I
tem 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our historical consolidated financial statements and related notes thereto in this Quarterly Report on Form 10-Q and with our A
nnual Report on Form 10-K for the year ended
December 31, 201
7
. This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and S
ection 21E of the Securities
Exchange Act of 1934, as amended, that are intended to be covered by the “safe harbor” created by those sections. Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, can generally be identified by the use of forward-looking terms such as “believe,” “expect,” “may,” “will,” “should,” “could,” “seek,” “intend,” “plan,” “estimate,” “anticipate” or other comparable terms. These forward-looking statements are subject to uncertainty and changes in circumstances. Actual results may differ materially from these expectations due to inaccurate assumptions and known or unknown risks and uncertainties, including those identified in “Cautionary Note Regarding Forward-Looking Statements” in this Item 2 and in “Risk Factors” in Item 1A of Part I of our Annual Report on Form 10-K for the year ended
December 31, 201
7
.
We urge you to consider those risks and uncertainties in evaluating our forward-looking statements. We caution readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made. Except as otherwise required by the federal securities laws, we disclaim any obligation or undertaking to publicly release
any updates or revisions to any forward-looking statement contained herein (or elsewhere) to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
Overview
Primo Water Corporation (together with its consolidated subsidiaries, “Primo,” “we,” “our,” or “us”) is North America’s leading single source provider of multi-gallon purified bottled water, self-service refill drinking water and water dispensers sold through major retailers in the United States and Canada. We believe the market for purified water continues to grow due to evolving taste preferences, perceived health benefits and concerns regarding the quality of municipal tap water. Our products provide an environmentally friendly, economical, convenient and healthy solution for consuming purified and filtered water. We are a Delaware corporation that was incorporated in 2017 in connection with the creation of a holding company structure. Our predecessor was founded in Delaware in 2004.
Significant Transactions
On June 22, 2018, we entered into a new senior secured credit facility (the “SunTrust Credit Facility”) that provides for a $190 million senior term loan facility (the “Term Loan”) and a $30 million senior revolving loan facility (the “Revolving Facility”). The SunTrust Credit Facility matures on June 22, 2023. The Term Loan requires annual principal payments (payable in quarterly installments) equal to 5% per annum, or $9.5 million, with the remaining indebtedness due at maturity. The SunTrust Credit Facility is secured by a first priority security interest in and lien on substantially all of our assets. The SunTrust Credit Facility and related obligations are guaranteed by certain of our domestic subsidiaries. See “Note 4 – Debt and Capital Leases, net of Debt Issuance Costs” in the notes to the condensed consolidated financial statements.
On May 22, 2018, we completed a follow-on offering of 5.3 million shares of our common stock at a price of $14.00 per share to the public, which included the exercise in full by the underwriters of their option to purchase 0.7 million additional shares of our common stock on the same terms and conditions. All of the shares were offered and sold by Primo. Net proceeds, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us of approximately $4.1 million, were approximately $70.8 million. We used the net proceeds from the offering to pay down existing indebtedness and on June 22, 2018, we refinanced our remaining outstanding indebtedness as described in the paragraph above.
On December 12, 2016, we completed the acquisition (the “Acquisition”) of Glacier Water Services, Inc. (“Glacier”), the leading provider of high-quality filtered drinking water dispensed to consumers through self-service water machines located at over 20,000 locations, including supermarkets and other retail locations. The Acquisition was consummated pursuant to the terms of the Agreement and Plan of Merger, dated October 9, 2016. Aggregate consideration was approximately $200.2 million consisting of cash, Primo common stock and warrants, plus the assumption of approximately $78.8 million of debt, net of cash. The Acquisition diversified our retailer concentration and offered cross-selling opportunities, while creating operational and shared service synergies. We financed the transaction through a combination of cash-on-hand and borrowings under the $196.0 million Credit Agreement with Goldman Sachs Bank USA (the “Goldman Credit Facility”).
