Primo Water Corporation (PRMW) CEO Matt Sheehan on Q2 2018 Results - Earnings Call Transcript

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About: Primo Water (PRMW)
by: SA Transcripts

Start Time: 16:30 January 1, 0000 5:36 PM ET

Primo Water Corporation (NASDAQ:PRMW)

Q2 2018 Earnings Conference Call

August 07, 2018, 16:30 PM ET

Executives

Matt Sheehan - President and CEO

David Mills - CFO

Analysts

Jon Andersen - William Blair

Amit Sharma - BMO Capital Markets

Kara Anderson - B. Riley FBR

Michael Petusky - Barrington Research

Michael Grondahl - Northland Securities

Mark Argento - Lake Street Capital

Operator

Good day, and welcome to Primo Water Second Quarter 2018 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions].

I will now turn the conference over to Madeleine Kettle [ph], Investor Relations. Ma’am, you may begin.

Unidentified Company Representative

Good afternoon, and welcome to Primo Water's second quarter 2018 earnings conference call. On the call with me today are Matt Sheehan, Chief Executive Officer; and David Mills, Chief Financial Officer.

By now, everyone should have access to the release that went out this afternoon at approximately 4.05 PM Eastern Time. If you have not received today's press release, it is available on the Investor Relations portion of Primo Water's Web site at www.primowater.com. This call is being webcast and a replay will be available on the company's Web site.

Before we begin, we would like to remind everyone that the prepared remarks contain forward-looking statements, including financial guidance, 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, Matt Sheehan.

Matt Sheehan

Thanks, Madeleine. Good afternoon everyone and thank you for joining us to review our quarterly results and an update on our business. I’m excited to review our results and discuss the momentum building in 2018 as we posted strong results in addition to successfully raising equity and refinancing debt.

For our call today, I will give a summary of the quarter, express the continued tap water issues in which consumers face and finally provide an update on some of our key initiatives. David will then provide more detail on the financial results of the quarter, recap the equity raise and debt refinancing as well as provide an update to our guidance.

To being, Q2 was a transformative quarter for the business and our team for a host of reasons. First, we raised equity at attractive prices on the heels of our successful Q1 and then refinanced our previous lending facility producing significant interest savings.

Additionally, we posted good growth numbers across our business and we have moved several key initiatives forward. All-in, we continue to show the operating leverage in our business model and we are excited to increase growth investment to drive even further results.

The combination of finding growth levers in our business and the equity refinancing step was an important formula and one well received by investors as we focus on driving long-term results.

With that summary in mind, we believe Primo is uniquely positioned to provide families a safe alternative at reasonable prices to alleviate their increasing concerns over tap water quality across the U.S. and Canada. Each week families continue to face hundreds of boiled water alerts and major U.S. cities continue to disclose issues with their municipal water systems.

Here are just a few recent examples. On May 29, Salem, Oregon faced a toxic algae bloom that prevented residents from drinking their tap water. While algae blooms are a regular current storing warmer months in many cities in the U.S., this was the first time that the blue green algae blooms reached the water distribution system in the Salem area. Residents were impacted by this issue for several weeks only recently being notified that the drinking water was safe again for consumption.

Moving from Oregon across the country to Washington D.C., residents were just recently alerted to a boil advisory order. What is alarming about this issue is that the cause was the simple threat of a possible contamination when a pumping station lost power. This caused a drop in water pressure along the distribution system which can allow ground contaminants to enter the drinking water. These types of boil advisories are a regular occurrence and now with the elevated risk mitigation by municipalities, the heightened alert to residents even for basic issues will only continue to create doubt with residents.

Now, in the Midwest, unfortunately and yet again in Michigan, residents of Kalamazoo County were alerted to stop drinking or even cooking with municipal water due to the presence of PFAS. PFAS is a toxic chemical widely used in firefighting foam, nonstick surfaces, stain guards and other commercial and industrial applications, clearly not what you want in your water.

With this chemical, boiling the water to remove the chemical when found at high levels is not a solution leaving citizens no alternative but bottled water. These cities are dramatically different in their populations and they represent different regions in the country pointing to the heightened and broad consumer concern that remains regarding tap water quality.

The sad thing is that just days after each of these events, municipalities told citizens that tap water is safe to drink. That is simply not okay and it both bothers and drives us here at Primo. I’m proud that our Primo team each day energizes on our purpose to make sure our Dispensers and our water are available to support better water for families across the U.S. and Canada.

More than the pure quality that we offer, consumers consistently tell us home consumption increases by 25% to 30% when using the Primo solution, which is a big increase in the amount of water consumed at home. Bulk water is no longer exclusively linked to the shift away from sugary beverages, but now also linked to a shift away from tap water.

All-in, Primo remains very well positioned for growth as our household offering drives a behavioral change in greater water consumption, a double value proposition for families looking to improve their health and wellness. While David will give greater details to our quarter, I’ll give a broad overview of our results and some notable achievements.

I’m pleased to report that for the second quarter, we exceeded our financial guidance for sales and achieved our guidance on adjusted EBITDA as we continue to increase marketing investments to drive long-term results.

For the second quarter, total sales increased over 1% to 75.8 million, the Exchange leading the way with 10.4% growth and total adjusted EBITDA increased over 7% to 15 million. With the momentum of Q2 and the progress against our key strategies, we felt confident to raise our full year sales guidance for 2018 which we’ll cover a bit.

U.S. exchange same-store unit growth was 9.7% for the quarter. This is an impressive number considering this is the 26th quarter of 6% plus same-store unit growth. More impressive, however, is that this is an even faster growth rate than the step change produced in Q1 when we posted a 9.5% number.

Our dispenser sell-thru in Q2 grew 16% compared to the prior period and yet again set an all-time record of 196,000 units. In resell, we achieved significant improvements in gross margin reaching 34.6%, up 440 basis points from last year and 300 basis points sequentially, driven by a number of operational efficiencies which we’ll cover shortly.

