Cott (Canada) (COT) Jeremy S. G. Fowden on Q4 2015 Results - Earnings Call Transcript

| About: Cott Corporation (COT)

Cott Corp. (Canada) (NYSE:COT)

Q4 2015 Earnings Call

February 18, 2016 10:00 am ET

Executives

Jarrod Langhans - Director-Investor Relations & Corporate FP&A

Jeremy S. G. Fowden - Chief Executive Officer & Director

Jay Wells - Chief Financial Officer

Analysts

Perry Caicco - CIBC World Markets, Inc.

Mark Swartzberg - Stifel, Nicolaus & Co., Inc.

William Marshall - Barclays Capital, Inc.

David Hartley - Credit Suisse Securities (Canada), Inc

Nicholas Coutoulakis - Canaccord Genuity Corp.

Operator

Welcome to Cott Corporation's Fourth Quarter and Fiscal Year 2015 Earnings Conference Call. All participants are currently in a listen-only mode. This call will end no later than 11:00 A.M. The call is being webcast live on Cott's website at www.cott.com and will be available for playback until March 3, 2016. 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 condition.

Such statements include, but are not limited to, statements that relate to the company's business strategy, anticipated refinancing, investment in organic and acquisition opportunities, including expected synergies and financial impacts related thereto, goals and expectations concerning our market position, commodities, future operations and estimated volumes, revenues, gross margin, EBITDA, free cash flows, 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, applied in drawing conclusions, in the forward-looking statements information available in the company's press release issued earlier this morning and its Annual Report on Form 10-K for the year ended January 2, 2016. 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 fourth quarter and fiscal year 2015 earnings announcement released earlier this morning as well on the Investor Relations section of the company's website at www.cott.com.

I'll now turn the call over to Jarrod Langhans, Cott's Head of Investor Relations. Please go ahead.

Jarrod Langhans - Director-Investor Relations & Corporate FP&A

Good morning and thank you for joining our call. In order to assist with some of the information that we will cover this morning, we have included a few schedules online at www.cott.com. Today, I'm accompanied by Jerry Fowden, our Chief Executive Officer; and Jay Wells, our Chief Financial Officer. Jerry will start this morning's call with some of his thoughts on our operations in 2015 as well as progress on our vision as we continue to build shareholder value and deliver consistent cash flow growth before turning the call over to Jay for a discussion of our fourth quarter and fiscal year 2015 financial performance. Jay will then turn the call back to Jerry, who will complete the call with an overview of our larger business units as well as expectations for 2016. Following our prepared remarks, we will open the call up for questions.

With that, let me now turn the call over to Jerry.

Jeremy S. G. Fowden - Chief Executive Officer & Director

Thank you, Jarrod. Good morning and thank you, everyone for joining our call today. Before Jay's comments on our 2015 financial results and our fourth quarter, I wanted to spend a little time discussing the progress we have made in transitioning Cott from a predominantly low margin private label and contract manufacturing business to one that has a much broader spread of customers, serviced through multiple channels and is increasingly focused on Good-for-You beverages. This transition started with the acquisition of Aimia Foods in the United Kingdom and was enhanced with the addition of DS Services in the United States at the end of 2014 and has seen our business undertake a significant and positive repositioning that is evident across multiple key metrics and key performance indicators.

Over the last three years our customer concentration has significantly improved with our top 10 customers now representing around 30% of revenues compared to 55% a few years ago. On the proportion of Cott's EBITDA coming from growing categories has increased from around 40% to over 70%.

Plus, if we look at 2015 alone our gross profit almost tripled to around $900 million and gross margins increased from approximately 13% to over 30%. Our adjusted EBITDA almost doubled to $357 million and adjusted free cash flow exceeded the top end of our $94 million to $114 million guidance range coming in at $134 million driven by increased earnings, stringent working capital management and approximately $15 million of lower than expected CapEx.

What's more important is that Cott is now well positioned with a clear strategy and a growing number of home, office delivery platforms to continue this transition toward a more diverse health and wellness beverage, water, coffee and tea business. This continued transition will be through a combination of organic and synergistic transactional activity that will see our business increasingly shift towards more attractive higher margin and/or higher growth categories while keeping our focus on our Four Cs, especially free cash flow generation with a goal of delivering strong compound growth in adjusted free cash flow for many years to come.

On that note, I'll pass over to Jay and will return later to provide some additional detail around the performance and operations of our larger business units in 2015 as well as expand on our recent acquisition of Aquaterra in Canada and our priorities and expectations for 2016.

Jay Wells - Chief Financial Officer

Thank you Jerry and good morning everyone. For the quarter, revenue increased by 29% to $699 million. Revenue increased predominantly due to the addition of DS Services. This growth was partially offset by a 4% impact from the continued mix shift in our traditional business towards contract manufacturing which as you recall has lower revenues but similar profit dollars versus the private label soda and shelf stable juice business, it is replacing.

As a reminder we continue to believe that 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 business. And although we expect to see growth in free cash flow, EBITDA and gross profit, we do not expect revenue growth over the next couple of years due to the ongoing mix shift into contract manufacturing and foreign exchange trends especially the Canadian dollar and UK pound relative to the U.S. dollar.

Gross margin for the quarter was 31.6% compared to 13.2%. Excluding DS Services gross margin was 14.1% for the quarter driven by broadly stable volumes in our Cott North America business unit, as well as cost savings initiatives within our traditional business. We've made good progress against our goal of reducing production costs within our Cott North America business unit by $30 million over three years with $9 million of cost savings realized during 2015.

As noted, within our previous quarterly filings the purchase accounting of DS Services had been completed except for a physical fixed asset inspection and final intangible valuation. This was completed in the fourth quarter and we have updated our intangible and fixed asset valuation and asset listings, which resulted in a net decrease to depreciation and amortization of some $4 million for the fiscal year.

