Aug 2, 2015
Executives
Jarrod Langhans - Director, Investor Relations Jerry Fowden - Chief Executive Officer Jay Wells - Chief Financial Officer
Analysts
Perry Caicco - CIBC World Markets David Hartley - Credit Suisse Peter Schanzer - Jefferies Amit Sharma - BMO Capital Markets
Operator
Welcome to Cott Corporation’s Second Quarter 2015 Earnings Conference Call. All participants are currently in a listen-only mode.
This call will end now later than 11 a.m. The call is being webcast live on Cott’s website at www.cott.com and will be available for playback there until August 14, 2015.
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 conditions. Such statements include, but are not limited to, statements that relate to the company’s business strategy, anticipated de-leveraging, investment in organic and acquisition opportunities, including expected synergies and financial impacts related thereto, rules and expectations concerning our market position, future operations and estimated volumes, revenues, gross margin, EBITDA, free cash flow, capital expenditures, taxes and the impact of foreign exchange rates.
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 quarterly report on Form 10-Q for the quarter ended July 4, 2015. 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 second quarter 2015 earnings announcement released earlier this morning, as well as on the Investor Relations section on the company’s website at www.cott.com. I will now turn the call over to Jarrod Langhans, Cott’s Director of Investor Relations.
Jarrod Langhans
Good morning and thank you for joining our call. Today, I am here with Jerry Fowden, our Chief Executive Officer and Jay Wells, our Chief Financial Officer.
I would encourage everyone to review a copy of our press release issued this morning as we continue to receive feedback from analysts and shareholders and in turn work to provide schedules within the press release that will assist our shareholders, analysts and potential investors with understanding the operations of various business segments as we continue to diversify the company. With that said, Jerry will start this morning’s call with some of his observations on the quarter before turning the call over to Jay for a discussion of our second quarter of 2015 consolidated financial performance.
Jay will then turn the call back to Jerry, who will complete the call with his perspective on our second quarter 2015 performance, including an overview of our larger business units, as well as expectations for the remainder of the year. Following our prepared remarks, we will open the call up for questions.
With that, let me now turn the call over to Jerry.
Jerry Fowden
Thank you, Jarrod and good morning everyone. In summary, the quarter was a solid quarter, the new Cott.
With positive progression in a number of key areas such as gross margin, DS synergies, improvements in EBITDA and cash flow, albeit alongside lower revenues as expected. The quarter saw revenues of around $780 million, which while lower than some industry observers might have expected.
We are in line with our expectations. Thus I would like to spend a little more time on revenue in order to allow everyone to better model frames as we go forward.
As you may recall, we have in two recent external presentations highlighted why we believe revenue is not currently the best leading indicator for our business due to a combination of certain macro factors plus a significant shift in our business and customer mix as we alter the shape of the entire company. The revenue drivers and macro factors that play are the mix shift in our traditional business towards growth in contract manufacturing and other categories such as sparkling waters and away from private label CSDs and shelf-stable juices.
Despite lower revenue per case, this new business has comparable margins. We estimate this change our mix shift in our traditional business will lower our revenues by around 2% to 3% on a constant volume basis.
Second, the broader macro factor of foreign exchange and its impact on principally our UK, European and Canadian businesses, which for 2015 we see as a headwind of some 3% plus revenues. And third, the lower diesel costs leading to a reduction in the DS services energy fuel surcharge, which while having no effect on profitability is reducing DS services revenue growth by around 1%.
So, let’s look at the impacts of these and their effect on our Q2 revenues. Our consolidated global Q2 revenue of around $780 million was flat on our pro forma basis, excluding the $20 million of foreign exchange headwind.
So, let’s break this revenue down separately for our traditional business and DS services. In our traditional business, reported revenues were lower by 5% on flat volume in actual cases.
This reflects the impact of UK, European and Canadian foreign exchange, which accounted for around a 4% reduction, as well as the business mix shift towards contract manufacturing and other categories, which accounted for a further 2% to 3% reduction offset by around a 3% benefit from two incremental months of Aimia Foods, which will not be present as we go forward as we’ll begin fully lapping its history. Obviously, there are other normal movements in volume by category and channel going on, but foreign exchange and the shift in business mix are key to understanding, un-modeling our traditional business revenue performance as we go forward.
Then DS Services reported revenues were up 2.2%, but would have been up 3.1% on an adjusted basis without the reduction if energy fuel surcharge, as a result of lower diesel cost. This revenue performance was a little lower than we expected for the quarter, which predominantly reflects a softer 6-week period in May and early June for water consumption on the West Coast, especially in California which seems to have been impacted by a general conservatism following all the media coverage of the draft.
