Primo Water Corporation
Q4 2016 Earnings Call Transcript

Published: 16 Mar 2017

[Operator:]

Good day, ladies and gentlemen and welcome to Primo Water Fourth Quarter 2016 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, today's program maybe recorded. I would now like to introduce your host for today's program Katie Turner. Please go ahead.

[Katie Turner:]

Thank you. Good afternoon and welcome to Primo Water's fourth quarter and full year 2016 earnings conference call. On the call with me today are Billy Prim, Chairman and Chief Executive Officer; Matt Sheehan, President and Chief Operating Officer; and Mark Castaneda, Chief Financial Officer. By now, everyone should have access to the release that went out this afternoon at approximately 4

[Billy Prim:]

Thank you, Katie. Good afternoon, everyone, and thank you for joining us today to review our results for the fourth quarter and full year of 2016. I will begin today with an overview of our recent result and provide an update on the positive consumer and industry trends. Additionally, I will share a brief update on our recently completed acquisition of Glacier Water. Then, Matt will provide the highlights on our recent quarter, year end and an update on our key progress strategic initiatives. Finally, Mark will review our financial information in more detail. We achieved record results in 2016, exceeding both our top-line and EBITDA expectations. Net sales increased 12% to $143 million and we expanded our gross margin over 250 basis points resulting in an adjusted EBITDA increase of 33% to $24 million, ahead of our recently increased guidance. Our results were fueled by a strong momentum across both our Water and Dispenser segments, coupled with the benefit of strong macro trends that continued to support our business. We finished the year with record levels in dispenser sell-through, as well as another strong quarter of same store sales in our Water business. In addition, in the fourth quarter of 2016, we completed the acquisition of Glacier Water, which I will touch on shortly. First, at Primo we remain committed to inspiring healthier lives through better water. Given that over 60% of the US population drinks bottled water, it’s fair to say that our company service is closely aligned with the millions of consumers seeking better for you alternatives to sugar filled carbonated soft drinks for strength and uses. According to beverage marketing, bottled water consumption increased 8.6% in Vigan [ph] in 2016. For the first time ever in the US the per capita consumption of water surpassed carbonated soft drinks to become the largest beverage category. Health and wellness trends continue to be a top driver for the bottled water segment. In addition to these trends in health and wellness, we also continue to see increasing concerns over municipal water quality and safety. Examples of contaminated ground water supplier are making headlines across the country. Increased consumer awareness of the issues, driven by media scrutiny of public water supply systems fueled consumer concerns over safety and help drive growth in the bulk water category. Not only does Primo provide great-tasting water, but we are proud to be the trusted solution for those in search of safe, quality drinking water across North America. To further capitalize on these opportunities, we completed the acquisition of Glacier Water in mid-December. This complementary combination now positions Primo as the market leader in all three categories we compete in, dispensers, exchange and refill. With this leadership position, we can now provide retailers with a single source solution for water appliances and consumables, while we also leverage our razor-razorblade system to capture the majority of the bulk water revenue at retail. We now believe, we have the majority of the market share with over 46,000 locations throughout the US and Canada, convenient availability to our razorblade after purchasing one of our razors has always been a trademark of accelerating sales in a hybrid category such as ours. In the short time since completing the acquisition, we have been finalizing our integration plan as we prepared to implement best practices across our organizations to deliver continued growth in sales, profit and cash flow. We are excited about the similarities of the company cultures and are well-positioned with a strong senior leadership team to help shape and execute the strategic growth of our business. Matt will review this in greater detail. For 2017, we expect to benefit from increased scale, resulting in synergy and greater operating efficiencies. Importantly, the strong recurring cash flows of our combined businesses will facilitate debt reduction and provide the capital for continued growth. This transformative deal has given us two the three times the earnings power we previously had. We are proud of our consistent track record and ability to deliver results to our retail partners, consumers and shareholders. Going forward, our team remains committed to the execution of our strategic growth objectives. Primo is better positioned than ever before with compelling brand, product offerings, scale and a dedicated team of associates to take us to the next level of growth. We will continue to increase household penetration of our water and dispenser solutions across North America and in turn drive long-term value for shareholders. With that, I will now turn the call over to Matt.

