Primo Water Corporation
Q2 2015 Earnings Call Transcript

Published: 4 Aug 2015

[Operator:]

Good day, ladies and gentlemen, and welcome to the Primo Water’s Second Quarter 2015 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] Please note today’s conference is being recorded. I’d now like to hand the conference over to Katie Turner. Please go ahead.

[Katie Turner:]

Good afternoon, and welcome to Primo Water's second quarter 2015 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 second quarter results. I’ll begin today’s call by providing a few comments on our overall business. Then, Matt will discuss our operational initiatives in more detail. Finally, Mark will review our financial performance and the outlook for the remainder of 2015. To start, the results we have generated in the first half of 2015 could not have been accomplished without the efforts of our employees, distributors, refill service providers, manufacturing and retail partners. We sincerely thank them for their continued dedication. Our growth opportunities continue to be supported by compelling industry trends as water and overall healthy beverage consumption increases in the US. Independent reports consistently confirm the shift from sugary to healthy beverages and Primo is on trend providing consumers with a convenient and affordable way to stay hydrated in a healthy manner. Now focusing on our second quarter results, the positive momentum we experienced in the first quarter continued into Q2 with our top line growth exceeding our expectations. We reported net sales growth of 21% to $32.4 million. Both our water and dispenser segments posted growth in the quarter. Importantly, we generated strong growth at retail with US exchange same-store unit sales up 8.7% versus the second quarter of last year. These sales results and the efficiency of our business model helped propel adjusted EBITDA growth of over 48% to $4.4 million, which was ahead of our expectations for the quarter. These results also generated strong cash flow for the quarter. Our record results and the momentum in the business give us confidence to raise our outlook for the full year of 2015, which Mark will provide in more detail in a few minutes. In the quarter, we continued to add more households with our dispenser sales, which in turn created growth in our exchange and refill businesses. We believe this is the most effective method in gaining new households to grow the water business. In summary, we’re extremely pleased with our second quarter and year to date performance. We ended the second quarter with approximately 24,700 retail locations and continue to believe we can grow this number to 50,000 to 60,000 over the next several years. At Primo, our team remains committed to inspiring healthier homes through better water. With that overview, I’ll turn it over to Matt.

[Matt Sheehan:]

Thank you, Billy. I’ll now discuss the details of our key strategies that continue to drive our results. These strategies span operational excellence, marketing and solid management practices. First, grow household penetration of dispensers. The dispenser business is the razor of our model and continues to grow. In the quarter, the sell-through of our dispensers increased to 130,000 units, up 3.8% versus prior year and a 9.2% increase over the first quarter. This confirms more and more households are entering the category and providing a strong indicator of future water sales. We continue to improve the quality and breadth of our dispenser assortment to reach a wide array of consumers. We sell these dispensers at low margins to gain future water households as one of our key marketing initiatives. Second, improve connectivity. Based on our household penetration strategy, we want to link those dispenser consumers with our water. We do so through several mechanisms, in pack couponing across merchandising, placement at retail, the retail promotions and messaging that tie the two together. We’re a unique brand and that we offer the full portfolio of the razor and the razor blade to consumers and retailers. Third, increase retail outlets. We remain confident in both our long and short term location goals. In parallel, we continue to focus on and improve our service levels for retailers during peak season. Although acquisition of locations maybe lumpy, we have confidence that we will achieve our goals while remaining focused on high performing locations with the right in-store placement. Fourth, drive unit economics. This quarter continued to demonstrate the leverage in our business with enhancements to the supply chain and margins we’ve made, such as the transition of our exchange distribution network, deployment of CORT, our company-operated retail territories, and telemetry, amongst several other non-headline initiatives. These have allowed us to narrow our focus to growth. With this foundation, we continue to drive a three-point revenue and marketing approach

[Mark Castaneda:]