The latter part of June and early July saw water consumption improve. I hope that helps you understand and be better able to model our revenue as we go forward.
While these macro factors exist and our transition is underway, we believe the best leading indicators for cost performance are stable volumes, low cost full and efficient plants, DS consumption and customer growth alongside pricing, integration and synergy catchup which should drive improved gross margins, EBITDA growth and strong cash generation. I will now go on and cover gross margins, EBITDA and cash flow for our consolidated business, which what all areas have showed good progress within the quarter.
Quarter two 2015 saw good gross margins and gross margin progression from a combination of the more stable, traditional business volumes, tight operating and cost controls and ongoing cost reduction or war on waste programs plus DS synergies starting to come through. Overall, Q2 2015 gross margins were 30.9%, up from 14.4% last year, also look at it another way, up 230 basis points on a like-for-like pro forma basis.
This good gross margin performance was reflected in EBITDA with consolidated adjusted EBITDA of $108 million, or 13.8% adjusted EBITDA margin compared to 10.2% last year, with comparable pro forma like-for-like adjusted EBITDA margin up 110 basis points. This $108 million of adjusted EBITDA was up just under $7 million on a pro forma basis, despite a $4 million adverse foreign exchange impact during the quarter.
In addition, we were pleased with adjusted free cash flow for the quarter at $46 million, up around 35% versus last year’s adjusted free cash flow at $34 million. This free cash flow puts us in a good position as the year unfolds and we move into the more cash generative second half.
So on a consolidated basis, revenues were in line with our expectations, comparable gross margins were up 230 basis points, comparable adjusted EBITDA margins rose 110 basis points and adjusted free cash flow was up around 35%. With that said on our financial performance, I would now like to spend a little time on one of our strategic priority that’s being our full strategic priority of deleveraging the balance sheet.
In speaking with shareholders and investor subsequent to the DS Services acquisitions, we learn that there were significant interests for new potential investors albeit with some concerns about the level of our leverage subsequent to the acquisition. So with our shares trading at a higher price, we felt there were a number of reasons, why it was an appropriate time to initiate an equity offering and redeem the preferred shares issued in connection with the DS Services acquisition.
Importantly, the equity offering would not only accelerate our deleveraging timeframe by around the year, providing greater comfort to those new potential investors, but it would be financially appropriate in its own right. Given the non-deductible high and ratcheting dividend plus dividend tax on the preferred shares, around $17 million in 2015 rising to around $19 million in 2016.
But it also opened up the ability to after undertake highly value creative home and office water, and office coffee tuck-in customer acquisition which were effectively restricted by various governments within the preferred shares. I am pleased to say the equity offerings received good demand and with almost two times subscribed and allow us along with cash to fully redeem all the convertible and non-convertible preferred shares on June 11.
With this done we are now in the process of evaluating a number of DS Services small tuck-in acquisitions and have signed two asset purchase agreements, which should close towards the end of the third quarter and represents around $9 million of revenue and over 20,000 new customers. As we have mentioned externally, we anticipate around $10 million to $20 million of DS customer tuck-in acquisitions per year and we see an attractive pipeline of opportunities.
On this note, I would now like to pass over to Jay to cover our financial performance in more detail and expand on the details of our equity offering, preferred share redemption and our deleveraging.
Jay Wells
Thank you, Jerry and good morning everyone. Total volume excluding the impact of DS Services and concentrates was flat in servings.
As we saw additional contract manufacturing volumes the addition of Aimia Foods and growth in sparkling waters and mixers offset the market declines in both private label CSDs and shelf stable juices. Revenue in the second quarter was higher by approximately 42%, excluding DS Services and the $21 million impact of unfavorable foreign exchange rates.
Revenue was lower by adjustment of 1% as a result of product mix shifts within our traditional business. Our North America reporting segments accounted for around $10 million of product mix shift of which around half was from the shift into contract manufacturing and the other half for the shipment of other products such as sparkling waters.
Both at a private label CSDs and shelf-stable juices. As Jerry mentioned we expect to see this mix shift trends continue.
Gross margin for the quarter was 30.9% compared to 14.4%. Excluding DS Services, gross margin increased to 16.1% from 14.4% driven by the addition of the Aimia Foods higher margin business and cost inefficiency savings of $2.5 million, offset in part by the competitive environment in our UK operations and the negative impact of foreign exchange rates.
We have made good progress in our ongoing focus in our North America business unit to reduce production costs by $30 million over 3 years with $11 million of cost savings realized to-date. Warehousing is a good example of an area we are focusing on operational efficiencies.