Business
Our business is designed to generate recurring demand for our purified bottled water or self-service refill drinking water through the sale of innovative water dispensers. This business strategy is commonly referred to as “razor-razorblade” because the initial sale of a product creates a base of users who frequently purchase complementary consumable products. Once our bottled water is consumed using a water dispenser, empty bottles are exchanged at our recycling center displays, which provide a recycling ticket that offers a discount toward the purchase of a new bottle of Primo purified water or they are refilled at a self-service refill drinking water location. Each of our multi-gallon Exchange water bottles can be sanitized and reused up to 40 times before being taken out of use, crushed and recycled, substantially reducing landfill waste compared to consumption of equivalent volumes of single-serve bottled water. As of September 30, 2018, our products were offered in the United States and in Canada at over 45,000 combined retail locations, including Lowe’s Home Improvement, Walmart, Sam’s Club, The Home Depot, Meijer, Kroger, Food Lion, H-E-B Grocery, Sobeys, Circle K, Family Dollar, Walgreens, Albertsons, Publix, and CVS. We believe the market for purified water continues to grow due to evolving taste preferences, perceived health benefits and concerns regarding the quality of municipal tap water. Our products provide an environmentally friendly, economical, convenient and healthy solution for consuming purified and refill drinking water.
We provide major retailers throughout the United States and Canada with a single-vendor solution for our three reporting segments, Primo Refill (“Refill”), Primo Exchange (“Exchange”), and Primo Dispensers (“Dispensers”), addressing a market demand that we believe was previously unmet. Our over 45,000 locations include approximately 25,500 Refill locations, 13,200 Exchange locations and 7,300 Dispenser locations. Our solutions are easy for retailers to implement, require minimal management supervision and store-based labor, and provide centralized billing and detailed performance reports. Exchange offers retailers attractive financial margins and the ability to optimize typically unused retail space with our displays. Refill provides drinking water for consumer purchase through the installation of self-service vending displays at retail locations. The Refill business model eliminates the bottling and distribution infrastructure required to deliver traditional bottled water, thereby allowing us to provide refill drinking water at a value price as compared to alternatives in the marketplace. Additionally, due to the recurring nature of water consumption, retailers benefit from year-round customer traffic, highly predictable revenue and health and wellness focused consumers.
In a notice published on June 20, 2018, the Office of the United States Trade Representative (the “USTR”) issued a determination and request for public comment under Section 301 under the Trade Act of 1974 (the “Notices”) concerning the proposed imposition of an additional 25% tariff on specified products from China (the “Tariff”). The list of products set forth in the Notices included self-contained drinking water coolers, including our Dispensers, which we import from China. We have worked with our suppliers and secured a reduction in our cost as well as worked with our customers to increase our prices to include the incremental cost of the Tariff. We believe the cost reduction and increased pricing will offset the impact of the Tariff, however, if retailers increase prices to consumers, consumer demand may be reduced or we may reduce pricing to retailers to offset the Tariff, which would reduce gross margins. In addition, in July 2018, we applied to the USTR for a Request for Exclusion from the Tariff for our Dispensers (the “Request for Exclusion”). Our Request for Exclusion is currently pending with the USTR, and there can be no assurance that the USTR will grant our Request for Exclusion or otherwise modify the application of the Tariff as applied to our Dispensers.
Business Segments
We have three operating and reportable segments, Refill, Exchange, and Dispensers.
Our Refill segment sales consist of the sale of filtered drinking water dispensed directly to consumers through technologically advanced, self-service machines located at major retailers throughout the United States and Canada.
Our Exchange segment sales consist of the sale of multi-gallon purified bottled water offered through retailers in the United States and Canada. Our Exchange products are offered through point of purchase display racks and recycling centers that are prominently located at major retailers in space that is often underutilized.
Our Dispensers segment sells water dispensers that are designed to dispense Primo and other dispenser-compatible bottled water. Our Dispensers sales are primarily generated through major retailers in the United States and Canada, where we recognize revenues for the sale of the water dispensers when the customer obtains control. We support retail sell-through with domestic inventory.
We evaluate the financial results of these segments focusing primarily on segment net sales and segment (loss) income from operations before depreciation and amortization (“segment (loss) income from operations”). We utilize segment net sales and segment (loss) income from operations because we believe they provide useful information for effectively allocating our resources between business segments, evaluating the health of our business segments based on metrics that management can actively influence and gauging our investments and our ability to service, incur or pay down debt.
Cost of sales for Refill consists primarily of costs associated with routine maintenance of reverse osmosis water filtration systems and filtered water displays, costs of our field service operations and commissions paid to retailers associated with revenues earned. Cost of sales for Exchange consists primarily of costs for bottling, distribution and bottles. Cost of sales for Dispensers consists of contract manufacturing, freight and duties.
Selling, general and administrative expenses for Refill, Exchange, and Dispensers consist primarily of personnel costs for operations support as well as other supporting costs for operating each segment.
