Aug 13, 2013
Executives
Katie M. Turner - Managing Director of Healthy Living, Packaged Food, Supermarket & Food Distribution Companies Billy D.
Prim - Founder, Chairman and Chief Executive Officer Matt Sheehan - President and Chief Operating Officer Mark Castaneda - Chief Financial Officer, Secretary and Assistant Treasurer
Analysts
Eric Wagoner Robert D. Strauss - Gilford Securities Inc., Research Division
Operator
Good day, ladies and gentlemen, and welcome to the Primo Water Corporation Second Quarter 2013 Financial Results Conference Call. [Operator Instructions] As a reminder, today's conference call may be recorded.
I would now like to introduce your host for today's conference, Ms. Katie Turner from ICR.
Ma'am, you may begin.
Katie M. Turner
Thank you. Good afternoon, and welcome to Primo Water's Second Quarter 2013 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 4:05 p.m.
Eastern Time. If you've 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, and management may make additional forward-looking statements in response to your questions.
The forward-looking statements should be considered with 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's CEO, Billy Prim.
Billy D. Prim
Thank you, Katie, and thank you for joining us on the call. I'm going to start out with a few comments on where we are in our core business, and then turn the call over to Matt Sheehan, who will go a little deeper in our operational initiatives.
Then Mark Castaneda will give you a second quarter 2013 financial recap and our outlook for the remainder of 2013. In the second quarter, we built off the momentum from last quarter and delivered another strong financial performance, which exceeded our expectations.
We are pleased to report our sixth consecutive quarter of positive adjusted EBITDA underscoring our successful execution and cost management improvements across our core business. We continue to see the benefit from our strategic decision to discontinue the Flavorstation sparkling business and focus on our core Water and Dispenser businesses.
In second quarter, we had several positives to note. First, our Water revenue grew.
Both our Refill and Exchange revenues are up. Secondly, our Dispenser sales to consumers was up.
We sold almost 20% more dispensers to consumers in the second quarter of this year versus last year. Dispenser sales into the retail channel will always be somewhat lumpy because of retailers' managing inventory.
But the consumer sales is the number that drives future water growth. Thirdly, our adjusted EBITDA increased almost 78%.
Lastly, and most importantly, we generated strong cash flow from operations, more than $5.7 million for the first 6 months of this year. Our team has made excellent progress on the initiatives we laid out at the beginning of the year.
Those were: First, to solidify the foundation of our core businesses; secondly was to refinance our debt to lower cost of capital; and third was to grow our core Water and Dispenser businesses. While solidifying the foundation of our core businesses, our gross margins continue to rise, and our SG&A continues to be lower as a percentage of sales.
We will continue to focus our efforts on managing the controllable aspects of our business to help enable our gross margin improvements to continue long term. As for refinancing, we refinanced our debt with Comvest to allow for increased capacity at a lower rate.
We believe this is the first step in a long process. As our trailing EBITDA grows, we will continue to lower our cost of capital and increase our capacity in tranches every few months.
Thirdly, our core Water and Dispenser growth. Based on our strong efforts to solidify the foundation of our core Water and Dispenser businesses, we now believe we are positioned better than ever before with the right team to grow same-store sales and the number of locations offering our water and dispensers.
Same-store sales of U.S. Exchange and Water Dispensers are on track, and we expect this trend to continue as we increase new location growth and enhance growth to existing customers.
Refill, after being flat to down, is also growing again. We believe as we lower our cost of capital, we will increase the rate of location growth going into 2014 and beyond.
Overall, based on the execution of our strategic plan and the strength of our operational results year-to-date, we are well positioned for positive growth and increased EBITDA long term. We are now raising the adjusted EBITDA guidance, which Mark will review later in the call.
With our focus on operational execution, we are well positioned to continue delivering improved financial results, both this year and years to come. We have a compelling product offering that will enable us to capitalize on America's growing interest in health and wellness, and we have only scratched the surface of our market's potential.
And importantly, we have a strong leadership team that is committed to creating long-term value and growth for Primo Water. As some of you may have seen, we have recently announced promotions and additions to our senior management team.
We believe that these enhancements to our corporate structure will help us as we focus on expanding our business. Matt Sheehan was promoted to President and Chief Operating Officer.
Rick Belmont, who has been with the company in various roles since 2009, was promoted to Senior Vice President of Consumer Innovation and Global Sourcing. And lastly, we hired Mary Leonard as Senior Vice President and General Manager of U.S.
Water. With that brief overview, I'll turn it over to Matt Sheehan, our President and Chief Operating Officer.
Matt Sheehan
Thank you, Billy. As we have consistently done this year, I'd like to provide an update on our foundational execution plan.
This plan continues to strengthen our proposition to our consumers and retail clients, while delivering stronger financial results. We continue our relentless operational focus on the core business by driving better service levels and growth, along with stronger economics.