[Matt Sheehan:]

Thank you, Billy. Today, I'll discuss the integration of Glacier Water, some of the highlights of the quarter and year. And lastly, provide a more detailed update on the progress against our key strategies. Since closing the acquisition of our largest competitor in mid-December, we are still on target to begin delivering against our integration objectives in the second half of 2017. We are integrating two national companies, with a combined 600 plus employees, over 5600 retailers in over 46,000 locations. Keep in mind, that the transaction brings greater financial diversity in our retail partners, channels and geography. We look forward to providing more details in the future quarters, keeping in mind the four major areas of integration, service network, shared services, purchasing power and lastly, refurbishment and assembly. Culturally, we are continually pleased with the similarity of the company, as we both share a laser focus on providing consumers with a highly trusted water solutions for the home. Overall, we couldn't be happier with our progress to date. Moving to our full-year performance, we are pleased with our record results that once again exceeded guidance for both revenue and adjusted EBITDA. The strength and consistency of our performance continues to be driven by our focus on our core business, along with disciplined execution of our strategies. We continue to drive and capitalize on the strength of dispenser unit sales, to convert these customers into new water households using our exchange or refill water. We are proud that Primo Water is increasingly trusted water solution for consumers in search of safe, quality and convenient drinking water across the US and Canada. With our performance in mind, I'll discuss a little more on our key strategies. Grow household titration, improve connectivity of our dispensers and our water, increase retail outlets, drive unit economics and finally, fostering highly engaged teams. First, grow household penetration. Dispenser sales are an important focus of ours, as well as the 1 gallon consumer in the newly combined retail business. These consumers are an important component of our household expansion strategy. In the fourth quarter, we continue to see strong dispenser sell-through with 135,000 units bringing year-end sell-through to over 611,000 units. We are excited by the new dispenser households, especially given the increasing base upon which we grow. This performance was not only in our core US business, but also in our license model in Canada. We continue to believe that increased awareness will further drive our business. The second strategy to note today is improving connectivity of our dispensers and our water. We believe that the strong year in dispensers help propel a 9.6% same-store sales growth rate in the US exchange third quarter and 9.4% growth rate for the full-year of 2016. We believe this continues to demonstrate how dispenser sell-through is driving water sales. Next, increase retail outlets. During the fourth quarter, we added approximately 20,400 locations, mainly due to the acquisition of Glacier, but also some from our core business, primarily from Walmarts in both the US and Canada. For the year, we've added 22,000 locations of which approximately 20,100 from the acquisition of Glacier and 1900 from the Primo core business, again, achieving our annual target of location additions, before taking into account retailer consolidation. We are confident in our location pipeline, while being mindful of the consolidation trends in the marketplace. This consolidation well it may impact our net location count, historically has had very little impact on our sell-through and consumers. Finally, drive unit economics. Driving unit economics comes from decreasing capital spend per location, increasing unit revenue, and reducing operating costs. As it relates to capital, we expect to see significant improvements in the cost of refill equipment, through the vertically integrated manufacturing model that Glacier brings, while we continue to improve our sourcing and design of our exchange equipment and bottles. As it relates to unit revenue, we will continue to focus on gaining productivity from existing location, which is much more valuable than a new location. We continue to study our consumer and run test in the market to drive per unit revenue. As we have previously discussed, we have regimented test protocol in which we test small, constantly iterate and scale successful test rapidly. We are excited about these tests and are now preparing to understand the impact gain from acquiring over 20,000 refill locations, most being outdoors. As always the pricing, our focus is first on integrating the service networks, so there was no disruption to service. And then we will begin to strategically assess revenue opportunities, including pricing. We do not expect any material impact from pricing changes in 2017. Moving onto operating cost, 2016 continued to demonstrate the availability of incremental leverage, driving a 250 basis point gross margin improvement for the year. This comes as we continue to grow and work on ways to drive our operating cost lower. Lastly, as it relates operations. We are thrilled to announce today that we have extended our contract with DS Services, as our primary bottler and distributor in our exchange business. DS is an excellent partner, with a scale and meets [ph] necessary to continually support our fast-growing exchange business. We have extended the current term of the agreement by five years, now reaching out through December 2025. This provides stability and confidence that we have a strong distribution partner for years to come, as we continue to push for growth. In summary, we are pleased with our execution of results, excited about the opportunities ahead with our integration and continue to stay focused on our core business and strategies. We look forward to discussing our progress in more detail on upcoming earnings calls. With that, I will turn the call over to Mark to cover our financial results.