As many of our plants operate with satellite or offsite warehousing and we have built-in shunts or shuttle cost in our system. These shuttle costs can be removed if we are able to add warehouse capacity on to our plants.
And have done so in Joplin, Missouri and San Bernardino, California where we have partnered with third party developers to build and lease warehouses better attached to our plants. The lease costs net against the costs already being incurred for the offsite locations and now products go straight from the plant production lines to the warehouse.
Thereby, removing the shuttle costs. Our most recent partnership with the developer to build a warehouse next to one of our facilities Metlife in Greer, South Carolina in June.
And we anticipate more projects such as this in North America and the UK over the next couple of years. We have previously noted that stable volume and our cost savings program should provide 100 basis points improvement in gross margin in our traditional business, with roughly a 50 basis point improvement in 2015 and a 50 basis point improvement in 2016.
Based on the positive improvements that we have seen today, we now believe we can achieve this 100 basis point gross margin improvement in 2015 and hold our margin stable in 2016. Turning to income tax, we continued to project the tax benefit of just under $20 million for the full year.
As discussed during our first quarter earnings call, we are calculating the quarterly income tax provision on a discrete basis rather than using the estimated annual effective rate for the year resulting in an income tax benefit of $1 million in the quarter. Cash taxes continue to be minimal with $1 million of cash taxes paid in the quarter.
As noted within our press release, we realized a foreign exchange charge in the quarter associated with the redemption of our preferred shares, that was a result of a non-cash charge of $12 million, despite issuing the shares in U.S. dollars as well as redeeming the shares in U.S.
dollars. This is due to the preferred shares being issued from our Canadian parent company whose functional currency is the Canadian dollar and we were required to record the issuance of the preferred shares in Canadian currency and to record a non-cash charge to the income statement as a result of the change in the Canadian exchange rate from the date of issuance to the date of redemption.
We did not incur any cash cost as a result of this accounting treatment. Adjusted net income and adjusted net income per diluted share were $18 million and $0.18 respectively, compared to adjusted net income of $17 million and adjusted net income per diluted share of $0.18.
The increase in adjusted net income was due primarily to an increase in operating income in our large business units, along side of tax benefit in the quarter. Offset part by an increase in interest expense as a result of additional debt from the DS Services acquisition, as well as additional depreciation and amortization from the step up of DS Services assets due to purchase accounting.
The additional amortization and depreciation for the quarter was just over $3 million. Adjusted EBITDA increased 93% to $108 million with the addition of DS Services along side growth in gross profit in our North American and UK operations, offset in part by a $4 million impact of unfavorable foreign exchange rates.
We continue to focus on our first strategic priority that being the 4Cs and controlling CapEx by managing projects tightly and vigorously managing working caporal. As a result, we saw adjusted free cash flow improved by $12 million during the quarter.
As we have discussed subsequent to the DS Services acquisition, our focus was on redeeming the preferred shares and further deleveraging the balance sheet. To that effect, we initiated a number of workgroups in order to identify methods of generating additional cash flow.
These workgroups developed a number of initiatives, including working with vendors, implementing sale leasebacks, offering a DRIP plan to our investors as well as issuing equity. As Jerry mentioned, we implemented a number of these initiatives, including the issuance of common stock with net proceeds of approximately $143 million, which was done in parallel with completing our sale leaseback of five of our facilities, which generated $40 million.
The proceeds of the common stock issuance and sale leaseback were used to redeem 100% for preferred shares that were issued as part of the DS Services acquisition as well as to reduce other debt obligations. As a result of these measures, additional projects in the pipeline and strong cash flow generation from our business operations, we believe that we are in a good position moving forward as it relates to rapidly de-leveraging the balance sheets.
With that said, we continue to expect the acquisition of DS Services to be accretive to adjusted free cash flows in 2015, with adjusted free cash flow projected to grow at an overall CAGR in the mid to high-teens from 2015 through 2018. I will now turn the call back to Jerry.
Jerry Fowden
Thanks, Jay. I will now review the performance in our larger reporting business units during the quarter.
Let’s start with DS Services. Overall revenues were up 2.2% to $257 million during the quarter with growth of 3.9% in the largest segment of home and office water delivery and growth of 12% in single cup coffee delivery and 7% in retail sales offset in part by a reduced energy fuel surcharge and lower sales in traditional brew basket coffee.
Overall, DS Services revenue on a energy surcharge-neutral basis, our like-for-like revenue increased 3.1%. Within home office water delivery, or HOD, the revenue growth of 3.9% was driven by an increase in average returnable 5-gallon and 3-gallon consumption, excluding Primo of 0.4% per customer location, an increase of 2.8% in average price per customer and a 0.7% increase in total customer numbers across all of home office deliveries.