In the quarter, adjusted EBITDA increased around 90% to $81 million as a result of the addition of DS Services alongside stability within our Cott North America operations despite the impact of $3 million of unfavorable foreign exchange rates.

Turning to fiscal 2015, revenue increased 40% to $2.9 billion as a result of the addition of the DS Services and Aimia Foods businesses in 2014 offset in part by foreign exchange rates, our ongoing product mix into contract manufacturing, a competitive traditional business landscape and lasting the 53rd week our traditional business had in 2014.

Gross margin for the fiscal year was 30.4% compared to 13.1%. As a reminder, we had previously noted that the broadly stable volume within our Cott North America business in addition to our cost savings programs would provide a 100-basis point improvement in the gross margin of our traditional business in 2015.

I am pleased to say, we exceeded this goal with the gross margin of our traditional business increasing 170 basis points to 14.4%. Adjusted EBITDA for the fiscal year was $357 million compared to $180 million. The increase in adjusted EBITDA was due primarily to the addition of DS Services and Aimia Foods, and the growth in synergy capture from these businesses, as well as the stabilization of our Cott North America business unit, offset in part by $12 million of foreign exchange headwinds and the competitive traditional business landscape.

With respect to free cash flow, we continue to focus on the Four Cs of controlling CapEx and rigorously managing working capital. This allowed us to deliver our seventh straight year of strong free cash flow with our adjusted free cash flow for fiscal 2015 being $134 million, and our reported free cash flows coming in at $144 million.

Adjusted free cash flows were higher than our earlier guidance of $94 million to $114 million as we incurred approximately $15 million left in CapEx than originally anticipated. This strong free cash flow allowed us to make good progress on deleveraging the company by redeeming our preferred shares, and reducing the amount drawn on our asset based lending facility. We ended 2015 with net leverage of around 4.4 times EBITDA versus pro forma net leverage of over 5.1 times EBITDA at the end of 2014.

Looking forward to 2016 and beyond, the impact of product mix shifts on 2016 revenue will be consistent with what we saw in 2015, and that the product mix shift of our traditional business will continue to reduce revenue at a similar rate, but generally not affect profitability.

In addition, on our third quarter earnings call, we noted that the UK business environment was challenging, and although we just completed a better than expected fourth quarter, we still anticipate the UK will provide headwinds to 2016 global revenue in the order of 1% to 2% and around $5 million EBITDA headwind, both on an FX neutral basis.

With respect to our outlook on foreign currency in 2016, if the U.S. to Canadian dollar and UK pound exchange rates stay flat at where they are today, exchange rates will provide a headwind to 2016 revenue of approximately 1% to 2%, and EBITDA of 4% to 5%. Even with these headwinds, we are looking for overall EBITDA to grow in the 3% to 4% range in 2016 from growth at DS Services and the addition of Aquaterra. And we see gross profit as a percentage of revenue being flat after the good progress on gross margin in 2015.

But as I said earlier, we believe that free cash flow is the best measure and valuation metrics for our business and we remain confident in delivering strong free cash flow over the coming years. When looking at 2015 and normalizing for some $15 million in lower CapEx, normalized 2015 free cash flow would be around $120 million, and we project it to grow to $135 million to $145 million in 2016 and to $165 million to $185 million in 2018.

There are a number of factors that are expected to assist in delivering this three-year free cash flow growth, including our traditional business continuing to provide good free cash flow for a well invested in business and asset base, a beneficial corporate tax structure, growth in DS Services, further synergy capture and tuck-in acquisitions. In addition, we plan to refinance some high interest debt at the end of 2017, and see the cash benefit of lower interest costs in 2018.

With that, I'll now turn the call back to Jerry.

Jeremy S. G. Fowden - Chief Executive Officer & Director

Thanks, Jay. I will now review the performance in each of our reporting segments. Let's start with our Cott North America business unit. For the quarter, we saw continued strong growth in contract manufacturing, up 40% or 4 million serving equivalent cases, as well as a 4% growth in sparkling waters and mixers, thus allowing the overall business to hold actual case volumes flat on a comparable 52-week basis. This flat actual case volume performance was achieved despite continued market declines of 3% in carbonated soft drinks and 4% in shelf stable juices.

For 2015 as a whole, Cott North American contract manufacturing volumes increased over 23 million cases, bringing us to a total of 47 million cases of growth over the first two years of our three-year program, which was designed to win some 50 million to 80 million serving equivalent cases of contract manufacturing.

Our Cott North American revenues were down 6% on a comparable basis of $305 million in the quarter. This reflects the continued business mix shift towards contract manufacturing that we have discussed, where the lower revenue per case, as the brand owner normally provides the ingredients and packaging, leads to lower revenues, but the profit dollars and free cash flow per case are pretty much the same.

When you consider everything, both the favorables and the unfavorable, including the adverse impact of Canadian to U.S. dollar foreign exchange, the business mix shift underway, and our continued War on Waste program, we were pleased with a 190 basis point increase in Cott North American gross margins to 12.5% for the quarter.

As we've mentioned in the past, our goal is to hold our North American volumes broadly stable, with growth in contract manufacturing and other beverage categories offsetting the ongoing market and private label CSD and shelf stable juice decline. I am pleased that for 2015 as a whole, this was achieved, alongside a 170-basis point growth in gross margins to 13.3%, and an increase in gross profit dollars to $174 million, in spite of the adverse foreign exchange rates that prevailed.

Although overall actual case volumes were flat on a consistent 52-week basis, our CSD servings were lower by around 7%, as we continued to see frequent pricing activity in large format retailers, with almost all two-liter PET national brands being sold for $1 most of the time. IRI data continues to show that national brand players have remained much more price aggressive in large format retailers than they have in other channels, where they have pushed higher pricing and more favorable price and small pack mix actions harder.