With those highlights in mind, let’s dive into the initiatives that we believe are changing the growth trajectory of our business. As we have said in the past, all of our initiatives are focused on five key strategies. First, grow household penetration; second, improve connectivity of our Dispensers to our water; third, increase same-store sales; fourth, drive unit economics; and fifth, foster highly engaged teams.

While I’ll walk through some of the notable initiatives that fall within those strategies, it’s important to keep in mind that our disciplined testing protocol helps us deliver across these strategies in a systematic way.

First, let’s look at the household penetration and connectivity, our first two in highly-related strategies. We are the market leader in dispenser sales at retail and are enhancing our focus on both growing our sell-thru of Dispensers while increasing the connectivity with our water. By packaging these strategies, we believe we can create an inflexion in the growth rate in our high-margin water businesses.

As we showcased in Q1’s water results, our Black Friday promotion created new water households because the promotion focused on three main ingredients; reduced dispenser retail pricing, increased product and category awareness and lastly, increased connectivity.

We recently completed a similar promotion over Memorial Day with Lowe's Home Improvement. With a full set of ingredients in place, we were able to deliver another successful promotion albeit at a much smaller scale due to the size differences between Walmart and Lowe's.

As we move forward in 2018, we will work to drive similar promotions and opportunistically drive either sell-thru or connectivity independently. As a reminder, unlike typical CPD companies, selling any number of Dispensers in a quarter will lead to new comp water households as many of the Dispensers we have sold in the past are still active and producing recurring revenue.

Frankly, while our sell-thru continues to increase, it could actually decrease and still provide significant new comp water households with a focus on connectivity. Over and above these types of promotions, we will continue fuel growth utilizing multiple marketing vehicles.

Like Q1, our attention to eCommerce dispenser sales delivered another strong quarter of unit sell-thru increasing 51% versus the prior year period. While this is still a small portion of our overall business, it proves we have an ability to deliver a quality online experience for dispenser shoppers.

This also allows us to directly monetize our social media activity through product pages, promotional activities and help explain our razor-razorblade model directly at the time of purchase. We’ve continued to build awareness of our brand online as we elevate and amplify the conversation around our products and water quality issues across our social media platforms.

Moving on from our first two strategies, we have a lot of updates and progress to share as we work to drive increased same-store sales and improve unit economics, our third and fourth key strategies at Primo.

As noted, we continue to emphasize driving same-store sales and unit economics rather than new locations. We believe this will drive efficient capital usage and retailer affinity. With the flexibility in interest savings under our new credit facility, we are now accelerating our branding, marketing and unit growth drivers in the second half of 2018.

These investments will be completed across several initiatives throughout the balance of 2018 with some drifting into '19. This allows us to graduate and accelerate some programs to scale which we call Phase 3 while we continue to monitor the test in Phase 1 and phase 2.

In addition to our focus on driving top line, we are also focused on the efficiency aspect of unit economics producing CapEx and increasing gross margins. Given that context, several notables to share.

We have completed a CD joint signage rollout across all Walmart Exchange locations. We are now beginning to roll it out beyond Walmart and we’ll upgrade all Exchange locations with this signage by the end of 2019.

As you may have seen, we have adopted this new signage on our dispenser packaging as well that has begun to hit shelves over the last few months and we are working on ways of bringing this successful messaging to Refill over time.

After Phase 2 testing, we are moving our big red sign program to Phase 3 by rolling it out to the majority of our indoor and outdoor Refill locations. This is an eye catching sign that captures consumer attention and displays the compelling value per gallon of our Refill business.

We are moving forward with credit card readers to Phase 3 by deploying them in several thousand high volume locations and some full markets. Credit card machine has not only tested very well showing that the presence of alternative payment options attracted new consumers but also allowed us to access more information about our machines. With the use of telemetry technology embedded in each credit card reader, we will have the ability to improve service levels through better machine uptime visibility.

Lastly, we will be expanding our video screens used in our outdoor Refill machines. The first round of this Phase 3 expansion will be Walmart across the second half of this year and into the beginning of 2019. In addition, we are beginning to see good results from our outdoor video test, but that test is still in early innings.

Based on the success of using video in Refill, we have recently begun testing video screens on our Exchange displays to help communicate our transaction process and reasons to use bulk water. Other tests continue while still not at their key decision or measurement points such as media, word-of-mouth marketing and many others.

As it relates to our brand, we have begun our brand harmonization in the Refill business which will bring the Primo brand to all Refill locations over time. We believe consolidation to Primo branded Refill equipment will not only streamline the effectiveness but the brand building and marketing spent, but also associate the machines with new technology and a better consumer purchase experience. This will be a longer-term initiative continuing beyond 2019.

Specific to unit economics and our cost to serve in Q2, we completed the implementation of Omnitracs' Roadnet routing software to our entire Refill operating network. With the deployment we have been able to improve routing and reduce our cost to serve. We believe this will have a long-term positive impact on our Refill gross margins, especially during peak seasonal quarters with the ability to leverage our relatively fixed cost.

Finally, as it relates to the notable initiatives, we are also nearing completion on the first phase of our pricing adjustments in the coin-based business. Across the first half of the year, we increased prices to the majority of our outdoor locations which currently totals 17,000 plus machines. We are now shifting focus to our indoor Refill machines across Q3 and Q4 as well as refinement on our recent outdoor coin increase.

I’d like to share some context for pricing. We do not include any pricing impact in our guidance as much of the pricing change is recent and it is important to give a time before we add it to guidance. As our testing showed and as we have previously communicated, we do see volume compression when we change pricing. But we continue to see net accretion with an increase in revenue per transaction is higher than the volume compression.

