Primo Water Corporation
Q3 2014 Earnings Call Transcript

Published: 9 Nov 2014

[Operator:]

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Primo Water third quarter 2014 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 would now hand the conference over to Katie Turner. Please go ahead.

[Katie Turner:]

Good afternoon, and welcome to Primo Water's third quarter 2014 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 and thank you everyone for joining us on the call. I am 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 discuss our operational initiatives in a little more detail. Mark Casteneda, our CFO, will then review our third quarter financial results, the outlook for the remainder of 2014 and the initial guidance for full-year 2015. We are very pleased that our positive momentum continued in the third quarter as we executed on our strategic initiatives driving growth and achieving the first quarter of profitability in the company history. Over the last several quarters, our team has executed on our initiatives to better position our business for sustained growth and long-term profitability. It's great to see our operational efforts yield strong financial results. Our third quarter is further evidence of this and as we generated record top and bottom line results. We continued year-over-year growth and adjusted EBITDA delivering a 34.7% increase to $4 million which was at the high-end of our guidance. Importantly these results demonstrate continued strength and leverage in our business with adjusted EBITDA growing more rapidly than the rate of our revenue growth. Strong double digit U.S. exchange same-store sales growth coupled with gross margin expansion helped drive our financial performance in the quarter. We continued to execute on each of our key strategies, scale, household penetration, growth, refinancing and efficiency. The water segment generated another quarter of strong same-store sales growth and improved gross margins. These results were driven by increased consumer demand and lower supply chain costs. In the exchange business, we have completed Phase 1 of the strategic alliance with DS Services ahead of plan. Phase 1 was the transition of our U.S. exchange bottling and distribution to DS Services. We have begun Phase 2 which is the transition of DS Services legacy customers over to Primo. Phase 2 is expected to occur over the next six to nine months and ahead of our two-year transition plan. We believe that positive industry tailwinds will continue to support the growth of our business as consumers seek better for you beverage options and focus more on their overall health and wellness. Primo water delivers this opportunity through our compelling product offerings. We continue to see increased household penetration of our water dispensers which helped drive U.S. exchange same-store unit growth of 10.5%. We ended the quarter with 23,500 retail distribution points. We remain focused on our plan to grow to 50,000 to 60,000 locations by expanding our water availability and providing the most comprehensive line of water dispensers available at retail. In summary we are very pleased with our consistent progress both in the terms of our strategic initiatives and financial results and believe we are well-positioned to further capitalize on future growth opportunities. With that brief overview, I will turn the call over to Matt.

[Matt Sheehan:]

Thank you, Billy. We continue our discipline approach making strong progress across our business. Based on our operationally focused year in 2013, we have continued to evolve our core business in 2014. As previously mentioned, we are operating 2014 on four key tenets that are guiding our decisions and driving increased financial performance. One, a team that delivers, two, better operating models, three, driving continued market leadership in our compelling brand and lastly, driving results. Our first tenet is a team that delivers. Using balanced scorecards at a corporate team and individual level, we are a company today with more discipline, visibility and control. Our team continues to improve on their achievement of targets focusing on the most important targets while we, as an executive team, support their efforts. We are proud of how well the team has adopted to discipline but we also see room for improvement which has us excited for the future. Our second tenet is better operating models and we continue to make progress. First as Billy mentioned, in our U.S. exchange business, Phase 1 of the strategic alliance with DS Services was completed ahead of plan. Phase 2 has begun and we expect this to be finished ahead of our original estimate of two years. Second within our retail business, both our telemetry and core projects continue to deliver as planned. Both are increasing our proactive partnership with retailers and decreasing our service costs which has resulted in a positive impact on our margins and increased service levels. Last but certainly not least, we continue to improve our dispenser segment. Consumer demand for our dispensers has continued to accelerate throughout the year with a 12.7% increase in dispenser sell-through in the quarter, which is over double the rate of the previous two quarters. We believe this is a result of improving our supply chain and inventory visibility which is leading to higher end stock rates and sell-through. We also continued to develop improved dispensers for the future with some trials hitting shelves in select stores around the country in the coming months. Turning to our third tenet, enhancing our brand and market leadership. We continue to drive market share and exchange as demonstrated by our strong same-store sales growth. With that growth, we continue to enhance our market position in dispensers as well. In addition to our market leadership efforts, we have continued to put focus on our consumer strategy. Just as we have outlined the last two years, it would be upon a stronger operating business that we would then turn our focus to consumers. We are learning a lot about how and why they shop, their water preferences and how we fit into their family's lives. We have begun to understand our target demographics and are designing tests accordingly. We believe these initiatives over time and after rigorous testing will increase trial, attachment, usage and loyalty. Finally we are making strong progress on the most important tenet, driving results. Our teams' focus on our core business continues to drive record results in growth. We are a team of metric driven results focused individuals organized into teams with clear goals and long-term targets. In summary we will continue our disciplined approach focusing on driving results in our core business that we very much believe in. We are increasingly confident in our growth prospects and are proud of our team. Now I will turn the call to Mark to review our financial results for the third quarter.

