Primo Water Corporation
Q2 2017 Earnings Call Transcript

Published: 9 Aug 2017

[Operator:]

Good day, ladies and gentlemen, and welcome to Primo Water 2017 Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will have a question-and-answer session and instructions will be given at that time. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the call over to your host for today’s conference Ms. Katie Turner. Ma’am, you may begin.

[Katie Turner:]

Thank you. Good afternoon and welcome to Primo Water second quarter 2017 earnings conference call. On the call with me today are Matt Sheehan, Chief Executive Officer; and Mark Castaneda, Chief Financial Officer. By now, everyone should have access to the release that went out this afternoon at approximately 4

[Matt Sheehan:]

Thank you, Katie. Good afternoon and thank you for joining us today to review our results for the second quarter of 2017. I’m pleased to report that our results were at the top end of our guidance. Based on our solid operating results and integration efforts ahead of plan we’re increasing our full-year guidance for revenue and adjusted EBITDA. Mark will provide more detail on our financial results and our updated guidance. Today I’ll discuss our purpose, the consumer beverage market, highlights of the quarter and finally provide an update on the progress of our key strategies. First however, I’d like to begin today by thanking our team of associates, retailers and partners for continuing their efforts to providing growth and achieving record results across all of our businesses and serving our end consumers with great taste and purified Bulk Water and Water Dispensers. As a reminder we are purpose driven company that is committed to inspiring healthier lives through better water. We will achieve our purpose by executing on our five core strategies. First, grow household penetration. Second, improved connectivity of our dispensers and our water. Third, increase retail outlets. Fourth, drive unit economics and fifth, fostering highly engaged teams. Consumer beverage trends continue to provide a tailwind and support our purpose as consumers continue to choose healthy beverages over sugary alternatives. Health and wellness trends have been the top driver for bottled water growth over the past several years and it expected to continue. More recently concerns over tap water are driving consumer to look for long-term bottled water solutions. Each week there are new stories of contaminants in drinking water systems that exceed government standards. In the past quarter alone there are several examples such as in a Central Valley of California PCP, a cancer-causing chemical continues to plague drinking water. In either North Carolina a chemical byproduct Gen X is making headlines for similar issues of chemical dumping and its potential effects on drinking water. And lastly, potential contamination issues were recently discovered in the groundwater at a coal-fired power plant in the Memphis Tennessee area that may include arsenic and lead. While these issues may not be getting the national coverage and focused on Flint, Michigan, the impact on consumers can be significant. We believe that increase consumer awareness of these issues will continue to fuel growth in a bulk water category. We believe we have the best water solution for the home with over 46,000 locations offer convenient purely amazing water at a fraction of the cost of most alternatives with no plastic waste. Now, few highlights from the quarter. First, we are beginning to report three separate segments, refill, exchange and dispensers. We split the water segment as a result of how we manage and operate the business and to provide more transparency to investors. Our second quarter results for both sales and adjusted EBITDA were at the high-end of our guidance. Sales and adjusted EBITDA more than doubled to $74.8 million and $14 million respectively. The acquisition of glacier water fueled most of the growth for a refill segment. Our exchange segment had 6.2% same-store unit growth, which represents our 21st consecutive quarter of same-store growth in excess of 6%. Additionally, our dispenser segment revenue increased to 24% which is partially result of timing and shipments to certain retailers being moved from the first quarter to the second quarter as we explained on last quarter's conference call. Our dispenser business had record sell-through to end consumers of a 169,000 units which exceeded a very challenging comp in the prior year of 24%. Having discussed the market and the results, I’ll now talk about our progress against certain key strategies including an update on integration activities related to the Glacier Water acquisition. First, grow household penetration. During last quarter’s call we indicated there would be an increased dispenser promotional activity in the second quarter compared to the prior year. In the quarter the promotional activity resulted in a record sell-through of dispensers surpassing last year's record sell-through quarter. Working with retailers, we learn even finer details of how to promote most effectively. We will apply these learnings to drive future promotional initiatives. Second, increase connectivity of our dispensers and our water. We have previously discussed that we are testing various marketing tactics which continue to be in different stages. Consumer segmentation and messaging, we believe is important to have a more appealing message and tighter connectivity between all the different products of our solution. After doing some significant consumer research and getting a better idea of our consumers we continue to test targeted messaging strategies in store for refill and exchange. One of those tests are complete we will tweak and rollout. Here are few of the tests we have ongoing. Refill consumer messaging, direct-mail, digital and social and partnerships. These tests show promise, we will extend or expand them across the business appropriately. We believe that when a consumer understands the value of our solution as being a low-cost environmentally friendly way to purchase purified water there are significant opportunity to grow water sales. Third, increase retail outlets. Overall our total locations are about flat compared to last quarter despite adding nearly 600 gross locations. Year to-date we have added about 1100 gross locations in over the past year we have added approximately 1700. We believe we have upgraded the quality of our retail footprint despite some retail closures, trading losses in chains like Kmart and Office Depot a high-quality locations such as Walmart and others. Fourth, drive unit economics. Our focus on unit economics is primarily on integration activities that bring best operational and technological processes online. First, we are very pleased with integration activities and a progress and speed of integration today. As a result we are raising our total expected integration savings to $7 million to $8 million, up from $6 million to $7 million. These additional savings will come from applying operational best practices to gain further savings in our U.S. operations and accelerating our integration of the Canadian operations that will [Indiscernible] later this year as opposed to 2018. This acceleration comes from a strong work and focus our team has put into the integration initiative. At the end of Q2 we completed the integration of our back-office finance, accounting, customer service, purchasing and human resource functions, all ahead of plan. Based on being ahead of schedule we decided to accelerate an additional 800,000 in one-time costs related to severance and transition which we didn’t expect to do until next year. But this will result in recurring savings in excess of this one-time spent. Moving from operational to revenue synergies, we have posted some small cross-selling wins to-date and are still on track to test refill pricing in the latter half of this year. To wrap up, we are proud that water team has accomplished across our company since closing the glacier acquisition. The culture fit of the two organizations were strong and now we are one company. We continue to believe that we have strong momentum going into the second half of the year to grow business, increase EBITDA and use our free cash flow to delever and increase shareholder value. With that, I will turn the call over to Mark, to cover our financial results.

