Katie Turner - ICR Inc. Billy Prim - Chairman and CEO Matt Sheehan - President and COO Mark Castaneda - CFO

Reed Anderson - Northland Securities Matt Blazei - Lake Street Capital Kara Anderson - B. Riley & Company Mike Petusky - Barrington Research

Thank you. Good afternoon, and welcome to Primo Water's first quarter 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 4:05 p.m.

Eastern Time. If you have not received today's press release, it is available on the Investor Relations portion of Primo Water's website at www.primowater.com.

This call is being webcast and a replay will be available on the company's website. Before we begin, we'd like to remind everyone that the prepared remarks contain forward-looking statements including financial guidance and Management may make additional forward-looking statements in response to your questions.

The forward-looking statements should be considered within the meaning of the applicable securities laws and regulations regarding such statements. Many factors could cause actual results to differ materially from those forward-looking statements and we can give no assurance of their accuracy and Primo Water assumes no obligation to update them.

We encourage participants to carefully read the section on forward-looking statements included in the press release issued this afternoon and in all documents that Primo Water files with the SEC. And now, I’d like to turn the call over to Primo Water CEO, Billy Prim.

Thank you, Katie. Good afternoon, everyone, and thank you for joining us today to review our first quarter 2016 results.

I’ll begin today's call by providing a few highlights on our recent quarter and trends in our business. Then Matt will update us on the progress with our key strategies.

Finally, Mark will review our financial information in more detail and our outlook for the second quarter and the remainder of the year. During our last earnings call, we covered in detail the positive macro trends propelling the water industry along with the challenges consumers are facing with drinking water quality.

These trends remain unchanged and we believe we are getting close to a tipping point where more and more households return to bulk water purchased at retail for their drinking needs. Primo remains well positioned as the trusted solution for consumers throughout the U.S.

and Canada, as well as a critical partner for our retailers who are looking to expand their bulk water offerings. In the quarter, we executed throughout the entire organization once again growing at a level that differentiates us and the current economic environment.

Our team delivered above our expectations across the Board. We capitalize on an acceleration in dispenser purchases and conversion of these purchases into new water households consuming either refill or exchange water.

In the first quarter, sales increased nearly 11% to $32.3 million and adjusted EBITDA grew over 34% to $4.9 million. This was above the high end of our guidance for both sales and adjusted EBITDA.

Also in the first quarter, we experienced some of the harsh growth rates ever in our dispenser sales which occurred during a seasonally weak quarter for consumer dispenser purchases. This gives us confidence in the future of our bulk water sales.

This momentum help drive same store unit growth in our U.S. exchange business of 9.3%.

Additionally this marks the 16th consecutive quarter of 8.5% or higher same-store unit growth in our U.S. exchange business.

Based on the strong start to the year, we are raising our full year guidance which Mark will discuss in greater detail. We believe the macro and broader consumer trends confirm that Primo Water is well positioned to achieve our long term strategic objectives.

We ended the quarter with approximately 26,000 retail locations and continue to believe we can grow this number to 50,000 to 60,000 over the next several years. With that overview, I will now turn the call over to Matt to discuss our key strategies in more detail.

Thank you, Billy. As a reminder we have six key strategies.

First, grow household penetration of dispensers. Second, improve connectivity of our dispensers and our water.

Third, increase retail outlets. Fourth, drive unit economics.

Fifth, highly engaged teams and lastly, doing all of these while living our company values. I would like to provide an update on a few of these key strategies.

Grow household penetration dispensers; in the first quarter dispenser sell through was up 22% to 146,000 units. This marks the second consecutive quarter with 20% growth in dispenser sell through.

We believe this is due to a few key items. First, the increased consumer focused on healthy living, as well as the concerns over drinking water quality.

Second, retail partners having the right assortment of products available on shelf for consumers. And third, heightened focus by our team on managing in stock levels with our retail partners.

The growth in sales was consistent across our lineup of dispensers confirming that we have the right on trend offering for consumers. The tremendous growth we experienced in dispensers help to drive an 8.3% increase in overall water sales led by a 9.3% increase in same storage units and our U.S.

exchange business. As Billy mentioned, the same-store unit growth of nearly 10% over the last four years despite an ever increasing base makes this trend even more impressive.

Additionally, we continue to see strong sales growth in our U.S. Refill business which grew 5.2% during the quarter.