All-in-all, we continue to believe our Cott North American business unit is in a more stable position, and we look towards broadly stable volumes in 2016 with revenue continuing to reflect our move towards more contract manufacturing. Taking current FX rates and some other factors into consideration, things point to a more difficult first-half phasing versus the second-half in 2016, as most of the U.S. dollar to Canadian FX impact falls in the first half.

Now, turning to the UK. Our UK and European operating segment, inclusive of Aimia Foods, represents around 15% of our consolidated EBITDA. As previously mentioned, we've seen headwinds in our traditional UK and European business for a number of factors. Now with that said, we were pleased with the operational results of our UK and European business unit this quarter, as they not only came in somewhat ahead of our expectations, but they also made good progress against a number of the cost and business efficiency programs we described last quarter.

As a reminder, we outlined a three-phase cost and operational efficiency program to be implemented over the next two years to three years in order to reposition the business, lower our cost base and improve our already market-leading customer service and beverage manufacturing platform, such that we are better placed to win and grow with all UK retailers including the hard discounters.

The first phase of this program centered on various cost action, inclusive of head count and benefit reduction, as well as manufacturing and operational measures. This phase was largely completed in the fourth quarter of 2015, although we still have a number of ongoing cost and efficiency program to progressively implement during the year.

The second phase involves the addition of a large and efficient warehouse at our largest UK plant. And in December, we received the required government approval to progress this initiative. Our plan is to have a third-party developer build the warehouse thereby avoiding the need for much Cott capital to be involved. We will rent the facility on a long-term lease from the developer with the cost of this rent actually being lower than the combination of external warehouse rents and associated product movement costs that we pay for today. As a result, we will get not just a more efficient warehouse and business that can provide even better service, but we will also get a lower cost operation. We believe that we can break ground on this project in the second half of 2016, and we will update you on our progress later in the year.

The third phase of our program includes the installation of a high-speed line with automated robotic rainbow packing capability. The combination of our three-phase UK action plan will best position our cost and capabilities to serve the changing nature of the UK retail landscape, which is seeing a significant growth in not just hard discounters, who still receive a lot of product supply from Continental Europe, but also growth in smaller format stores that need the space saving capability of rainbow packs.

And looking at the operating results for the quarter, on a constant 52-week basis, revenues in local currency were lower by 6%. Actual case volume was down 3%, but serving equivalent volume was up 2%, and overall gross margin was up over 440 basis points in the quarter and 140 basis points when looking at the year as a whole.

Now, turning to DS Services, overall revenues were up 8% to $256 million during the quarter on a pro forma basis with growth of just over 9% in the largest segment of home and office water delivery, growth of around 16% in single cup coffee, and 14% in retail sales. Excluding four additional shipping days and the impact of the variable energy fuel surcharge, DS revenues were up 4%. DS gross margins continued to perform well with gross margins of 62% for the quarter and 60.6% for the year, supported by the operational gearing benefit associated with the growth of the business, as well as the capture of synergy benefits.

As we sit here today, I can confidently say that we have fully integrated DS Services into Cott under the culture, work ethic and commitment to customer service is consistent throughout our companies. We captured $4 million of synergies in the quarter and $10 million of synergies in fiscal 2015.

Key actions included consolidating three customer service centers into one new state-of-the-art facility. Savings from our capabilities and scale as it relates to procurement, alongside benefits from the initial phase of vertical integration, where we are now manufacturing a portion of the case pack water, as well as all of the sparkling and ice-type beverages for DS Services within our traditional business facilities.

We are anticipating that the 2016 and 2017 synergy figures will come in at a simpler rate of around $10 million per year.

Integration costs incurred during the quarter, related primarily to the new customer service center and thus shown in the acquisition and integration cost adjustments. Looking forward, the new call center should not only provide improved customer service, which we are already starting to see, but also deliver financial synergies from 2017 onwards.

We generated approximately $185 million of adjusted EBITDA for the year supported by good performance in the core home, office water category, good operational gearing and synergies, which supported the margin improvement and allowed us to cover some $9 million to $10 million of increases in workers' compensation and certain higher health and welfare cost during the year. As a note we do not foresee additional increases in these areas as we look forward.

Now, with regards to Aquaterra and our acquisition announced late last year, we closed this transaction on January 4th, and we continue to expect the transaction to be accretive to adjusted free cash flow in its first year. The transaction was funded using some cash on hand, but also via C$40 million drawn against our asset-backed lending facility in order to provide a natural currency hedge or offset. We anticipate the three-year post synergy adjusted EBITDA multiple to be in the mid five times range and the cash-on-cash IRR in the mid-teens.

In developing our Aquaterra model, we included expected cost synergies to be realized over the first three years to four years, with year one being dedicated to the introduction of DS Services operating processes, routing software and best practices. Once this first year integration is behind us, we'll shift our focus to delivering the cost synergies in our acquisition model. We also believe Aquaterra is a great Canadian platform for further value creating tuck-in acquisitions. Just as was seen for DS in the United States.

While we've already been approached by a couple of such companies our plan as mentioned is to spend the first year getting Aquaterra onto the DS Services platforms prior to commencing such tuck-ins in Canada. On a wider note and as mentioned in our introduction, we do see the potential for further roll up consolidation in home and office delivery or in the HOD, water, coffee and tea categories and are pleased, but as in the case of Aquaterra they can be purchased at a fair rate, offer synergies with our existing businesses. And that they can become platforms for follow-on tuck-ins and add-ons. All of this has us comfortable. The scope exists for Cott to build its leadership position in HOD, water, coffee, and tea solutions as we go forward.