Expenses not specifically related to operating segments are shown separately as Corporate. Corporate expenses are comprised mainly of compensation and other related expenses for corporate support, information systems and administration. Corporate expenses also include certain professional fees and expenses and compensation of our Board of Directors.
In this Management’s Discussion and Analysis of Financial Condition and Results of Operations, when we refer to “same-store unit growth”, we are comparing retail locations at which our products have been available for at least 12 months at the beginning of the relevant period. In addition, “gross margin percentage” is defined as net sales less cost of sales, as a percentage of net sales.
Results of Operations
The following table sets forth our results of operations (dollars in thousands):
|
|
Three months ended September 30,
|
|
|
Nine months ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Consolidated statements of operations data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
81,770
|
|
|
$
|
82,207
|
|
|
$
|
231,231
|
|
|
$
|
217,762
|
|
Operating costs and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales
|
|
|
58,312
|
|
|
|
57,273
|
|
|
|
164,462
|
|
|
|
154,166
|
|
Selling, general and administrative expenses
|
|
|
7,369
|
|
|
|
7,939
|
|
|
|
26,169
|
|
|
|
26,703
|
|
Non-recurring and acquisition-related costs
|
|
|
139
|
|
|
|
158
|
|
|
|
626
|
|
|
|
7,583
|
|
Depreciation and amortization
|
|
|
6,194
|
|
|
|
6,358
|
|
|
|
18,365
|
|
|
|
19,571
|
|
Impairment charges and other
|
|
|
67,940
|
|
|
|
(72
|
)
|
|
|
68,184
|
|
|
|
(90
|
)
|
Total operating costs and expenses
|
|
|
139,954
|
|
|
|
71,656
|
|
|
|
277,806
|
|
|
|
207,933
|
|
(Loss) income from operations
|
|
|
(58,184
|
)
|
|
|
10,551
|
|
|
|
(46,575
|
)
|
|
|
9,829
|
|
Interest expense, net
|
|
|
2,465
|
|
|
|
5,153
|
|
|
|
18,909
|
|
|
|
15,177
|
|
Change in fair value of warrant liability
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
3,220
|
|
(Loss) income before income taxes
|
|
|
(60,649
|
)
|
|
|
5,398
|
|
|
|
(65,484
|
)
|
|
|
(8,568
|
)
|
Income tax (benefit) provision
|
|
|
(2,411
|
)
|
|
|
451
|
|
|
|
(8,907
|
)
|
|
|
823
|
|
Net (loss) income
|
|
$
|
(58,238
|
)
|
|
$
|
4,947
|
|
|
$
|
(56,577
|
)
|
|
$
|
(9,391
|
)
|
The following table sets forth our results of operations expressed as a percentage of net sales (percentage amounts may not add to totals due to rounding):
|
|
Three months ended September 30,
|
|
|
Nine months ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Consolidated statements of operations data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
Operating costs and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales
|
|
|
71.3
|
|
|
|
69.7
|
|
|
|
71.1
|
|
|
|
70.8
|
|
Selling, general and administrative expenses
|
|
|
9.0
|
|
|
|
9.7
|
|
|
|
11.3
|
|
|
|
12.3
|
|
Non-recurring and acquisition-related costs
|
|
|
0.2
|
|
|
|
0.2
|
|
|
|
0.3
|
|
|
|
3.5
|
|
Depreciation and amortization
|
|
|
7.6
|
|
|
|
7.7
|
|
|
|
7.9
|
|
|
|
9.0
|
|
Impairment charges and other
|
|
|
83.1
|
|
|
|
(0.1
|
)
|
|
|
29.5
|
|
|
|
(0.1
|
)
|
Total operating costs and expenses
|
|
|
171.2
|
|
|
|
87.2
|
|
|
|
120.1
|
|
|
|
95.5
|
|
(Loss) income from operations
|
|
|
(71.2
|
)
|
|
|
12.8
|
|
|
|
(20.1
|
)
|
|
|
4.5
|
|
Interest expense, net
|
|
|
3.0
|
|
|
|
6.3
|
|
|
|
8.2
|
|
|
|
7.0
|
|
Change in fair value of warrant liability