[Mark Castaneda:]

Thank, Matt. I will first review our financial results in more detail and discuss our outlook for the third quarter and full year 2017. Then I’ll turn the call back over to Matt for closing remarks. To help investors understand our operating results we do provide adjusted EBITDA and adjusted EPS, which are non-GAAP financial measures. A reconciliation of these can be found in today's earnings press release posted on our website. We are very pleased with our financial results in the second quarter, which we’re at the top end of our guidance for both sale and adjusted EBITDA. As Matt mentioned, our second quarter top line more than doubled to $74.8 million driven by growth in all segments. The glacier acquisition contribute to most of the grow as our refill segment sales increased over six fold to $44.2 million. Additionally our exchange business generated 6.2% same-store unit growth, which is the 21st consecutive quarter of growth in excess of 6%. This growth is driven by continuing to add consumer households for the sale of Primo Water Dispensers. Dispenser segment sales increased 24% to a record $12.5 million from $10.1 million in the prior year. As a reminder we recognized sales as dispensers are sold into the channel which can change from year to year based on the time the retailers orders promotions and store sets. For the quarter sell-through dispensers to end consumers was up to 159,000 units, that represents 26% growth over two-year comp basis. Moving down to P&L. Total gross margin for the quarter was 27.7% compared to 30.3% the prior year. The increase mix of lower margin dispenser and glacier refill sales resulted in lower gross margin in the quarter. Next, SG&A for the quarter increased to $8.2 million from $4.8 in the prior year primarily from the acquisition. We continue to see leverage in the business model with SG&A decreased to 11% as a percent of sales from 13.9% in the prior year period. In addition there were nonrecurring and acquisition-related costs totalling $3 million in the quarter. There are two components of these costs, 900,000 settlement costs related to the final litigation of former distributors, clearing up litigation related to the transition of our exchange network that resulted in improved distribution and service improvements. And $2.1 million in costs related to the glacier acquisition. We believe any additional cost in the future quarters will be more than offset by increased synergies expected to be achieved this year Moving now to P&L. Interest expense for quarter was $5 million compares to $500,000 in the prior year. The increase in interest expense as a result of refinancing our current facilities in connection with the acquisition of Glacier Water, adjusted EBITDA for the quarter more than doubled to $14 million from $6.2 million in the prior year. On a GAAP, our net loss from continuing operations for the quarter was $2.5 million or $0.07 per share compared to net income of $2.3 million or $0.08 per diluted share in the prior year period. The loss in the current year period is primarily the result of one-time charges as described above. On a comparable adjusted basis when adjusted for non-cash stock compensation nonrecurring acquisition related costs, net income from continuing operations was $2 million or $0.06 per diluted share compared to $3.2 million or $0.11 per diluted share in the prior year period. Continuing on to our balance sheet, we ended the year – we ended the quarter with $4.5 million in cash. Our accounts receivable DSO decreased to 21 days from 31 days as a result of improved collections as well as the addition of the glacier business that carries low receivables compared to revenue. Additionally, our inventory increased by $1.3 million and our accounts payable and accrued expenses increase $5.4 million due to [seasonal]. Turning to our outlook. We increase our guidance for revenue and EBITDA for the full-year based on solid operating performance and synergies ahead of plan. We now expect full-year revenues of $283.5 million to $287.5 million from originally $280 million to $285 million. An adjust EBITDA $54 million to $55.5 million from $53 million to $55 million. For the third quarterly we expect revenues of $76.3 million to $79.3 million and EBITDA of $15.7 to $17.7. In summary our second quarter results were the top end of our plan. We are confident raising your guidance to reflect the positive synergy and consumer trends. I would now turn the call over to Matt for closing remarks.