Our talented team continues to successfully execute against our 3 core themes: consumer and retailer focus, simplicity and analytics. With these major themes in mind and the goal of improving our unit economics to provide more productivity per store, we have matured the way we put actions against these themes, as well as allocate resources.
We have constructed a project structure and format that is beginning to show dividends. We now review any project on how it supports our themes and how it increases unit revenue, decreases cost of goods sold or reduces CapEx.
Each project has an executive sponsor and an analyst along with a cross functional team. Further, we're refining our ability to test different operational concepts and improvements using statistical planning and analysis.
This is all important as we deliberately improve our business at a unit level and have built a structure to do so. With this project structure in mind, here are a few updates on the progress we have and will continue to make.
In our Refill business, we are getting our arms wrapped around how to drive demand through empty bottle merchandising and execution. We continue to expand our company-owned operations in Refill to improve service and reduce cost.
This will not only improve our uptime for consumers, it will greatly improve our service levels to our retail partners. We have begun our national rollout and implementation of our remote management technology called Telemetry, which will increase unit uptime and revenue, improve service and reduce service costs.
This technology will arm our Refill business with the best monitoring software in the market and continue to strengthen our relationships with retailers. In our Exchange business, we are designing and beginning to test lower cost equipment while improving the consumer experience.
We are testing several concepts on improving our capital optimization through demand analysis and in-store placement optimization. Corporately, or across divisions, we have seen the expected improvements in how we measure our business after this first year of running the business through a balanced scorecard process.
And we have created external scorecards for all of our service providers, giving us tremendous insights and control of the service levels in the business. Within these scorecards, we are measuring: in-stock rates, which drive revenue; trip frequency, which drives store-level relationships, and anesthetics and other service metrics that either drive revenue or keep costs in line.
In addition to our focus on operational projects, our focus on increasing connection with consumers and analytics, while still early in the process, is expanding our understanding of consumers. This will help to increase our value proposition and demand by understanding a few things: First, how stores, with all 3 of our offerings, perform better in each offering than stores without the entire portfolio.
Two, our consumer segmentation within each business line are matching up to other business lines, opening up ways to combine purchase and increase market basket size. Three, how demographics drive each of our business units.
And lastly, affirming that average household continues to purchase our Exchange product a remarkable 35x a year, which drives significant repeat traffic to our retail clients and how those consumers also spend money in the stores. Our focus on improving our unit economics is driving increased per location performance, effectively strengthening our business without significant capital needs and driving stronger performance for our retail clients.
With this, we are beginning to grow our sales team to strengthen our retailer relationships and grow our footprint. All in, we have attracted some incredible talent, are measuring our business daily and continue to improve performance.
Now I will turn the call over to Mark to review our financial results for the second quarter.
Mark Castaneda
Thanks, Matt. I'm going to review the second quarter financial results in a little more detail.
To help investors understand our operating results, we do provide certain non-GAAP financial measures, including adjusted EBITDA, which I'll discuss in a few minutes. Overall, as Billy mentioned, we delivered a strong financial performance in the quarter, as we continue to generate significantly more EBITDA from sales as a result of improved gross margins and lower overall SG&A spend.
As expected, total sales for the quarter decreased 3.2% to $23.8 million compared to $24.6 million for the second quarter of 2012. The decrease reflects the anticipated lower Dispenser sales as compared to last year, due to channel fill for a new retailer in the prior year.
Drilling into the top line. Our recurring Water revenue increased 5.5% to $16.2 million.
Our second quarter Water revenue reflected an increase of 8.6% in Exchange sales, driven by strong same-store unit growth in the U.S. Exchange of 10.6%.
We are also pleased that the Refill sales improved 1.8%, driven by an increase in locations and improved sales of empty bottles versus the prior year's quarter. Dispenser units sell-through to end consumers increased nearly 20% to a record of 119,000 units in the second quarter of 2013.
This also represents an acceleration of growth compared to the first quarter of 2013. We continue to believe that the increased household penetration of water dispensers will lead to increase recurring Water sales.
Our gross margin increased a solid 460 basis points to 24.7% for the second quarter from 20.1% in the prior year, which is driven by improvements in both Water and Dispenser gross margins. Gross margin for the Water segment increased to 34.1% compared to 31.8% in the second quarter, reflecting improvements in Exchange and Refill margins, primarily due to improved supply chain cost management.
Gross margin for the Dispenser segment increased to 4.8% from 0.7% the prior year, primarily due to retail margin management over the past year. Next, we continue to see improvements in SG&A spend, which decreased 7% to $4 million.
As a percentage of net sales, SG&A decreased to 16.8% from 17.5%. The improvements are a result of focusing the cost structure to align with our core business.
