Nov 7, 2012
Executives
Katie Turner – IR Billy Prim – Chairman and CEO Mark Castaneda – CFO
Analysts
Andy Wolf – BB&T Capital Markets Mitch Pinheiro – Standing Capital Markets
Operator
Good day ladies and gentlemen, and welcome to the Primo Water Third Quarter Fiscal Year 2012 Earnings Conference Call. (Operator Instructions) I would now like to introduce your host for today’s conference, Katie Turner.
Ma’am, you may begin.
Katie Turner
Thank you. Good afternoon, and welcome to Primo Water’s third quarter fiscal 2012 earnings conference call.
On the call with me today are Billy Prim, President and Chief Executive Officer; and Mark Castaneda, Chief Financial Officer. By now everyone should have access to the release which went out this afternoon at approximately 4:05 p.m.
Eastern Time. If you’ve not received today’s press release, it’s 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 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 incorporated into – 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 President and CEO, Billy Prim.
Billy Prim
Thank you, Katie. Good afternoon, everyone, and thank you for joining us.
I will provide some opening remarks, then Mark will review our financial results for the third quarter. And finally, I will provide some closing remarks, then we will open up the call for questions.
Before I begin, I would like to make a comment on Hurricane Sandy. While we are fortunate not to have incurred any damages at our offices related to the hurricane, our hearts go out to those that were impacted and we wish everyone a safe recovery.
We will continue to provide water for those relief efforts through our partners. Now, as we discussed on the second quarter call, we are focusing on improving results through ending our investment in the launch of Flavorstation and executing on our core business by adding more households through selling water dispensers, which should lead to continued re-occurring water sales, which generates continued increases in cash flow through operating margin improvement.
I’m pleased to report that we have made progress on all fronts this past quarter and we expect to continually make improvements throughout the next year. These results enabled us to report third quarter net sales and adjusted earnings in line with our expectations.
Furthermore, the strength of both our core Water and Dispenser businesses has led to improved EBITDA and positive cash flow from operations in the quarter. First, we have continued positive trends in our core business, Dispensers and Water.
Both continued to post improvements and growth in the quarter. In the third quarter, consumers purchased a record 114,000 plus dispensers at retail, which is up 30% over the prior year.
This growth illustrates that consumers continue to change their habits in consuming water at home. We believe there are approximately 780,000 households that use Primo Water today, which is up 14% over the last year.
Additionally, we have added 400 net new locations during the quarter that offer our water and/or dispensers. Included in that number are several Wal-Mart exchange-and-refill locations.
We ended the quarter at total locations of 24,600. In addition to increased dispenser sales, we improved our dispenser gross margin to 8% versus 0.5% in last year’s third quarter as a result of price increases and a favorable mix of sales from our higher-margin, bottom-load dispensers.
Our operating margin in our dispenser business did not improve, as we incurred some one-time cost of expediting product for a rollout which allowed us to get our bottom-load dispensers in more locations. Going forward, we do expect to see improvements in the operating margin of the Dispenser business.
Our water business continued to grow and generate higher operating income. Our Water segment sales increased approximately 3% to $17.3 million and income from operations increased 21.8% to $4.5 million compared to the prior year.
Our water business was up against some difficult comps from Hurricane Irene in the prior-year’s third quarter that impacted the Mid-Atlantic States in August of last year. Despite the challenging comps, our US Exchange business grew 9.1% in revenues which was driven by a 13% same-store unit sales increase.
Our Refill business was down 3.4% compared to prior year, primarily as a result of positive hurricane volume from the prior year. Our operating income improvement was the result of gross margin and expense management.
Looking forward, we believe the impact of Hurricane Sandy will benefit our same-store unit sales in the fourth quarter. However, at this point, is still too early for us to quantify.
We are in a strong position with our water business to leverage our existing regional operator network to service customers. We’ve also started to test servicing our refill machines with company employees.