As mentioned earlier, while we continue to see growth in water consumption per customer location, we experience some softness in consumption for a 6-week period in May and early June linked to what we believe to be a shorter term consumer behavior change as a result of the significant media retention around the drought and the need for water conservation on the West Coast, especially California. From the second half of June, we saw consumption rates move back up to prior levels.
DS Services gross margin continued to perform well within the quarter with adjusted gross margins of 61.1%, up 165 basis points on a pro forma like-for-like basis during this seasonally strong quarter supported by the operational gearing benefit of incremental customers and flat operating costs in the quarter within HOD as well as the capture of synergy benefits. Adjusted EBITDA reflected the benefits of this revenue growth and the positive operational leverage on gross margins and increased $3 million or 7% to $49 million.
On DS Services synergy and integration, we continue to make good progress with synergy benefits of $2 million in the quarter and $3 million year-to-date, thus good progress towards our $10 million 2015 target. It’s also important at this point to highlight the benefit of redeeming the prepared shares as the DS team now has the opportunity to progress small, highly value created tuck-in acquisitions.
As I noted earlier, we currently had two signed asset purchase agreements that represents a combined $11 million of revenue and over 20,000 new customers and we see an attracted pipeline of opportunities as we look out over the next 12 plus months. Now, turning to our North American business unit, our second quarter 2015 volumes were down just 0.6% in actual cases and 2% in servings driven by a decline in the CSD market in the channels where we operate and in private label CSD sales and shelf-stable juice sales, which were largely offset by our continued growth in contract manufacturing, which grew 7 million serving equivalent cases despite lapping a very strong 2014 second quarter, which was up 170% supported by high initial volumes in support of the new customers in addition to high single-digit percentage growth across sparkling waters and mixers.
Our North American revenues as previously explained tailed volumes at $359 million being down 4% on a foreign exchange neutral basis due to our mix shift into more contract manufacturing and other categories and away from private label CSDs and shelf-stable juices. Although these growth areas have lower revenue per case, as the brand owner normally provides the ingredients and packaging, the gross profit dollars are fairly consistent.
Gross margins increased 165 basis points to 14.5%, a North American EBITDA increased 9% to $39 million. This $39 million of adjusted EBITDA was supported by the relatively stable volumes and tight cost control, alongside our war on waste or efficiency programs.
In terms of the national brand promotional and pricing environment in CSDs, we saw an increase in activity two weeks pre and post the Memorial Day holiday in big box retail on two-liter PET and 12-pack, 12-ounce cans. This activity was at lower price points, many $2.50, a 12-pack can promotions and lasted a little longer than we would have expected or liked.
Despite this activity, we saw our CSD volume fall around 3% versus a total category CSD volume decline of around 5% in the same channels where we compete. IRI data shows that national brand players have remained more price aggressive in large format retailers than they have in other channels, where they have pushed higher pricing a more favorable price pack and mix actions harder.
Again, it’s worthy of note that we managed to hold our total North American volume to a 0.6% decline with the growth in contract manufacturing and other areas largely offsetting these CSD declines. All-in-all, we continue to believe our North American business is in a more stable position.
Next, turning to the UK, our UK volumes rose 10% in total servings due primarily to the addition of two months of incremental Aimia volumes. If you recall, we closed on this acquisition at the end of May 2014 as well as growth in contract manufacturing in our traditional business, which offsets some general market and private label softness.
Revenues decreased 3% in U.S. dollar terms to $154 million, but increased 7% in local currency driven by the increased volumes partly offset by product mix shifts to contract manufacturing and other categories within the UK.
We continue to believe that over and above the adverse effects of foreign exchange on the translation of earnings, the market and competitive environment for our traditional business within the UK will be challenging for the next couple of years. With national brand pricing pressure within the energy category and increase in low cost imports from a devalued zero plus the significant restructuring business change and commercial pressure within the UK multiple grocery channels as it works out how to better compete with the dramatic rise in fortune of half discount retailers within the UK.
Again to this backdrop, we will continue to run our UK operations tightly focused on customer service and believe the more diverse mix and capabilities of our UK business better positions us today to limit these impacts versus where we would have been just a few years ago. To summarize the second quarter and look out to 2015 as a whole, we remained focused on DS Services integration and synergy capture and we expect DS Services to continue to deliver customer growth as we moved through the second half of 2015.
