, safe and conservative on our projection on that. That said, I believe that with all of this, we just found growth. And oftentimes you will find growth in supply chains. So what we did was, we will just find, I believe, we found growth in Q3 and Q4 last year that will more -- of next year that will more than make up for any sort of any decrease in Q1 and Q2. Keep in mind, again, this business has been operating with a month's worth of waiting revenue that we think we can capture. So we think we will start to capture that in Q3 and Q4, which will make up for any decline in Q1 and Q2. And frankly, I think it's going to more than make up for it.

[Jon Andersen:]

That's helpful. Can you remind me again, I know you've been kind of dragged through the Refill several times here, but the specific steps again just high-level if you can run through them, because you've mentioned Omnitracs, you've mentioned more people, you've mentioned cashless technology. Could you just step through one more time what you have to accomplish, put in place, technology, people, infrastructure-wise to get to that point whereby the second half of next year it's an opportunity; you are uncovering revenue.

[Matthew Sheehan:]

Sure. Yes, let me take this in, probably, a couple of bite-sized pieces. So first, I would say all the technology we need is in place today. Now all the telemetry is not installed at the machines, but we are installing, we have our hands around the technology in place today. Let me step back. We have Omnitracs Roadnet software. It's the best routing software there is. We've put a lot more reporting into the business with Tableau, with Salesforce.com. That's already in place, we're just getting better and better with that usage and getting smarter about the business. We put more -- we put handhelds in the technicians' hands that replaced, frankly, a very old handheld system that was more than aged. And so our team now has smartphones, we have world-class routing, we have Salesforce and Tableau driving our insights and the communication to the field. And now, we're going to have real time visibility to the machines that will get to the handheld very fast. Jon, we have all of it within our hands. All we need to do right now is implement that real time visibility technology and the rest of it, along with learning how we use it because as I always say you can't just plug in technology and it'll take a little bit to learn. We are really confident though that all this technology is going to make us a much better, faster, stronger Refill business once we get that all in by Q2 of next year. So we have it all in place today. We're going to learn along the next couple quarters. Really confident what it looks like coming out of the other end.

[Jon Andersen:]

Great, that's helpful. A couple of quick ones. The transition to one brand, how quickly does that happen? And then, if you can talk about selling the Ice operation, what your expectations are there for timing, et cetera?

[Matthew Sheehan:]

Yes. On the brand side, again, a lot of thought went into this, and I think this is a really great step for us to get the real power of any and all of our marketing. This is going to take a couple of years though to really roll out. We want to make sure that our CapEx is in check with our projections and roll that out accordingly. And also, given the service focus we will have we want to make sure that we're servicing the locations, learning our technology at the foundation of the business. But that transition will take a couple of years. Frankly, I'm really excited about our decision to do this because as you market and you announce the Primo on our website in any media we do, Glacier was never going to get any of that benefit. And unfortunately, when you do any media of any type of mass marketing and you have a lot of Glacier machines in the market, they're just not going to benefit. So we're going to put an end to that. I think Refill will certainly benefit. On the ice machines, we have been assessing that for a couple of quarters now, and had basically come to the conclusion that it is not a core offering for us, for a host of reasons. But when we really dug into the downtime issue on Refill, it was glaring. The routes that have Ice and Refill were far off a Refill-only route. We have really good technicians that manage both, but frankly, the piece of equipment that runs Ice is much more complicated, goes down more often than Refill, and stays down longer and takes a lot of time to finish. That was frankly, diluting the performance of really good technicians that have Refill -- that refill machines as well. So we are basically announcing the divesture today, and we are talking to potential targets on how to sell the business. We hope in the next -- this quarter to next quarter, we'll have that completed.

[Jon Andersen:]

Okay, thanks for all the color, everybody. Good luck.

[Matthew Sheehan:]

Thanks, Jon.

[David Mills:]

Thanks, Jon.

[Operator:]

And I'm showing no further questions at this time. I'd like to hand the call back over to Matt Sheehan for any closing remarks.

[Matthew Sheehan:]

Thank you for participation on today's call and interest in Primo Water. Have a great night.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's program. You may all disconnect. Everyone, have a great day.