Increased retail outlets, we have white space opportunity to expand locations in new and existing retailers. As we have communicated, the timing of new locations is highly dependent on our retail partners.

We are fortunate to have strong unit growth across all of our businesses which helps to further our location base. During the first quarter, we had 300 retail locations, and over the last year we have added approximately 1500 net locations, so 300 additional locations in the quarter represented a mix of dispensers and water locations.

This provides Primo a great connectivity opportunity for consumers and our brand, as well as the faster ramp in sales for all segments. Drive unit economics.

Driving unit economics comes from increasing unit revenue, affectively managing and seeking improvements in operating costs, and decreasing capital spend per installation. As it relates to unit revenue, we will always balance gaining productivity from an existing location which is much more valuable versus the installation of a new location.

As a reminder, we have been driving consistent comp unit growth in our retail business for several years now. Moving on to operating costs, the first quarter was a great example of incremental leverage throughout the business model.

Here are some specific improvements that influenced results during the quarter and will have lasting impact throughout the year. First, an exchange, we saw gross margins increase to 31.2% during the quarter, up from 26.8% a year ago.

This is primarily due to improvements in distribution costs. Second, we have significantly improved the gross margins in the empty bottles that support our refill water sales.

Third, dispenser margins continue to see improvement during the quarter, resulting in 9.8% compared to 6.8%. The improvements in dispenser margins is due impart, to improve supply chain cost as well as the licensing model we continue to test with retail partners.

Lastly on capital spend pro-location we have two projects underway as we explore more efficient display and equipment solutions in exchange and refill business. We believe these will provide greater flexibility in the locations we have installed and drive greater ROI.

In summary, we are pleased with our execution today and excited about the opportunities ahead as we continue to deliver on our key strategic initiatives. With that, I will turn the call over to Mark.

Thanks, Matt. I'll review our first quarter financial results in more detail.

Then I'll provide the second quarter guidance followed by an update on our annual guidance. Lastly I will turn the call back over to Billy for closing remarks.

To help investors understand our operating results, we do provide adjusted EBITDA, which is a non-GAAP financial measure. A reconciliation of this can be found in today's earnings press release posted on our website.

We are very pleased with our financial results for the first quarter which exceeded our guidance for both sales and adjusted EBITDA. Top line growth for the first quarter was 10.6% to $32.3 million, driven by increases in both our water and dispenser segment.

Water sales increased by 8.3% driven by increases of 11.9% and 5.2% in the U.S. Exchange and U.S.

Refill businesses respectively. U.S.

exchange growth was driven by an increase in same-store units of approximately 9.3% compared to 8.6% in the prior year's first quarter. In our dispenser segment, sales increased 15.9% to $9.9 million.

This was ahead of our plan as retailers experienced in shipments to increase inventory for the peak season. Consumer purchases of dispensers in the quarter increased 22% to 146,000 units.

Consumer sell-through sales have accelerated to its highest level for the past two quarters, as we believe is due to consumer choosing healthier beverages, as well as heightened concern by the tap water. Moving down to P&L, gross margin percentage increased approximately 270 basis points to 28.9% compared to 26.2% in the prior year.

The increase in margin is due to gross margin expansion in both the water and dispenser segment primarily as a result of improvement as previously mentioned by that. We believe our gross margins will remain near this elevated levels through 2016.

Next, SG&A increased to $5 million from $4.7 million in the prior year. However as a percentage of sales, SG&A decreased 15.6% from 16% in the prior year.

We believe we can continue this leverage of our expenses in the future. Interest expense for the quarter decreased 9% to 500,000 as a result of lower debt balances.

Adjusted EBITDA increased 34.3% to $4.9 million from $3.7 million in the prior year driven by strong top line growth and margin expansion. The $4.9 million represents an EBITDA margin of 15.2% compared to 12.5% in the prior year.

On a GAAP basis net income increased to $1 million resulting in diluted earnings per share of $0.04 compared to a loss of $0.01 per share in the prior year's first quarter. Continuing on our balance sheet, we entered the first quarter with $1.1 million in cash, accounts receivable increased to $14.3 million from $11.1 million at December 31, 2015 primarily as a result of the timing of sales during the quarter.

Our revolving credit facility balance was $1.5 million with our total leverage ratio decreasing to $1.1 from $1.8 in the prior year. Seasonally we generally use more working capital in the first half of the year and generate more free cash flow in the back half of the year.

