Primo Water's CEO Discusses Q4 2013 Results - Earnings Call Transcript

Mar.11.14 | About: Primo Water (PRMW)

Primo Water Corporation (NASDAQ:PRMW)

Q4 2013 Earnings Conference Call

March 11, 2014 16:30 ET

Executives

Billy Prim - Chairman and Chief Executive Officer

Mark Castaneda - Chief Financial Officer

Matt Sheehan - President and Chief Operating Officer

Analysts

Eric Wagoner - Source Capital

Robert Strauss - Gilford Securities

Operator

Good day, ladies and gentlemen and thank you for standing by and welcome to the Primo Water Corporation’s Fourth Quarter 2013 Financial Results Conference Call. At this time, all participants are in a listen-only mode. (Operator Instructions) As a reminder, today’s conference maybe recorded.

It’s now my pleasure to turn the floor over to (Hunter Walles). Please go ahead.

Unidentified Company Speaker

Good afternoon, and welcome to Primo Water’s fourth quarter and full year 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 have not received today’s press release, it is available on the Investor Relations portion of Primo Water’s website at www.primowater.com. This call is being webcast and a replay will be available on the company’s website.

Before we begin, we would 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 this afternoon and in all documents that Primo Water files with the SEC.

And now, I’d like to turn the call over to Primo Water’s CEO, Billy Prim.

Billy Prim - Chairman and Chief Executive Officer

Thank you, Hunter and thank you for joining us on the call. I am going to start out with a few comments on our overall business 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 our fourth quarter and fiscal year end results and the outlook for 2014.

We are pleased with our fourth quarter results as we continued to experience positive momentum across our business. The fourth quarter marked the eighth seventh consecutive quarter of adjusted EBITDA growth, which was a 70% increase to $1.9 million. For the full year 2013, we had adjusted EBITDA of $9.1 million, an increase of 66% over the prior year. The strong adjusted EBITDA was due to improved gross margins and operating efficiencies that enabled us to generate $6.6 million in cash flow from operations in 2013.

Our team has continued to improve the operational fundamentals of our core business. As we go into 2014, our company is well-positioned to execute our long-term growth strategies. These strategies are first to continue to scale through incremental revenue and operational improvements; second, to increase household penetration of our innovative water dispensers; third, to grow our points of refill and distribution to 50,000 to 60,000 locations; fourth, to refinance our debt and lower cost of capital; and lastly, to continue to drive the operational efficiencies of this business model. We believe that we can make improvements in all the five of these areas during 2014.

We believe the strategic alliance with DS Waters will bring lower distribution cost and add new locations in revenue. We expect the DS Waters transition will happen over a two-year period and we will continue to update you on our progress. We expect the CORT and Telemetry programs will continue to improve gross margins in our refill business. We also believe we will continue to drive more dispenser households, which in turn leads to more Primo Water users. As we continued to grow our adjusted EBITDA, we believe we can refinance our debt with lower cost of capital. All of these combined should drive earnings.

The water industry trends continued to be very favorable. People are sending traditional soda and looking for healthier lower calorie options and we have an offering that can fit most households. We do not see this trend slowing down. In fact, we believe it is accelerating. You can see that in our same-store unit sales which were up more than 10% in the U.S. Exchange business in 2013 compared to 2012. So to recap, we are pleased with the business momentum and believe we are better positioned than ever before with the right team and the right operational strategies and products to fully capitalize on the Primo business model.

With that brief overview, I will turn the call over to Matt Sheehan, our President and Chief Operating Officer.

Matt Sheehan - President and Chief Operating Officer

Thank you, Billy. Keeping our five long-term strategies in mind our scale, household penetration, growth, refinancing and efficiency, we are both proud and excited about our business. We are proud of what our team has done in 2013 to strengthen the very core of this business, sticking to our plan and achieving our targets. From that work, we are excited about our future as we turn to grow in 2014 and beyond. Today, I will first recap 2013 and then layout our approach for 2014.