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
1.4
|
|
(Loss) income before income taxes
|
|
|
(74.2
|
)
|
|
|
6.5
|
|
|
|
(28.3
|
)
|
|
|
(3.9
|
)
|
Income tax (benefit) provision
|
|
|
(2.9
|
)
|
|
|
0.5
|
|
|
|
(3.9
|
)
|
|
|
0.4
|
|
Net (loss) income
|
|
|
(71.2
|
)%
|
|
|
6.0
|
%
|
|
|
(24.5
|
)%
|
|
|
(4.3
|
)%
|
The following table sets forth our segment net sales in dollars and as a percent of net sales and segment (loss) income from operations presented on a segment basis and reconciled to our consolidated income from operations (dollars in thousands) (percentage amounts may not add to totals due to rounding):
|
|
Three months ended Semptember 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
Percent
|
|
|
|
|
|
|
Percent
|
|
|
|
Dollars
|
|
|
of Net Sales
|
|
|
Dollars
|
|
|
of Net Sales
|
|
Segment net sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Refill
|
|
$
|
48,330
|
|
|
|
59.1
|
%
|
|
$
|
51,287
|
|
|
|
62.4
|
%
|
Exchange
|
|
|
21,513
|
|
|
|
26.3
|
%
|
|
|
20,435
|
|
|
|
24.9
|
%
|
Dispensers
|
|
|
11,927
|
|
|
|
14.6
|
%
|
|
|
10,485
|
|
|
|
12.8
|
%
|
Total net sales
|
|
$
|
81,770
|
|
|
|
100.0
|
%
|
|
$
|
82,207
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment (loss) income from operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Refill
|
|
$
|
14,565
|
|
|
|
|
|
|
$
|
15,413
|
|
|
|
|
|
Exchange
|
|
|
6,274
|
|
|
|
|
|
|
|
6,039
|
|
|
|
|
|
Dispensers
|
|
|
323
|
|
|
|
|
|
|
|
970
|
|
|
|
|
|
Corporate
|
|
|
(5,073
|
)
|
|
|
|
|
|
|
(5,427
|
)
|
|
|
|
|
Non-recurring and acquisition-related costs
|
|
|
(139
|
)
|
|
|
|
|
|
|
(158
|
)
|
|
|
|
|
Depreciation and amortization
|
|
|
(6,194
|
)
|
|
|
|
|
|
|
(6,358
|
)
|
|
|
|
|
Impairment charges and other
|
|
|
(67,940
|
)
|
|
|
|
|
|
|
72
|
|
|
|
|
|
|
|
$
|
(58,184
|
)
|
|
|
|
|
|
$
|
10,551
|
|
|
|
|
|
|
|
Nine months ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
|
|
|
|
|
Percent
|
|
|
|
|
|
|
Percent
|
|
|
|
Dollars
|
|
|
of Net Sales
|
|
|
Dollars
|
|
|
of Net Sales
|
|
Segment net sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Refill
|
|
$
|
134,542
|
|
|
|
58.2
|
%
|
|
$
|
131,814
|
|
|
|
60.5
|
%
|
Exchange
|
|
|
59,777
|
|
|
|
25.9
|
%
|
|
|
55,301
|
|
|
|
25.4
|
%
|
Dispensers
|
|
|
36,912
|
|
|
|
16.0
|
%
|
|
|
30,647
|
|
|
|
14.1
|
%
|
Total net sales
|
|
$
|
231,231
|
|
|
|
100.0
|
%
|
|
$
|
217,762
|
|
|
|
100.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment (loss) income from operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Refill
|
|
$
|
40,043
|
|
|
|
|
|
|
$
|
35,619
|
|
|
|
|
|
Exchange
|
|
|
17,567
|
|
|
|
|
|
|
|
16,572
|
|
|
|
|
|
Dispensers
|
|
|
2,309
|
|
|
|
|
|
|
|
2,657
|
|
|
|
|
|
Corporate
|
|
|
(19,319
|
)
|
|
|
|
|
|
|
(17,955
|
)
|
|
|
|
|
Non-recurring and acquisition-related costs
|
|
|
(626
|
)
|
|
|
|
|
|
|
(7,583
|
)
|
|
|
|
|
Depreciation and amortization
|
|
|
(18,365
|
)
|
|
|
|
|
|
|
(19,571
|
)
|
|
|
|
|
Impairment charges and other
|
|
|
(68,184
|
)
|
|
|
|
|
|
|
90
|
|
|
|
|
|
|
|
$
|
(46,575
|
)
|
|
|
|
|
|
$
|
9,829
|
|
|
|
|
|
Three Months Ended
September
30,
201
8
Compared to
Three Months Ended
September
3
0
,
201
7
Net Sales
. Net sales decreased 0.5%, or $0.4 million, to $81.8 million for the three months ended September 30, 2018 from $82.2 million for the three months ended September 30, 2017. The change was due to a decrease of $3.0 million in Refill, partially offset by increases of $1.4 million and $1.1 million in Dispensers and Exchange, respectively.