Our adjusted EBITDA increased 77.9% to $2.3 million, which was above the high-end of our guidance range. This strong improvement underscores our ability to leverage our business model, and we view this growth as particularly notable, given the slight decline in top line sales for the quarter.
Our net loss from continuing operations improved to $2.1 million or $0.09 per share from $13.6 million loss or $0.58 per share in the prior year. Net loss from continuing operations in the second quarter of last year was primarily impacted by a noncash goodwill impairment charge of $11.5 million in the Water segment.
On a non-GAAP pro forma fully taxed basis, net loss per share from continuing operations improved to $0.04 compared to a $0.05 loss in the prior year. We do not expect to pay cash taxes in the near term due to net operating loss carryforwards.
In the first 6 months of 2013, the cash flow from operations increased significantly to $5.7 million compared to just $1.3 million in the prior year. The increase in cash flow from operations resulted in free cash flow of $2.5 million during the first half of 2013 compared to negative free cash flow of $1.1 million in the first 6 months of the prior year.
We define free cash flow as cash flow from operations less cash used in investing activities or CapEx. Continuing onto the balance sheet.
Highlights for the quarter include the reduction of about $2.1 million in debt compared to year-end 2012, which was funded by operations and improvements in working capital. Our accounts receivable decreased $4 million from June of the prior year as a result of improved cash flow management.
Our DSO improved to 34.5 days from 45.1 days in December of 2012. We also announced we amended our term loan, which resulted in improved terms and reduced borrowing costs by 350 basis points.
We believe that the debt refinancing is a reflection of our improved credit quality, underscoring the improvements we have made in our business over the past year. Turning to our outlook.
We are raising our full year guidance for adjusted EBITDA, which is now expected to be in the range of $9.3 million to $9.5 million. We continue to expect full year net sales to increase 2% to 4% to $93.3 million to $95.2 million and our full year Water segment net sales to increase between 5% and 7% to $65.8 million to $67.1 million.
For the third quarter, we expect net sales to be in the range of $26 million to $27 million, and adjusted EBITDA to be in the range of $2.5 million to $2.8 million or an increase of approximately 36% to 52% over the prior year's third quarter. We also continue to expect capital expenditures to be in the range of between $2 million to $3 million for the remainder of the year.
Our anticipated capital expenditures are related primarily to growth for our Water segment and rollout of Telemetry technology. We believe we have sufficient debt capacity to continue to invest in growth and add new locations.
This concludes our financial review. Now I'd like to turn the call back over to Billy.
Billy D. Prim
Thanks, Mark. We remain focused on growing our core Water and Dispenser business, and we remain confident that we will continue to add dispensers to households, which, in turn, will lead to continued reoccurring Water sales.
Industry dynamics remain positive for us. A growing number of consumers are increasingly focused on improving their health and wellness, and as a result, are consuming more water in place of high-calorie beverages.
Earlier this year, a report from the International Bottled Water Association noted that in 2012, both overall consumption of bottled water and per-capita consumption of bottled water increased in the mid-single digits. On the other hand, we have seen a slow in sales trends from major soda companies.
We feel that we are well positioned to capitalize on this increased volume of water consumption and look forward to continuing to execute on our strategies and deliver a long-term sustainable growth for Primo. Thanks for your participation today.
Operator, we will now open the call for questions.
Operator
[Operator Instructions] I'm showing we have a question from the line of Eric Wagoner from Source Capital.
Eric Wagoner
Billy, you guys had a good quarter. I just wanted to touch base if you could go over the dispenser unit sells-thru versus sell-in because actually, the [indiscernible] if you look at the numbers that makes [indiscernible] on the [indiscernible] [indiscernible].
Billy D. Prim
Okay. Sales -- Eric, you were cutting out a little bit, but just to interpret it, if the question is that sell-in of dispensers to retailers was down, but sell-in -- sell-through to consumers was up.
That's part of the, what I call, the lumpiness of the Dispenser business. Sell-through to consumers has continually increased quarter-to-quarter, but some quarters, because retailers are managing inventory, you don't sell as much to retailers.
Last year, in the second quarter, we had a major rollout to a retailer to add a lot of dispensers into the channel. So therefore, it sort of skews the year-to-year numbers.
Eric Wagoner
Okay. And one other question in that regard, you were talking about the, in the last conference call, dispenser sales going forward, do you see dispenser sales being a profit center as opposed to kind of a breakeven.
Or can you talk about the pricing of dispensers to the retailer and to the -- to the sell-in?
Billy D. Prim
As for pricing and profits in Dispensers, kudos to Rick Belmont and his team who've done an excellent job of really managing that business. And they've managed to supply same dynamics and have taken that gross margin from a, basically, breakeven or negative gross margin and increased it steadily over the next -- over the last year, and I think that, that will continue.
