May 1, 2013
Executives
Michael Massi Jerry S. G.
Fowden - Chief Executive Officer and Director Jay Wells - Chief Financial Officer and Vice President
Analysts
Perry Caicco - CIBC World Markets Inc., Research Division Bryan C. Hunt - Wells Fargo Securities, LLC, Research Division Mark D.
Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division
Operator
Welcome to Cott Corporation's First Quarter 2013 Earnings Conference Call. [Operator Instructions] The call is being webcast live on Cott's website at www.cott.com and will be available for a playback there until May 15, 2013.
We remind you that this conference call contains certain forward-looking statements reflecting management's current expectations regarding future results of operations, economic performance and financial condition. Such statements include, but are not limited to, statements that relate to the estimated revenues; volumes; selling, general and administrative expense; net income; free cash flow; and earnings per share and leverage ratios; and estimated working capital.
This conference call also includes forward-looking statements reflecting the company's business strategy and includes statements related to the company's capital deployment strategy; the payment of future dividends; share repurchases under our share repurchase program; the reduction of interest expense; and the investment in organic bolt-on opportunities, such as the recently announced Calypso Soft Drinks transaction; future revenue enhancements and cost savings; and goals and expectations concerning our market position, future operations, product mix and estimated capital expenditures. Forward-looking statements are subject to certain risks and uncertainties, which could cause actual results to materially differ from current expectations.
These risks and uncertainties are detailed from time to time in the company's securities filings. The information set forth herein should be considered in light of such risks and uncertainties.
Certain material factors or assumptions were applied in drawing conclusions or making forecasts or projections reflected in the forward-looking information. Additional information about the material factors or assumptions applied in drawing conclusions or making forecasts or projections reflected in the forward-looking information is available in the company's press release issued earlier this morning and its Annual Report on Form 10-K for the year ended December 29, 2012, which are available on the Investors section of the company's website.
The company does not, except as expressly required by applicable law, assume any obligation to update the information contained in this conference call. A reconciliation of any non-GAAP financial measures discussed during the call with the most comparable measures in accordance with GAAP is available on the company's first quarter 2013 earnings announcement released earlier this morning as well as on the Investor Relations section of the company's website at www.cott.com.
I'll now turn the call over to Michael Massi, Cott's Director of Investor Relations.
Michael Massi
Good morning, everyone. And thank you for joining our call.
Today, I'm accompanied by Jerry Fowden, our Chief Executive Officer; and Jay Wells, our Chief Financial Officer. Jerry will start this morning's call with some introductory remarks before turning the call over to Jay for a discussion of our first quarter 2013 financial performance.
Jay will then turn the call back to Jerry, who will complete the call with his perspective on our first quarter 2013 performance as well as the discussion of business drivers and expectations for the remainder of 2013. Following our prepared remarks, we'll open the call for questions.
With that, let me now turn the call over to Jerry.
Jerry S. G. Fowden
Thank you, Michael. Good morning, everyone.
Before Jay reviews our financial results, I wanted to comment on our first quarter's performance. As you can see, our first quarter has been a challenging quarter with lower volume and gross margins, hence, lower EBITDA.
If you recall, we set out in 2013 to reduce our rates of volume decline in the first half of the year and move towards roughly stable volumes in the second half. While our first quarter volume reduction of 5% was less than in prior quarters, we had hoped our quarter 1 volumes would have been higher than those actually achieved.
This softer first quarter volume resulted in unfavorable fixed cost recoveries in our plants, which alongside the product mix in the quarter with lower CSD volumes and slightly higher juice volumes in North America as well as lower volume in higher gross margin products in the U.K., compressed our overall gross margins. Last quarter 1, and our current trading, which is following a similar trend, is a clear reminder of the challenges and bumps in the road we face.
And hence, the focus we need to keep on our 4 C's of customers, cost, CapEx and cash, it also highlights the importance, at this stage of our strategy, of not just following the 4 C's but improving our growth and gross margin prospects as we progress over the next few years by a stronger customer programs and wins alongside organic and bolt-on diversification. Given this objective, and the challenging market conditions that saw our first quarter CSD market decline of over 4%, we have and are placing greater emphasis and resources on managing our U.S.
operations, given the size and importance of these operations to our consolidated business. We have moved Steve Kitching, who successfully ran our U.K.
and European operations over the last 4 years, to run our U.S. operations effective March 2013, and have just appointed a new U.S.