In addition, our North American business unit continues to demonstrate broad volume stability as contract manufacturing wins and growth in other categories broadly offset CSD and other private label declines. This in turn allows our plants to stay well utilized and efficient and allows some of the benefits of our war on waste or cost efficiency actions to show up in gross margin EBITDA and importantly cash flow.
While I would not say the subjective, the market or competitive environment is easy. We will stay focused on this plan as it bodes a lower risk, more diversified North American traditional business platform and is an essential part of new Cott’s wider cash generation, diversification and deleveraging strategy.
While talking about cash generation our 4Cs approach remains central to everything we do. And we will continue to focus on cash generation, which will see us continue to manage 2015 capital expenditure tightly at around $120 million, split $50 million for our traditional business and $65 million to $70 million for DS, but the one-time $5 million DS Services integration capital expenditure previously communicated.
As it relates to cash taxes, we still expect our cash taxes to be minimal in 2015 at $3 million to $6 million. On commodities it’s pleasing to see 2015 as the year when commodities on a net basis have been fairly benign once foreign exchange and high end niche fruit costs as well as our advanced coverages and hedges are all added up.
A short update on commodities, we are well hedged on our menu, PET resin had dipped a little in quarter one, following the oil price softness. However, its firmed some $0.04 to $0.05 during quarter two and this continued to firm over recent weeks.
On corn, we are fully covered for 2015 and the initial 2016 indications after higher corn costs as well as conversion costs. As recent cold weather is impacting U.S.
corn yields and the closure of a major mill in Tennessee is likely to drive higher HFCS conversion costs. On fruits, very little has changed during the quarter, for the larger fruits and higher prices alongside occasional shortages persist on certain smaller fruits such as lemon, lime, raspberry and prune, with lemon being an important ingredient not just in juices but also in many CSD concentrates.
As an update on foreign exchange we anticipate that FX will impact our top line by three plus percent in 2015. However, at this stage we do not see a need to update the previous estimates that foreign exchange provides $10 million to $12 million 2015 EBITDA headwind.
In closing, we have a clear strategy, strong cash generation and we are pleased with the performance for new Cott as a whole this quarter, which when we look at all aspects together, we would describe a solid and on track. We believe the equity issuance, its associated dividend and tax reduction improved interest cover and the accelerated deleveraging it’s allowed.
Along side, the ability to pursue value created DS, HOD water and office coffee tuck-in acquisitions is an attractive development during the quarter, that positions things well as we look forward. So on that note, I would now like to turn the call back to Jarrod, to open up our question-and-answer session.
Jarrod Langhans
Thank you, Jay and Jerry. During the Q&A, so that we can hear from as many of you as possible, we would ask for a limit of one question and one follow-up per person.
Thank you for your time. Operator, please open up the line for questions.
Operator
Thank you. [Operator Instructions] We will take your first question from Perry Caicco from CIBC World Markets.
Perry Caicco
Thank you. Good morning.
I was wondering if you could describe the two acquisitions, give us a little bit more information perhaps the multiple or the EBITDA that would be represented by those?
Jerry Fowden
Yes. Hi Perry, good question and good morning to you, that’s pretty much in line with a broad half line shape that we have discussed in the past and but just remind ourselves of that which is normally you buy these things at about one-times revenue and they synergize down very quickly within a month or so to about three times post synergy EBITDA over that cost.
But without naming them, one of them has about 13,000 coolers at customer locations and around 5,000 water only customers as well. It doesn’t do any coffee and it has 30 to 40 odd routes.
The other one is smaller, just under 4,000 customers, just under a couple of thousand cooler rental customers with another just under a couple of hundred – couple of thousand water only customers and may have a limited number of routes plus or minus kind of five. So they are very much in this typical standard of small tuck-in acquisitions, but we have put material out there on the path which if you recall Perry shows that these kind of things are a low cost and value created way of gaining new customers.
Actually more cost effective doing it this way than quite a number of the marketing programs that they used to attract new customers, but happy to expand on that, if that misses anything that, that’s simple.
Perry Caicco
That’s one thing. So my second question is the update on the contract manufacturing business, 7 million cases added, can you just update us as to how many cases you have added in the last 12 months, how big that business is now and what you expect from it going forward?
Jerry Fowden
Yes. I mean I think this brings our growth in contract manufacturing over the last 18 months to north of 39 million cases.
If you remember we set a goal of some 50 million to 80 million cases over a 3 year timeframe. So we are half way in at 39 million cases, which makes us happy to say we think we are heading towards the upper end of that 50 million to 80 million kind of win range.
Perry Caicco
And the - what is the environment like at this point for adding more contract manufacturing has to become more competitive, since you have got into the game?