Thanks, Matt. I’ll now review the financial results in more detail. To help investors understand our operating results, we do provide certain non-GAAP financial measures, including adjusted EBITDA and water unit sales. Overall, we’re very pleased with our financial results for the quarter. We exceeded the high-end of our growth expectations for both sales and adjusted EBITDA. As Billy mentioned, sales for the second quarter grew 21% to $32.4million, driven by growth in both the water and dispenser segments. Looking deeper at our top line results, water segment sales increased 29% to $22.1 million, primarily due to the addition of retail locations and US same-store unit growth of 8.7%. In addition, our US refill business has been showing comp unit growth after several years of flat to no growth. We believe this growth is additional confirmation that our water solutions are resonating with consumers as they search for healthier beverage alternatives. In our dispenser segment, sales increased 5% to $10.3 million, which is over last year’s very strong Q2. As a reminder, the dispenser segment can be lumpy based on the timing of orders by our major retail customers. However, this revenue has limited impact on our EBITDA. We continue to believe that increased water dispenser penetration will lead to momentum in our recurring higher margin water sales. Overall, gross margin percentage increased to 25.3%, primarily due to sales mix. Next, SG&A expenses decreased slightly to $4.3 million in the quarter. SG&A as a percent of sales decreased to 13% compared to 16% for the prior year’s second quarter, illustrating the leverage in our model. Interest expense for the quarter decreased by 87% to $0.5 million, due to more favorable borrowing rates under the credit facility we entered into in the second quarter of 2014 as well as one-time charges of $2.8 million related to the refinancing during the prior year. Adjusted EBITDA increased 48% to $4.4 million from $3 million in the prior year, which is well ahead of our guidance, primarily due to top line growth ahead of our expectations. On a GAAP basis, net income from continuing operations was about $800,000, or $0.03 per diluted share for the second quarter, compared to a loss of $6.2 million or $0.25 per share in the prior year. The second quarter results also put the company in positive EPS position for the year to date basis, demonstrating our business model can generate profits as well as strong cash flow. We generated free cash flow for the first half of the year of approximately $4.5 million, driven by a 70% increase in cash flow from operations to $8.5 million, while CapEx was down slightly. Continuing on to our balance sheet, we paid down our revolving credit facility $2.7 million during the quarter. We continued our solid receivables management as demonstrated by our DSO decreasing to 31 days from 34 days at year end. Our total leverage ratio decreased to 1.4 times from 2.4 times EBITDA a year ago through an increase in EBITDA and the pay down of debt. Turning to our outlook, as a result of our strong year to date results, we are raising our 2015 outlook. We now expect sales to be in the range of $122.8 million to $124.8 million, up from our previous guidance of $114.5 million to $118.5 million. We’re also raising our adjusted EBITDA to a range of $15.8 million to $16.8 million, up from our previous guidance of $14.7 million to $16.2 million. Today, we are also introducing guidance for the third quarter of 2015. We expect sales of $31.5 million to $32.5 million and adjusted EBITDA of $4.7 million to $4.9 million. Now, I will turn the call over to Billy for closing remarks.

[Billy Prim:]

Thanks, Mark. Our team continues to execute on our strategic initiatives and we believe we’re well positioned for a record year as we head into the second half of 2015. Our foundation is stronger than ever and we continue to see compelling industry tailwinds which give us confidence in our ability to grow the business through the increased distribution of our water and dispensers. At Primo, we have a great team and the right products in the right market with plenty of potential ahead. This concludes our prepared remarks. We are now ready to take questions. Operator?

[Operator:]

[Operator Instructions] Our first question comes from the line of Kara Anderson from B. Riley & Company.

[Kara Anderson:]

Just first housekeeping question, how many water locations were added in the quarter and what was the total water location count at the end of the quarter?

[Matt Sheehan:]

The water locations were 18,400 at the end of the quarter, so we added about 200 locations.

[Kara Anderson:]

And then can you provide gross water and dispenser margin breakout?

[Mark Castaneda:]

Water and dispenser margins? The dispenser margins were around 8% and the water margins were just over 33%.

[Kara Anderson:]

And then on the guidance, just wondering if you could provide some color as to why such a large revenue increase, but just a smaller increase on the EBITDA?

[Mark Castaneda:]

That’s more a function of mix and the mix on the dispensers. The dispenser business has been coming in stronger than we had anticipated and we expect to see some continued strength. So that’s why the margins are being adjusted because of the lower margins in that dispenser business.

[Operator:]

And our next question comes from the line of Mike Petusky from Barrington Research.

[Mike Petusky:]

I guess a couple of questions. How much revenue can you guys tie to DS customers coming on board? Are you able to quantify that?

[Matt Sheehan:]

We haven’t in the past, because there is really no additional DS customers that came on board during the quarter. The big change in DS customers was Q4 of last year.

[Mike Petusky:]

Is that customer conversion done at this point?

[Matt Sheehan:]

Yes.

[Mike Petusky:]

I thought it was still a little bit left to go, okay. Can you just talk about, obviously great quarter in terms of dispenser sales, are you seeing any trends in terms of price points where really the action is in terms of price points, in terms of the sales?

[Billy Prim:]

We continue to see people trading – we continue to see bottom load dispensers which were at higher price points increase in the percent of volume. So although $99 top load is still the biggest seller, we continue to see people go up to continue.

[Mike Petusky:]

Do you guys have any ability to track what you call trading up in terms of a customer moving from a $99 price point to a higher price point, do you have the ability to see how many of these are truly new purchases versus replacing lower-end price points with higher-end price points?

[Billy Prim:]

We do some. We have better information that we’ve ever had today. Through our Club Primo and our warranty usage, we can track and stay in touch with a lot more consumers than we were able to a few years ago. So yes, we’re starting to get a lot of those consumer insights.

[Mike Petusky:]

Do you have any guesstimate, even if it’s just a range, of how many of the dispenser sales might be actually customers trading up from one product to another?

[Billy Prim:]

It’s over the board in different regions, Mike. I wouldn’t want to throw out something that I really can’t validate. But what I can say is and what we’re seeing in this momentum of water revenue and growth is that we’re selling a lot of dispensers which equals new households using Primo Water. And you’re seeing that and that in our business model means a lot of it falls to the bottom line. And that’s what you saw this quarter and the fact that we’re seeing more dispensers open up more households that really started well for the rest of the year and future quarters.