Now, let's turn to 2016 in a little more detail. As it relates to DS Services, we see a continuation of 2015 priorities, being front and center for DS. These include revenue growth of around 3%, on a comparable 52-week basis, a continuation of our HOD, water, coffee, and filtration tuck-ins, and the progressive implementation of our synergy plan.

For Cott North America, we see volume and cash flow stability in 2016 as we continue to grow contract manufacturing, follow our Four Cs and implement our War on Waste programs. However, based on where currency stand today, we see FX headwinds that are likely to impact Cott North American revenue, along with the much discussed mix shift of contract manufacturing. Thus revenue trends in Cott North America in 2016 are likely to be similar to those seen across 2015, with this impact weighted to the first half.

Current FX rates would also impact Cott North American EBITDA, which again will be more evident in the first half, for the exact same FX-phasing reasons. All that said, as things stand today, I feel good about our plans and the actions we have in place and that we will continue to produce good, strong North American free cash flow.

Now as it relates to our UK, European business I spent quite a bit of time earlier outlining our plans not just for 2016 but for the next two to three years. Yes, the market environment, FX and the changes taking place in the retail landscape are not all helpful to our business but we are well underway in implementing our three-phase action program and again I feel good with the free cash flow generation prospects of our UK operations.

As it relates to cash taxes we continue to expect our cash taxes to be minimal in 2016 at some $5 million to $8 million. With cash taxes being slightly higher in 2016 versus 2015, as we will be paying a one-time tax of some $3 million to $4 million connected with the preferred shares that we redeemed in 2015. On commodities, we're looking at another year in which on a net basis commodities overall are not a significant headwind. And once higher niche fruit costs, as well as our advanced coverages and hedges are added up, we're likely to see total commodities slightly up year-over-year due mainly to increased high fructose corn syrup costs.

Now at this point it's worth reminding ourselves that DS Services has relatively little commodity exposure as their energy surcharge introduced in 2012 effectively acts as a monthly pass-through mechanism up or down based on the published price of diesel. So this alongside Cott's traditional business where most of the volume is transported by our customers means that gas prices have limited impact on Cott's cost structure and financial results.

As Jay noted earlier, we believe free cash flow is the best metric to both track Cott's performance and used to determine our value. For 2016, we anticipate generating $135 million to $145 million of adjusted free cash flow with around $120 million to $125 million of expected CapEx despite FX headwinds of around $15 million. By 2018, we expect this to grow to somewhere in the range of $165 million to $185 million.

Now I think that covers the quarter, the past year and 2016 fairly fully. And I'd like to finish by saying I believe we have a very clear direction and strategy, one that generates strong free cash flow from our traditional business, one that's seen great progress in our transition to supply a broader customer base with better-for-you beverages and an opportunity to continue to expand its presence in water solutions and supply multiple channels, homes and offices by organic and acquisition-based growth. This continuing transition and I would say we are only halfway there is in pursuit of a higher margin and/or higher growth, more predictable and dependable business but once complete, we'll not only deliver strong free cash flow but we'll be well positioned for sustainable top and bottom line growth, and known throughout the industry for being a leader in better-for-you beverages, water, coffee and tea solutions.

I'd now like to turn the call back to Jarrod.

Jarrod Langhans - Director-Investor Relations & Corporate FP&A

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.

Question-and-Answer Session

Operator

And we'll go to Perry Caicco with Canadian Imperial Bank of Commerce.

Perry Caicco - CIBC World Markets, Inc.

Yes, good morning.

Jeremy S. G. Fowden - Chief Executive Officer & Director

Good morning, Perry.

Perry Caicco - CIBC World Markets, Inc.

Jerry, what does the 7% carbonated soft drink volume decline mean for your asset base? Are there changes that are going to be needed over the course of time, or is it just a matter of shifting existing lines over to the co-pack business?

Jeremy S. G. Fowden - Chief Executive Officer & Director

Good question, Perry, and while it was a 7% decline in carbonated soft drinks the overall volumes were flat and we did have a 4% growth in sparkling waters and mixers category, which are made on exactly the same production line. And as we look at things today, and I won't get it exactly right, Perry, but whether it's the end of 2017 or the end of 2018 we would actually imagine our sparkling waters and mixer business to be the same size if not larger than our CSD business. So, there's no real implications for our kind of traditional business manufacturing base, because overall volumes are stable and the majority of the products that are growing are made on the same installed capital base as the carbonated soft drink decline.

Perry Caicco - CIBC World Markets, Inc.

I would assume you still have significant capacity, is that fair?

Jeremy S. G. Fowden - Chief Executive Officer & Director

Yeah, I wouldn't say significant. On PET we are relatively well utilized, in the area of cans we do have some spare capacity and in the area of hot fill, if we were to shift our manufacturing, we are seven days a week, 24 hours a day in certain plants, and there are some other plants where we're running a five-day or six-day shift, so by moving to 24/7, over time we could adjust capacity. So, we still feel confident that we have the opportunity to continue to grow contract manufacturing and that that growth will allow us to offset the decline in private label and shelf stable juice categories, as well as private label decline in those categories, and that an overall CapEx of $120 million to $125 million, of which $50 million to $55 million is the traditional business as we look out over the next few years, means that modest capital expenditure, still have the capacity to win contract manufacturing with this overall goal of keeping volume stable.

Perry Caicco - CIBC World Markets, Inc.

Okay. Thank you.

Jeremy S. G. Fowden - Chief Executive Officer & Director

Thank you Perry.

Operator

And we'll go next to Mark Swartzberg with Stifel, Nicolaus.

Mark Swartzberg - Stifel, Nicolaus & Co., Inc.

Yeah, thank you. Good morning, gentlemen, nice to see how you're doing there on the free cash flow.