[Mark Castaneda:]

Thanks, Matt. Let me spend a few minutes reviewing our financial highlights for the third quarter and our outlook for the remainder of 2014 and for 2015. 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 from continuing operations, which I will discuss in a few moments. Overall we are very pleased with our financial results which were inline with our expectations of growth for revenue and adjusted EBITDA. Adjusted EBITDA grew 34.7%, a 3.4% increase in revenues as we expanded gross margin 300 basis points to 28.8% and leveraged our SG&A spend. Additionally we reach the milestone of attaining profitability for the first time in our company's history. Looking deeper at our topline results. Water revenue increased 7.5% to $18.9 million. The increase was driven by U.S. exchange same-store sales unit growth of 10.5% as we continued to add new consumers to our exchange service. In our dispenser segment, revenue tends to be lumpy based on the timing of orders by our major retail customers. For Q3, dispenser revenues declined 5.8% to $7.5 million compared to Q3 of the prior year as retailers delayed shipments to future quarters. We have increased our Q4 revenue guidance to reflect this shift in timing. Dispenser revenue has a much smaller impact on our EBITDA as we manage this segment with thin operating margins to drive consumer adoption. This pricing strategy continues to work as we experienced our second consecutive quarter of record consumer purchases of dispensers at retail, which were up 12.7% to 131,000 units. This also represents an acceleration of growth of consumer purchases compared to the first half of the year. We believe the increased water dispenser penetration will continue to lead to further increases in recurring higher-margin water sales. Moving on to gross margin. Our water segment gross margin increased 340 basis points to 37.1%, primarily due to lower supply chain cost in both our exchange and refill businesses. As we progress through Phase 2 of the DS Services strategic alliance and add their retail customers, the incremental revenue will generally be at lower margins. On the refill side, we expect margins to continue to expand with the implementation of employees service territories. Turning to dispensers. Gross margins were 8% compared to 6.5% last quarter and 8.5% in the prior year. Margin movement is primarily due to the mix of products sold. Our operating income for the water segment increased 26% to $6.3 million due to the 7.5% growth in revenue, margin expansion and SG&A leverage. Next we saw an increase in overall SG&A expenses primarily attributable to higher levels of non-cash stock compensation expense compared to the third quarter of 2013. However, we expect to continue to leverage our SG&A costs across the businesses. Moving down the income statement. Our net income from continuing operations for the third quarter was around $300,000 or $0.01 per share compared to a loss of $1.6 million or $0.07 per share in the prior year. On a pro forma fully taxed basis, we reported earnings from continuing operations of about $500,000 or $0.02 per share compared to a loss of $800,000 or $0.03 per share for the prior year. Continuing on to the balance sheet. As planned, with the flexibility provided by our new credit facility, we lowered our accounts payable balance during the quarter by paying off higher cost supplier financing we had in place. We also improved our working capital management with our accounts receivable DSO to 32 days from 34 days at prior year's quarter-end. Inventory levels at quarter-end were higher than the prior year due to seasonality. Now turning to our outlook. We are increasing our full year 2014 revenue guidance to a range of $102 million to $104 million reflecting an increase of 12% to 14% over the prior year and up from our previous range of $98 million to $102 million. We are also increasing our full year 2014 adjusted EBITDA guidance to a range of between $11.7 million to $12.2 million, an increase from our previous range of $11.1 million to $11.6 million. This is the third consecutive quarter of increase adjusted EBITDA guidance as we are driving dispenser and exchange revenues ahead of our expectations. Today we are also introducing initial guidance for 2015. We expect revenues between $111 million and $115 million and adjusted EBITDA between $14.2 million to $15.5 million. This represents a 10% topline growth and 24% adjusted EBITDA growth at the midpoint of guidance. This also supports our long-term financial goals of double-digit revenue growth and 20% adjusted EBITDA growth annually. I will now turn the call over to Billy for closing remarks.