Turning to our outlook, for the second quarter and the remainder of 2016, we expect sales for the second quarter of $33.3 million to $34.3 million and due to better than expected results for the first quarter, we now expect sales for the full year to be in the range of $132.2 million to $134.2 million up slightly from our previous guidance. Looking at cash flow, for the second quarter we expect adjusted EBITDA up to be in the range of $5.5 million to $5.9 million for an EBITDA margin of 16% to 17% up from 14.3% in 2015.

We are also raising our outlook for 2016 as we now expect adjusted EBITDA to be in the range of $21.5 to $22.3 million up from our previous guidance. We continue to expect interest expense in approximately $1.9 million and CapEx to be in the range of $10 million to $12 million resulting in free cash flow between $7 million and $10 million.

I will now turn the call over to Billy for closing remarks.

Thanks Mark. We are very pleased with our start to 2016.

We appreciate the efforts of our dedicated employees, service providers and retail partners. Together we are executing on our mission of inspiring healthier homes through better water.

We remain intently focused on the execution of our strategic plan, to further grow our business and enhance long term shareholder value. This concludes our prepared remarks.

We are now ready for questions. Operator?

Thanks, good afternoon and congrats on another terrific quarter, good work. Just a couple of questions on my end, I think the big - not the big but the one that seem to jump off the page more than any first in my model was the dispenser side.

Even though it's not a huge million dollars this type of number, seeing that number grow on top of what was good growth last year, I think is very compelling. So do you characterize it kind of as - I don’t want to say a full forward but it’s kind of an acceleration of timing, shipments that kind of thing.

So I guess my question is, do you expect that segment to grow this year overall or does this kind of - whatever was expected this is it and then it's sort of flat in the back two or three quarters, just trying to get a sense of how that's going to look the next few quarters?

Yes, thank Reed. This is Mark.

We do the full year numbers which we ticked up a little bit but not significantly so kind of to what as you said, we did have some full forward more for inventory purposes for peak periods. So we don’t at this point expect a huge growth in that business on the revenue side, we do expect sell through growth as we talked before – the headwinds for the revenue side.

Okay, that helps. And I just want to make sure we don’t get too carried away, but I mean it’s a great start, I don’t want it to be loss to anyone.

And then just kind of related to that on the dispenser side, just curious were there any pricing or promotional activities that would have helped drive that as well or was it all pretty status quo other than the fact the inventory will go forward?

Reed, this is Matt, good question. It was very little on the pricing side, most of it was just the right assortment, better in stocks and frankly their trends keep going where more and more households want long term solutions in house.

That's great. And then the last question for me, Matt as long as you are there and respond to that one, I was just curious you had the brief comment and on the CapEx, you are testing a couple of things, I’m sure it’s too early to give any precision but just kind of curious order of magnitude what do you see as potential opportunity, it does not like a huge investment anyway but obviously you see some opportunity to make the economics even better.

What is the order of magnitude that might be available as you continue to do that?

Reed we're not really estimating the opportunity at this point but again as we drive unit economics, three ways to do it; drive the unit revenue, improve gross margins and then bring down CapEx. So what we’re trying to do is always make sure these are better consumer experience that help drive revenue and then make sure that the capital expense to do that is lower.

So it’s hard to give an estimate right now thought there are still projects but that’s what we are trying to drive.

Sounds good. I will let somebody else jump in the queue and I will come back later.

Thanks guys, good luck.

Hi guys, nice quarter as always. Just a couple of things, the previous caller was getting to that point but as you know and your model your dispenser sell-through is always a very high - highly correlated predictor of your water sales going forward.

And regional as a couple of quarters where you are approaching or exceeding 20% sell-through on dispensers, yet your guidance continues to be in sort of the high single digit for the water side. Is there a reason why that correlation has disconnected of anyway?

Matt it’s just one quarter end, we still have a long way to go and a peak season to go. So it's little too early for us to rate the guidance at this point.

Okay. But as far as you know there has been no change in terms of the correlation between dispenser sell-through and water sales?

No. We don’t believe there is a change.

We do believe as we add more household, sales households we need water - water in most of the cases.

Yes. You said you added 300 locations, was that a net number or gross number in the quarter?

No, the net number, Matt.

That was a net number. And is that, what we consider to expect quarterly throughout the year something in that range?