Jeremy S. G. Fowden - Chief Executive Officer & Director

I'm very pleased that you are on the call to say that, Mark. It's something we focus on very much and I do know it's something that you personally wanted to get comfortable with. So, we are pleased with the results, and as we've said we see ourselves continuing to grow that cash flow to the $135 million – $145 million range for 2016 then the $165 million to $185 million range for 2018.

Mark Swartzberg - Stifel, Nicolaus & Co., Inc.

Yeah, thank you, too...

Jeremy S. G. Fowden - Chief Executive Officer & Director

So I think we're awfully pleased about that.

Mark Swartzberg - Stifel, Nicolaus & Co., Inc.

Yeah, thank you, too, for being clear about where you see it shaking out in the future. I had a couple of questions. One is on the contract manufacturing. Jerry, can you give us some sense of the pipeline, so to speak, how you feel? Obviously the business is doing well versus the objectives you set out a while back. Can you give us a sense of the pipeline, the negotiations, how those are shaking out? And I guess you never really know when someone might choose to discontinue your services but can you somehow comment on any risk that that might have to how you feel about the pipeline?

Jeremy S. G. Fowden - Chief Executive Officer & Director

Yeah, I mean, as you know Mark, our official goal was 50 million to 80 million 8-ounce cases over three years, we're at 47 million after two years, so we feel very comfortable with that goal. At some stage through this year it's probably right that we'll lay out a view of where things go beyond then because I think as you're aware the pipeline for certain contract manufacturing agreements can actually be looking out one to two years because you're becoming a significant, an embedded part of the supply chain of many big global companies. So we are working our way on three big contract manufacturing projects at the moment, that have anything up to a 24-month range before they would be starting production. You can never guarantee whether all three of those, two of those, one of those comes off, but we do feel comfortable there's a good pipeline, that we'll continue to see momentum in that area.

And then with regards to when someone leaves, it's very interesting; in this year we've just completed we did have a big company install some capacity of their own and take some business away from us but they also launched some new products which they didn't have the capability to make and gave them to us, such that even with that dynamic in 2015, we ended up with a net overall growth that well hit the upper end of our expectations.

Mark Swartzberg - Stifel, Nicolaus & Co., Inc.

That's great, okay, that's helpful and encouraging. And then on commodities, your business has been reshaped quite a bit and the pricing environment has changed net to the positive. As you think about the legacy North America business, if you find yourself with a commodity windfall, with oil being where it is, PET might produce a benefit or – in some other component of your cost structure – or your inputs I should say, if you get a windfall is that – how do you think about that from a cost perspective? Does that produce some earnings flexibility to you because of a better competitive pricing environment or do you think the old rules still apply, you're going to see that kind of go back to the retailers and consumers effectively?

Jeremy S. G. Fowden - Chief Executive Officer & Director

Yeah, I mean, there's a number of themes in there, Mark, but sticking with our traditional business overall, we did exceed our expectation on the improvement in gross margin during 2015, coming in something like I think 170 bps instead of the 100 bps that we had hoped for. Our goal for 2016 is to broadly hold gross margins flat to that above target performance in 2015.

As we look at commodities for 2016, and by and large the majority of our positions are kind of covered. As you know we take between 50% and 80% advanced coverages in nearly all areas except resin. And as we look at things today, we see a slight overall commodity increase. And let me explain why. Mainly that's because we have high fructose corn syrup going up and the significant benefit many of the national brand companies get from the cost of diesel in their enormous DSD operation is something that we don't see. A), because in DS it's a pass-through up or down, but B), more specifically on the traditional business that you were talking about, the vast majority of all our shipments to our retailers' DCs are paid for by them. So, if there is a freight saving advantage through diesel prices that's something our customers see given they're either picking things up or they're arranging collection through a third party.

Mark Swartzberg - Stifel, Nicolaus & Co., Inc.

Okay. And yet you know you've got aluminum, you've got PET, I know that get pushed on in the contract side, but I think those are your burden, so to speak, I mean, I'm still surprised that the view and again...

Jeremy S. G. Fowden - Chief Executive Officer & Director

Yes, aluminum...

Mark Swartzberg - Stifel, Nicolaus & Co., Inc.

I am still surprised you're saying up slightly?

Jeremy S. G. Fowden - Chief Executive Officer & Director

Yeah, you got to remember things like prune, and lemon and lime you know more than double in price. Other fruit cost fairly benign, favorable environment on aluminum, more so resin, adverse cost on high fructose corn syrup.

Mark Swartzberg - Stifel, Nicolaus & Co., Inc.

Got it. And then if we take the scenario that that slightly up scenario just proves to be – the reality proves better than that slightly up, what do you think happened, is that just become more price competitive or do you see margin benefit from it?

Jeremy S. G. Fowden - Chief Executive Officer & Director

I mean as we look at the business mix today, we've probably got about a third of the business as we grow contract manufacturing and as we kind of set arrangements with our other customers a third of the business would have zero commodity impact, because it's either commodities provided by the brand owner or we're on direct pass-through up and down mechanisms. And then in the other two-thirds of that traditional business, I would say the normal, is it closer to three months or four months lag today versus the five months to six months where it is, you'd have that lag and lead advantage, just for a few months either before you pass commodity advantages on or before you take the corresponding price increases from where they're going up. And obviously in an environment where you've got a couple of things down aluminum and resin and a couple of things up or one big thing up, high fructose corn syrup, that's in both of those packaged formats, its leading to no real net change or a slight increases.

Mark Swartzberg - Stifel, Nicolaus & Co., Inc.

Fair enough. Okay, great. Thank you Jerry.

Jeremy S. G. Fowden - Chief Executive Officer & Director

Thank you. You're welcome, Mark.

Operator

And we'll go next to Bill Marshall from Barclays.

William Marshall - Barclays Capital, Inc.