Refill
.
Refill net sales decreased 5.8% to $48.3 million for the three months ended September 30, 2018. The decrease in Refill net sales was primarily due to a 14.5% decline in five-gallon equivalent units to 25.6 million, partially offset by price increases implemented on certain outdoor coin-operated machines.
Exchange.
Exchange net sales increased 5.3% to $21.5 million for the three months ended September 30, 2018. Exchange sales were driven by U.S. same-store unit growth of approximately 10.4% for the three months ended September 30, 2018 and offset by the decrease in initial purchase transactions as a result of demand related to two hurricanes in 2017. In addition, five-gallon equivalent units for Exchange increased 10.5% to 4.4 million for the three months ended September 30, 2018 compared to 4.0 million in the same period of the prior year.
Dispensers.
Dispensers net sales increased 13.8% to $11.9 million for the three months ended September 30, 2018. The increase in Dispensers net sales was primarily due to increased consumer demand. Consumer demand, which we measure as the dispenser unit sales to end consumers, increased 10.6% to 187,000 units for the three months ended September 30, 2018.
Gross Margin Percentage.
The overall gross margin percentage was 28.7% for the three months ended September 30, 2018 compared to 30.3% for the same period of the prior year primarily due to the change in sales mix as dispensers made up a larger portion of sales in the current quarter.
Refill
.
Gross margin as a percentage of net sales for our Refill segment was 33.4% for the three months ended September 30, 2018 compared to 33.5% for the three months ended September 30, 2017.
Exchange.
Gross margin as a percentage of net sales for our Exchange segment was 31.1% for the three months ended September 30, 2018 compared to 31.7% for the three months ended September 30, 2017. The decrease was primarily due to costs associated with certain promotional efforts as well as a change in product and customer mix compared to the prior year.
Dispensers.
Gross margin as a percentage of net sales for our Dispensers segment decreased to 5.2% for the three months ended September 30, 2018 from 12.3% for the three months ended September 30, 2017. The decrease in gross margin percentage was primarily due to an unfavorable change in product and customer mix and, to a lesser extent, the impact of the Tariff.
Selling, General and Administrative Expenses (“SG&A”).
SG&A decreased 7.2% to $7.4 million for the three months ended September 30, 2018 from $7.9 million for the three months ended September 30, 2017. As a percentage of net sales, SG&A decreased to 9.0% for the three months ended September 30, 2018 from 9.7% for the three months ended September 30, 2017. The decrease in SG&A expense was primarily due a $0.9 million decrease in non-cash stock-based compensation expense (see “Note 6 - Stock Based Compensation” in the notes to the condensed consolidated financial statements) and a $0.4 million decrease in incentive compensation partially offset by a $0.7 million increase in marketing and advertising expense and professional fees.
Non-recurring and acquisition-related costs
.
Non-recurring and acquisition-related costs were $0.1 million for the three months ended September 30, 2018 compared to $0.2 million for the same period in 2017. Non-recurring and acquisition-related costs for both periods consisted primarily of costs associated with the Acquisition.
Depreciation and Amortization.
Depreciation and amortization decreased to $6.2 million for the three months ended September 30, 2018 from $6.4 million for the three months ended September 30, 2017 as certain assets became fully depreciated during the prior year.
Impairment Charges and Other.
Impairment charges and other consisted of an expense of $67.9 million for the three months ended September 30, 2018 compared to income of $0.1 million for the same period in the prior year. During the three months ended September 30, 2018, we decided to discontinue the use of the Glacier trade name acquired as part of the Acquisition in order to more effectively and efficiently focus our brand building and marketing efforts in Refill around the Primo brand (the “Re-branding Strategy”). As a result of the Re-branding Strategy, we recorded a pre-tax, non-cash intangible asset impairment charge of $60.8 million to reduce the carrying value of the trade name to its estimated fair value during the three months ended September 30, 2018. In addition, as a result of the Re-branding Strategy, we recorded a $2.4 million pre-tax, non-cash asset impairment charge related to certain Glacier-branded Refill equipment that is not expected to generate future cash flows sufficient to recover the net book value of the equipment.
During the three months ended September 30, 2018, we concluded that a sale of certain assets of our Refill segment (the “Ice Assets”) was probable to take place within one year. Accordingly, we recorded a $4.6 million pre-tax, non-cash asset impairment charge to properly reflect the Ice Assets at their fair value less costs to sell at September 30, 2018. See “Note 3 – Impairment Charges and Other” in the notes to the condensed consolidated financial statements for additional information regarding each item above.