Business Unit CFO. These changes, alongside our 4 C's and diversification into U.S.
pouch production and U.S. alcohol capability later this year plus added resources in our U.S.
commercial and contract manufacturing teams together with smaller bolt-ons such the recently announced U.K. Calypso Soft Drinks transaction, should help.
However, I do not want to minimize the challenges we face. I'll comment more on this and our volume and margin performance by each business unit later in the call.
But now, on the separate note, I am pleased our Board of Directors again approved the quarterly dividend. And at the same time, renewed our discretionary share repurchase program.
Both of these reinforce our commitment under our capital deployment strategy of allocating around 30% of our annual free cash flows to the return of funds to shareholders. Jay will comment in more detail later.
Additionally, debt reduction and it's associated reduction in interest cost is an important part of this strategy. And as we get closer to our opportunity for early redemption of our 2017 senior notes, we'll be able to fine-tune our plans to achieve a meaningful reduction in interest cost which should result in increases in earnings, EPS and free cash flow.
Lastly, I want to reaffirm my commitment to strive towards our better growth profile over time, with greater products, package and channel diversification through both organic and bolt-on means, such that slowly and consistently, we improve the shape of our business. On this note, let me hand the call over to Jay to cover our financial metrics, our quarterly dividend and the renewal of our share repurchase program in more detail.
Jay Wells
Thank you, Jerry. Total filled beverage case volume, excluding concentrate sales, was lower by 5% at 193 million cases versus the first quarter of 2012.
The volume decline was from a combination of factors including loss of market share by the CSD private label segment within the overall CSD category, the impact of exiting low gross margin business last year and a general market decline in the North American CSD category. Revenue was lower by 4%; 3%, excluding the impact of foreign exchange, due primarily to lower global volumes slightly offset by an increase in average price per case in North America.
Average price per case increased as a result of higher juice product mix alongside price increases on certain CSD and juice products where certain fruit commodities have significantly increased versus 2012. Gross margin was 11.2% compared to 12.1% last year.
Lower global volumes resulted in unfavorable fixed cost absorption across our CSD and cold fill plants as well as on the favorable product mix alongside the cost of carrying higher inventory levels. These directly impacted our gross margins.
The reduced North American volumes lowered our fixed cost absorption and impacted our gross margin to an extent that was not offset by increased pricing and operational efficiencies at the plant level. SG&A was lower by 1% at $41 million versus the prior year due primarily to reduced cost associated with our IT strategy.
As we continue to implement SAP across our manufacturing facilities and move more IT services in-house, we gain SG&A efficiencies that assist in offsetting normal inflation. We should complete our SAP implementation later in the year.
And as a reminder, we continue to believe that our total SG&A for 2013 will remain in the 7% to 8% range as a percentage of revenue which is considerably less than most companies in our industry. We believe this level of SG&A reflects our low-cost philosophy.
Net income was effectively 0 compared to $6 million in the first quarter of 2012. Earnings per share on a diluted basis was 0 compared to $0.06 last year, and EBITDA was $40 million compared to $45 million in the prior period.
Turning to our balance sheet. Cash on hand at the end of the first quarter was $93 million.
Net debt was $510 million and our unused borrowing availability was $252 million. Cash on hand declined during the quarter due to the seasonality of our business and we should see positive free cash flow in the second half of the year.
And as always, we will manage working capital tightly, but we do feel that flat working capital for 2013 would be a success after the great progress we made in the last few years. Our capital deployment strategy provides for returning approximately 30% of our free cash flow to shareholders.
And we believe the most effective means of doing so is through our quarterly dividend supplemented by our discretionary share repurchase program. Thus, as announced this morning, our Board of Directors approved the quarterly dividend of $0.06 per share in Canadian currency payable on June 12, 2013.
Our Board of Directors also approved the renewal of our discretionary share repurchase program which gives management the authority to opportunistically repurchase shares in line with objectives outlined in our capital deployment strategy. As announced yesterday, we signed an agreement to purchase Calypso Soft Drinks, a privately-owned soft drink and freezable products business based in the United Kingdom, for approximately $31 million.
The purchase price includes an adjustment for high seasonal working capital and approximately $5 million of deferred consideration payable over a 24-month period. Calypso Soft Drinks has annual revenues of approximately $50 million and will become EPS- and EBITDA-accretive once we have lapped various purchase kind of adjustments such as inventory step-up and integration cost.
We anticipate closing the transaction in June 2013. Lastly, the Calypso Soft Drinks transaction does not impact our anticipated redemption of a majority, if not all, of our 2017 senior notes later in the year because this level of bolt-on acquisition was factored in as part of our balanced capital deployment strategy.