Jerry Fowden
No I mean most of the advantages I think we bring Perry to this contract manufacturing area is well invested in all SQF Level 3 certified, extensive plant network throughout North America such that on average even existing prices, if there is another supplier there can be a saving to the brand owner through the lower freight costs from our plant network, compared to past and existing supplier. And then when you add-on our commitment to service, our SQF Level 3 qualifications, everything we see, say once we win a pizza business with someone, it’s not long before they are asking you about another area or a new pizza business, because they see the benefits of working with us.
So it’s less about price competition and more about location of our plants and the quality of our operation in that area. With regards to the quarter specifically, in quarter two last year, we started business on a big new contract and there was all the initial pipeline build.
So we are actually quiet pleased with the seven million case growth this year over last year’s Q2. But I think while we averaged 110% growth in this area last year, we actually had 170% growth in Q2.
So we have 7 million growth over that tough comp still gives us confidence that we are heading to the upper end of this contract manufacturing growth. And I think when we get to the end of 3-year period it’s not that we see that’s the finish of things, we think that is some additional opportunity beyond that to continue to win business and what we are likely to do in somewhere towards the middle of next year layout some metrics and frameworks to allow people to better understand and model where we go forward after that first 3-year period, Perry.
Perry Caicco
Okay. Just if I could sneak in one more question, the heavy pricing activity that you saw at Memorial Day and I am assuming continued through July 4 weekend, normally your North American soft drinks volume would be worst in the market during that time period you said you came in at minus three.
What are the dynamics that held your volume together?
Jerry Fowden
Yes. It was particularly aggressive on cans rather than PET.
We are very strong on PET. So, I think that was one factor.
And we had some important customers that seemed to be getting cleaner about supporting our business with them and the opportunity in private labels. And I think what we have seen is the price pack architecture work and new approach towards, let’s say, more historic levels of pricing from the national brands, which is something that I see is good for the consumer.
That activity was good for the consumer and I think good for the national brands is biased more towards the other channels, convenient gas, daily dispense, etcetera. And they have remained and that’s clearly evident in the IRI data, more kind of promotional and price competitive within big box retail.
So, I think we had a better trend and a better performance in the channels we are in that quarter that history would have suggested, so well spotted, Perry.
Perry Caicco
Okay, thanks.
Operator
We will hear next from David Hartley with Credit Suisse.
David Hartley
Thank you. So...
Jay Wells
Hi. How are you doing?
Jerry Fowden
Thank you very much for initiating coverage on us. It looks like we did a lot of work there 70 something pages.
So thank you.
David Hartley
That’s like 12 years of work, Jerry. Just want to ask you about your synergies first of all in the quarter, you talked about getting synergies.
Now, is that net of integration costs or is that before integration costs, because I believe you had $4 million to $8 million worth of integration costs for the year?
Jerry Fowden
Yes. That is a synergies separate from the integration costs and we think last time we updated we said we saw synergies of about $10 million coming through in this year as we saw one-time integration costs of around $10 million coming through this year.
But we haven’t got a new official number to give you there, but we are trying to pull things forward as fast as possible. So, as I look at things today and the fact that we have now publicly announced the consolidation of our customer call centers, 2.5 centers into one center that will mainly take place in the second half and the latter part of this year.
I could imagine those one-time integration costs slightly increasing this year by maybe an additional $2 million to $3 million, but we don’t see the overall integration costs for the first two years being any higher. We are just trying to pull some things forward.
And simply put, while it might not pan out like this, $1 million of synergy cost in – of synergy benefit in quarter one, $2 million in quarter two, you know we are looking for something like $3 million in quarter three, and $4 million in quarter four and that gets us to the $10 million for the year is maybe a fairly high level way to look at it, David.
David Hartley
Okay, that’s great. And just on the shuttle costs warehousing costs that you referenced the savings that you are getting there in the two plants.
Is this a result of part of the sale leaseback discussions that you are able to do that or is just something that made sense for you? And I guess these are all third-party facility owners.
So, is there more of that to come that kind of opportunity where you are putting the two opportunities together?
Jerry Fowden
Yes. Let me pick up on the whole warehousing program, what we have done and what we have an opportunity to do.
And then separately I will ask Jay to comment on the sale of leasebacks that we executed in the quarter, because that is different, that was part of our accelerated deleveraging strategies. On the warehousing staff, if I come straight to the point to say, why did we put a paragraph on this in the prepared script, it’s because there was a particular announcement from the Governor’s office, I think it was South Carolina, but Cott was spending $10million on a new warehouse in Greer.
