Primo Water Corporation
Q2 2014 Earnings Call Transcript

Published: 6 Aug 2014

[Operator:]

Good day, ladies and gentlemen, and welcome to the Primo Water Second Quarter 2014 Earnings Conference Call. [Operator Instructions] Please note today's conference is being recorded. I would now turn the conference over to Katie Turner for opening remarks. Please go ahead.

[Katie M. Turner:]

Good afternoon, and welcome to Primo Water's Second Quarter 2014 Earnings Conference Call. On the call with me today are Billy Prim, Chairman and Chief Executive Officer; Mark Castaneda, Chief Financial Officer; and Matt Sheehan, President and Chief Operating Officer. By now everyone should have access to the release that went out this afternoon at approximately 4

[Billy D. Prim:]

Thank you, Katie, and thank you for joining us on the call. I'm going to start with a few comments on our overall business, and then turn the call over to Matt Sheehan, our President and Chief Operating Officer, who will go a little deeper into our operational initiatives. Mark Casteneda, our CFO will then review our second quarter financial results and the outlook for the remainder of 2014. Our positive momentum continued in the second quarter as we executed on each of our strategic initiatives to drive growth and better position our business for long-term profitability. We are pleased to report the sixth consecutive quarter of year-over-year growth and adjusted EBITDA reflecting a 29% increase to $3 million, which is ahead of our guidance. These results demonstrate the continued strength and leverage in our business, with adjusted EBITDA growing at more than double the rate of our revenue growth. Dispensers sales growth along with strong U.S. exchange same-store sales growth coupled with gross margin expansion led to our strong increase in adjusted EBITDA. Our team remains focused on achieving profitability as we continue to focus on our strategic initiatives to drive increased household penetration of our dispensers, which we believe will lead to more Primo Water users long term. In the quarter, we continue to execute on each of our key strategies, scale, household penetration, growth, refinancing and efficiency. We continue to scale our business. Our positive sales growth led to operational and margin improvements through our strategic alliance with DS Services. We believe the complete transition of bottling and distribution to DS Services will happen over a 2-year period and that transition remains on plan. We continue to experience strong industry tailwinds as consumers increasingly focus on health and wellness. And Primo Water delivers on this opportunity evidenced by the increased household penetration of our innovative water dispensers and U.S. exchange same-store unit growth of 9.7%. We are reminded of the importance of clean drinking water solutions as highlighted in Toledo, Ohio over the weekend. We believe we are positioned to empower families that are searching for trusted drinking water sources as they commit to pure water in their homes. We now have the financial capacity to grow our business. We ended the quarter at 23,700 retail distribution points and plan to grow that to 50,000 to 60,000 locations by expanding our water availability and providing the most comprehensive line of water dispensers available at retail at attractive prices with innovative features. We believe that additional dispenser household will lead to more Primo Water users. As previously mentioned, we refinanced our debt to give us more capacity and to lower interest cost with expected annual savings of $2 million. With this new credit facility, we believe we are well positioned to further deliver on our strategic initiatives during 2014 and to capitalize on future growth opportunities. With that brief overview, I will turn it over to Matt.

[Matthew T. Sheehan:]

Thank you, Billy. Keeping in stride with our 5 key strategies of scale, household penetration, growth, refinancing and efficiency, we continue to make strong progress across our business. Our team undertook an operationally focused approach in 2013 to drive foundational improvements, which have led to financial gains, mostly in our margins and adjusted EBITDA. We believe these improvements have positioned us to begin evolving and growing the business here in 2014. In the second quarter of '14, we continue to evolve our core business while operating it with more control and visibility. As previously mentioned, we are operating 2014 on 4 key tenets

[Mark Castaneda:]