As previously mentioned, we are often serving a very value-focused customer. In our rollout we have seen some volume shift outdoor from – indoor from outdoor since we have moved – we haven’t moved our indoor prices yet, hence why our second half focus on indoor is so important.

In many cases, our existing coin markets have a diverse spectrum of prices. To-date, our initial outdoor rollout only included a single move of a nickel increase and did not include rationalizing market prices. We believe that the effectiveness of this price increase could be somewhat diluted until we drive consistent pricing. In either case, we are committed to optimizing these results.

We believe pricing will be an ongoing optimization process as there are differences in regional and demographic elasticity which we continue to see as we rollout. Even after the price increase across the indoor network, we will still have a very attractive price for amazing water.

Lastly, relative to price but also to the larger Refill business, it should be clear the amount of work we are putting to market the Refill business to consumers. We believe strongly in this business given the quality of the water we offer versus tap and the price at which we are offering. We believe that we can bring lots of new customers to its base, but that will take some time doing so as we rollout programs like big red sign, videos and others on top of the price increase we believe will be a winning combination.

As you can see, our team is working hard to drive revenue growth and efficiencies across our key strategies. We believe the current progress to-date highlights our challenger mindset in an unwavering dedication to develop a greater growth trajectory with strong EBITDA margins. In addition to these growth initiatives, it is important that we put the right people in place to drive our strategies.

As we focus more and more on the consumer, we are also making a shift in our senior leadership team to support that focus. We have created a new position of Vice President of Consumer Experience. And effectively immediately, Maria Mullen, previously Vice President of Sales will lead this team. We believe we have one of the best products on the market and we want a greater presence of our consumers’ voice in our decision making.

This position will help steer internal and external activities on behalf of the consumer and their experience using our product as well as how they engage with our company. Maria brings a passion for the consumer and our business along with a forward-looking perspective that we believe will help us drastically improve the experience that consumers have when using our products.

Moving into the role of Vice President of Sales will be Chad Alger-Hardt who previously held the role of Senior Director of Shopper Marketing for Primo. Working in various sales and shopper marketing positions throughout his career, including here at Primo for the last two years, we are thrilled for Chad to lead our sales team. We believe promoting Chad to this position with a shopper marketing background is instrumental in our shift to unit economic growth drivers.

With that, I would like to congratulate both Maria and Chad on their new focus of Primo and share my excitement for this renewed focus on the consumer and shopper marketing within our sales team.

All-in, we have a very loyal and investable customer, a healthy core business and significant industry tailwinds at our back. We are seeing benefits of our disciplined testing strategy and long-term view while our financing activities position us to accelerate our investment.

Always fueling our focus is our purpose of inspiring healthier lives through better water. I remain confident in our ability to drive value for consumers, employees, clients and shareholders.

With that, I will turn the call over to David to cover our financial results.

David Mills

Thanks, Matt, and good afternoon, everyone. Today, I’ll review our financial results for the second quarter and then discuss our outlook for the third quarter and the remainder of 2018. Following my review, I will turn the call back over to Matt for closing remarks.

To assist investors in understanding our operating results, we do provide adjusted EBITDA, which is a non-GAAP financial measure. A reconciliation is included in our earnings press release issued this afternoon and available on our Web site.

Turning to our results for the quarter, as Matt mentioned, we had a great quarter, exceeding our expectations for sales and in line with our expectations for adjusted EBITDA. Sales for the second quarter were up over 1% to 75.8 million, led by the continued acceleration of growth in Exchange.

Looking at the segments, while dispenser sales for the quarter were down 11.8% to 11.1 million, they were ahead of our expectations due to the increased demand resulting from strong sell-thru. The decrease from prior year’s second quarter is primarily the result of the shift in timing of orders in 2017.

For the fifth quarter in a row we saw record consumer demand of Dispensers with 196,000 units sold through. This demand coupled with Q1 sell-thru drove the 24% increase in Dispenser sales in the first half of 2018 leading to strong same-store unit growth in Exchange.

Turning to Exchange, we continue to see strong growth as sales increased 10.4% to 20 million for the quarter, driven by U.S. exchange same-store unit growth of 9.7%, an increase over the 9.5% in the first quarter.

Refill sales were up 1.3% to 44.7 million for the quarter. The increase was primarily the result of the last portion of the Glacier contract integration mentioned on the last call. The pricing increase had a minor impact in the quarter but was partially offset by a reduction in total unit volume as well as a decrease in the number of installed locations when compared to 2017.

Turning to gross margins, the overall gross margin percentage increased to 30.4% for the quarter compared to 27.7% in the prior year. The increase is primarily the result of improved gross margin in Refill. Drilling into the details, Dispenser gross margin for the quarter was 9.9%, in line with our expectations given our increased promotional activities designed to drive the top line, sell-thru and water connectivity.

Exchange gross margin for the quarter increased to 32.5% from 32.3%. And lastly, gross margins for the quarter in Refill increased to 34.6% from 30.2% in the prior year, primarily due to the full quarter impact of integration enhancements. In addition, as Matt mentioned, we implemented new routing technology in the quarter that resulted in improved operating costs.

Next, SG&A costs for the quarter increased to 9.6 million from 8.2 million, primarily due to an increase in marketing and promotional activities. As a percentage of sales, SG&A excluding non-cash stock compensation was in line with our expectations at 10.8% in the second quarter.

There was a significant decrease in nonrecurring and acquisition-related costs to 410,000 compared to 3 million in the prior year. The decrease is a result of a $2.1 million reduction in costs associated with the Glacier acquisition as well as a 900,000 arbitration settlement in the prior year. Going forward, the cost related to the Glacier acquisition will be minimal.

Moving down the income statement, interest expense for the quarter was 11.2 million compared to 5 million in the prior quarter with the increase due to the one-time expenses incurred in connection with the refinancing. Going forward, we expect interest expense to be significantly lower at approximately $5 million for the second half of 2018.