[Mark Castaneda:]

Thanks, Matt. I will first review our financial results in more detail and discuss our outlook for 2017, then I'll turn the call back over to Billy for closing remarks. To help investors understand our operating results, we do provide adjusted EBITDA and pro forma EPS, which are non-GAAP financial measures. A reconciliation of these results can be found in today's earnings release posted on our website. We are very pleased with our financial results for the fourth quarter and full year 2016, which exceeded our guidance for both sales and adjusted EBITDA. Our fourth quarter top-line grew 28.2% to a record $40.4 million, driven by growth across both the water and dispenser segments. The results include 20 days related [ph] to the acquisition of Glacier, which contributes approximately $6.6 million to sales. During the quarter, water segment sales increased 32.9%, primarily as a result of 9.6% same-store unit growth in our US exchange business, as well as the acquisition of Glacier. Dispenser segment sales increased 16.7% to $10.6 million from $9.1 million in the prior year. For the full year, dispenser sell-through to end consumers was a record 611,000 units. Moving down to P&L, gross margin for the quarter was 28.6% compared to 29% in the prior year period. The slight decrease was primarily due to the sales mix. Gross margin for the full-year increased 250 basis point to 29.7% from 27.2% as a result of improvements in supply chain cost, as well as an increase in mix of higher margin water sales. Next, SG&A for the quarter increased $11.7 million from $5.1 million in the prior year, primarily as a result of $6.2 million charge related to the non-cash performance based stock compensation, which was triggered by exceptional financial results. We continue to see leverage in our business model as SG&A excluding the non-cash compensation decreased to 13.1% as a percent of sales from 13.9% in the prior year period. We also incurred a $3.7 million non-recurring costs related to the Glacier acquisition in the fourth quarter. Interest expense for the quarter was $4.6 million compared to 500,000 in the prior year. The increase in interest expense was the result of refinancing of our credit facilities in connection with the acquisition of Glacier. As a result of the refinancing, the interest expense includes a $3.1 million in non-recurring charges related to our prior closed facility. Adjusted EBITDA for the quarter increased 33% to $6.3 million from $4.8 million in the prior year period. For the year, adjusted EBITDA increased over 33% to $24.1 million. This compared to our top-line growth of 12% for the year, continues to illustrate the leverage and high quality of earnings in our business model. On a GAAP basis, our net loss from continuing operations for the quarter was $11.7 million, or $0.39 per share, compared with net income of $300,000 or $0.01 per share in the prior year period, primarily as a result of one-time charges related to the Glacier acquisition. On a comparable pro forma basis, net income from continuing operations for the full year almost doubled to $10.7 million, or $0.35 per share, compared to $5.5 million, or $0.20 per share. Continue on to our balance sheet, we ended the year with $15.6 million in cash, compared to $1.8 million in 2015. The increase cash was a result of strong free cash flow generation in the business. The balance sheet reflects a preliminary purchase accounting which adds a fair value of the Glacier acquisition, and respective fixed and intangible assets. Our DSO ended the year at 31 days, as a result of improved collection, as well as the addition of the Glacier business that carries lower receivable, as a result of selling direct to the consumer. Other notable changes related to the capital used to fund the acquisition and refinance our existing debt. We added two layers of debt with the Glacier acquisition, a senior credit facility of $186 million, led by Goldman Sachs and we assumed a net $83.1 million of trust preferred securities. Our total net senior leverage ratio at the end of 2016 was approximately 3.7 times and total leverage was 5.4 times and factoring in cash and pro forma EBITDA for the acquisition. We remain confident in our outlook for the first quarter and full-year 2017. We do expect to incur one-time cost during 2017 from three areas. First, an incremental non-cash stock compensation charge related to our 2016 stock-based performance incentive plan of approximately $1.5 million in the first quarter. Second, a non-cash valuation charge of approximately $4.5 million in Q1 related to warrants issued in acquisition of Glacier. We do not expect any future charges related to these warrants. Finally, as it relates the acquisition costs, which includes severance third-party professional fees and other expenses, we expect to incur integration costs throughout 2017 for approximately $1.5 million to $2 million. In summary, we remain confident in the opportunities to create value, as we combine the two businesses. I will now turn the call over to Billy for closing remarks.