This redemption should strengthen our balance sheet and improve our financial metrics, specifically, our net income, earnings per share, free cash flow and leverage ratio. We also anticipate refinancing our 2018 senior notes near the end of 2014 with a lower interest rate.
The combination of these actions will allow us to lower our interest expense by approximately $20 million by the end of 2015. And at that time, we'll give further consideration to the allocation and balance of our capital deployment strategy, returning funds to shareholders and investing behind diversification of product, package and channel that should assist in the improvement of the overall business and maximize shareholder value.
With that, I will now turn the call back to Jerry.
Jerry S. G. Fowden
Thanks, Jay. I'll now review the performance in each of our reporting segments.
In North America, revenue was lower by 4% for the quarter and volume was lower by 5%. The decrease in volume was largely the result of lower CSD volumes from exiting low gross margin business in the first half of last year and the general market decline of over 4% in the CSD category, slightly offset by 1% higher Cott juice volumes versus a juice category that declined 1%.
This mix shift contributed to an increase in average price per case as juice cases are about double the revenue of CSD cases. On CSD and cold fill volumes, private label lost some market share within the overall CSD category during the quarter, although we held our share within private label.
And as previously mentioned, we have made management changes and increased commercial resources in our U.S. business that should bring benefits within the next 6 to 18 months.
Related to juice volumes, we did see a 1% increase in volume versus a market decline of 1%. This small increase in volume was predominantly from apple-based products and apple promotional activity where we have seen some renewed retail interest in supporting the category.
On gross margins, we saw North America's gross margin decline by 80 basis points as our lower volumes adversely impacted our cold fill plant's fixed cost recovery and also, to a lesser degree, due to the mix shift between CSDs and juice. We continue to focus on gross margins and getting the right balance between gross margin and volume while at the same time, adding some new and increased U.S.
management and commercial resources. As mentioned on previous conference calls, the case pack water category is not an attractive category for Cott and we will continue to reduce our water volumes over 2013 and 2014.
Lastly, North America implemented its pricing required to cover commodity cost increases associated with certain fruits and other items. We also continued our North American investment in operational efficiencies via our increased U.S.
on-site bottle blowing, which will be completed during quarter 3 of 2013. Turning to the U.K..
Revenue declined by 2%; 1%, excluding the impact of foreign exchange. In the U.K., we saw narrowing price gaps relative to national brands, especially in the energy and sports drinks categories.
The narrowing of the price gaps adversely impacted our volume momentum and our level of stored inventory and, in turn, our gross margins. The U.K.
also continued to experience poor weather across most of January to March. As we look forward, we have already transitioned our U.K.
leadership to Steve Corby, a proven 7-year Cott executive, who previously headed up our U.K. sales organization.
Additionally, we are installing new U.K. capacity that is expected to come online towards the end of quarter 2.
We will also benefit from new products and packaging formats such as single serve Combi cartons, which is a form of tetra, single serve cups and cuplets and 2 freezable formats that will be acquired as part of our recently announced bolt-on of Calypso Soft Drinks, which we anticipate closing in June. Collectively, these actions, alongside a more normal U.K.
summer, should assist in improving volume and revenue trends. In RCI, revenue was flat as an increase in average price per case offset RCI's volume reduction.
The volume reduction was due primarily to lower shipments from reduced concentrate inventory levels in RCI's Asian bottler. Turning to Mexico.
Mexico's results continued to reflect the cessation of our regional brand license at the end of its term and the exiting of some unprofitable 3-liter volumes that required very high shipping and freight cost. While volumes and revenues were low, overall cost management, foreign exchange and a higher contract manufacturing mix improved financial results.
As we summarize the first quarter and look to 2013 as a whole, we were disappointed in this quarter's results as they were lower than we would have wished. But we remain focused on following our 4 C's as well as adding new management resources to our U.S.
operations. We realized there will always be some challenges in our business and some bumps in the road as we have seen in quarter 1 and in our current volume trends, but we remain focused on being a low-cost, high-service provider while diversifying our overall business to fill in the gaps and become a better one-stop shop provider.
We believe we can make progress towards the back end of 2013 and beyond in winning new contract manufacturing business in the U.S. and we'll continue to look towards diversifying our product, package and channel offerings over time.
We believe these actions, along with our balanced capital deployment strategy that sees us allocating some 30% of free cash flow for the return of funds to shareholders while continuing to reduce our level of debt and interest cost during 2013 and '14, will create shareholder value. As of commodity update, high fructose corn syrup represents a significant increase versus 2012 due to the drought last summer which resulted in a lower corn yield.