Interest Expense
, net
.
Interest expense decreased to $2.5 million for the three months ended September 30, 2018 from $5.2 million for the three months ended September 30, 2017. The decrease is due to the refinancing of our senior secured credit facility in the second quarter of 2018, which resulted in lower interest rates in addition to lower outstanding indebtedness as the Junior Subordinated Debentures were redeemed in connection with the refinancing. See “Note 4 - Debt and Capital Leases, net of Debt Issuance Costs” in the notes to the condensed consolidated financial statements.
Incom
e Tax (Benefit) Provision
. We recorded an income tax benefit of $2.4 million for the three months ended September 30, 2018 compared to a provision of $0.5 million for the three months ended September 30, 2017. The income tax benefit recorded for the three months ended September 30, 2018 was primarily attributable to the trade name intangible impairment described above, partially offset by the reversal of a benefit recorded in the second quarter of 2018 associated with the completion of our assessment regarding the deductibility of certain performance-based compensation plans under the 2017 Tax Act. In the three months ended September 30, 2017, we recorded income tax expense of $0.5 million related to goodwill and certain intangible assets.
Nine
Months Ended
September
30, 2018
Compared to
Nine
Months Ended
September
30,
2017
Net Sales
. Net sales increased 6.2%, or $13.5 million, to $231.2 million for the nine months ended September 30, 2018 from $217.8 million for the nine months ended September 30, 2017. The change was due to increases for Dispensers, Exchange, and Refill of $6.3 million, $4.5 million, and $2.7 million, respectively.
Refill.
Refill net sales increased 2.1% to $134.5 million for the nine months ended September 30, 2018. The increase in Refill net sales was primarily due to the Glacier Refill integration, in which the Primo locations with a retailer were moved under the Glacier contract in April 2017. Under the Glacier contract terms, revenue is recognized as the gross amount charged to the end consumers. During part of the nine months ended September 30, 2017, revenue from this retailer was reported as the revenue net of the commission amount paid to the retailer. This resulted in an increase in revenue recognized of $4.6 million in the Refill segment for the nine months ended September 30, 2018. Price increases implemented on certain outdoor coin-operated machines also contributed to the increase, partially offset by a 10.9% decline in five-gallon equivalent units to 73.9 million.
Exchange.
Exchange net sales increased 8.1% to $59.8 million for the nine months ended September 30, 2018. Exchange sales were driven by U.S. same-store unit growth of approximately 9.9% for the nine months ended September 30, 2018. In addition, five-gallon equivalent units for Exchange increased 10.2% to 12.2 million for the nine months ended September 30, 2018 compared to 11.1 million for the same period of the prior year.
Dispensers.
Dispensers net sales increased 20.4% to $36.9 million for the nine months ended September 30, 2018. The increase in Dispensers net sales was primarily due to increased consumer demand. Consumer demand, which we measure as the dispenser unit sales to end consumers, increased approximately 18.0% to a record 567,000 units for the nine months ended September 30, 2018.
Gross Margin Percentage.
The overall gross margin percentage was 28.9% for the nine months ended September 30, 2018 compared to 29.2% for the nine months ended September 30, 2017.
Refill.
Gross margin as a percentage of net sales for our Refill segment increased to 33.2% for the nine months ended September 30, 2018 from 31.8% for the nine months ended September 30, 2017. The increase in gross margin percentage is primarily due to a reduction in employee-related expenses attributable to synergies realized since the Acquisition.
Exchange.
Gross margin as a percentage of net sales for our Exchange segment decreased to 31.7% for the nine months ended September 30, 2018, from 32.4% for the nine months ended September 30, 2017. The decrease was primarily due to costs associated with certain promotional efforts as well as a change in product and customer mix compared to the prior year.
Dispensers.
Gross margin as a percentage of net sales for our Dispensers segment decreased to 8.5% for the nine months ended September 30, 2018 from 12.0% for the nine months ended September 30, 2017. The decrease in gross margin percentage was primarily due to an increase in promotional activities as well as an unfavorable change in sales mix towards lower-margin products and, to a lesser extent, the impact of the Tariff.
Selling, General and Administrative Expenses (“SG&A”).