[Billy Prim:]

Thanks, Mark. We are very pleased with the efforts of our team which enabled Primo to generate results above our expectations throughout the year. We have made significant progress on our strategic initiatives, resulting in top line growth, improved operational efficiencies and greater profitability. We believe the macro and broader consumer trends will continue to fuel growth in households and increase usage of Primo Water. Additionally, the combined businesses of Primo and Glacier create a stronger foundation to our business and significant opportunities for value creation. We are operating from a position of strength and remain confident that our positive momentum will continue into 2017. As always, we appreciate the hard work and dedication of our associates, service providers and retail partners, while remaining committed to our purpose of inspiring healthier lives through better water. With that, I'd like to open up the lines for questions. Operator?

[Operator:]

Certainly. [Operator Instructions] Our first question comes from line of Mike Grondahl from Northland Securities. Your question please.

[Mike Grondahl:]

Hey, guys. Congratulations on the December quarter. First off, Glacier, you are about 90 days into it. Any positive surprises, any negative surprises, just kind of - what are you learning 90 days in?

[Billy Prim:]

Thanks, Mike. I think that the biggest positive take away is the quality of people that have joined our company. They have very similar culture layer, all driven by how to serve the customer and we are very pleased of what we found in this first 60 days.

[Mike Grondahl:]

Got it from. Secondly, maybe for Matt. Matt, you talked a little bit about productivity enhancements or even some testing that you are doing in various markets. Can you talk just a little bit about what you are testing, what you are trying to look at, what you are learning there?

[Matt Sheehan:]

Yes. Mike, thanks. Again, we've shared that. We have pretty regimented testing protocol, most of that testing is on the marketing side. We're seeing really good growth in our business. Frankly though over the years we haven't marketed all that much, whether that’s in-store or out of store. So we have a battery of tests going on both in-store and out of store to help drive more awareness to the category and to our brand and it ranges everywhere Mike from better pricing signage on our refill business, better you know, better communication on our exchange business and better value prop communication for dispensers. So we have a battery of tests going on. And again, as we test them in a small scale we'll begin to role them more nationally only if they work.

[Mike Grondahl:]

Got it. And I know maybe lastly, I know cost synergies were kind of the top of the list for priority, any just update on what you are seeing there and then have you even had a chance to think about or consider the revenue synergy side yet or is it too early?

[Mark Castaneda:]

Let me take the cost side first. We stand behind our forecast of $6.7 million of synergies over the next three years. So we still feel good about that number. What we wanted to do Mike was focus on the integration - operational integration first before we do look at revenue. We believe is revenue synergies there, but we want to make sure we focused on op [ph] first and then start to focus on revenue, including pricing as I mentioned earlier.

[Mike Grondahl:]

Got it. Great. Thanks a lot guys.

[Billy Prim:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Kara Anderson from B. Riley & Company. Your question please.

[Kara Anderson:]

Hi, good afternoon.

[Billy Prim:]

Hey. Thanks, Kara.

[Kara Anderson:]

I guess, first, would you mind talking little bit about refill performance in the quarter, I don't think it was mentioned?

[Billy Prim:]

Refill was strong. We continue to see single digit comps in the refill business. And again, we only had a small period of the Glacier business, but as we're referring to the Primo refill business, we continue to see consistent single digit comps in that business.