As you may recall, we undertook an operationally intensive approach in 2013 which has resulted in significant financial improvements. We executed the year with three key themes in mind: customer focus, simplicity and analytics. With those themes in mind our team created several initiatives that changed the financial performance and health of the company. To round out our 2013 story, here are some of the things that we accomplished. We aggressively strengthened our talent across the company. We focused, renewed and stabilized our retail relationships. We continued to optimize and reduce on SG&A. Using our unit economic focus we began to shed underperforming assets, relocate them to better performing locations and to judge retail opportunities by the projected returns, not just revenue potential through a process we call field review.

We executed several network service level performance improvements from KPI tracking service level monitoring and SIPs, service improvement plans. Finally we built the dedicated team managing and supporting KPIs across all aspects of our business. These efforts improved service levels, increased operating margins and drove much of the financial performance in 2013 as we focused on growing the bottom line of the business and setting us up for growth in ‘14 and beyond.

Turning to 2014 this is a year of evolution for us, as we not only continued to improve the core, but we transform our company upon four key tenants. First, a team that delivers; second, better operating models; third, a compelling brand and market leadership; and lastly, driving results. With those key tenants in mind, here are the key updates from each of our businesses. In our refill business, which already has strong operating margins, we expect to see further gross margin expansion through technology and service improvements. First, we have CORT, company-operated regional territories, where we shift from extensive third party technicians that do not allow efficiency to scale to deployment of company’s service technicians in dense regions. We are on plan to transition territories to CORT and are confident in the impact this team will have on this business.

Second, we are more than halfway complete with our Telemetry installations. Telemetry is remote monitoring technology, which relays meter flow data to us at headquarters and opts people on the field. The technology signals equipment issues to us immediately, gives us much better visibility, improves our billing procedure and helps us become more proactive. We expect to complete our Telemetry rollout in 2014. Lastly, using 2013 as a test bed, we have launched a new empty bottle reordering and replenishment program which is beginning to show financial dividends as well as driving trial and new customers. We believe these initiatives will improve service, drive revenue, improve gross margins and help us to leverage future growth.

Moving to exchange, there continued to be much excitement about this business. First, we continued to see strong comps, which is a sign for the future health of the business unit. From here we are well underway transitioning from a group of independent regional operators to primary bottling and distributor, DS Waters. We believe this alliance will decrease our distribution cost, increase our service levels for retailers and bring new revenue to us as we assume responsibility for DS’ current retail clients such as Home Depot. The alliance is well underway with several territories already transitioned and several client transitions in process.

We are pleased by what we have seen from DS and are highly confident in the strength of the partnership. Lastly but not least, the team has made and continued to make great strides in our water dispenser business the Razor and our Razor-Razorblade model. The industry has come a long way since the big brown (indiscernible) heavily due to our involvement in space. Our customers expect high quality, innovative and expertly designed appliances, which suit the needs of families and most beautiful in their homes. We continue to create new and innovative beverage dispensers, which will increase the overall household penetration each year driving our water businesses.

We continue to believe in our ability to innovate than no one else and believe this is important to our success in driving our business long-term. With those updates in mind, which drive from our key operating tenants of 2014 a major theme of evolution for the year in the five key long-term strategies, we are excited to turn from the year of foundational improvement in 2013 to grow a stronger core business in ‘14. We have on the right team operating with the balance of humility and drive and look forward to updating you each quarter on our progress. Given our ability to do what we said we would in 2013, we have strong confidence in our ability to grow our business in 2014 and beyond.

Now, I will turn the call over to Mark to review the financial results for fourth quarter.