[Mike Petusky:]

I know that you put that 50,000 to 60,000 retail locations out there for a multi-year, longer term goal, do you guys set goals in terms of say the next year, the next one to three years, I mean, is there any help you can give in terms of what you’re shooting for over the next year or two in terms of retail outlets?

[Billy Prim:]

I’m going to Matt talk about locations and how he thinks about it.

[Matt Sheehan:]

We have a lot of confidence in our ability to hit that long term target, but that’s exactly what that is. We’ve shared before that we’re shooting for 2000 locations a year and we’re on track to do that. We’ve done that in the last year.

[Mike Petusky:]

So if you were at 2000 locations for 2015, that would put you at what, a little over 26,000 something like that?

[Matt Sheehan:]

So yes, we started the year at around 24,000, 24,500, so yes, around 26,000.

[Operator:]

And our next question comes from the line of Matt Blazei from Lake Street Capital.

[Matt Blazei:]

Couple of questions. Regarding your new found free cash flow, which is the first time, I think it’s been a while since you had that, you talked before about how you’ve been hampered in adding retail locations because of your lack of free cash or capital, I should say, to pursue that. At the same time, I saw Mark being quoted yesterday in a newsfeed on acquisitions in your space. Can you give us a little feel for how you think you’re going to grow those locations? Whether it’s through internally generated capital or acquisitions here over the next – now that the DS waters thing is complete, going forward.

[Billy Prim:]

One thing you hit on is we do have a lot of flexibility now. We’ve paid down our debt, our multiple is a little over 1 and headed south. So it gives us flexibility to do. We will always be opportunistic in looking at things within our core competencies. But that said, having capital will give us the ability to grow faster organically, which we’re going to put some of those dollars to work doing that. So the focus will not be on debt pay down as much as growth in locations, whether it’d be through internally generated organic or acquisitions.

[Mark Castaneda:]

We’ve got less than 1.5 turns of debt. We’re very comfortable with more debt. So yes, we would be focusing on growth at this time.

[Operator:]

[Operator Instructions] Our next question comes from the line of Eric Wagoner from Source Capital.

[Eric Wagoner:]

Just kind of looking at the top line, do you think that you’ll be able to maintain the existing gross margins that you’re currently experiencing, there is a two-edged sword, with the dispenser growth and the water growth, what’s your viewpoint on the current gross margin you have going forward?

[Mark Castaneda:]

From a gross margin standpoint, we actually expanded gross margins in dispenser business up to 8% versus I think a little bit over 6% last year. And that’s more a function of mix. But you’re right, it’s a double-edged sword. Overall, gross margins come down as our mix of dispensers goes up, but that creates new household which is going to help us down the road as those consumers buy water and that’s going to bring the mix of water up in the future which should enhance our margins. So you may see that as margins coming down as a negative thing, we said it’s a very positive thing, as more and more consumers adding households to buy water. So we feel much more confident in our ability to add households, that’s why we had such a high raise on our top line revenues for this quarter.

[Operator:]

And our next question comes from the line of Reed Anderson from Northland.

[Reed Anderson:]

Back to the original question on guidance, Mark, I guess what I noted is it looks like you tightened the range nicely, is that just a reflection of confidence, better forecasting, what would account for that as well?

[Mark Castaneda:]

As we go through the air, we tightened up the guidance just because we feel much more confident in our forecasting.

[Reed Anderson:]

Matt, you too highlighted in your prepared remarks about some of the branding, marketing initiatives, et cetera, and talked about some tests you’re running. I’m curious, when you talk about a test, how many locations would typically be in a test? And what would roughly the timeframe be? Is it a few months, is it quarters, I’m just trying to understand the way you would approach that.

[Matt Sheehan:]

On locations, it could range anything from 20 locations to 100, but it’s never too many. And then on timing, those tests could go two months to six months. So it’s really a range based on how long we want to give it and how long it would take to see the results.

[Reed Anderson:]

So the ones you were obviously referencing in your remarks, have those been in place that you’d think you’re going to have something material, you’ll come back to us with this year or are we a little bit early to that?

[Matt Sheehan:]

We’re slightly early on that, but we will share those when we’re confident we understand we can scale them.

[Reed Anderson:]

One other question here, relative to the same sort of dialog, results have been remarkably consistent, at least from a reported standpoint, I’m just kind of curious as you look at where you’re seeing the growth, particularly I think about dispensers, new households, Billy, your commentary there, does it tend to be all more regionalized whether its relation to certain promotions or new locations opening or has that been pretty consistent too as you’ve added those new customers on?

[Billy Prim:]

It’s been pretty consistent across our portfolio. Now, we have some areas that are always stronger than others, but as far as the growth aspect, it’s been in every state. And we measure every state.

[Operator:]

And that concludes our question-and-answer session for today. I would like to turn the conference back over to management for any closing comments.

[Billy Prim:]

Thank you. We appreciate your interest in Primo and appreciate your participation in today’s call. We look forward to providing you with an update on our business progress next quarter. Have a good evening. Thanks.

[Operator:]

Thank you. Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may now disconnect. Everyone, have a good day.