We are 100% covered for our 2013 high fructose corn syrup requirements. Aluminium appears to be flat as the commodity itself has somewhat declined, but has been broadly offset by increases in conversion costs and the Midwest premium.
We are covered for approximately 70% of our 2013 aluminium requirements. Regarding fruit and fruit concentrates, we are covered for a majority of our 2013 requirements, specifically apple juice concentrate where we are not expecting to fully benefit from the current softer prices until the back end of the year.
Grape represents the largest increase in fruit and fruit concentrates year-over-year and PET resin remains a slight headwind, and as a reminder, is a spot exposure for us. We anticipate 2013 CapEx to be just below $17 million as we complete our investment in the vertical integration of bottle blowing.
Thus, all in all, we continue to aim to be a tightly-run, cash-generative, high-service, low-cost producer while implementing our balanced capital deployment strategy, which includes investing behind the diversification of our product, package and channel mix, alongside the return of funds to shareholders and continued debt and interest reduction. In summary, this quarter was impacted by lower volumes, which resulted in an unfavorable fixed cost absorption, and led to a financial result below that we would have wished.
However, as things stand today, trading still remains challenging. Thus, we have placed greater emphasis on our U.S.
management team; transferring in a new president; increasing our commercial and contract manufacturing teams; adding some new U.S. and U.K.
manufacturing capabilities which, along with additional packaging formats from our Calypso Soft Drinks bolt-on, should move us in the right direction. I'd now like to turn the call back to Michael.
Michael Massi
Thank you, Jerry. [Operator Instructions] Thank you for your time.
Operator, please open the line for questions.
Operator
[Operator Instructions] Our first question comes from the line of Perry Caicco with CIBC World Markets.
Perry Caicco - CIBC World Markets Inc., Research Division
Jerry, a management change kind of midstream in the North American business is a pretty serious action. So I'm wondering, I suppose without telling too many tales out of school, what prompted that change and how soon could the issues you're trying to address be repaired?
Jerry S. G. Fowden
Yes. Good question, Perry.
And I mean, I guess to help everyone understand the background of it, most people would know that our U.K. business has not only increased its EBITDA by some 50-odd percent over the last 4 years, grown it's volume from around 80 million raw cases to over 100 million raw cases, but especially what it's done is it's managed to shift the mix of its business so that less than 50% of its business is now dependent on that traditional 2-liter, 12-ounce Cott private label sort of business.
It's a much more diversified business across contract, packing, private label, our own control brands. And that diversity reduces the risk of volatility that we often see in our business.
So it's with that goal of accelerating the shift in mix of our U.S. business that we've moved Steve across from U.K./Europe to the U.S..
And we still have within our business, looking up to the commercial side of it, the former president of our U.S. business.
So I see it more as the addition of a resource rather than as a replacement.
Perry Caicco - CIBC World Markets Inc., Research Division
But the challenge, Jerry, in changing the mix in the U.S. is overcoming both customer and consumer resistance to the types of products that you would prefer to sell.
How do you intend to address that?
Jerry S. G. Fowden
Yes, I think there's a number of streams to it. We need to strengthen our own control brand portfolio in the U.S., which is not as strong as we have in Canada here or in the U.K..
We need to get a larger share of contract manufacturing business. And as I mentioned in the prepared remarks, we have increased the size of our contract manufacturing commercial teams, which I believe will bring incremental business back end of this year and next year.
So it's really placing more focus on those areas and more resources behind those areas in addition to the defense and tight management of our existing core business that we'll look into within the U.S. over the next 6 to 18 months.
Operator
Our next question comes from the line of Bryan Hunt with Wells Fargo Securities.
Bryan C. Hunt - Wells Fargo Securities, LLC, Research Division
And just to keep along the same line of questioning and the same -- can you talk about maybe what new products over the last 3 years, whether it's packaging, innovation, in the U.K. contribute to the top line relative to the United States?
Jerry S. G. Fowden
Yes. I mean in our U.K.
business, we have in excess of 20% of that business in volumes of this contract manufacturing. Around 12% to 15% of the business in the U.K.
is control brands. Around 30% of the business in the U.K.
is energy, sports or new age business. And it's those far greater penetrations of those sectors that drive to an overall business shape that is much more different in U.K./Europe than in the U.S..
Now Canada has made great progress along those same lines over the past 2 to 3 years with our recent growth in our non-private label business in Canada being up in excess of 30%. But what we need to do is really get that same kind of focus moving within the U.S..