And as you will know David, I have been pretty clear with people we will not be spending a lot of capital behind our traditional business. And therefore, I didn’t want anyone to think that Cott was spending $10 million behind that facility.
That is a third-party that is building a warehouse right next to our facility so that we get the benefits of lower shuttle costs. We are still paying for warehousing space like we were before.
And the overall outcome of that is it produces a more efficient lower cost business of cost at someone else’s CapEx dollar. So, we put a little bit in this script to ensure that no one bought back $10 million that was announced by the Governor being spent on Greer was Cott’s $10 million.
And we do have at least in the pipeline over the next two years, two more of these warehouse projects, which was again follow the same model where someone else builds a warehouse right next to our facility. They might buy the land from a neighbor and do it.
They might – if we had spare land buy the land of us. But the goal is not so much us selling that land, it’s a third-party developing an adjoining warehouse to provide a more efficient operation.
Now, completely separate to all of that, it was the sale and lease...
Jay Wells
And to add on to Jerry’s point, you know, keep in mind we are already paying third-party rents for this offsite warehousing. All we are doing is incurring the same type of rent, but having the warehouse to test our plans.
So, it’s really just the way of saving the shuttle cost. On the sale leaseback, it truly was part of the work we were doing on how we could raise cash in order to redeem the preferreds and delever quicker.
And we identified five properties, three were in the traditional business, two were in the DS business that we entered into a sale leaseback with a fund that acquired the properties for the $40 million and we entered into 20-year leases with the ability to expand those plans. It’s just the only time we are looking to do that.
We don’t believe there is any more opportunity to do so. It was just a one-time opportunity to raise cash to accelerate the leveraging.
David Hartley
Okay. And if I can sneak in the third, just want to ask you a tough question in the UK, so Tesco, it looks like will be provided for in the CSD side by another player sometime next year?
Could you talk about the impact to your business there? I know you have given us a darker outlook for the UK going forward.
Could you maybe talk about that and give us some color around that?
Jerry Fowden
Yes, about, I can’t remember exactly when three or four months ago, I think the announcement came out that there will be some supplier changes in Tesco in the UK. We supply them some private label programs, waters and some CSDs.
We don’t do their colas. Globally, it will be less than 1% of our revenues.
And obviously, our plant runs at pretty full kind of mid 90% capacities in the UK. So, we will now have that capacity to offer to some other players.
And what I will do is towards the end of the year, I think give everyone a full puts and takes of update as to where we have got. We did sign an agreement last week that replaces 40% of that business.
And we are in the process of another piece of business that we think would replace around 25% of that business. So, overall, between that and tough cost actions and it being less what the 1% of our global revenues, I am not expecting a big impact, David, as you know within the number one private label supplier of the year for the last 6 or 7 years within the UK.
So, we are the kind of customer of record and I think we will do a good job of keeping our facilities in that high capacity utilization area, which means they will continue to generate a lot of cash, which is what the task is for that traditional business. Keep the plans full, when they are full.
They are low cost and efficient. And therefore, they generate cash and that cash goes towards deleveraging returns to shareholders and growing the newer parts of our business.
David Hartley
That’s great. That one was always a tough nut to crack that customer.
That’s great. Thanks a lot guys.
Jerry Fowden
Thank you, David.
Operator
We will hear next from Kevin Grundy from Jefferies.
Peter Schanzer
Hi, this is Peter Schanzer for Kevin. Our question relates to pack sizes in North America.
As you know Coke has made significant investments behind expanding pack sizes in its CSD portfolio and this has been a very key component of the company’s strategy of driving favorable price mix in this market for years to come. Can you guys talk about your current offerings relative to the industry and relative to the channels in which you compete and your willingness to potentially increase your investment in these areas as consumers migrate to smaller pack sizes?
Thank you.
Jerry Fowden
Peter, I will split my answer into two halves here, first let me say I think that we are up the national brand we are doing on offering a greater variety in choice of pack sizes and pack types, that very much fit, different usage occasions of customer preferences is a very good and sensible approach of a market. Not just financially for them, but to stimulate new consumer interest on appetite within the category.
So that’s what they are doing, so working well, I think keeps very wise. Now, we too but in a different way are very much focused on diversifying our product, pack, architecture and expanding our channel presence.
And if you think we have taken CSDs from 85% to 90% of our portfolio around the time I joined in 2008, 2009 down to 19% of our portfolio today. The addition of DS water puts 27% of our business in large three or five gallon returnable water containers.
So I very much support the strategy of operating alternative products, tanks and sizes to better meet consumer needs among two different channels. We just believe there is a bigger opportunity in us driving contract manufacturing wins and the home office water and coffee services wins.