Good morning. Thank you.

Jeremy S. G. Fowden - Chief Executive Officer & Director

Good morning Bill. How are you, Bill?

William Marshall - Barclays Capital, Inc.

I'm good, I'm good, I'm good. Just first wanted to dig into North America a little bit. I know we've been talking a lot about the shift to contract manufacturing for some time and the impact that has on the P&L and it's certainly great to see you keep the volume number flat. Nonetheless the North American price mix came in a little bit below where I was expecting. So I was wondering if you could maybe give a little bit of color. Was there any abnormal shift between hot fill and cold fill or any other timing items that we should be thinking about in that North American price mix number?

Jeremy S. G. Fowden - Chief Executive Officer & Director

Yeah, I mean on a constant currency basis, it was down around 6%. And obviously you've got this 40% growth in contract manufacturing that pulls the revenue down. We've also got growth in waters and sparkling waters and flavored waters versus CSDs and fruit juice. So there you have a mix effect, but hits the revenue. If you consider a case of fruit juice might average $12 if it's a private label case, versus a case of soda pop up $4 and a case of sparking waters at around $4 or a bit less. So, with growth in the sparkling water area and declines within CSD and shelf stable juice, where the market alone were down 3% in CSD volume and 4% in shelf stable juice volume, you do have a mix shift within the products within the business unit, Bill, as well as the move to contract manufacturing.

William Marshall - Barclays Capital, Inc.

Okay, and then if I can just get one more in there. So it sounds like, reading from prepared remarks, really no philosophical change in your thought process on the tuck-in acquisitions. The market has been a little choppy in how it's valuing some of these roll up stories. Just wondering if there's been any thought process on slightly larger acquisitions, may be in the range of Aquaterra or even bigger and how you're thinking about that in the balance with your leverage and just generally how the market is treating these deals recently? Thank you.

Jeremy S. G. Fowden - Chief Executive Officer & Director

Yeah, let me pick up on half of that, Bill, and then maybe I'll ask Jay to comment on our leverage side of the equation. Yeah, it's certainly been a very choppy market. I think I went out for a very pleasant evening somewhere over the Christmas break when our stock was at $11.21 and thought, well, that was a nice end for the year for Cott, stock up 64% or 65%, finishing the year at $10.99 and lo and behold, by the time I got to a week into New Year, it was at $11.20 and since then everything seems to have gotten very choppy. But, if you actually look at the underlying nature of our business, it's very much continued to perform exactly like it said on the tin, 4% kind of revenue growth on an adjusted basis in DS Services, flat volumes in our North American traditional business. Therefore the way we are looking at things we don't actually see anything has changed.

We find the small tuck-in acquisitions that delivery 3 times post-synergy EBITDA multiples and you get at those synergies in those small acquisitions within a month or two, are something that we very much want to continue. I think we did nine last year but don't let the numbers carry people away because some of those were $103,000 and $211,000, et cetera, but all very profitable and they synergize down to that 2.9 times to 3.1 times EBITDA. So we very much want to carry on with that and we still see a pipeline of those. We were only reviewing what that pipeline looked like just a couple of days ago.

And then, as we said in the prepared remarks, I do see and I genuinely believe there is an opportunity for us to continue to shift the shape of our business to be more oriented towards better-for-you beverages, water, coffee and tea solutions to multiple channels that are not the big box retailers and I believe as we continue that shift both organically small tuck-ins and larger opportunities, if we're very confident they're going to deliver the same value you not only get the financial benefits of those transactions but we've shown in the case of DS can be substantive, but you should probably continue to close the value gap that Cott has. I mean someone wrote this morning about our 13% free cash flow yield versus many peers being at 5.5%. Well, if were just a 7.5% free cash flow yield then you take our free cash flow, multiply it by 15 to get the value of the company and you'd be somewhere between $15 and $20.

So, I do see this transition towards more water, coffee and tea solution as being attractive and we'll do that through organic growth, small tuck-ins and larger opportunities where they exist. But we'll be certain that they're attractive opportunities, fairly priced like DS and where we can leverage synergies from them. And to do that we, we kind of probably should look up where the balance sheet is because I think we're pleased with what we did during 2015.

Jay Wells - Chief Financial Officer

And Jerry answered the bulk of the question there, but let me add a little bit. I mean you look at, I talked about on the call, our leverage down to 4.4 times EBITDA, very happy with our free cash flow generation that we had in the year. And as we generate cash, as Jerry said, we look to spend $10 million to $20 million a year on the tuck-in acquisitions, we look to pay our dividend, but as we've discussed until we get our leverage closer to around 3 times EBITDA, we won't look to increase our dividend, and really focus on deleveraging. But at the same time, as Jerry talked about, we will continue to look at larger scale opportunities, as they come along to continue our acceleration of our diversification into growing and/or higher margin type beverage categories.

William Marshall - Barclays Capital, Inc.

Great, perfect. Thank you very much guys, I appreciate it.

Jeremy S. G. Fowden - Chief Executive Officer & Director

Thanks a lot Bill.

Operator

And we'll go next to David Hartley with Credit Suisse.

David Hartley - Credit Suisse Securities (Canada), Inc

Yeah, thanks. Good morning everyone.

Jeremy S. G. Fowden - Chief Executive Officer & Director

Good morning David.

David Hartley - Credit Suisse Securities (Canada), Inc

Hi. Just some questions on the cadence of your top line. So, yeah, loud and clear about revenue growth being flat in the coming year. But as you see a transition towards more sparkling water, and away from the traditional CSD juices kind of business, I mean do you actually see your volumes in your traditional business potentially moving up, sorry, not your volumes, but your revenue in your business moving up as you hit on to 2018?