I don't see it breaking double digits or anything. We're not -- it's just not a category that's going to be a major profit contributor, but we do see it as a profit center, and is our major initiative to drive new households.
Mark Castaneda
And Eric, I'll add to that a little bit. The improvement in the operating results for the Dispenser segment was about a negative $800,000 last year on the EBITDA line, and it is a positive $250,000 this year or about $1 million improvement on the EBITDA line versus last year.
So we've made great strides and turned that from a big negative to a slight positive, and we expect that positive to be positive EBITDA for this year.
Operator
Our next question comes from the line of Robert Strauss with Gilford Securities.
Robert D. Strauss - Gilford Securities Inc., Research Division
Mark, I have a bunch of questions for you, so I'm just going to kind of rattle them off. First, let's just talk about the cost structure of the business a little bit.
I know you've reduced, over last year, the cost structure quite a bit. Where are you in that process?
And is there more to go?
Mark Castaneda
Yes, we've done a lot of reductions in the SG&A side. And SG&A, you'll see it show up in corporate, as well as in each of the segments.
And that's one of the big reasons or one of the reasons why we did have an improvement -- such large improvements in EBITDA. We believe we're finished with those changes in cost structure.
We probably went a little bit farther than we needed to go, and we'll probably add some of those -- add a little bit of cost back into next year. So we're finished with the cuts in costs.
Robert D. Strauss - Gilford Securities Inc., Research Division
Okay. And then your NOLs, where did that end up at the end of the quarter?
Mark Castaneda
We're around $100 million in NOLs.
Robert D. Strauss - Gilford Securities Inc., Research Division
Okay. And then when I think about the potential growth rate for the Exchange and Refill sales, as I look kind of, not next quarter or so, but longer term, what do you think reasonable growth rates for those businesses are?
Mark Castaneda
Well, what we've shared for this year for guidance on the Water segment, we did say that the growth rate would continue in the 7% to -- kind of 7% to 8% range. And that's really a little bit skewed because the Exchange growth rate will be much higher than that.
And the Refill growth rate has been flat to up 1%. So we do see Exchange growing at a much faster growth rate than the Refill business.
Robert D. Strauss - Gilford Securities Inc., Research Division
And what strategies are you implementing to, I guess, grow that Refill business quicker?
Billy D. Prim
I would add to that, Robert, what you're going to see is we really needed to go back and make sure our executional strategies were in place. You will now see -- and we have added people to the sales team, and you will see us start to increased locations, especially going into the first of next year and get those growth rates back up in double digits in both categories.
Robert D. Strauss - Gilford Securities Inc., Research Division
Okay. And then just moving on to, Mark, channel inventory.
What's the quality of your inventory now in the channel? And then also, maybe you can give me a percent of the inventory that you consider obsolete.
Mark Castaneda
Yes. The inventory and the channel is actually held by the retailers.
They don't push that inventory back to us if they're having trouble selling it. And they've brought inventory levels down at retail.
So inventory levels are down, and we see -- continue to see good strong sell-in. So we don't see any issues of any product coming back to us, so the quality of the inventory is very good.
Robert D. Strauss - Gilford Securities Inc., Research Division
And how much is that retail level inventory down year-over-year? Do you have that number?
Mark Castaneda
It really varies by retailer. So if you think about the clubs, they buy a much more in bulk, so they carry much heavier inventory than someone like a Wal-Mart, which will carry a less inventory.
It will be more just in time. So it really varies by inventory, but overall days, I have a check list between 5 and 7 days, I believe.
Robert D. Strauss - Gilford Securities Inc., Research Division
Okay. And then, do you have a target long-term gross profit margin level for where you see this business?
And whether that's a year out, 2 years out? But what's your long-term gross profit margin target level?
Mark Castaneda
So the current, for this quarter, was around 25%. And that's based on the mix of Water gross profit at around 35% and Dispensers, call it, between 5% and 10% gross margin.
We do see that 25% inching up to closer to 30%, as we do expect improved margins on the Water side of the business over the next few years. And we see the Water business growing at a faster rate than the Dispenser business, which would have changed the mix of higher margin business.
So instead of 25%, we see closer to 30% overall gross margins.
Robert D. Strauss - Gilford Securities Inc., Research Division
And we're thinking that the Dispenser 5% to 10% remains pretty much in that range, correct?
Mark Castaneda
Correct.
Operator
I'm not showing any further questions at this time. I'd like to go ahead and turn the call back over to management for closing remarks.
Billy D. Prim
Thank you, operator. I'd like to thank our employees, regional operators, refill service providers and our retail partners for their efforts and our growth and continued execution improvement.
We will continue to execute our long-term growth strategies of increasing locations to 50,000 to 60,000 retail points of distribution, increase the households through water dispenser sales and improve our operating results to achieve profitability and lowering our cost of capital. We 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
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect.
Everyone, have a great day.