SG&A decreased 2.0% to $26.2 million for the nine months ended September 30, 2018 from $26.7 million for the nine months ended September 30, 2017. As a percentage of net sales, SG&A decreased to 11.3% for the nine months ended September 30, 2018 from 12.3% for the nine months ended September 30, 2017. The decrease in SG&A expense was primarily due a $1.1 million reduction in employee-related expenses attributable to synergies realized since the Acquisition, a $1.9 million decrease in non-cash stock-based compensation expense (see “Note 6 - Stock Based Compensation” in the notes to the condensed consolidated financial statements) and a decrease of $0.5 million in incentive compensation, partially offset by a $2.7 million increase in marketing and advertising expense and professional fees.
Non-Recurring
and Acquisition-Related
Costs.
Non-recurring costs were $0.6 million for the nine months ended September 30, 2018 compared to $7.6 million for the same period in 2017. Non-recurring and acquisition-related costs for the nine months ended September 30, 2018 primarily related to costs associated with the Acquisition. Non-recurring and acquisition-related costs for the nine months ended September 30, 2017 included costs related to the settlement payments and legal expenses totaling $4.8 million associated with former Texas Regional Distributors and Prism Distribution, LLC, and costs associated with the Acquisition totaling $4.0 million. These costs were partially offset by a settlement reached with Omnifrio Beverage Company LLC resulting in a $1.2 million gain (see “Note 7 – Commitments and Contingencies” in the notes to the condensed consolidated financial statements).
Depreciation and Amortization.
Depreciation and amortization decreased to $18.4 million for the nine months ended September 30, 2018 from $19.6 million for the nine months ended September 30, 2017 as certain assets became fully depreciated during the prior year.
Impairment
Charges
and Other.
Impairment charges and other consisted of an expense of $68.2 million for the nine months ended September 30, 2018 compared to income of $0.1 million for the same period in the prior year. During the nine months ended September 30, 2018, we decided to discontinue the use of the Glacier trade name acquired as part of the Acquisition in order to more effectively and efficiently focus our brand building and marketing efforts in Refill around the Primo brand (the “Re-branding Strategy”). As a result of the Re-branding Strategy, we recorded a pre-tax, non-cash intangible asset impairment charge of $60.8 million to reduce the carrying value of the trade name to its estimated fair value during the nine months ended September 30, 2018. In addition, as a result of the Re-branding Strategy, we recorded a $2.4 million pre-tax, non-cash asset impairment charge related to certain Glacier-branded Refill equipment that is not expected to generate future cash flows sufficient to recover the net book value of the equipment.
During the nine months ended September 30, 2018, we concluded that a sale of certain assets of our Refill segment (the “Ice Assets”) was probable to take place within one year. Accordingly, we recorded a $4.6 million pre-tax, non-cash asset impairment charge to properly reflect the Ice Assets at their fair value less costs to sell at September 30, 2018. See “Note 3 – Impairment Charges and Other” in the notes to the condensed consolidated financial statements for additional information regarding each item above.
Interest Expense, net.
Interest expense increased to $18.9 million for the nine months ended September 30, 2018 from $15.2 million for the nine months ended September 30, 2017. The increase was primarily due to the refinancing of our remaining outstanding indebtedness, which resulted in $3.9 million of prepayment penalties and $3.0 million related to the non-cash write-off of deferred loan costs and debt discount related to the prior senior credit facility.
This increase was partially offset by: (1) the refinancing of our senior secured credit facility which resulted in a lower interest rate in the third quarter of 2018 under the current credit facility compared to the prior credit facility; (2) lower outstanding indebtedness during 2018 following the refinancing of our senior secured credit facility; and (3) a gain of $0.5 million due to the accretion of the remaining fair value adjustment initially recorded at the time of the Acquisition resulting from the redemption of the Junior Subordinated Debentures during the second quarter of 2018. See “Note 4 - Debt and Capital Leases, net of Debt Issuance Costs” in the notes to the condensed consolidated financial statements
Income Tax (Benefit) Provision
. We recorded an income tax benefit of $8.9 million for the nine months ended September 30, 2018 compared to a provision of $0.8 million for the nine months ended September 30, 2017. The income tax benefit recorded for the nine months ended September 30, 2018 was primarily attributable to the trade name intangible impairment described above. In the nine months ended September 30, 2017, we recorded income tax expense of $0.8 million related to goodwill and certain intangible assets.