While we are still early in this testing phase, we believe from early test results that it will lead to improved sales and profitabilities in the markets we service long-term. Earlier this week, we announced a three-year sales, distribution and licensing agreement with Cuisinart.
They will market and sell our existing line of sparking beverage appliances and related consumables in North America, and Primo will supply CO2 cylinders for Cuisinart’s new proprietary sparkling beverage appliance. Beginning this month, Cuisinart will devote its own sparking beverage maker, which will be powered by our CO2 cylinders and available in Cuisinart’s traditional retail channels, which encompass department and specialty stores, as well as online sales.
Additionally, we will provide the distribution and refilling of CO2 cylinders from both our units, Cuisinart and Flavorstation branded sparking appliances. We believe this strategic alliance is consistent with our decision to refocus on our core businesses and strengths and we are excited to partner with Cuisinart who is a leader in kitchen appliances, cookware and other housewares.
Cuisinart has the experience and proficiency to grow and maintain appliance sales in this growing category. When you combine that with our expertise in retail DSD distribution for CO2, you create a strong offering for retail.
Going forward, we are confident that our strong product portfolio and distribution capabilities will enable us to realize continued growth and improved operating results. Now I will turn the call over to Mark to review our financial results for the quarter.
Mark Castaneda
Thank you, Billy. I’m going to briefly review the third quarter financial results in more detail.
Due to changes in our strategy for the Flavorstation business, we began to report that business as a discontinued operations during the third quarter. In accordance with GAAP, we adjusted the prior year periods to reflect changes in the reporting to allow meaningful comparisons between the years.
Additionally, to help investors understand our operating results, we do provide certain non-GAAP measures, including pro forma EPS and adjusted EBITDA, which I’ll discuss further. Overall, we experienced improved results in sales, gross margin and SG&A leverage across our core business.
We achieved these positive results across all measures through a renewed focus on executing our core. In the third quarter we generated $26.2 million in sales, an increase of approximately 8.6% compared to the prior year period and in line with our guidance for the quarter.
The year-over-year increase was driven by growth in both our US Exchange and our Dispenser businesses. Our net loss per share from continuing operations on a GAAP basis was $0.10 per share, which was slightly improved from the prior year’s loss of $0.11.
On a non-GAAP basis, our pro forma loss was $0.04 per share, which is flat with the prior year. Despite our improved operating results from the prior year, we incurred higher interest expense and appreciation cost of approximately $0.05 per share.
The primary difference in GAAP and non-GAAP earnings was a pro forma effect of full income taxes. The company does not expect to pay income taxes in the near future as it has sufficient net operation loss carry-forwards to offset future taxable income.
Drilling into the sales for the quarter, water sales which include our Exchange and Refill Services grew approximately 3% to $17.3 million. As Billy mentioned, we continue to experience strong same-store unit increases in our US Exchange business, which was up 13% for the quarter.
This is an acceleration from the first half results of 5.3% same-store sales. Sales for our Dispenser segment for the third quarter of this past year increased 21.6% to $8.9 million compared to $7.3 million in the third quarter of last year.
The increase was due primarily to a favorable mix of higher-priced bottom-load dispensers and increased prices per unit as sell into retailer units was down 4% to about 106,000 units during the quarter. Moving on to gross margins, in the quarter gross margins increased 24% from 22.3% for the third quarter of the prior year.
Gross margin improved in our Water segment to 32.3% from 31.9% as we continued to improve our execution. We do expect the trend of increasing gross margins to continue as we develop further execution improvements.
As Billy mentioned, our Dispenser segment experienced gross margins of 8% compared to 0.5% in prior year, which is a result of favorable mix of dispenser sales and price increases. SG&A decreased 3.5% to $4.8 million in the third quarter compared to the same period last year.
As a percent of sales, SG&A decreased to 18.3% from 20.5%. The decrease was due to cost reductions in the Water and the Corporate segments, partially offset by an increase in the Dispenser segment.