[Matt Sheehan:]

Thanks, Mark. We are very pleased with the efforts of our team to post solid results or making major changes to the service infrastructure of the business. We believe the macro and broader consumer trends will continue to fuel future growth in dispenser households and increased usage of Primo Water. Additionally the combined businesses of Primo and Glacier have resulted in a stronger foundation for our business and significant opportunities for value creation. As we look to the future we’re operating from a position of strength and remain confident that our positive momentum will continue to build. As always we appreciate the hard work and dedication of our associates partners and retailers and remain committed to our purpose inspiring healthier lives better water. With that, I’d like to open up the line for questions. Operator?

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Amit Sharma with BMO. Your line is open.

[Unidentified Analyst:]

Hi. This is [Drew] on for Amit. Thank you for taking questions and also thank you for breaking up the segments. That’s really helpful. So, just want to ask on the dispenser promotion in the quarter, obviously drove nice sell-through. Can you talk about basically where those promotions were, if it was in one chain of large customer or if there was more widespread and how you kind of plan to roll that out going forward?

[Matt Sheehan:]

Yes. This is Matt. Thanks for the question. As mentioned before we had plan to do is concentrate some promotions in Q2, Q3 and Q4 of the year, so we just saw some promotions across a couple of our major retailers in the quarter and obviously that grew the comp over, frankly very challenging comp, last year of $.24 so we were very pleased with the production and we’re going to continue to promote in the peak season in future years. But we’ll continue to learn about how to do it more effectively.

[Unidentified Analyst:]

Thanks. And just clean up an item on the gross adds during the quarter. Would you build to quantify how many Walmarts were added?

[Mark Castaneda:]

This is Mark. Drew, that was few hundred out the 6000 total.

[Unidentified Analyst:]

Great. Thank you. And just last one from me. I guess just a broader question. I think last quarter you mentioned that you were selling dispensers through Amazon, so I just wanted to kind of get a feel for how developed the e-commerce channel is and what kind of connectivity you might see well about on dispensers that are sold through e-commerce? Thank you.

[Matt Sheehan:]

Drew, this is Matt. Great question. We’ve been working e-commerce with our core retail partners for while, and that’s Walmart and Lowes et cetera. Amazon still fairly new for us. We did launch that over the last couple of quarters, and as it works with Amazon you earn your way up to bigger volume. We’re still in early stages with Amazon. We continue to push inventory and test the marketing tactics within Amazon. We do believe that’s a good channel for us to grow.

[Operator:]

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

[Mark Argento:]

Hi, guys. Good afternoon and nice quarter. Just wanted to drill down a little bit more on if you guys made any progress in terms of introducing some exchange into maybe some of the glacier footprint or vice versa on the refill and wanted to drill down more on the cost synergies, sounds like you realizing some of the synergy a little bit more quickly and maybe can you just delve in that. Where are you seeing those synergies kind of come about and how did you drive that little more quickly than anticipated? Thanks.