In the quarter, we recorded an income tax benefit of 4.8 million primarily related to the 2017 Tax Act. Net income for the quarter was 500,000 or $0.01 per diluted share compared to a net loss of 2.5 million or $0.07 per share. This is primarily the result of improved gross margins, a reduction in nonrecurring and acquisition-related costs as well as the income tax benefit, partially offset by the one-time refinancing costs.

Adjusted EBITDA increased 7.2% to 15 million or 19.7% of sales from 14 million or 18.7% of sales in the prior year. Although our investment in marketing and promotions will continue to increase, we believe we will continue to improve the adjusted EBITDA margin over the next two to three years to our target of 20% to 22% on an annual basis.

Before turning to the details of the balance sheet, I want to recap the transformation of our capital structure during the quarter. On the heels of our strong first quarter results, we completed a very successful secondary offering in which we raised 75 million to pay down a portion of our debt.

This allowed us to refinance our debt with very favorable terms in a new credit facility led by SunTrust, with BMO, U.S. Bank and JPMorgan as joint leads. Needless to say with these names we had a lot of interest and our pleased to have been able to enter into a credit facility with such quality financial institutions.

The new credit facility provides a $190 million term loan and a $30 million revolver with a five-year term and minimal principle payments of 5% per year on the term loan. The interest expense under the new credit facility starts at LIBOR plus 2.5% and decreases as we reduce the leverage ratio with expected cash interest savings of $10 million to $11 million annually.

Now let’s turn to the balance sheet. We ended the quarter with 6.2 million in cash. Accounts receivable increased 27% from year-end to 22.8 million primarily the result of timing. Our DSOs remained strong and for the quarter was about 25 days. Total outstanding debt was 198.7 million, down from 273.3 million at the end of 2017. At the end of the quarter, our leverage ratio was 3.4x which is down from over 4.8x at year-end.

Now looking at the statement of cash flows for the first six months of the year. Free cash flow increased significantly to 4.7 million from negative free cash flow in the prior year. Cash flow from operations more than doubled to 10.2 million compared to 5 million, primarily driven by an increase in income from operations offset somewhat by changes in working capital.

Due to the seasonality of our business, we generally use working capital in the first half of the year and see positive working capital in the second half of the year. Cash flow used in investing activities decreased to 5.5 million from 10.5 million as a result of lower capital expenditures and the proceeds received from the redemption of the trust preferred securities.

Turning to our outlook for the third quarter. We expect sales in the range of 80.5 million to 83.5 million. As you recall, our third quarter of 2017 sales were positively impacted by the hurricanes in Texas and Florida which we believe resulted in approximately 2 million in revenue being pulled forward.

Looking at the segment details, we expect Dispenser sales to be relatively flat for the third quarter compared to 2017. While we do not expect any near-term impact to our guidance for same-store unit growth in our water business, our imported dispensers were included in the recently announced Section 301 tariffs, which went into effect in July.

We have, however, negotiated a cost reduction from our supplier as well as worked with our retail customers to increase our wholesale prices to include the cost of any tariffs. We believe the cost reduction and increased pricing will materially offset the impact of the tariff on our gross margins.

As a reminder, there are no North American suppliers of retail-based dispensers. Therefore, Primo’s market share and leading price position should remain unaffected. Regardless, Primo is working with the respective channels and protocols to receive an exemption for our products. In addition, at this time no retailers have raised on-shelf prices.

Exchange sales continue to be driven by what we believe is the creation of new households as a result of our marketing and promotional activities and strong dispenser sell-thru. Even with the impact of hurricanes in 2017, we expect Exchange to grow 5% to 7% in the third quarter.

For Refill, we continue to analyze the impact of the price increase as well as shift focus to optimizing prices in certain regions. We believe that our marketing and operational efforts will begin to drive growth in Refill but it will take some time.

For adjusted EBITDA, we expect the third quarter to range from 18.2 million to 18.7 million. At the midpoint, this represents an adjusted EBITDA margin of 22.5%, a significant improvement over the 19.7% realized in the second quarter and ahead of prior year.

Looking at the full year, based on the results of the quarter, we are increasing our top line guidance and now expect sales of 305 million to 309 million, up from our previous guidance of 303 million to 307 million. As we did last quarter, we continue to focus on investing incremental dollars into marketing initiatives that we believe will continue to drive top line growth.

With that, we are reiterating our full year guidance of 61 million to 63 million for adjusted EBITDA. At the midpoint, this represents an adjusted EBITDA margin of 20.2% which is an improvement of over 100 basis points compared to 2017.

In summary, we are focused on investing in initiatives that we believe will drive long-term growth. With improved operating cash flows and our new credit facility, we have sufficient capacity to make those investments.

With that, I will turn the call over to Matt for closing remarks.

Matt Sheehan

Thanks, David. We believe our results and progress represent the strength of our business and ability to increase our growth rate. We have an extremely loyal and valuable consumer base, and knowing their long-term value allows us to invest, while we balance consumer acquisition costs with our retail partners.

This quarter was impressive across many key metrics, such as Exchange, same-store unit growth, Dispenser sell-thru, Refill gross margins, SG&A, leverage, among many others, hinting at the potential of our business, while doing so with already strong EBITDA margins.

Our strategy has been intentional for years, create great products and gain massive distribution, then turn to marketing. With over 45,000 points of distribution, we have convenient scale to leverage our marketing spend and communicate to households. We are excited to increase our investment in marketing and believe it will lay the foundation for long-term and sustained growth.

As we increase our marketing investment and pair it with our testing philosophy, we have the capacity for an inflection in our revenue growth with a healthy core business with strong fundamentals and pairing our challenger mentality with a new focus on the consumer experience. I’d like to thank our team, our retailers and our partners for the continued loyalty and support of our purpose.