Thanks, Matt. I'm going to spend a few minutes reviewing the financial highlights from the second quarter and our outlook for the remainder of the year. To help investors understand our operating results, we do provide certain non-GAAP financial measures, including adjusted EBITDA and pro forma fully taxed earnings per share, which I'll discuss in a few moments. Overall, we are very pleased with our financial results which were ahead of our expectations, specifically, revenue and adjusted EBITDA. Adjusted EBITDA grew 29% on a 12.6% increase in revenues as we expanded overall gross margins to 40 basis points to 25.2% and leverage our SG&A spend. We experienced revenue growth in both our Water and Dispensers segments. First, our Dispensers segment revenues grew 28% to $9.8 million compared to the second quarter of the prior year. This increase was due primarily to the timing of shipments to major retailers as they replenished inventory. Dispenser revenue had a much smaller impact on economics as we manage the segment at 10 operating margins to drive household penetration. The pricing strategy continues to work as we experienced a record quarter of consumer purchases of dispensers at retail, which were up 5.6% to 126,000 units. Additionally, our operating income for the segment increased fourfold to $400,000 compared to $90,000 at the second quarter of the prior year as we expanded gross margin and lowered SG&A spend. We believe that increased water dispenser penetration will continue to lead to further increases in recurring water sales. Next, our Water revenue increased 5.3% to $17.1 million. The increase was primarily due to 11% increase in U.S. exchange sales, driven by same-store unit growth of 9.7% as we continue to add new consumers. Moving on to gross margin. Our Water segment gross margin increased to 180 basis points to 35.9%, primarily due to lower supply chain cost. Our operating income for the Water segment increased 14.5% to $5.4 million due to revenue growth, margin expansion and SG&A leverage. We continue to leverage SG&A spend, which decreased to 16.4% from 16.7% as a percent of sales. We expect to continue to leverage our primarily fixed SG&A costs across the business. Moving down the income statement. Our net loss from continuing operations for the second quarter was $6.2 million or $0.25 per share compared to a loss of $2.1 million or $0.09 per share in the prior year. On a comparable basis, our net loss from continuing operations, when adjusted for the nonrecurring items, improved to $0.06 per share from a loss of $0.08 per share. During the quarter, nonrecurring items were driven by a few factors. First, the refinancing of our credit facilities resulted in a $2.1 million noncash write-off of deferred loan cost, as well as a cash charge of $700,000 for early prepayment fee. Next, we incurred a $900,000 charge for nonrecurring cost associated with our transition of our Exchange distribution network. We incurred $900,000 loss on the disposal of impairment of our equipment of our Water segment related again to a transition of our Exchange distribution network and a customer transition for certain refill equipment. We do not expect to incur significant nonrecurring charges in the second half of the year. On a pro forma fully taxed basis, we incurred a net loss from continuing operations adjusted for these items, as well as a noncash stock-based compensation of $600,000, or $0.02 per share, compared to a loss of $1 million, or $0.04 per share, for the prior year, again, on equivalent basis. Continuing to our balance sheet. As Billy mentioned, we refinanced our debt and entered into a new $35 million credit facility with Prudential consisting of a $15 million revolving credit facility and a $20 million in term loans. Interest rates on the new credit facility reflect a significant reduction from rates in our prior debt. We expect to save $2 million annually in interest expense. The new credit facility also increases our borrowing capacity, providing additional capital needed for growth. We improved our working capital management with accounts receivable DSO to 33 days from 35 days at June in the prior year. Inventory and accounts payable levels at quarter end were also higher than prior year end due to seasonality. We do expect the accounts payable benefit to cash flow to reverse in the second half of the year as we pay down higher-cost supplier financing that we had in place. Turning to our outlook. We continue to expect full year 2014 sales to increase between 7% and 12% to a range of $98 million to $102 million. We are increasing our full year 2014 adjusted EBITDA guidance to a range of between $11.1 million, $11.6 million as we gain further confidence in the improved contribution of new consumer growth, as well as positive results from our DS Services alliance. We expect third quarter 2014 sales to be in the range of between $26 million and $28 million and adjusted EBITDA to increase 21% to 34% to a range of $3.6 million to $4 million. We did experience Dispensers sales pull forward in the second quarter that originally expected in the third quarter, which will temper the revenue growth rate in the third quarter. We continue to expect solid EBITDA growth in the Water segment. This concludes our prepared remarks. Now I would like to open the call over to questions.

