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Executives

Katie M. Turner - Managing Director

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

Primo Water (PRMW) Q3 2013 Earnings Call November 12, 2013 4:30 PM ET

Operator

Good day, ladies and gentlemen, and thank you for standing by, and welcome to the Primo Water Corporation's Third Quarter 2013 Financial Results Conference Call. As a reminder, today's conference is being recorded for replay purposes.

It's now my pleasure to turn the floor over to Ms. Katie Turner from ICR. Ma'am, you may begin.

Katie M. Turner

Good afternoon, and welcome to Primo Water's Third Quarter 2013 Earnings Conference Call.

On the call today with me 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'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 included in the press release issued today and in all documents that Primo Water files with the SEC.

And with that, 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 our core business and the DS Waters alliance, and then turn the call over to Matt Sheehan, who will go a little deeper into our operational initiatives. Mark Castaneda will then give you the third quarter financial recap and the outlook for the remainder of 2013.

We are pleased with our third quarter results as we continued to experience positive momentum across our business. The third quarter marked the seventh consecutive quarter of adjusted EBITDA growth, which was an increase of 62% to $3 million. This exceeded the high end of our guidance.

Our strong growth in EBITDA is due to improved gross margins and improved operating efficiencies, enabling us to generate a record $9.1 million in cash flow from operations for the first 9 months of 2013, reflecting the continued improvement in the fundamentals of our business.

Focusing on our initiatives for a moment. We continue to be very pleased with the progress our team has made on the objectives we laid out at the beginning of the year, specifically: first, to solidify the foundation of our core business; second, then to refinance our debt to lower our cost of capital; and finally, we will begin to focus on the top line of our core Water and Dispenser businesses for long-term growth.

We believe we have made consistent progress in our first objective to solidify the foundation of our core businesses. We will continue to drive improvements in gross margins and lowered SG&A as a percent of net sales. Our team has continued to focus on managing the controllable aspects of our business. This has enabled margin improvement, which, in turn, helps us drive EBITDA growth and improved cash flow generation for the long term.

On the second objective, to refinance our debt, as we highlighted last quarter, we refinanced our term debt to allow for additional borrowing while also lowering the interest rate. As our trailing EBITDA continues to grow, we will continue to look to refinance with lower cost capital and increase our capacity.

We've made improvements in points 1 and 2, and now, we turn to our growth initiatives. We believe we took an important step in the long-term growth of our core Water and Dispenser businesses today with the announcement that we have recently entered into a strategic alliance agreement with DS Waters. This 7-year agreement will enable us to enhance our existing retail relationships and assume the DS Waters' retail exchange business. Presently, DS Waters' exchange business consists of over 3,000 locations in the U.S. Over time, DS Waters will become our primary service provider for U.S. exchange.

We believe DS Waters' national scale and service footprint will reduce our operating costs, increase our operating margins and give us more capacity for increased growth. This strategic alliance goes into effect January 1, 2014, and we believe will be accretive to earnings once fully implemented. The initiatives that we have put in place to solidify our foundation, improve our balance sheet and align with DS Waters as a major bottling and distribution partner position us well for long-term growth.

With that brief overview, I'll turn it over to Matt Sheehan, our President and Chief Operating Officer.

Matt Sheehan

Thank you, Billy. I'd like to provide you with an update on our foundational execution plan. As our team executes this plan, we remain focused on world-class execution of our core business, strengthen our financial results and improving our propositions to both consumers and our retail clients.

As we have mentioned previously, we are focused on 3 key themes in 2013: first, consumer and retailer focus; second, simplicity; and last, analytics. Utilizing these themes, we have set out 3 objective approach. We are executing initiatives that support these objectives and are allocating resources accordingly.

Here's an overview of our objectives and our key initiatives. Our first objective is about improving the core Water and Dispenser businesses by increasing our operating margins long term. This focus will help us improve financial strength, make the most of future capital outlays and help ensure profitable growth. During this phase, our focus has been on cost management, unit economics, client retention and service level performance.