[Matt Sheehan:]

Mark, thanks. I’ll take them in orders. So on our cross-selling side, still early innings on this one as well as you share this one will be long growth path for us. We have seen in the quarter our team begin to cross-sell exchange into some previously glacier customers. As we mentioned in the past we've proven that refill and exchange can exist in the same store, in fact they feed and grow up each other. So we’re going to continue to push that and proud that the team is not only introduced the combined business in the first quarter and now start to get some wins in the second quarter, but it's really early innings on that one, we want to continue to push that. On the synergy side, again we are proud of the team for what they’ve done, a lot of that is we’ve seen some more synergy opportunity while we’re raising and the team has done really great against the timeline. We’re fairly metric driven business. We measure everything. We measured our integration down to the last line item. And the team has been great about moving them all forward fairly well, that’s across everything, that’s across customer service integration, finance integration and certainly the teams done great on the operational side of it. So it's all gone really well, hence the acceleration and then increase.

[Mark Argento:]

That’s helpful. And this one quick follow-up for Mark. Could you update us on where you sit right now in terms of your leverage relative to covenants, I think last quarter you guys provided us with little bit visibility, I know the calc is a little nuanced with some add-backs, what have you, but where are you sitting right now relative your covenants and do you remain comfortable with kind of leverage paydown schedule?

[Mark Castaneda:]

Yes. So as far as cushion on covenants, we do have plenty of cushion as far as covenants go and that’s really across all the covenants we have and there's some details in the queue that we’ll file tomorrow, but we have plenty of cushion. As far as our leverage ratio itself it didn’t move much. This is a peak quarter where we are using some capital. The second half of the year is what we generate cash, so you’ll see that come down more than second half of the year as far as leverage ratios.

[Mark Argento:]

Great. Thanks, guys.

[Mark Castaneda:]

Thanks, Mark.

[Operator:]

[Operator Instructions] Our next question comes from the line of Mike Petusky with Barrington Research. Your line is open.

[Mike Petusky:]

Hey, guys. [Nice up]. I guess Mark, a question I have around gross margins and just how to think about it going forward. I mean, I heard what you said, obviously a little bit a mix issue, but it kind of, I mean, how should we think about gross margins going forward. I mean, is it more high 20s kind of going forward or will you get kind of back over 30 as maybe dispenser is more normalized. I mean, how should we think about?

[Mark Castaneda:]

Yes. So it will vary somewhat by quarter, so as you go into the peak seasons Q2 and Q3 you’ll see higher gross margins just because you have more water in the mix and when you think about the refill business you’ve got higher volume going through with relatively fixed cost basis, so you’ll see nice margins in Q2 and Q3 on refill. Those margins will take down a little bit in Q4. And again the dispenser makes a difference. So, as you saw our dispenser sales rep 24% versus last year that did bring overall margin averages down. Sold in it the 28% to 31% gross margins going forward for the full year, again, that would be closer high 20s the low 30s.

[Mike Petusky:]

All right. Great. And then I was just wondering if you guys would be willing to talk about kind of the pricing test that you’re doing next year. I mean, how limited kind of – how quickly are you going to kind of try to roll that out. Can you just try to flush that out little bit in terms of what you’re – what the timing is and how limit is the test is and how you plan to proceed there?

[Matt Sheehan:]

And Mike, this is Matt. Thanks for the question. Our plan remains consistent. We’re going to do testing in the second half of this year. Frankly we hesitate, we want to learn from and pricing is a sense that we want to make sure that customers walk with that pricing, so we’ll be testing in the bottom half of this year that could extend into next year, if we get early results that are fairly conclusive we could expand those results. So it's hard to predict exactly how we will respond to that based on the results, but we will be testing the second half of this year.

[Mike Petusky:]

Yes. Is that very limited geographies or customers or could that actually move the needle in terms of numbers even in the back half?

[Matt Sheehan:]

It won’t be one customer and it won’t be one region, it will be broader than that and we’ll try to do some representative samples, so probably across couple of different regions, couple of different clients and to get a good sense of what it might be certainly by region and across the country and working on those plans right now.

[Mark Castaneda:]

But Mike, we don’t think it will have an impact on the numbers for this year.

[Mike Petusky:]

That’s right. Okay. All right. And then lot of helpful information and obviously I heard the few hundred Walmarts were added. Was it actually Kmarts and Office Depot that were kind of the attrition there or were there other stores?

[Mark Castaneda:]

Yes. That was the significant majority of those and frankly we do expect some of that attrition to continue with those changed. We are consolidation. But we are very strong with the retailers that are strong in the market in terms of mass, and improvement. So we will continue to see that trade-off with more growth that walmart and likely some of other chains shedding some stores.