With that, I’d like to open the line for questions. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. Our first question comes from the line of Jon Andersen from William Blair. Sir, your line is now open.

Jon Andersen

Thanks. Good afternoon, everybody.

Matt Sheehan

Hi, Jon.

Jon Andersen

Hi. I wanted to start with the Dispenser business. Obviously another very strong sell-thru number and I’m wondering if you could talk a little bit about the incremental consumer or the incremental household that you think you are picking up here? Is this a conversion of kind of case pack users to dispensing systems? How do you think about it I guess that consumer and where that incremental household is coming from in general? Thanks.

Matt Sheehan

Yes, Jon, this is Matt. I’ll take that. So keep in mind a few things. First, only 5% of American households have a Dispenser and there’s a lot of opportunity there, so that’s one thing. Number two is we see most of the major water sort of verticals if you look case pack on and so forth growing. So we think that as some predicted, bottle water is – I think AMR predicted bottle water is going from 170 billion in the world to 350 billion in the next decade. So frankly we think everything can grow. And as water just becomes more and more important, we think that CSPs will decline and water will rise. And then lastly, though, as we’ve shared before, there are a percentage of our Dispensers that are sold through repeat customers and because we sell through retail, we can’t perfectly align those incremental households. But when we see numbers like this which we have for a while, we are confident that that’s going to, in some perspective, continue to drive water.

Jon Andersen

Okay. On the Exchange business, congrats on another terrific same-store unit number.

Matt Sheehan

Thanks.

Jon Andersen

Should we be thinking about this as a reflection of kind of the coordinated promotional work you’ve done with some of your large customers over the past handful of quarters. Is there a lag between that kind of – that Exchange usage and the Dispenser sale such that we should expect this kind of exchange rate to continue because the Dispenser sell-thru has continued to be quite strong? If you can provide a little bit more color around that.

Matt Sheehan

Yes, so a couple thoughts. One is, we believe that our research has showed that once you get a consumer to like the second, third, fourth bottle, they’re going to be in it for a while. There will certainly be some consumers that try it out and don’t stick, but it’s a pretty sticky business from that perspective. I think your insights on will Dispensers lead to this kind of exchange comp, we have always said that our goal is to have 10% plus comps. Quarter-to-quarter might not be perfectly aligned with that. As Dave mentioned, we’re going to try to comp the hurricane in Q3. That might be a little hard to comp and we obviously don’t pray for hurricanes around here. So quarter-to-quarter, we think that could dip. But as we’ve said, even if it’s 5% to 7% on top of the numbers that we’ve been posting for years, frankly I’m not sure I’ve seen another SKU do that period. And so even if it is 5% or 7%, we’re happy with that. We’re going to push as hard as we can to continue the promotional activity to your point that absolutely had been a driving force to that. And as we said, we did it Walmart, we then just rolled it with Lowe’s and we continue to have conversations not only about this year but also future years with these retailers as we now have a formula that we know works, we’re going to lean in and heavy with it. So yes, our goal is that 10% target but frankly we won’t be sad if it dips a little bit below that because again that’s still going to be long large numbers on – those are comping on top of large increases.

Jon Andersen

Makes sense. Last one for me and I’ll pass it on, on the Refill business the gross margin performance was obviously quite strong year-over-year and sequentially. How much of that is tied into the Glacier integration contract work and how long if that’s the case should that element of the contribution persist? And then a second point on just Refill, it sounds like you’re making good progress on the pricing front, yet you still maybe haven’t kind of fully found the solution, the optimal solution. Can you talk about that a little bit more because it sounded like in the prepared comments it may still be some time before you expect to see material revenue growth in that part of the business? Thank you very much.

David Mills

Hi, Jon, this is David. I’ll talk with the first part of that question around gross margins for the quarter and yes, I agree. It was a great quarter for the retail business and the gross margin being at 34.6%. That was largely influenced by the full quarter impact of the integration and synergy activities from 2017. In addition, we did implement the technology this quarter. When you get halfway through the quarter and you got that technology, so that resulted in improved routing which drives fuel cost, vehicle cost as well as employee cost and overtime related. So that contract integration doesn’t impact the margins. That’s primarily just a revenue adjustment on the top line. As far as the other part of the question, I’ll turn that over to Matt to talk through about the pricing issue.

Matt Sheehan

Yes, so we did expect in our testing what we saw and before we began to rollout across the network is that when you – we have a value-based customer, we expected and sort of proclaims that we would see some volume compression. The formula, Jon, we see in our head is less quarterly and more long term where we’re going to get higher transaction revenue that will be offset by some volume decrease. And then what we’re doing is sort of underneath of this big red sign and videos we believe through our testing, because it’s pretty empirical, that will drive volume to the machines. So we’re frankly less concerned about quarter-to-quarter with this and really trying to invest in the business for long term. We do believe that all of this is accretive to the business long term. We still think we sit really well on our price comparison to any other water alternative for the consumers, specifically when tap water gets bad and things like arsenic and lead and mercury and so on and so forth are in there. There are some things like filters that aren’t going to take out all of that. And so we think we are really well positioned specifically in our price point even after we add a nickel or optimize it across the country. And if you think about our sort of volume-driving activity and marketing the business, we think net-net that’s going to be accretive to us long term. We’re not putting it in our guidance just because again it’s a value-based customer and we want to make sure we give ourselves some time to optimize that. There are some places, as Dave has mentioned, in the remarks that are a bit more sensitive to price and so we’re going to really optimize this thing down. We’re pretty scientific around here and we’ll continue to share with you what we see. Net-net of this is we believe pricing is accretive for us or we wouldn’t be doing it. It’s certainly accretive when we drive volume to the machines.

Jon Andersen

Thanks so much. Congrats on everything you accomplished into the quarter here. Thanks.

Matt Sheehan

Thanks, Jon. I appreciate it.

David Mills

Thanks, Jon.