Here are some of the objective's key initiatives. In our Refill business, we've revamped and strengthened our leadership in this business, tested and built a solid process to increase empty bottle sales, which is now just beginning to run, and we are excited by the rollout of our remote monitoring technology called Telemetry.

With the release of Telemetry, the installation is progressing on schedule and allow us to increase service levels by having better visibility, decrease our multiservice costs and lastly, increase supply side revenue. This technology puts us in position to roll out our new service model we call CORT, company-operated retail territories, where it makes sense.

This model furthers our cost reduction, increases our service levels and gives us much greater control of key metrics driving the business. We see an anticipated reduction in cost of goods sold when Telemetry and CORT are implemented.

In our Exchange business, we have improved our ability to predict revenues in new locations, helping to forecast and validate capital for installations using factors like geography, demographics and store characteristics that influence performance.

In our Dispenser business, we focused on cost reductions which led to increased gross margin. We continue to drive consumer sell-through with innovative, high-quality products.

Our second objective is about growth, where we began proactively telling our story to the retail community, securing more locations and focusing on increasing same-store sales. Here are some of the objective's key initiatives. We have created scorecards at the store, retailer, region and operator level to measure the service level of our business. These scorecards provide us tremendous insights and control of the business. We are measuring in-stock rates, trip frequency, aesthetics, uptime and other service metrics that drives same-store sales. we can now point to locations, regions of service providers that require service level improvements. We expect to see the benefit of this in sales and retail confidence.

In addition, we have recently secured deals with retailers using lower-cost equipment, which allows us to expand our footprint, increase locations and increase the rate of return on new installations.

Lastly, our third objective is long-term innovation. We will support our future growth with strategic new products and go-to-market ideas within the Water category. Here are some of those initiatives. We have begun prototyping new dispenser products through design and expanded features and functionality. These innovations have received strong reviews from retailers. We are beginning to improve our assessment capabilities of long-term ideas within our core business segments. As we execute these objectives, we expect continued improvement in the core metrics of our business. While there's still much work to do, we are proud of the team's ability to deliver on our plan to fix our core Water and Dispenser businesses. We are building momentum and are now ready to grow our business.

Going forward, we believe Primo will win in our space, grow our business and deliver value for our employees, consumers, retailers and stakeholders.

Now I will turn the call over to Mark to review our financial results for the third quarter.

Mark Castaneda

Thanks, Matt. I just want to review our third quarter results in more detail. To help investors understand the results, we do provide certain non-GAAP financial measures, including adjusted EBITDA, which I'll discuss in a few moments.

Overall, we are very pleased with the third quarter results as we exceeded our EBITDA guidance. Our significant EBITDA growth occurred despite a reduction in net overall sales, which was due to the delayed timing of dispenser shippings. As a reminder, our dispenser sales can be lumpy as we recognize revenue selling products into the retail channel.

Retailers manage their inventory timing based on many factors, are outside of our control. This revenue has had a much smaller impact on our economics as we manage the dispensers at thin margins to drive household penetration.

We believe our pricing strategy continues to drive consumer purchases of dispensers at retail, which were up 2% in the quarter and 10.7% for the 9 months. We believe that increased water dispenser penetration will lead to continued increase in recurring Water sales.

Total sales for the quarter decreased 2.4% to $25.5 million compared to $26.2 million for the third quarter of 2012. The decrease reflects a 10% reduction in Dispenser sales compared to last year, which was partially offset by an increase in Water sales.

Drilling into our top line. Our Water revenue increased 1.6% to $17.5 million. Our third quarter Water revenues reflected an increase of 4.6% increase in Exchange sales, driven by same-store unit growth of U.S. Exchange of 8.5%. For the 9 months, same-store unit growth in the U.S. Exchange was up 10.4%.

Refill sales declined by 2.1%, as we did experience some unfavorable cooler weather in the third quarter of this year, which had a negative impact on Water segment revenue growth.