Mark Castaneda - Chief Financial Officer

Thanks Matt. I am going to review 2013 results and discuss guidance for 2014. To help investors understand our operating results, we do provide certain non-GAAP financial measures, including adjusted EBITDA, which I will discuss in a few moments. Overall, we are very pleased with our full year financial results, which were in line with our expectations with adjusted EBITDA up substantially on similar level of sales. We achieved these results through gross margin management and lowering our SG&A expenses. As we expected total sales for the fourth quarter decreased 6.6% to $19.5 million, the decrease reflects lower dispenser sales as compared to the prior year. Our Dispenser segment revenues decreased 25% compared to fourth quarter of the prior year to $4.4 million. As a reminder, our dispenser sales can be lumpy as we generate revenue selling products into retail inventory.

Retailers manage their inventory timing based on factors outside of our control. This revenue does have a smaller impact on our economics as we manage the dispensers at thin margins to drive household penetration. This pricing strategy continues to work as we had another quarter of growth of consumer purchases at retailers were up 12.5% in the quarter and 11% for the 12 months. We believe that increased water dispenser penetration will lead to continued increase in recurring Water sales.

Our Water revenue increased about 1% to $15.1 million despite being up against tough comps due to demand from Hurricane Sandy in the prior year. Our fourth quarter Water revenue included 9.6% U.S. exchange same-store unit growth. For the 12 months, same-store unit growth in the U.S. exchange was 10.4%. Our same-store units were greater than our overall sales as we removed about 800 locations to the store closures or locations that did not meet our hurdle rate requirements.

Moving on to gross margins, our gross margins increased 260 basis points to 26% for the fourth quarter from 23.4% for the fourth quarter in 2012, which was driven by improvements in both Water and Dispenser gross margins. Gross margin from the Water segment increased 40 basis points to 31.3% for the fourth 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 to 7.6% up from 4.1% in the prior year, again, primarily due to improvements in supply chain costs and a more favorable sales mix of higher margin product.

Next, we continued to manage improvements in SG&A spend, which decreased 15.4% to $3.4 million. As a percentage of net sales, SG&A expense decreased to 17.6% from 19.4%. We continued to leverage our primarily fixed SG&A expenses across the businesses. Our net loss from continuing operations have improved to $2.8 million or $0.12 per share from a loss of $3.11 per share in the prior year. For the full year of 2013 cash flow from operations increased 13% to $6.6 million compared to $5.9 million in the prior year.

Continuing on to our balance sheet, highlights for the quarter include a reduction in inventory by about $1.2 million compared to the prior year. We believe that our inventory is now at the proper levels to support our expected sales in the coming quarters. Our accounts receivable also decreased by about $2.3 million as a result of improved DSO which improved to 36 days from 45 days in the prior year.

Turning to our outlook, we expect total full year 2014 sales to increase between 7% and 11% to a range of $98 million to $102 million and full year adjusted EBITDA to increase between 17% and 22% to a range between $10.6 million and $11.1 million. We expect to update this guidance as we have more visibility to the DS Waters transition as the year progresses. First quarter 2014 net sales are expected to be in the range of $22 million to $22.3 million and adjusted EBITDA to increase between 5% and 21% to a range of $2 million to $2.3 million.

For the first quarter, we expect positive Water segment growth and negative comps on dispenser selling to the channel. We do expect the negative dispenser comp trend to end in Q1 and turn positive in Q2 and the remainder of 2014 as consumer sell through continues to be strong. We do expect to refinance our debt in the second half of 2014 as we continued to improve our balance sheet and operating metrics. We are less than three times lever at the end of 2013 and expect the lever to continue to decrease.

This concludes our prepared remarks. We would now like to turn the call over to operator for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) And presenters, it looks like our first phone question will come from the line of Eric Wagoner with Source Capital. Please go ahead. Your line is now open.

Eric Wagoner - Source Capital

Guys congratulations on a great year end and a great fourth quarter. Going through the numbers, it looks fairly good the – I was thinking if you give us little overview on sell-in versus sell-through and how that’s important in terms of having the dispensers ordered versus the demand on the retail side. It looks like that’s kind of the key portion and the other question looks like the margins continue to improve and if you would give us guidance on the gross margins and the SG&A?

Billy Prim

Thank you, Eric. And I will let Mark go into the sell-in versus sell-through?