[Billy Prim:]

Thanks, Mark. In closing, I am pleased with the progress we have made this far in 2014. I would like to take this time to thank our employees and associates for their hard work and dedication to Primo Water. We have executed on many initiatives and still have a long runway ahead of us, but without their efforts, our operational and financial achievements would not be possible. Looking ahead to 2015, we are well positioned to leverage our core business and generate increased growth. We will utilize Primo's compelling brand and market leadership to drive results and increase cash flow in an effort to deliver enhanced shareholder value. This concludes our prepared remarks. We are now happy to take your questions.

[Operator:]

(Operator Instructions). Our first question comes from the line of Matt Blazei fro Lake Street Capital.

[Matt Blazei:]

Hi, guys. Good job. Great job on the profitability this quarter. I had a question for you on the DS waters transition Phase 2. Can you remind us again how many doors are currently potentially transferred to Primo over the next year?

[Billy Prim:]

Yes. They are in about 3,000 doors that we do expect to transfer over in Primo, like I said, over the next six to nine months.

[Matt Blazei:]

Okay and obviously the big news today for them being acquired by Cott Corp. Can you give us any sense in terms of how that may affect Primo? Obviously Cott has a lot of retailer relationships themselves? Is it an opportunity? Is it a risk? Give us your ideas.

[Billy Prim:]

Yes. This is Billy. For those the don't know, it was announced today that DS Services is being acquired by Cott Corp. Guys, I spoke with Tom Harrington, CEO of DS Services Tom assured me, we are an important part of this strategy Tom and the management team have signed agreements to stay on and run DS Services. We will be dealing with the same people. It will be business as usual. Other than that, we will have a partner that has more access to capital. And we are excited about the opportunity.

[Matt Blazei:]

That's great. We can talk about that more, obviously, going forward. My last question was in reference to your guidance for this year. It's calling for a very strong Q4 revenue number. Can you give us some sense of what's driving that?

[Mark Castaneda:]

Yes. As we mentioned the dispensers were pushed in to Q4. So dispenser revenue is a big part of that. And we see continued strength in the exchange side.

[Matt Blazei:]

Okay. Great, guys. Thanks.

[Operator:]

Thank you and our next question comes from the line of Ryan MacDonald form Northland Capital.

[Ryan MacDonald:]

Hi, guys. First of all, can you talk about, I think you mentioned that the retail points of distribution were around 23,500 this quarter? It looks like it's a decline on a sequential basis. Can you talk about where that decline came from? Or what the cause of that was?

[Matt Sheehan:]

Sure. The decline came as about 100 products or dispenser locations that were reduced, and that primarily was from store closing. So Kmarts and another retailers that had closing in stores. And then on the waterside, we were down about 100 locations and again mostly from store closings.

[Billy Prim:]

And I would add, that we still feel good in getting close to the 2,000 number for the year in increase. It will be back-end loaded and a lot in Q1. We feel good about the topline and are going to see some strong results in Q4 and in Q1 in those numbers.

[Ryan MacDonald:]

Got you, and then switching to DS Waters just quickly. I mean, so not that we are in Phase 2, this is where we will start to see the transition of the Home Depot coming on. Is that correct?

[Billy Prim:]

That is correct.

[Ryan MacDonald:]

Okay and that's expected to happen over a six to nine months period?

[Billy Prim:]

That is correct.

[Ryan MacDonald:]

Okay and then I guess as we kind of enter into the holiday season here, is there any like promotional activity that you are kind of starting to do to further grow dispenser sales there in retailers?

[Matt Sheehan:]

That's great, a good question. Most of our focus is on the supply chain side of dispensers. We have seen a direct correlation between our in-stock rates, which have improved and the larger numbers you see here on dispensers. That's the majority of our focus. That said, we always look for promotional opportunities with our retail partners and look out a year to do so.

[Ryan MacDonald:]

Got you. All right. Thank you very much.

[Billy Prim:]

Thank you.

[Operator:]

Thank you. (Operator Instructions). Our next question comes from line of Mike Petusky from Barrington Research.

[Mike Petusky:]

Hi, guys. Congratulations. Just I guess a quick question around the fourth quarter revenue bump. Is there an assumption of some of that DS Water customer transition also driving that? Os is that just purely dispenser, kid of the push out in the dispensers?

[Matt Sheehan:]

It will be a combination of both. There will be some DS Water volume coming in.

[Mike Petusky:]

Okay. All right. That's all I have got. Thanks.

[Billy Prim:]

Thank you.

[Operator:]

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

[Billy Prim:]

Yes. Thank you. Thanks for joining us on the call this afternoon. We do appreciate your interest in Primo Water and look forward to providing you with an update on our business progress next quarter. Thank you.

[Operator:]

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