Dispenser segment revenues decreased compared to the third quarter of the prior year to $8 million. This business was up against tough comps as the Dispenser segment benefited from additional sell-in related to the rollout of new locations for a major retailer in the prior year.

Additionally, at the beginning of the third quarter of this year, we added a new major retailer that we expected to begin shipments during the third quarter. However, due to delayed timing from that retailer, we now expect the rollout to begin in early 2014.

Our gross margin increased 180 basis points to 25.8% for the third quarter from 24% in the third quarter of 2012, which was driven by improvements in both Water and Dispenser gross margins.

Gross margins for the Water segment increased 140 basis points to 33.7% for the third quarter, reflecting improvements in Exchange, due primarily to improved supply chain cost management and a slight improvement in Refill margins.

Gross margins for the Dispenser segment increased 8.4% from 8% in the prior year, again, primarily due to improvements in supply chain cost.

Next, we continue to manage improvements in our SG&A spend, which decreased 19% to $3.9 million. As a percentage of net sales, SG&A decreased 15% versus 18.3% in the prior year. The decrease is primarily due to expenses in 2012 related to the rollout of new Dispenser retail locations that were not incurred in the current quarter. We continue to leverage our relatively fixed SG&A expenses across the business.

Our net loss from continuing operations improved to $1.6 million or $0.07 per share from $2.5 million or $0.10 per share in the prior year. We do not expect to pay cash taxes in the near term due to net operating cash -- net operating loss carry forwards.

In the first 9 months of 2013, cash flow from operations nearly doubled to $9.1 million compared to $4.6 million in the prior year period. This increase in cash flow from operations resulted in free cash flow of $3.4 million during the first 9 months of 2013 compared to $200,000 free cash flow from last year. We define free cash flow as cash flow from operations, less cash used in investing activities or CapEx.

Continuing on to our balance sheet. Highlights for the quarter include the reduction of about $2.9 million in debt compared to the prior year -- or compared to year-end 2012, which was funded by operations and improvements in working capital. Inventory was down also by $700,000 compared to the year-end of 2012.

We believe that our inventories at the proper levels support our expected sales in the upcoming quarters. Our accounts receivable decreased approximately $2 million as a result of improved DSO, which improved to 34 days from 45 days at year end.

Turning to our outlook. Our full year guidance reflects changes in the timing of expected Dispenser sell-in. Our top line sales are expected to be in the range of $90 million to $93 million, resulting in adjusted EBITDA in the range of $9.1 million to $9.3 million or an increase of approximately 68% to 71% over the prior year.

Regarding the impact of the strategic alliance that we announced today, we expect the alliance to have a positive impact on our net overall financial results, specifically the addition of 3,000 DS Waters Exchange customer locations and improve gross margins through lower distribution costs, the improved financial results will be phased in over the next couple of years. We will also expect to incur certain nonrecurring costs related to the transition of customers and distribution centers, which we will separately break out in future results as nonrecurring costs.

We will provide guidance for 2014 in early 2014 to reflect the impact of the strategic alliance with DS Waters.

This concludes our financial review. Now I'd like to turn the call back over to Billy.

Billy D. Prim

Thanks, Mark. Industry dynamics remain positive for us, and our team remains focused on growing our core Water and Dispenser business. Our strategic initiatives will enable us to add dispensers to more households across the U.S. which, in turn, lead to reoccurring water sales.

We feel that we are well-positioned to capitalize on the increased volume of water consumption and look forward to continuing to execute our strategies and deliver long-term sustainable growth for Primo.

I would like to thank our employees, regional operators, refill service providers and retail partners for their efforts in our growth and continued execution improvement. We will continue to execute on our long-term growth strategies of increasing locations to 50,000 to 60,000 retail points of distribution, increase households through 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

Thank you, presenters, and thank you, ladies and gentlemen. This does conclude today's call. Thank you for your participation, and have a wonderful day. Attendees, you may now all disconnect.

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