Operator

Our next question comes from the line of Amit Sharma from BMO Capital Markets. Your line is now open.

Amit Sharma

Hi. Good afternoon, everyone.

Matt Sheehan

Hi, Amit.

David Mills

Good afternoon.

Amit Sharma

Matt, just a clarification. So in that 1.4% top line for Refill, how much of that was pricing versus volume? Is there a way to just aggregate that?

Matt Sheehan

Yes, we’re not sort of sharing the specific numbers. We can tell you a couple of things though. One is that we had less locations, so we continue to see retail consolidation, Amit. And so that 1.4% is total revenue on top of fewer locations. We have been doing some smaller testing in the big red signs and the video but that’s probably not that impactful yet but will start getting into Phase 3. So we believe it did have an impact but it’s still early innings as we were really rolling out that pricing through Q2. Keep in mind that when consumers have an option to go to indoor pricing potentially across a street that hasn’t been moved yet, we did see some volume of what we call walk across the street. And these things will sequence as they sequence as you work with retailers. As we increased pricing on the indoor side, we think that’s going to rationalize the pricing in the entire market and that will certainly help. When that’s done, we still think we’re very competitive and very attractive to consumers and we will potentially get some of that volume back. So that’s how we look at pricing. Dave, did you want to add?

David Mills

Yes, one thing to add, Amit, when you look at the change from last year, we – I think in the script we mentioned the impact of the contract integration related to Glacier and that’s a big chunk of the change this quarter, about 0.5 million of the total increase year-over-year which I think was about 600,000. So the rest of that is made up of pricing offset somewhat by the location change Matt mentioned.

Amit Sharma

And didn’t – on the optimization of pricing across different markets and regions, obviously it will be hard to give us detail of every location, right? But on an average, once you optimize it, whether you take pricing on a certain market or not, when you look at average price increase across 20,000 or so locations, what should we be thinking of I guess? Like there still a nickel pricing average or is it more or less?

David Mills

Yes, it’s a – you know how averages work, right? So it’s a little hard to do averages here but if you literally took just the empirical average, it’s going to probably float around 30 but you’ll see markets that will be higher than that and maybe some that will be lower than that where there’s more or less elasticity. So as you know, it’s a really hard question to answer but you’re probably looking at $0.30 across the board. But then again that’s why we continue to rollout and we’ve always said this is going to be an optimization process. When you have 90% of the market, then we think our optimization will stand for the market but it’s hard to give you an average.

Amit Sharma

And the indoor pricing that would kick in, in what you call Phase 3 later in 2019?

Matt Sheehan

It will happen in late Q4 of this year.

Amit Sharma

Got it, okay. And then --

Matt Sheehan

And one thing – Amit, let me just add one more thing on that. So outdoor you have to go up a nickel because the machines don’t take pennies, right, just to get really basic about it. On the indoor side we do not have to go up that high, and likely we would not. And so again, it will be an optimization process and we’re pushing for the increase. But just to keep that in mind as you’re thinking about your own projections.

Amit Sharma

Yes, perfect answer. And then on the gross margin, given that pricing hasn’t really rolled through across as many locations as you would like to, should we expect this level of gross margin given that it was driven by just technology changes to continue for the rest of the year and then first half of 2019 as well?

Matt Sheehan

Yes, I would just give you the strategic view of it. Dave can give you a sum of the numbers. We think for the peak what we’ve been saying is we can see this and higher gross margins in peak quarters when you just have much more volume over sort of '16. Year-over-year, we should see really good improvements. Dave, you want to comment on sort of the number? There’s some seasonality here, right.

David Mills

Yes, sure. So obviously the Refill business with the fixed cost structure is very leverageable and when volume goes up in peak season, we tend to see improved margins. And we saw that last year in the third quarter with 33.5% margins. We’ll see that again this third quarter. I think margins will be comparable to this quarter or a little bit higher. But then when you get into non-peak seasons; Q1, Q4, they’ll drop down to normal levels, a little bit higher than last year based on the operating efficiencies, but more in line.

Amit Sharma

And you haven’t seen a – I’m assuming that the fixed cost pertains to employees who are going to service these machines, right? And you haven’t seen any higher inflation and wages and whatnot given the tight labor market yet?

Matt Sheehan

No, we’re watching that pretty closely but we haven’t seen a major impact on that. But to your first – part A of your question is if we can get more efficient where John in a truck can do more stops per day, that’s really that efficiency model that we have. And before we just didn’t have the technology to more effectively route and what we found is frankly we need less routes and we now have tighter routes. Not to mention as we grow and volumes shifts, we can re-optimize that over time which we didn’t have the ability to do before we had this software. So we’re obviously really excited about putting it in and we can see these kinds of margins and probably even north of this, as David mentioned.

Amit Sharma

One last for me. You talked about pricing on Refill but on the Exchange side there’s probably a little bit bigger freight component to it. Are you seeing your competitor or larger competitor taking some pricing to offset freight inflation there?

Matt Sheehan

We have seen some – a little bit of price increase but again we have the majority of that market too, so it’s a little hard in the Exchange business to say what a much, much, much smaller competitor is doing. But if you look at sort of HOD in the larger thing, we’ve seen a little bit of that – sort of that pricing impact.

Amit Sharma

Got it. That’s all for me. Thank you so much.

Matt Sheehan

Thanks, Amit.

David Mills

Thanks, Amit.

Operator

Our next question comes from the line of Kara Anderson from B. Riley. Your line is now open.

Kara Anderson

Hi. Good afternoon.

Matt Sheehan

Hi, Kara.

David Mills

Hi, Kara.

Kara Anderson

I’ll leave it to two questions, one for each of you. Matt, I think you highlighted the problem with tap water pretty well. Just wondering if you’re doing anything specific to those regions under boil alert and how the boil alert itself impacts your resell location and then how fast you can move to react on that based on marketing or maybe moving Exchange volume?