[Kara Anderson:]

Okay, thanks. And then just a little housekeeping, can you supply the gross margin by water and dispensers for the quarter?

[Mark Castaneda:]

Sure. The gross margin for water for the quarter was 34.7%, for the year was 37.1%, for dispensers was 11.3%, and for the year was 10.6%.

[Kara Anderson:]

And can you talk a little bit about why the water was materially lower than the year?

[Mark Castaneda:]

Sure. So the exchange margins were actually up versus the prior year, just that the new margins coming from Glacier art around at 30% margin or as our historical refill margin were around 50%. So you'll see that refill margins have come down and it’s more a function of mix and because the models are different. I think we've explained before, Glacier sells primarily to end consumers. So the revenue is higher per transaction, but the margin percentage is lower, the actual margin dollars are actually slightly higher as well. So it's more just a - more of a model change, Glacier model versus the Primo model on the refill side.

[Kara Anderson:]

Great. That’s helpful. And then, I guess last question from me. On the DS Services extension have the terms of that agreement changed that all?

[Billy Prim:]

Well, the terms are pretty much the same. What we've done, we've extended that agreement out and put some assurances is in place that the terms would not change dramatically over the several years. So really it’s a – it’s a big positive for Primo and really something that we're glad to know is going to be around for several years to come.

[Kara Anderson:]

I will jump back in the queue.

[Operator:]

Thank you. Our next question comes from the line of Mike Petusky from Barrington Research. Your question please.

[Mike Petusky:]

Hi. Good evening, folks. So a lot of my questions have actually been answered already. But let me ask a couple. So in terms of – just going back to the idea of the revenue synergies, so what's the timing of really trying to have serious conversations around that and trying to begin that process. You know, is that second half '17 or is that more '18, '19 where you really kind of get serious about the revenue piece?

[Mark Castaneda:]

I think we're serious about assessing those, but as they do show up, that’s going to be more in the '18 piece, you may see some this year, but it very light. So we're again focused on operations first and second on revenue side.

[Mike Petusky:]

Okay. And then I may have missed this, but you guys have a sell-through, either sell-through growth number or decline number for just Q4. I know you're up against, I think a pretty tough comp?

[Mark Castaneda:]

Sell-through on dispensers, Mike, is that what your question was?

[Mike Petusky:]

Yes.

[Mark Castaneda:]

Yes, was around 5% up.

[Mike Petusky:]

Okay. I think that’s all I have got guys. Thank you so much, a great year. Thanks.

[Billy Prim:]

Thank you.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from line of Mark Argento from Lake Street Capital Markets. Your question please.

[Mark Argento:]

Yes, good afternoon. Just wondered if you could drill down a little bit in terms of the service network, I know that you guys were going to do some serious integration work in terms of third-party versus first party service network or field service guys, where are you in that process and is that a multi-year process or is that something where you kind of go geography-by-geography in terms of making the change?

[Matt Sheehan:]

I think it’s a little bit of – Mark, thanks. This is Matt. I think it’s a little bit of both. We want to take this and do this the right way, so it could stretch out over a couple years and do it right. So keep in mind that we step back, that we did have a fair amount of our business in hand about service providers. We do believe down the road we will get very close to 100% of our service coming from our own employees. But that’s a process we want to – we've taken now seriously, we want to do right. So that could take a bit of time to get through.

[Mark Argento:]

Got it. I think in your prepared remarks, you guys mentioned that you don’t anticipate any material impact from pricing changes in 2017. Should we read that as – its supposed to just going to be kind of testing at this point in terms of '17 or that you aren’t going to make any real changes in '17?

[Matt Sheehan:]

If we do make any changes that will be slight, Mark. So we want to make sure we assess pricing very carefully and then likely do some testing. So the timing of that is probably pushing into '18, may see a little bit in '17, but the big focus is on '18.

[Mark Argento:]

Great. That’s it from me. Thanks.

[Billy Prim:]

Thank you.

[Operator:]

Thank you. And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to Billy Prim for any further remarks.

[Billy Prim:]

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

[Operator:]

Thank you, ladies and gentlemen for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day.