[Mike Petusky:]

How – and if I could just agreed. How many more walmarts over the next couple of years is a reasonable target for your guys getting to, are there many more that you think, you have a real chance to kind of be able to sell into.

[Mark Castaneda:]

We think those anyway from two to 500 opportunities and again, we want to make sure that there’s enough room in the stores certainly some of the older walmart stores are smaller, but we think we’re going to have a decent penetration in all of our business across walmart. We will never be fully penetrated with any line of business of walmart, but we’ll say we’ll say offhand there's probably two to 500 stores that we’re not in or we could overlap the portfolio. So still a decent amount of growth at walmart.

[Mike Petusky:]

All right. Fantastic. Good stuff, guys. Thanks.

[Operator:]

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

[Mike Grondahl:]

Thanks guys and congratulations on the progress. Matt, you mentioned that you are kind of working on the marketing, the messaging, you kind of talk about, you need some research in refill, direct-mail, social media partnerships, what have you learned there and how is the message getting tighter. Can you kind of talk about that evolution?

[Mark Castaneda:]

Yes. Thanks for the question. So we've been doing research over a good 18 months and we’re getting a much more specific on who that customer profile is. I won’t necessarily share that at this time, but much tighter as it relates to who’s buying our product. Who has bought our product and who would be a good fit for our products and the combination of our product, so feel in better shape of targeting there and that’s always a constant journey for us. What that is doing is that has fueled a host of tests that are in the market today in terms of messaging. I can share the couple of different mediums, right? One is, it’s an in-store signage. We have decent size billboards that we can use. We are starting some online what work as well, so across the board given those mediums we can push things like tap water quality, drinking more in the household and so forth. So we’ve learned a lot, testing a lot, as we speak, and we believe we’re going to find some good clarity over the coming months and year on what that will look like and then I’ll certainly lean into that heavier.

[Mike Grondahl:]

Got it. And in overall at a very high level, how would you handicap this success of your promotions so far in 2Q and maybe early 3Q. Are you happy with the 169, its only a slight lift from last year. Just help us understand that a little bit?

[Matt Sheehan:]

Well, yes, I’d say, we’re real happy with it. We are a humble business and we always want to grow and learn more and get better. That said, last year it was a monster year for us. And on a 24% comp year-over-year last year, to beat that, that’s a pretty quarter for us. That said, we certainly learn things in the quarter that along us in the retail we could have better and we’re working on that with retailers, so we think there’s room there, but yes, we frankly feel real good about being able to beat last year, that was a monster year for us.

[Mike Grondahl:]

Got it. Great. Okay. Hey, thanks a lot guys.

[Matt Sheehan:]

Thank you.

[Operator:]

And our next question comes from the line of Terra Anderson with B. Riley. Your line is open.

[Terra Anderson:]

Hi, good afternoon.

[Matt Sheehan:]

Hi.

[Terra Anderson:]

I apologize if this is already asked, I missed the first part of Q&A. I got kicked off but I am back. The lighter exchange growth rate in the quarter relative to the same-store sort of unit sales in the 6% range, could you talk about the dynamic behind that?

[Matt Sheehan:]

Sure. There’s couple of things that are impacting the unit growth of the 6.2% versus the revenue growth rate which was in the mid threes, and the difference is really a couple of thing, one is its mix, our IP units versus our exchange units, our IP unit mix, that was down. And IPs are twice the price of an exchange unit. So when that mix changes, it does have an impact on the revenues. Secondly its a mix of customers. So we have some customers that are growing faster. They are larger customers that have more advantaged pricing. So as those customers mix gets higher that it has an impact. And then finally there is some of the locations that were lost, some locations came off, so that does impact the revenue growth. That’s a much smaller extent though.

[Terra Anderson:]

Okay. Thanks. And then just a housekeeping question. What was the gross margin for water and for dispensers in the quarter?

[Matt Sheehan:]

The water gross margins, the total water gross margins were 30.9 and the dispenser gross margins were just over 12.

[Terra Anderson:]

Great. Thank you. That’s it from me.

[Matt Sheehan:]

Thanks Terra.

[Operator:]

Thank you. I’m not showing any further questions. I’ll now turn the call back over to Mr. Sheehan for closing remarks.

[Matt Sheehan:]

Thank you for your participation on today’s call and interest in Primo Water. Have a good evening.

[Operator:]

Ladies and gentlemen, this does conclude the program. You may now disconnect.