And it's for that reason that we've added more management resource, the addition of Steve Kitching; the addition of a new commercial resource in the contract manufacturing area to really drive those areas: new age, control brands, energy and sports, contract manufacturing; finding some initial ways to penetrate food service; all the things that are in line with our product, pack and channel diversification strategy.
Bryan C. Hunt - Wells Fargo Securities, LLC, Research Division
And I guess, when you talk about non-private label growth in Canada, that would include Red Rain?
Jerry S. G. Fowden
We have Red Rain, we have other premium products that are in private label but don't reflect the same normal trends and characteristics of private label: 100% sparkling juice, all-natural, still and carbonated products; recent additions of Golden Sea as a juice drink; recent launches of sparkling 8.4-ounce fruit and veggie products; substantial volumes of contract packing of alcohol products and ready-to-drink 4% to 6% alcohol products. All of those are what's contributing to that Canadian mix shift.
We currently have plans by the end of quarter 2 to have our alcohol packing capability up and running in the U.S.; by around September to have our first 2 pouch fillers up and running in the U.S.. As I mentioned, we're adding this contract manufacturing commercial sales force and I believe we will have some contract manufacturing wins towards the back end of this year.
All very much following the tried and tested formula that we have executed in the U.K. and Canada.
Operator
[Operator Instructions] Our next question comes from the line of Mark Swartzberg with Stifel, Nicolaus.
Mark D. Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division
Also trying to better understand what's happening here from a North American mix perspective and some of what you've shared with us is helpful. I wonder if also another factor here is per case economics.
Are we seeing any degrade in per case economics for some of your core carbonated products or some of your core juice products? And that's kind of part one.
And part two, if that's the case, is that more because you're kicking up promotions or because you're choosing to spend more behind the products? I'm not sure it's a fair assessment, but trying to get a better understanding there.
Jerry S. G. Fowden
Good question, Mark. I mean, I think that, by far and away, the largest factors are volumes lower than we wanted, inventory levels were higher than we wanted, so some of our de-crewing during the quarter was even greater than the volume performance.
And that's impacted our fixed cost recoveries. So that, by far, in a way, is the largest degree.
The fact that we were down on CSDs and slightly up in volumes, slightly up in market share on juices, has had an overall mix effect on our margins because our juice margins, with the step-up of assets of the acquisition of Cliffstar, our juice reported margins are lower than our CSD margins. And therefore, that mix effect has had a slight impact on margins.
When you look at things on a case-by-case basis, I do not see that -- a kind of deterioration in the margin on each case-by-case basis is behind this, other than in the water category, whereas we've said that's an unattractive category from Cott's perspective.
Mark D. Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division
Okay, so that's helpful. So it really is -- it sounds like if you're trying to take a #1 cause, it's simply that the absolute level of carbonated performance is not what you had hoped?
Jerry S. G. Fowden
Correct. And as I kicked off, while it's not down as much as it was in the back end of last year, it was lower than we would've wished.
And we're disappointed in that performance.
Mark D. Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division
Right. And your making management changes, is it -- it's early, but here we are day 1 of May, it happens to be a sunny day in this part of the country, is there anything that makes you feel better or worse about a, the category; and b, the way competition is playing out heading into peak season?
Jerry S. G. Fowden
Yes. Good question again.
And let me just step back. I mean, we changed Steve into the U.S.
in March. I think you'll all appreciate, when you move people across the Atlantic, we probably started those discussions quite away before that, so I wouldn't want anyone drawing a kind of conclusion: this quarter's performance, therefore, we changed someone in the middle of that quarter.
This desire to increase our resource in the U.S. to get the U.S.
moving quicker and faster in the direction of our other business units was something that we started talking about in the middle of last year. So given the earlier couple of questions, I wouldn't want people to take the coincidence of timing and put those things together.
Coming back to your kind of question, we don't see the carbonated soft drink market, in particular, picking up at the moment. I think most people know, we've always build a kind of strategic plan around a 1% to 3% modest decline in the carbonated soft drink market.
So after 4.3% decline last year and a 4.4% decline in that overall market, quarter 1 this year, that is running ahead of the level we had expected, even despite the significant step-up in above the lines of pull in marketing activity that many of the national brands have done.
Mark D. Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division
[Operator Instructions] There are no further questions at this time. I would like to turn the floor back over to management for any closing remarks you may have.
Michael Massi
Thank you very much for joining our call today. This will conclude Cott Corporation's first quarter call.