Today that’s a more attractive use of our effort, time management and people than eight ounce packs of soda. We have the manufacturing capability to make those smaller packs.
And if the market opportunity gets large enough that there is an appropriately sized opportunity for us to go after. Private label is about 5% of the total market, so when this market gets bigger that 5% or 6% or 7% we might naturally get becomes a piece of business that’s worthwhile and we would add those packs too to our product offering to big box retail.
I hope that kind of the two approaches, why it’s their priority and what we are doing with similar in strategy, but with different channel priorities and product priorities at the moment makes sense.
Peter Schanzer
Thanks guys.
Operator
Your last question today will come from Amit Sharma from BMO Capital Markets.
Amit Sharma
Hi, good morning, everyone.
Jerry Fowden
Good morning, Amit.
Amit Sharma
Jay, a question for you first, you talked about deleveraging, can you provide us any prepayments schedule on the fixed debt that you have today as you look to repay or prepay some of that?
Jay Wells
Yes. I mean you really look for this year and next year.
Our focus will be to pay down on the one debt that we have available being our ABL, so that will be our focus for 2105 and 2016 and then really is any extra cash we have build in order to do the redemption and to the extent we have to refinance the DS in September of 2017.
Amit Sharma
Got it. And then for Jerry, I mean margins even on a FX neutral basis are ahead of our expectations.
And you have touched on some of those drivers. So that could you provide a little bit more color how sustainable is this level of margin improvement as we go through the rest of the year and look into 2016?
Jerry Fowden
I think what Jay kind of mentioned in the prepared remarks is we always had a plan of around about 100 basis points of margin improvement over ‘15 and ‘16. And at that time we set that plan was back around the middle of ‘14.
We anticipated that coming in around 50 bps a year. We have had a couple of quarters now where we have made good progress.
We are running of over 100 bps this year. So what we are really saying is we think we can achieve that 100 bps of margin improvement in 2015 and then we believe holding that flat in ‘16 is probably the right way to look at things.
And obviously, as things progress we will do our best to update people towards the end of the year, as to whether our view of things got a bit better already. But at the moment I would assume we get those 100 bps for this year or we held it flat next year.
Over and above that, because that’s really the traditional business, we do see as the synergies come through $30 million of synergies on DS over 3 years came in the first year somewhere in the kind of $18 million to $20 million in the second year, probably $30 million, by the end of the third year, but DS Services margins should continue to improve as those synergies come through.
Amit Sharma
That’s great. And if I may ask one more on the Javarama K-Cup launch earlier in the year also Sparkletts ice, if there is any update on how those are tracking versus your expectations?
Jerry Fowden
Yes. And I think for the Javarama K-Cup, let me expand your question on your behalf which I know might be a bit cheeky Amit is single serve coffee.
So we have the AquaCafé that we are rolling out. The current expectation is we will launch the residential version of the AquaCafé around about October, November, this year and we have the single cup.
They are all different of the single K-Cup. They are all initiatives in driving our single served coffee.
And I will let Jay, may be see if he has any numbers to correct me. But over the last couple of months, we have seen approximately enough growth in single cup coffee to offset the decline in brew basket coffee.
If you look back at last year, the growth in single cup was not sufficient to offset the decline in brew basket. So we think we are now getting closer to that breakeven point and that as we roll these other initiatives out, Javaroma K-Cup, more commercial AquaCafé, the launch of the residential AquaCafé we can be in a position that we can go from a broad tipping point of those as we look to 2016 being in a position that the growth in single serve should exceed the decline in brew basket.
And Jay?
Jay Wells
I don’t have the numbers exactly in front of me I would say you are close to be in right I would say definitely over this year we have really seen an improvement in the trend of single serve growth offsetting the decline in brew basket where we are getting close to I would say and netting but we are not quite there yet.
Jerry Fowden
So I hope helps Amit what we obviously will have the potential to do is when we rollout the residential AquaCafé. Then that should be an additional assistance to our job around the K-Cup.
But that’s more likely to show up in our results in the first and second quarters of next year as we roll those residentials out.
Amit Sharma
Got it. I really appreciate the color.
Thank you very much.
Jerry Fowden
Thank you, Amit.
Operator
This does conclude today’s question-and-answer session. Mr.
Langhans, I would like to turn the conference back over to you for any additional or closing remarks.
Jarrod Langhans
Thank you very much for joining on our call today. This will conclude Cott Corporation’s second quarter 2015 call.
Thank you for attending.
Operator
And that does conclude today’s teleconference. We thank you all for your participation.