Matt Sheehan

Yes, so there’s a couple of pieces to that, Kara, so let me try to break that down quick. So keep in mind what will happen is when a boil alert happens, consumers rush to the store and the store calls us right away. So we can be really fast but the store is going to be as fast and then we start making more water and getting it. Salem, Oregon was a really good one. It did not take a long time. When we were watching it, we started to build up our bottling and distribution and then the retailers started calling us fast and furious. And we sold a lot of water in Salem during the time because the folks needed it. So we’re pretty good in our ability to respond in Exchange is pretty fast. We obviously have in our partner with DS, they have a lot of capacity and they can turn on bottling and distribution pretty quickly at elevated rates. We feel pretty good about that. And then on your second question on Refill, there are some places in the country when there is a boil alert, we have to go visit the machine to test it. And so there’s different rules around the country about how that works. And we’re working with municipalities and states to make sure they understand how good that reverse osmosis is so that we can make sure we stay open and offer that to consumers throughout those issues. Did that answer your two questions?

Kara Anderson

Yes. And just on the other point was, what aren’t you doing on the marketing side maybe around sensors during these events?

Matt Sheehan

We do, yes. Sorry, missed that one. So this is really where social media and eCommerce is helping. So we have absolutely started to target – geo target through eCommerce and social media message, ads, awareness campaigns when this happens. We like to say it’s early innings around here a lot because we’re still learning about that. We’ve been building up our team both on social media and digital. We have in the last six months hired somebody who is ex-Amazon. So we’re really building our eCommerce ability not only because eCommerce is a great platform for us to communicate and sell to consumers but because it allows us to respond really, really quickly. Now when a boil alert happens, consumers go to stores right away because often times they can’t wait for 24, 48 hours. But we are definitely working on the awareness campaigns and frankly we can turn it on pretty quick. We have some of that messaging ready. We can now target by zip code. So when that stuff happens, we’re still early testing mode about how effective those are. Clearly the more drastic the situation, the more consumers will look for a long time solution and that will also change our messaging. So we’re working on it pretty hard and certainly found some things that work.

Kara Anderson

Great. Thanks. And then, David, just a quick one for you. How should we think about CapEx needs or expectations given the number of Phase 3 rollout kind of in play here?

David Mills

Yes, great question. So for CapEx for the year we were originally estimating around 20 million with about half of that related to growth. With the refinancing and the freed up interest savings, we’re now looking at an additional 3 million to 4 million in the second half of the year as we can accelerate some of the marketing initiatives, especially in-store signage and some of the new signage in our Exchange display, pushing out video screens as Matt mentioned, so an additional 3 million to 4 million on top of the original 20 million.

Kara Anderson

Great. Thank you.

Matt Sheehan

Thanks, Kara.

Operator

Our next question comes from the line of Mike Petusky from Barrington Research. Your line is now open.

Michael Petusky

Hi, guys. David, if you gave the Exchange and Dispenser gross margin, I missed it. Could you give those figures?

David Mills

We did. So Exchange gross margins for the quarter were 32.5% compared to 32.3% a year ago. Dispenser gross margins were 9.9%. Last year there were 12.2%. Those were abnormally high in pre doing a lot of the promotional efforts and product mix was a lot different last year as well. So the 9.9 is probably a better number as you look forward, but a strong number for the quarter as well.

Michael Petusky

Okay, great. And then I’m not completely clear on the outdoor pricing increases. How much of that is done at this point? Is it all done or is it mostly done? Can you give me a sense of that, Matt?

Matt Sheehan

Yes, what we said is the significant majority. So we have just north of 17,000 machines. Mike, we said the significant majority have been completed at this time but we’re – some of those were just recently finished.

Michael Petusky

Okay, so not a lot of that really was in the second quarter results then?

Matt Sheehan

No, and that’s what we’re trying to be very open with is that impact will take a little bit of time. And so it was a rolling change by retailer, some of it by region as well and we don’t think a lot of that impact was in Q2 and that’s where it will be more in the future.

Michael Petusky

So in the first markets where you made these changes, had there been certain markets where you’ve essentially not really seen any volume compression and it kind of gives you confidence it will? Maybe the nickel wasn’t enough. Have you seen any of that or do you have enough history with this to say that?

Matt Sheehan

I think there’s some elasticity as it relates to the volume impact. But in general we saw at least a little bit of volume impact everywhere. Some was a little, some was more and so it’s again this is like an average question. It’s a little hard to give you a specific on that one and that’s why we’re being honest with ourselves and everyone else that we think there’s going to be a little bit dialing, potentially up more than we are today because we’re seeing some volume drop off as much. So we’re going to keep playing with that over time and make sure we get it right.

Michael Petusky

Can I ask just more question around that? Has there been any markets where you put in the nickel and you saw such a volume drop off that you’ve already pulled it back?

Matt Sheehan

No.

Michael Petusky

Just I guess last question, any high volume store adds during the quarter, Walmart or any other kind of – some of your better customers added in the second quarter or I guess also as you look forward to the second half, are there any meaningful adds that you know you have teed up?

Matt Sheehan

We’re always working on a few ones. We’re getting really picky about the locations we add just given our same-store sales focus. But nothing major from an addition in Q2. Again, we are always going to prune where we can as well. So if there are locations that are not that successful, then those are great opportunities for us to reduce the capital and potentially put that elsewhere.

Michael Petusky

Okay, anything meaningful that you know is teed up for the second half or just things you’re working on?

Matt Sheehan

Yes, just things we’re working on, Mike, at this time. Nothing meaningful.

Michael Petusky

Okay. Well, give me the first call when you are clear about that. All right, thanks guys.

Matt Sheehan

Thanks, Mike.

Operator

Our next question comes from the line of Michael Grondahl from Northland Securities. Your line is now open.