Our target as we continue to stay this 1500 to 2000 locations across the year, so you know quarter-to-quarter that could shift a bit.

And if I remember right, I think you mentioned you're going spend $9 million at CapEx, so that would be obviously to expand the locations and we have $7 million of free cash flow, are you anticipating that to mostly go to cash I mean debt pay down?

Yes, we expect our CapEx to be between 10 and 12 for the year, perhaps a little bit higher and the free cash flow would be paid on our revolver which is a 0.5 million today and then we would figure out what we will do with the rest of the free cash flow.

Got it. All right, great job as always you guys, thanks.

Hi, good afternoon guys. Just wondering if you can break out the location how water versus dispenser location.

Yes, there was again net 300 again that is a mix we had 100 water locations and 200 dispenser net location for the quarter.

And as far as driving water sales out of dispenser sell-through, what kind of strategies are you doing there, has anything changed?

On the dispenser side, it's really about assortment care and we continue to increase our location base and then make sure that assortment is right for those retailers and make sure their pricing is right and continue to promote that in store wherever we can and that’s clearly working fairly well so far.

Kara also one of the other things, those 100 water locations that we installed almost all of them are going in where we have dispensers and we've found a much higher correlation with the two in the same store.

I think previously you guys have talked about offering coupon along with the dispenser, is that still the case or there any other sort of things you trying to do - to drive attachment?

Yes, we’re doing a host of tested markets but the coupons are big ones so the majority of our dispensers that are sold have a coupon that comes with it and that certainly drives attachment.

Okay. And then has anything changed on the refill side, I mean I am seeing 5.3% growth in the quarter, this is up from kind of flattish, maybe slight growth that we have seen over last few years.

I am just wondering if there is anything new to update upon?

From our perspective Kara that continues to be really a great value proposition for the consumer, so I think the trends they're are driving refill but to give our teams some credit, we've worked really hard on the operation side, a lot of the changes we made with geometry and our core – our own employees servicing those units that's definitely driving some of that growth as well.

Okay. And then lastly you may have already touched on this with a previous caller's question, but are you still expecting the $5 million headwind in dispensers from currency and the new licensing model impacts in your guidance for the full year?

Yes we do, so we haven't changed our full year guidance that much and we gave a little bit of upside after Q1, but we still have several quarters to go before we start looking at significant changes.

Great. That's it for me.

Thank you.

Hi guys, I didn't catch if it was mentioned earlier, but how many of those 300 store ads were Wal-Mart?

Mike the majority were. We actually added - gross we had about 300 water locations added, but then you’ll always have some retail consolidation and some closures that netted our number down.

So we had a fairly good quarter from a new location add and the majority of those were Wal-Mart.

Okay. So those are like 90% plus or was it like two-thirds or any that would end all of it.

Little more than two-thirds.

Okay, all right, great. And then are you guys noticing any kind of shift at all either on the last quarter or over the last few quarters in terms of types of dispensers that are being sold, is there any move towards people kind of moving up the food chain, buying in more expensive products or are you not really seeing anything there?

Mike, we've seen a movement in both ways so folks are buying up, if they've already had a dispenser they'll buy up to a bigger unit or more expensive unit. And then frankly we’ve seen a lot of folks enter the category with some of the pumps or tabletops the smaller units that are more entry vehicles for them in the category, so we’re seeing growth on both sides.

Okay. Is there any way for you guys to on - that's something these low end products I mean to essentially track that business and try to encourage moving up the food chain or no?

We have done a little bit of that but with these being sold at retail, we don't have information on every consumer that buys our product but we continue to get some of that information and try to promote that accordingly. So that's something we'll continue to push because we clearly understand the benefit as you see it.

Yes. And I guess the only other question I have, obviously you guys are not particularly levered at this point, you're generating cash most quarters financially you're probably about as well positioned as you've been in the last several years.

Is there any M&A or anything to do out there that you guys are saying that's interesting, I mean are there opportunities for you to grow externally?

Mike I think we continue to look at opportunities but as we look at opportunity, we really realize how much our core businesses are performing and growing and so we look to invest our capital into the core businesses that we're operating today.

All right, fair enough, makes sense, thanks.

I want to thank you for your participation on today's call and interest in Primo Water. We look forward to providing you with an update on our business progress when we report the second quarter earnings.

Have a good evening.