We currently expect SG&A as a percentage of net sales for the remainder of 2012, to compare favorably to 2011, as we leverage our cost base with increased sales. Now focusing on our balance sheet, our balance sheet was re-classed to reflect the assets and liabilities related to our discontinued operations, as assets and liabilities under disposal grew.
Our working capital levels were consistent with the second quarter. Cash flow from operations for the nine months increased to $3.6 million contribution, compared to a use of cash of $1.1 million in the prior year, or a $4.7 million improvement in cash flow from operations.
Reporting our core business separately from the Flavorstation initiative illustrates the cash flow from operation improvements in our core business compared to the prior year. In conjunction with re-classing our Flavorstation business, we ended our cross-distribution agreement with SDS, which eliminated our cross-purchase commitments.
We had no material commitments for capital expenditures at the end of third quarter and we do expect – anticipate capital expenditures in the range of $1 million to $1.5 million for the remainder of 2012. The capital expenditures will primarily be for growth capital in the Water segment.
Additionally, we amended our debt agreement to reflect the discontinued operations and correspondingly reset covenants to reflect the change in our business going forward. Associated with the amendments, the company paid $a 150,000 fee and increased the early prepayment penalties, as well as reset some warrant exercise prices from $2.30 to $1.20 per share.
The warrant exercise price was set at the 150% of the 30-day trailing average stock price. We believe we have sufficient debt capacity to continue to invest in growth and add exchange and refill locations.
The Cuisinart announcement is expected to impact our financial results in the following way. One is monetizing our inventory and tooling investment of about $3 million over the next four quarters.
Two, providing a royalty stream for flavor sales, which will be dependent on the success of the Cuisinart rollout. Third, providing a revenue and margin stream for CO2 sales and exchanges which will also be dependent on the success of the Cuisinart rollout this holiday season.
And fourth, Primo will invest in CO2 cylinders to support the Cuisinart business, and that investment will be scaled based on demand. Finally, we do not expect a material impact on our financial results in the fourth quarter as the CO2 exchange demand is typically lagging the holiday appliance sales.
We will provide updates as we generate results from this holiday season. Finally, we have decided to focus on long-term growth and achieving profitability in 2013 and will now provide short-term quarterly guidance.
To achieve profitability, we will focus on improvements in operating income and adjusted EBITDA which increased over two-and-a-half times to $1.8 million in third quarter of 2012 from $662,000 in the prior year, which was driven by revenue growth, gross margin and expense management. We believe we can continue to improve our operating results and refinance our existing debt to lower cost capital in the next 12 to 18 months.
This concludes our financial review. Now I’d like to turn the call back over to Billy.
Billy Prim
Thanks, Mark. In closing, we are excited about our partnership with Cuisinart and remain focused on growing our core businesses and achieving profitability.
We believe, based on the positive industry trends and the success of our water business to-date that we will continue to gain share in the water market. Our management team believes we have the strategies in place to grow our business long-term.
Going forward, we believe we can continue to add appliance households, which should help lead to continuing re-occurring water sales. Thanks for your participation today.
We will now open up the call for questions.
Operator
Thank you. (Operator Instructions) Our first question comes from Andrew Wolf of BB&T Capital Markets.
Your line is now open.
Andy Wolf – BB&T Capital Markets
Good afternoon. On your – the 780,000 households that are using the water, is that sort of bottom up, that estimate from retailers?
Has it helped them informed by that or is it more of a – based on – how did you get to estimate?
Billy Prim
Yes, Andy. This is Billy.
Good to have you. The number, the way we calculate that number, we take the last four quarters and we take the five gallon equivalents of water that we have sold and we divide that by an average of 35 bottles a year, which a household uses.
So that would – that’s how we get to the number.
Andy Wolf – BB&T Capital Markets
Okay. And just on the Cuisinart deal that you have, kind of simple question but I just want to understand it.