Michael Grondahl

Yes, thanks, guys. How many locations did you lose year-over-year?

Matt Sheehan

For the last 12 months, Mike, just over 2,000 locations on a gross basis but we’ve added just under 1,500, so net around 750 decrease. A lot of those Refill as we continue to see retail compression there as well as a lot of low performing locations that just didn’t make sense from a profitability standpoint, ROI.

David Mills

I’d just add, Mike, a lot of those are K-marts and office depots and all that. As the same story continues to persist, the really, really strong retailers are the ones who are gaining ground, keeping stores open and the ones who aren’t as strong as marketplace, they likely didn’t do as well for us either. So those are ones usually going away.

Michael Grondahl

Got it. Do you think – by the end of '18, do you think that will level out so it will be more stable or do you think there’s still – a net decrease will creep into 2019?

Matt Sheehan

If I could predict retail at the landscape – I’ll give you my perspective on this but it’s really hard to predict. I think retail is clearly changing. Some folks are going to do great in this new landscape and others won’t. Let me jump over the question for a second and believe that through retail compression we believe we can grow through it. We think there will be settling out here over time. But given where we are strong; home improvement, grocery, mass, convenience, we’re really well positioned. We’re not in fashion stores and apparel and things like that. So we think we’re really well positioned with the retailers that are going to not just survive. I think they’re going to prosper certainly over time and we’re also leaning more and more on our eCommerce platform to help. So the longwinded answer is we’re going to grow – we believe we’re going to grow right through it.

Michael Grondahl

Got it. In terms of the indoor Refill units that you’re looking to reprice a little bit, how many units do you have indoor that you’re targeting?

Matt Sheehan

About 7,000. That’s the total number of locations. As with an indoor location, it will take a little bit longer, Mike, the process. You’re dealing with retailers, POS systems and dealing with the retailer directly because they have to manage the price change with our input.

Michael Grondahl

Right, got it. And then just lastly, where would you call out upside in the quarter versus your guidance? Was that kind of a big chunk in Exchange and a little bit in Refill or how would you handicap that?

Matt Sheehan

Yes, two things, Mike, and Dispenser sell-thru hit another record quarter. We didn’t predict that. That drove sell in at retail. So our Dispenser sales were significantly ahead of where we originally discussed on the last quarter. And that led to an acceleration again in Exchange sales at the 10.4. And I think when we talked last quarter, we were in the range of 7% to 8% maybe when we were giving guidance. So both those were significantly ahead of where we had expected.

Michael Grondahl

Got it, okay. Thanks, guys.

Matt Sheehan

Thanks, Mike.

David Mills

Thanks, Mike.

Operator

Our next question comes from the line of Mark Argento from Lake Street Capital. Sir, your line is now open.

Mark Argento

Hi, guys. Just a quick one. I know David you had mentioned you’re going to crank up the CapEx a little bit just given the incremental cash flow you have from the debt refi. Can you quantify a little bit, I know you talked $3 million to $4 million but where do you see – maybe you can throw into some buckets in terms of incremental marketing spend I know accelerating some of the signage, but maybe you could touch on video and some of the other as you see an opportunity to deploy some capital there?

David Mills

Yes, Mark, we don’t give the details of where we spend the CapEx. We focus more on either growth or maintenance. But as we talked about, our focus is on driving growth in the initiatives that we’ve had positive signs are obviously signage. We talked first part of the year we rolled out new signage in Exchange at Walmart. And with the additional freed up cash, we can roll that out – that signage out to other retailers in the second half of the year and into 2019. Video screens, another big one Matt mentioned, and credit card readers, there’s a little bit of CapEx there as well. And the big red sign in Refill shows positive signs from a ROI standpoint and that’s rolling out as well. So there are all point of purchase, all display kind of signage CapEx that we believe is going to drive top line into late this year and into long term.

Matt Sheehan

Mark, I just add that these are all programs that have tested well and we would have got there anyway. The exciting thing for us is that we can accelerate that stuff. So these will now start to impact, whether it’s late '18 but certainly '19 rather and rolling those out in '19 and waiting until second half of '19 to see impacts. So this has not changed our testing philosophy at all. We have not green-lighted anything that didn’t hit the hurdles. We’re super excited though to turn the juice on a little bit to really get these moving quicker.

Mark Argento

Great. That’s helpful. And then just one quick follow up. So the concept of – you created this new position, VP of Consumer Experience. Are you looking to kind of add kind of – I don’t want to call it an aspirational component here but really start to focus a little bit more on the health benefits or – I’m trying to understand the consumer experience. Is it new products? Maybe you can just give us two seconds on that? Thanks.

Matt Sheehan

Yes, sure. So I’m really proud of the team because we’ve grown and I always say the best marketing is the best product. So when you look at what we provide, we’re really proud about just the quality of the water we provide, the ease of use of our Dispensers and the role that plays in family. That said, frankly, we have not had a great consumer lend yet here. We’ve been really focused on financial strength, operating strength and we’re good at those things. We realized over the last six months that the growth from here is going to be a lot about bringing in the consumer voice inside. So that when we do think about everything from an Exchange rack or the way we present Refill, the way we answer calls in customer service, the way we send welcome letters and I could go on and on, those things have been fine but they have not had enough of the consumer voice in that. And we believe that that is a real opportunity for us to grow the business by just making it easier, simpler, more effective for the consumer. So this is a very recent promotion and we’re really excited about what it will bring. But it’s really that to make sure – and Maria will do a great job of making sure that voice is heard and that when we are designing programs they have the consumer in mind.

Mark Argento

Thanks, Matt.

Operator

And I am currently seeing no further questions. I would like to turn the call back to Matt Sheehan for any further remarks.

Matt Sheehan

Thank you for your participation on today’s call and interest in Primo Water. Have a great night.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference call. This concludes today’s program. You may all disconnect. Everyone, have a great day.