[Operator:]

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

[Kara Anderson:]

Wondering if you could tell me the water location count at the end of the quarter.

[Mark Castaneda:]

Sure. Kara. The water locations were 165 at the end of the quarter. That compares to 162 last quarter and 157 at the beginning of the year. So that's where the growth in locations have come from.

[Kara Anderson:]

Okay. And I know you mentioned that you're in the beginning stages of transitioning any DS Waters customers, but was any of that, I guess, addition in the quarter due to DS Waters?

[Matthew T. Sheehan:]

Kara, this is Matt. It was in a small amount.

[Kara Anderson:]

When can we expect to see more from that transition?

[Matthew T. Sheehan:]

We believe that transition will take over the next 18 months.

[Kara Anderson:]

Okay. Did you guys provide the gross margin for Dispensers?

[Mark Castaneda:]

Gross margin for dispensers was up to just over around 6.5% or about 170 basis points up over last year.

[Kara Anderson:]

Okay. And just in terms of adding water locations by a way of growing organically and not through the DS Waters customers for the remainder of 2014, what do you expect as far as on a quarterly basis?

[Matthew T. Sheehan:]

I think there's 2 buckets. Not exactly stating the number, Kara, but it will come from 2 buckets. One is grand openings of current retailers, and we are putting more effort on acquiring new customers.

[Kara Anderson:]

I think last quarter, we were looking at maybe 500 or more per quarter. So I'm just wondering if that is still an expectation.

[Matthew T. Sheehan:]

Fairly reasonable but that could go up and down based on demand and time of the deals, and frankly, grand openings, which sort of can get scheduled and change throughout the year.

[Operator:]

[Operator Instructions] Our next question comes from the line of Robert Strauss from Gilford Securities.

[Robert D. Strauss:]

I have a number of questions. First, the top line sales was really nice, double digit. I just wanted to give maybe Mark and others an opportunity to discuss the margin and leverage opportunity for the company, probably over the next couple of years? How much do we think we'll get from that and if you can tie that quantitatively to basis points, that would be helpful.

[Mark Castaneda:]

Sure. As far as the revenue growth over the next couple of years, again, we haven't given guidance out for next year or beyond that. But as you know how our model works, it primarily got fixed cost, so the key-leverage point is our SG&A cost. So as we add revenue, we expect to add significantly more bottom line or EBITDA. So as you saw this quarter, EBITDA grew at double the rate of our revenue growth. Now that's going to matter depending on the mix of that revenue growth as our Water revenue has much higher margin and much higher contribution to the bottom line than our Dispenser revenue. So if we have a quarter where it's all Dispenser revenue growth, we're going to have a lot less leverage. So that's why I'm not going to give you specific numbers or even a range because the range varies so much because of the Dispenser revenue. It only has single-digit margins, whereas, the Water revenue has nice solid double-digit margins.

[Robert D. Strauss:]

Okay, understood. Next question is regarding DS Waters. What percentage of the Primo locations are now being serviced by DS Waters?

[Billy D. Prim:]

I'll take that, Robert. We don't give exact percentages of the transition. But our goal is over the 2-year period for DS Waters to, either through them or through their affiliates, to manage around 90% of our distribution network. And again, that's sometimes through their affiliates or a DS Waters transition. That transition is well ahead of that schedule. So we feel like we'll completed it in less than a 2-year period. We're well over that 50% mark at this point.

[Robert D. Strauss:]

Okay. Matt, one question for you, or I guess, 2 questions. First, I'd like you to make some comments regarding attachment rates. And then, also make some comments on the refill business, and what you think is going on there and what the opportunity is.