Jeremy S. G. Fowden - Chief Executive Officer & Director

That's a good question David. And I think we said revenues for 2016, we see very much following the trend for 2015, which would actually be lower revenues, but that's sort of a combination of predominantly the continuing mix shift that we've discussed into contract manufacturing, where the brand owners supply the ingredients, the packaging, et cetera, as well as foreign exchange, and that come and goes across Cott manufacturing, whether it's in the U.S., whether it's in the UK, et cetera. So that picked up on revenue.

Now, there will be a point in the future, but we don't see it over the next two years to three years, where we think we've probably got to a stability with the growth of contract manufacturing and the changing consumer appetite and desire for carbonated soft drinks and shelf stable juices. And that's when that business ought actually be flat in revenue as well as flat in volume. When you add flat revenue and flat volume in that traditional business to our growing revenue in DS, you would have a growth overall within Cott.

David Hartley - Credit Suisse Securities (Canada), Inc

Okay.

Jeremy S. G. Fowden - Chief Executive Officer & Director

But as we see that trend towards significant growth in contract manufacturing continuing for two years or three years, while that's going on, I don't think you'll see that change in the revenue trajectory. Does that kind of got to it for you David?

David Hartley - Credit Suisse Securities (Canada), Inc

Yeah, no, I just was kind of taking it back to a route to trying to get an idea what your thought about contract manufacturing and other business lines within your business and how that will grow? So, yes, thank you.

Jeremy S. G. Fowden - Chief Executive Officer & Director

Yeah. We like the contract manufacturing. We see ourselves as a manufacturer of beverages for others in that traditional business, whether that be a brand owner, a distributor, a retailer, and since the financial profile in terms of dollar contribution per case is pretty much the same, you know, we are happy to do either. And then you have the additional element within contract manufacturing, but as the brand owner supplies the IMP, we are not carrying the working capital for that.

David Hartley - Credit Suisse Securities (Canada), Inc

Right.

Jeremy S. G. Fowden - Chief Executive Officer & Director

So, that is a small additional benefit there as well.

Jay Wells - Chief Financial Officer

I mean if you look at your traditional business and how we look at our traditional business, if raw case volume is flat, because really what we are doing is selling line time. When you follow it down the P&L skip revenue, gross profit, you look at the quarter, it was flat to up a little bit with some cost savings program and EBITDA being flat to up a little bit.

So, focusing on the revenue line, while we have this significant mix shift in our business, is very hard to follow, because frankly me having declining volume in this quarter, but generating the gross profit and the EBITDA we did in our traditional business, I am very happy with that result.

David Hartley - Credit Suisse Securities (Canada), Inc

Yeah, 100%. And the question earlier on commodities, and I guess really currency, I mean the interplay of those two factors will move around maybe opposite to one another in some cases. And I mean commodities have never really been – increasing commodity price has never really been the friend of this company. With DSS, I guess that changes a lot, but when we look out towards a potential reversal of fuel cost and other commodities, you know, over time, I mean do you think that's a manageable headwind as opposed to what you saw in the past? I mean in the past, competition ratcheted up, really affected your business, now with the mix of business you have, how manageable is that risk?

Jeremy S. G. Fowden - Chief Executive Officer & Director

A very good question David. And let's start with saying we've got about a third of our revenues, just over $1 billion in DS Services, where frankly commodities are not a factor. A), it's a returnable, reusable five-gallon container that has a life of several years, and then we grind it down, and then we remake it into a new container in our own plant. So, the polycarbonate commodity element that is present within DS Services is kind of irrelevant on a commodity cost scale, given 60 trips to 80 trips a container, and then we reuse the polycarbonate anyway.

And the energy fuel surcharge mechanism, which is adjusted monthly based on the published price of diesel, takes someone's monthly bill down or up based on that published price of diesel. And we are talking about when diesel was very expensive that was maybe $3.30 on a monthly bill for someone, on a $45 bill, and today it's $2.30 or $2.40, might be wrong by a few cents there. So, it's not meaningful, and it changes every single month based on the published price of diesel, and the feedback we get from our customers with the transparency and the simplicity and the ease to understand that, is that that's a good way to do it. Yes, at the moment it means we are not seeing a diesel benefit in DS, but it also means we won't see a diesel disadvantage. So that third of our revenue, feel very comfortable about.

Then within the other two-thirds of our revenue, today we have about a third of that business either contract manufacturing or agreements with customers that are on pass-through mechanisms, and it wasn't like that, as you know David, five years or six years ago, so we're also making that business slowly and steadily over time a business that's more insulated from commodity changes.

Now, I don't want to paint a picture that they are not relevant. When commodities are going down, you might get a one, two, three, four-month lag benefit before that's passed on, and when they're going up, you might get a one, two, three, four-month lead disadvantage before you get the pricing back. But the overall business, much better positioned in that regard than it was a few years ago.

David Hartley - Credit Suisse Securities (Canada), Inc

Thank you, and if I could just sneak in one more, just on the UK. So we know that I think a contract falls off in February, I believe, correct me if I'm wrong, and you've managed to backfill loss of some of those volumes. I also heard you mention, hard discount business, and I'm starting to get an inkling here that maybe you're playing a bigger part in supplying that channel. Could you give us an update on those kind of changing volume, headwinds, tailwinds, and how it's settling out right now, and where you sit in terms of offsetting some of the losses in the business over there?

Jeremy S. G. Fowden - Chief Executive Officer & Director

Yeah, I mean first thing, let's start with a couple of the fundamentals, which is the UK retail landscape, driven by consumer preference and consumer habit is undergoing, I think as many of the CEOs of the retailers said, the greatest change in its makeup that people have seen within their kind of working lives of this generation. And that is a shift towards urban regeneration, growth in smaller store formats and the growth in the hard discounters that got consumer trial during the recession, and they actually quite liked what they tried, so they're staying there and continuing to shop there.