Mark Castaneda

Sure, Billy. On the sell-in versus sell-through, the sell-in is what we sell into the channel and if you would think about what we sell to the channel it’s the inventory levels at retailers. Retailers at the beginning of the year were building inventories as they saw that Christmas was not going to be as strong as they expected they started pulling inventory levels down. We actually in the Q2 through Q4 sold-in less than we did in the prior year despite the consumer purchases being up every quarter this year. Just to give you an example we sold-in approximately 350,000 units this year, the consumers purchased 450,000, almost 450,000 or 440,000, so a decrease of almost 100,000 units this year in inventory. Again we expect Q1 to have somewhat similar as retailers will have like Q1 inventory levels, but we do expect to see – we do get some POs in advance for the dispenser business that we do expect to see better comps in the second through fourth quarters.

Eric Wagoner - Source Capital

How far had the retailers ordered the dispensers?

Mark Castaneda

They typically go 60 to 90 days out but they give us indications four to six months out.

Eric Wagoner - Source Capital

Okay, thank you.

Operator

Thank you, sir. (Operator Instructions) Our next phone question will come from the line of Robert Strauss with Gilford Securities. Please go ahead sir. Your line is open.

Robert Strauss - Gilford Securities

Hey guys. Congratulations on last year and turning the company around. I have a few questions. First on the margin structure of the business tell me how sustainable fourth quarter gross profit margins are? And then if you were to look out over the next 24 months, is there an EBITDA margin target that you think you can get to? And I ask that question because EBITDA margins look like they were about 6% in 2012 going to 10% in 2013 and it looks like we can be closer to 11% in 2014? So that’s where I will start.

Billy Prim

Rob, I am going to talk about the EBITDA margins and I am going to let Mark get into the specifics on how they change, because it does change a lot of mix. So you need to always have the mix in mind as you think about gross margins. You are correct and that we went from EBITDA margins of 6% in ‘12 to close to 10% in ‘13. And that starts to show the power in the leverage in our business model. As you will remember, a lot of this model was built out for Blue Rhino’s business model. We had 20% EBITDA margins there. That’s our target. Now, we are not going to get there in the next 12 months to 24 months, but we do believe we can get there in the next three to five years and that’s the target of where we are headed. As far as gross margins, Mark, why don’t you break it down a little bit and tell him how to think about gross margins from 2014.

Mark Castaneda

Yes. So gross margins and looking at the trends for the last couple of years, 2012 was 23.4% gross margin, 2013 was 25% overall gross margins, but what we will see is we will see some of that changing dynamics. We do expect gross margins in each of the business lines of dispensers and water to increase. However, based on the mix of how much dispensers are in the mix that could cause a reduction in gross margins just based on mix. As you remember, our dispenser gross margins are on the single-digits whereas the water gross margins are in the 30% range, 30%, 35% range.

Robert Strauss - Gilford Securities

Great. And then just as a follow-up, if we are at, let’s just call it, 10%, 11% in EBITDA margins today and one day, I don’t know if we hit the target of 20%, but let’s say it’s substantially higher, can you discuss a couple of the buckets that get us to that point or in that direction, what’s important to move that up so substantially?

Mark Castaneda

Yes, two factors. One is improvements in gross margins, so again we do see gross margins expanding of both the water and the dispenser side. We also see reduction in our leverage of our SG&A expenses. So, this past year SG&A was about 15% of sales, which stood at going to 10% to 12% of sales for the next few years.

Robert Strauss - Gilford Securities

Okay. One more question and then I will get back in the queue. If I were to look over the next 24 months and consider the top line growth potential of the company, which do you think is more important to growth, new locations or incremental revenue at existing locations?

Billy Prim

I am going to ask Matt to chime in on that a little bit and let him talk about growth and what he has in mind.