So your revenue streams from them going forward is CO2 and flavors, and it read that they’re going to market the Flavorstation appliance and their own appliance, or is it basically mean the Flavorstation appliances is sort of going to be phased out?
Billy Prim
No, the plan would be – and as you know that Cuisinart has a certain channel that they sell to today – and the plan would be to sell Cuisinart to one channel, and they would use the Primo Flavorstation to sell to other channels. We would in turn gain a royalty from all of the flavors that were sold in any channel, and we would provide CO2 into all channels.
Andy Wolf – BB&T Capital Markets
Okay. And are you – are they going to own the patents for Flavorstation?
Is that part of the deal? You’re accepting that?
Billy Prim
We have licensed them the right to sell our IP.
Andy Wolf – BB&T Capital Markets
So is Primo going to get any revenue from a Flavorstation appliance sale or is that not part of where the revenues are expected?
Billy Prim
No, we’ll focus on the other. We will gain revenue because what we’re doing, and I think it’s important for everybody to note in the company, we’re turning our inventory into cash and that’s something that can be used in our core businesses a lot better.
Andy Wolf – BB&T Capital Markets
Okay. But sort of back to the original model of razorblades, sounds like this one you really given away the razor, hoping Cuisinart – or thinking, Cuisinart is much better positioned to place the product and to be able to – and channel into people’s houses.
And you’re still getting the revenue stream, assuming that happens from the razorblade size. And I’m just trying to understand conceptually if that’s how it’s really what you’re trying to achieve.
Billy Prim
Yes, Andy, I would even elaborate and say that we believe that category is growing. And that category is a great category.
I don’t think Primo is positioned to introduce the appliance product, educate consumers and do everything that’s needed while we grow our water business at the same time. And what we feel is, the most important thing is to rid ourselves of that distractions of trying to roll out the Flavorstation Appliance business and focus what we really do well.
Where we are fortunate is we’ve got a partner that does that every day, that is a large company that has extensive relationships that rolls out new appliances each and every year. And so we’re pretty proud and fortunate to partner with them.
Andy Wolf – BB&T Capital Markets
Lastly, on the Cuisinart Flavorstation appliances, are both brands ready to – are you going to – are those products going to be in, in time to retailers for Christmas or is this sort of a calendar 2013 project?
Billy Prim
No. Cuisinart will be on the shelf with their product for this holiday season and so will Primo, which is already in the market.
Andy Wolf – BB&T Capital Markets
Okay. And on the Exchange business – you might have explained this, I had to – got a call.
But why was the unit growth better – above the – dollar growth was – was there some price in there or mix or something else?
Billy Prim
We’ve got some large customers that are growing very rapidly that have lower prices than some of the small customers. So it’s more of a mix of customer growth.
Mark Castaneda
Andy, there’s also some mix in there. So as – when new customers come on, they buy an IP which is at double the price as an exchange.
Andy Wolf – BB&T Capital Markets
Got it. And yes, that leads me to the – my last question is, with the way you’re changing the capital structure, if you will, or the capital allocation at least, and the focus, what do – do you anticipate that the number of water locations were you sell water could – is going to go up?
I mean, I’ve asked you this before. You’ve kind of indicated it’s not really demand-driven, it’s more – I think you’ve indicated, it’s more capital-driven.
So do you feel there is demand in that you’re going to – it’s been pretty flat for a year, around 16,500.
Billy Prim
Yes. That will grow in 2013.
As you know, most of the retailers don’t like you in their stores installing things in the fourth quarter, but I think you’ll start to see that number grow and – as we go into 2013 pretty rapidly because we don’t think we’ll have the limitations in capital restrictions. And with the number of dispensers we’re selling, we know that the demand will be there.
Andy Wolf – BB&T Capital Markets
Last question about, do you have a backlog or do you have to sort of re-engage in the selling cycle to the – with the retailers?