Therefore shifting our business to be better able to cope with the needs and wants of those smaller store formats, plus making sure we have the leanest cost base and the best service, is really the driving factors behind our three-phased cost and efficiency program in the UK. We've already removed 80 heads, we did that end of November, early December. We've changed, with the agreement of our employees, the pension program and some other benefits programs that reduces our cost. So, I am pleased with the way the initial steps of the cost reduction program are going.

Getting the planning permission for an 80,000 pallet warehouse in the UK, which is something like 13 stories high, is much more of a challenge than getting the equivalent zoning for that here in the U.S., and I am delighted that we now have that planning permission, because with relatively no to small or modest CapEx from Cott, because an external developer will build that, we will move from 20,000-ish pallets on our UK largest factories (61:18) warehouse to close to 80,000 pallets, which means every week you have that external warehousing cost, shuttle and freight cost of the other 60,000 pallets that you have saved.

So, we will end up with a more efficient business and a lower cost business, and we hope to start digging, construction on that in the second half of this year. And we will also install a kind of high-speed robotic rainbow pack line. And what do I mean by that, that's the ability to put two or three or four flavors in a single case, which means if you are a small store format, you can buy a case of a product and just putting one case on your shelf, you can offer the customer three or four varieties, which means if you are a small store, that's very attractive.

And being able to do that on a high-speed line, that's automated to produce the four flavors and store it in a warehouse that's at the end of the production line without freight and shuttle, I believe when we've completed these three cost phases, and we have had detailed discussions with customers, that we will be well-positioned to meet all types of retailers' demand within the UK, whether that be small stores, hard discounters or the traditional multiple grocers. So it's going to take a bit of time, but I think it's an attractive program, and one of the biggest non-controllables, getting the planning permission for that warehouse, is already behind us.

David Hartley - Credit Suisse Securities (Canada), Inc

I will leave it there, thank you.

Jeremy S. G. Fowden - Chief Executive Officer & Director

Thanks, David.

Operator

We'll go next to Nick Coutoulakis with Canaccord.

Nicholas Coutoulakis - Canaccord Genuity Corp.

Hi, guys, congratulations on a solid quarter. In terms of your balance sheet comfort level, at 4.4 times net debt-to-EBITDA, would you be comfortable making an acquisition similar in size with Aquaterra, or would you prefer to wait until you're, say, down under 4 times?

Jeremy S. G. Fowden - Chief Executive Officer & Director

Yeah, I will have Jay expand on this, but the one point I would like to make, which I think is often overlooked with regards to Cott, yes, we've done, I think relatively well getting our leverage down from 5.1 times EBITDA to 4.4 times in one year. But if you – and I understand most people look at EBITDA-to-debt ratios. But actually interest cover is important in this equation, and given our disproportionately high free cash flow generation, we actually have at 4.4 times leverage much more interest cover than many other CPG package grocery companies would have. But I haven't got the numbers in front of me, and Jay is much better on math, so I'll pass over to Jay.

Jay Wells - Chief Financial Officer

And I think Jerry said it right. I mean, I think at this level of debt, I mean we are comfortable, because you look at our interest cover at over 3 times have more than the ability to service our debt, pay down our debt, and we always tested on potential recessions, potential headwinds in the business, and even in factoring some of the most stiff headwinds available, still very comfortable with our debt levels, and even if that would happen to service our debt, pay down our debt, pay our dividends. So, even though it's higher than Jerry, and I would like during this transformational period, we really much more look to interest cover to get comfort that this is an okay amount of debt to cover at this point in time, and to continue to focus on large scale opportunities if they come along.

Jeremy S. G. Fowden - Chief Executive Officer & Director

But I think the other thing we look at and Jay will know the exact number, Aquaterra is a mid-teen what we call cash-on-cash IRR, therefore when you compare that to cost of debt or cost of equity or WAC rates, there is a quite a nice incremental return above any of those metrics. So if we are looking at adding anything on there, I would like all our owners and shareholders and investors and stakeholders to fully understand that we very much focus on free cash flow and a cash-on-cash IRR from those transactions, where we will be looking for mid-teens.

Nicholas Coutoulakis - Canaccord Genuity Corp.

Okay, great, thank you very much for that color. And I guess I know you touched on this a little bit, but in your contract manufacturing business, do you have enough capacity to move above the top end of your range of 80 million incremental cases over time, is that something you may want to do?

Jeremy S. G. Fowden - Chief Executive Officer & Director

And I think the answer is, as long as – and for the benefit of everyone else on the call, as long as we remember that there is decline going on in private label, shelf stable juice and carbonated soft drink, and that's happening in the market as well as in private label, each year that passes, that market decline in CSDs and shelf stable juices freeze up capacity. And it's that capacity that our goal is to fill, so that we continue to have highly utilized lines, highly utilized lines are efficient, and when they are efficient they generate free cash flow.

Nicholas Coutoulakis - Canaccord Genuity Corp.

Okay. Great.

Jeremy S. G. Fowden - Chief Executive Officer & Director

So the answer is yes, we would look to continue to grow our contract manufacturing in order to take out that slack from the decline that freeze up capacity elsewhere.

Nicholas Coutoulakis - Canaccord Genuity Corp.

Okay, great. Thank you very much. Thanks again.

Jeremy S. G. Fowden - Chief Executive Officer & Director

Thank you.

Operator

And that does conclude our Q&A session. I'll turn it back over to Jarrod Langhans for any closing remarks.

Jarrod Langhans - Director-Investor Relations & Corporate FP&A

Thank you very much for joining our call today. This will conclude Cott Corporation's fourth quarter and fiscal year 2015 call. Thanks for attending.

Operator

And that does conclude today's conference call. We appreciate your participation.

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