Matt Sheehan

I think, it’s a great question. I think it’s going to be based on both. I think one is we have to continue to increase locations and as mentioned we have a tighter process for choosing the right locations for high returns. We are being more diligent about making sure that the locations we do go into give us high returns and part of that will be revenue. On the other side, we are focused heavily on same-store sales. We are and some great retailers that have a lot of traffic. And we can turn more of that traffic into consumers and whether that’s the presentation of retail and our overall strategy of retail, we believe we can get more of the consumers that are walking by our setups in retail to convert to customers. So, I think it’s heavily based on both and we have a balanced strategy on both sides.

Robert Strauss - Gilford Securities

Sure. Is it too difficult to tell at this point or can you give us a sense of whether top line growth can be expected to be a 50-50 mix from new locations versus incremental revenue at existing, is it possible to say or is that too difficult?

Matt Sheehan

It’s hard to tell you across the board, Robert it varies in different regions of the country. As and for folks to remember, our main marketing program is selling dispensers to create new households, which in turn become Primo Water users either in the refill or the exchange business, it really doesn’t matter to us. So we are selling record numbers of dispensers and to create new households. And as we see where those dispensers are sold and located that’s when we know that we need to expand the location count to make sure we are within reach of those new consumers. Now, it’s obvious that we have less density in the Western part of the United States and you are going to see us start to focus more attention on that to become more available to the consumers in the Western United States.

Robert Strauss - Gilford Securities

Great, I am going to get back in the queue, let someone ask the question, I will follow-up. Thank you.

Operator

Thank you, sir. (Operator Instructions) We do have another question in queue and it’s a follow-up question from Mr. Strauss. Please go ahead. Your line is now open.

Robert Strauss - Gilford Securities

I did wait a couple of seconds. So, last topic, on DS Waters you previously presented some numbers on DS Waters incremental revenue and EBITDA, could you discuss with us a little bit more about those numbers, are they entirely from DS Waters or have you also incorporated especially in the incremental EBITDA number feedings that Primo overall as a company will get because of the DS Waters alliance?

Mark Castaneda

Robert, there is a couple of components. It’s a combination. So there are some DS Water numbers baked in our guidance, but it’s not everything that we expect. So as we get more visibility to the transition and the timing of the transition, we do expect to increase our guidance throughout the year. Now, we did say that those numbers from DS Waters of $15 million of top line and $4 million of EBITDA will occur over two years, but again there is a transition time. So we do expect to have some of that’s baked in our guidance and some of that guidance is also baked on improving our core business.

Robert Strauss - Gilford Securities

Last question and Matt this is for you. I think a couple of quarters ago you had discussed perhaps some surveys and things like that that you are doing, at the retail level, so that we learned potentially more about our customer, is there anything that you would like to discuss regarding those surveys, any results if you see, I am sure it’s driving your strategy, but any additional color would be appreciated?

Matt Sheehan

Yes, sure. I think what we will try to do is understand our retailers more and it’s a great question. Retailers more and also our consumer and what we found from retailers is it they want high service levels and we stay focused on that. It relates to the consumers, those haven’t changed all that much frankly and that gives us some predictability about this business both from the dispenser business. Family is buying dispensers and so forth. And also the repeatability of our model since there is an exchange we see a very good loyalty where the average household is buying a very healthy amount of bottles per year. So I don’t think demographically we have seen any surprises and that gives us some comfort to keep focus on what we know about our business and keep delivered.

Robert Strauss - Gilford Securities

Great, thanks a lot and good luck for the year.

Billy Prim

Thank you.

Operator

Thank you, sir. And gentlemen at this time I am currently showing no additional phone question is in the queue. I would like to turn the program back over to you for additional or closing remarks.

Billy Prim - Chairman and Chief Executive Officer

Thanks. As you can see we are excited about what we have accomplished and are optimistic about our growth in the long-term. Our reoccurring revenue model gives us clear visibility in the future quarters. We are well positioned for 2014 and expect that the coming year will be one of the great success. 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 appreciate your interest and thank you for your support. We look forward to providing you with an update or 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 log off at this time.

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