Billy Prim
We’ve been engaged all along and have a pipeline that we’ve been working on for some time, and we think they’ll be – most of those will be ready to be installed starting in Q1.
Andy Wolf – BB&T Capital Markets
Thank you. Appreciate it.
Operator
Thank you. Our next question comes from Mitch Pinheiro of Standing Capital Markets.
Your line is now opened.
Mitch Pinheiro – Standing Capital Markets
Good afternoon.
Billy Prim
Hey, Mitch.
Mitch Pinheiro – Standing Capital Markets
Hey, so, looking at your core business, just looking at the nine months, if you exclude the goodwill impairment, you lost about $5.5 million or so. And so – and just making just an assumption for the – say, you can be flat, what’s it take – in the fourth quarter, what’s it take for you guys to turn a profit in the Water segment?
I mean where are you – where were you losing this $5 million through the nine months? And how are you fixing that?
Mark Castaneda
Yes, good question. So on the Water segment itself, you’ll see when we file the Q, the segment income from operations was about $12.3 million on the nine months versus $10.9 million, so up around 13%.
This quarter was up 22%. The Dispenser business was a negative $1.2 million.
We’ve changed that business around. That business will be breakeven or positive into – going into next quarter and next year.
So that will change and that’s what we talked before about. We’ve had bad pricing in that and negative or flat margins or very small margins and negative EBITDA there.
The other is, corporate expense is – was around $8 million for the nine months. We do expect that to come down for next year, and then depreciation and amortization was around $8 million this year versus about $6.5 million last year.
We also had some nonrecurring cost of about $0.5 million this year. So what’s going to change is, Water will continue to improve, the Dispenser business will turn from a negative to a positive, and then you’ll get some efficiencies on the corporate side.
Mitch Pinheiro – Standing Capital Markets
So for the Water business to improve, what do you need to see there? What’s happening?
Mark Castaneda
What’s happening is, as you saw this quarter 22% improvement in the EBITDA or operating income from that business from margins and from revenue growth.
Mitch Pinheiro – Standing Capital Markets
Let me back-up then. Then what was causing – what were the issues that – I mean obviously you’re improving, which is a good thing, but what are the areas that you are seeing improvement on?
Is it pricing? Is it – what – I know you made some changes in the Refill business.
What is it – if you can be a little more specific that – where you’re seeing the turn?
Mark Castaneda
Sure. So it was execution really in both businesses.
As we put both businesses, the Refill and the Exchange business together, we had some challenges executing at retail. So these challenges were with distributors and incurring extra cost and changing the distributors around and service providers, incurring more expense for upgrading equipment, as we had new providers change over.
That’s improving, so that’s where the gross margin improvement is coming from and you’ll see continued gross margin improvement on that side. And then also we’ve cut cost out of that business.
So in addition to revenue growth, gross margin improvement and lower cost, those are the three factors that got us to a 22% improvement over last year’s third quarter.
Mitch Pinheiro – Standing Capital Markets
Okay. And then on D&A, is D&A going to be flat year-over-year?
If you look forward, I mean is there any kind of – is there any change in the run rate, I should ask.
Mark Castaneda
D&A actually will come down a little bit next year and that’s because we had some amortization of some customer list. That’s down year-over-year.
And without much investment this year in the Water business, D&A will come down slightly.
Mitch Pinheiro – Standing Capital Markets
Okay. When it comes – when you’re looking at the Cuisinart arrangement, how big does like the install base have to reach to become meaningful for Primo?
I mean, can you – when you start, will it be a positive contributor on a couple hundred thousand households or is it going to take a lot more than that? Is there any way you can frame how meaningful it could be?
Billy Prim
That’s a great question, Mitch, and it’s one of the reasons it’s difficult for us to give short-term guidance. I would say this; you can look at SodaStream’s results in the US, and they came here as an unknown brand and a category that was unknown.