[Matthew T. Sheehan:]

Great questions. First on attachment, the way we look at attachment and measure it, is really 2 ways. One is, what percentage of consumers buy water at same time they buy dispensers. And then secondly, over the time, what percentage of customers that buy our dispensers end up buying our water. And so we do measure that and we are just starting now frankly to start to test and design some test around increasing that number. We have some retailers that are strong and some months that are strong in attachment, and we want to do drive that number up. That's on attachment. On the refill business -- the refill business continues to be strong for us. But it is flat at this point. And we believe given the value proposition that this offers consumers from a price perspective and value proposition, we believe that this is a strong business and we will put some energy against growing that business. That has not been our attention to date.

[Robert D. Strauss:]

What you think you need to do for the refill business to be successful?

[Matthew T. Sheehan:]

What we started to do is a bit on the supply chain side. And that has started to -- started to help. What we also need to do is understand the consumer more. A bit of what I mentioned is understand the consumer, understand why they use the refill business and continue to communicate them in that fashion. And we're just starting that understanding process. I think it's a little bit about messaging, a little bit about marketing at point of sale. But we do feel confident in the value proposition that we do offer the consumer.

[Mark Castaneda:]

And I'll add to that a little bit. I think it is a successful business that has north of 50% gross margins. So it is a solid contributor to our numbers. It just hasn't grown and we haven't frankly invested in trying to grow that business. Now we're ready to turn that growth on now that we have some more capital and some resources to throw against it.

[Operator:]

Our next question comes from the line of Eric Wagoner from Source Capital.

[Eric Wagoner:]

Earlier on, you mentioned something about Toledo, Ohio's example. And I was listening, but could you guys give a little more detail on the Ohio, in Toledo and the good things going there?

[Billy D. Prim:]

Yes, Eric. I'll take that question. And make it add to it. We did have an unfortunate incident in Toledo with the quality of public water system there. Our retail locations in that area have experienced a lot of sales and we've shipped truckloads into that area to make sure we're servicing those customers in that area. But from a bigger picture standpoint, I think what this does is it really highlights the potential -- the image that the public water system has in people's minds. And we've seen in West Virginia, who had a problem earlier this year, we are still seeing 200-plus percent increases in our water consumption in those areas. I think you're seeing this across the board as you experienced a breakdown in your public water system. Many times, people are going to turn to another source for their drinking water. And it's our job to be at the right place at right time to make sure they have that option.

[Operator:]

And our next question is a follow-up from the line of Robert Strauss from Gilford Securities.

[Robert D. Strauss:]

Just a couple of follow-up questions. First, Mark, I just want to focus on the capital structure a little bit. Congratulations in putting together your new financing. The debt now is nearly $25 million. The company was really starved of capital and -- previously and couldn't really grow the business much. Where do you see that debt level going and how do you manage the capital structure with balancing the growth that you want to drive going forward?

[Mark Castaneda:]

Yes. Thanks, Robert. Yes, today, we're around 2.5x levered based on our EBITDA. So as our EBITDA grows, we expect to keep that leverage level between 2, 2.5x. So as we have more EBITDA, we'll be able to generate or be able to have more debt and more capital for debt -- more capital use for growth, I'm sorry. So we think the 2 or 2.5x on a recurring revenue business is an efficient use of using that leverage and we'll use our growth capital from there.

[Robert D. Strauss:]

Okay. And the last question from me is you had mentioned earlier on the call that there was some dispenser sales that pulled forward. Is there any way you quantify that number?

[Mark Castaneda:]

No. It's based on our internal estimate so you could see our revenue was well advanced of our guidance, and our EBITDA was slightly in advance of our guidance, so you could tell the difference was lower margin revenues that came through as opposed to high-margin revenue on the waterside.

[Operator:]

Thank you. And that concludes our question-and-answer session for today. I would like to turn the conference back to Primo Water for any closing comments.

[Billy D. Prim:]

Yes, thank you. We do appreciate your interest, and thank you for your support. We look forward to providing you with an update on our business progress next quarter. Thank you.

[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.