Now you got a category that’s growing rapidly and you got a brand name in Cuisinart that has relationships in every segment and can capitalize on those investments. So it’s got a chance to be very meaningful, but I just don’t know how long that will take.
And that will start – we’ll start to see that in the next couple of quarters as the holiday season rolls out. But I don’t think that I would feel comfortable in putting a number on it today.
Mitch Pinheiro – Standing Capital Markets
I was in Bed Bath on Monday and saw the Cuisinart on the shelf and saw the CO2 canisters. They were unaware of any exchange program, any refill program.
Is that something that you have to reach out to every store or how is that going to be communicated?
Billy Prim
Cuisinart will handle that store sale of the selling and we will handle it after that. Since we just signed the agreement, that handoff has not taken place at many retailers.
Those calls are being made now jointly.
Mitch Pinheiro – Standing Capital Markets
Okay. What’s the...
Billy Prim
They will have exchange in Bed Bath.
Mitch Pinheiro – Standing Capital Markets
Okay.
Mark Castaneda
There is some shipping timing of getting it in place, but they will have exchange at Bed Bath for Cuisinart.
Mitch Pinheiro – Standing Capital Markets
Okay. And then obviously the CO2 cartridges seems like, I don’t know, half or a third of the size of the SodaStream, what’s the thought behind that?
Billy Prim
Yes. Well, I think it’s a pretty good move on Cuisinart’s part.
They will offer two sizes of cylinders. There will be the traditional size that SodaStream has been using, but they do have a starter cylinder that has less in it, which improves margins, lowers the cost of the initial purchase and gives a person – gives them a chance to try this before they purchase a full-sized cylinder.
So – and those are pretty convenient to carry in and out, especially for females.
Mitch Pinheiro – Standing Capital Markets
Right. Well, it’s not like carrying a tank of propane; it’s – this is a little smaller, but...
The other question I had was what – so your part of the CO2 return business, your distribution network will pick-up the empties, bring them back and have them refilled and then bring them – and then return them to the store? Is that how it’s going to work?
Billy Prim
That will be a mature model. That’s the model we’re heading toward, yes.
Mitch Pinheiro – Standing Capital Markets
What’s the immature model?
Billy Prim
The immature model would be to UPS the cases back and forth to the store until they get enough volume that they would warrant DSD delivery.
Mitch Pinheiro – Standing Capital Markets
Okay. And then final question is, and what costs do you incur here?
So you get a revenue stream on the CO2. You’re – what are the different parts of your cost structure there?
Mark Castaneda
Yes, from a cost structure, today we’re outsourcing the CO2 refills, so we don’t have any incremental cost or any infrastructure cost to start-up. Once this business gets to be a certain size, then we may look to invest in our own refilling system.
Mitch Pinheiro – Standing Capital Markets
And then there is delivery cost. I mean, who picks up, like right now, the UPS charge?
Billy Prim
That would all be in a distributor model, Mitch. Just the same way we did it at Rhino for years, we pay a distributor a certain amount to fill and deliver that bottle, whether it’s UPS’d or whether it is direct store delivery.
So that third party is – we’re paying them on a per-bottle price and we get paid on a per-bottle price.
Mitch Pinheiro – Standing Capital Markets
Okay. Okay, thank you very much.
Appreciate the...
Billy Prim
Thanks.
Mitch Pinheiro – Standing Capital Markets
Thanks.
Operator
Thank you. (Operator Instructions) And at this time, I’m not showing any further questions from the phone line.
Billy Prim
Thank you, Operator. I would like to thank our employees, our regional operators, and resale service providers for their efforts in growth and continuous execution improvement.
We will continue to execute on our core strategies of growing our locations to 50,000 to 60,000 retail points of distribution, increasing household through the dispenser sales and improve our operating results to achieve profitability. We appreciate your interest and thank you for your support.
We look forward to providing you an update on our business next quarter. Thanks.
Operator
Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program.
You may all disconnect.