Liquidity and Capital Resources
Adequacy of Capital Resources
Since our inception, we have financed our operations primarily through the sale of stock, the issuance of debt, borrowings under credit facilities and cash provided by operations. On May 22, 2018, we completed a follow-on public offering of our common stock as described in “Note 1 - Description of Business and Significant Accounting Policies” in the notes to the condensed consolidated financial statements. We used the net proceeds from the offering to pay down existing indebtedness and on June 22, 2018, we refinanced our remaining outstanding indebtedness upon entering into the SunTrust Credit Facility (see “Note 4 – Debt and Capital Leases, net of Debt Issuance Costs”
in the notes to the condensed consolidated financial statements).
We had capital expenditures of $15.8 million for the nine months ended September 30, 2018 and we anticipate net capital expenditures to range between $4.0 million and $8.0 million for the remainder of 2018. Anticipated capital expenditures are related primarily to growth and maintenance in Refill and Exchange locations.
At September 30, 2018, our cash and cash equivalents totaled $5.6 million and we had $30.0 million in availability under our Revolving Facility. We anticipate using current cash, cash flow from operations and availability under our Revolving Facility to meet our current needs for working capital and capital expenditures in the ordinary course of business for the foreseeable future. If we do require additional debt financing, such debt financing may not be available to us on terms favorable to us, if at all.
Our future capital requirements may vary materially from those now anticipated and will depend on many factors including: the number of growth initiatives that will drive same store sales and the rate of growth in new Refill and Exchange locations and related display, rack and reverse osmosis filtration system costs, cost to develop new Dispenser product lines, sales and marketing resources needed to further penetrate our markets, the expansion of our operations in the United States and Canada, the response of competitors to our solutions and products, as well as the completion of future acquisitions. Historically, we have experienced increases in our capital expenditures consistent with the growth in our operations, and we anticipate that our expenditures will continue to increase as we grow our business.
Our ability to satisfy our obligations or to fund planned capital expenditures will depend on our future performance, which to a certain extent is subject to general economic, financial, competitive, legislative, regulatory and other factors beyond our control. We also believe that if we pursue any material acquisitions in the foreseeable future we will need to finance this activity through the issuance of equity or additional debt financing, and such financing may not be available to us on terms favorable to us, if at all.
Changes in Cash Flows
The following table shows the components of our cash flows for the periods presented (in millions):
|
|
Nine months ended September 30,
|
|
|
|
2018
|
|
|
2017
|
|
Net cash provided by operating activities
|
|
$
|
22.8
|
|
|
$
|
10.7
|
|
Net cash used in investing activities
|
|
$
|
(10.3
|
)
|
|
$
|
(15.5
|
)
|
Net cash used in financing activities
|
|
$
|
(12.5
|
)
|
|
$
|
(6.5
|
)
|
Net Cash Flows from Operating Activities
Net cash provided by operating activities increased to $22.8 million for the nine months ended September 30, 2018 from $10.7 million for the same period of the prior year. The increase was driven primarily by an increase in income from operations, excluding impairment charges and other, which are non-cash in nature, and the positive impact of the changes in operating assets and liabilities.
Net Cash Flows from Investing Activities
Net cash used in investing activities decreased to $10.3 million for the nine months ended September 30, 2018, from $15.5 million for the same period of the prior year, primarily as a result of the proceeds received from the redemption of the Trust Preferred Securities issued by Glacier Water Trust I of $6.3 million (see “Note 4 – Debt and Capital Leases, net of Debt Issuance Costs” in the notes to the condensed consolidated financial statements).
Net Cash Flows from Financing Activities
Net cash used in financing activities was $12.5 million for the nine months ended September 30, 2018 compared to $6.5 million for the same period of the prior year.
In the nine months ended September 30, 2018, the proceeds upon entering into the SunTrust Credit Facility, together with the approximately $70.8 million in net proceeds from our recent follow-on equity offering, were used to pay off the Goldman Credit Facility and Junior Subordinated Debentures (see “Note 4 – Debt and Capital Leases, net of Debt Issuance Costs” in the notes to the condensed consolidated financial statements). Additionally, for the nine months ended September 30, 2018, the net cash used in financing activities included proceeds from warrant exercises, offset by an increase in shares purchased to pay taxes associated with certain incentive stock award payouts as well as debt service payments under the SunTrust Credit Facility and capital lease payments.
For the nine months ended September 30, 2017, net cash used in financing activities resulted primarily from an increase in shares purchased to pay taxes associated with certain incentive stock award payouts, as well as debt service payments under the Goldman Credit Facility and capital lease payments.
Adjusted EBITDA U.S. GAAP Reconciliation
Adjusted EBITDA is a non-U.S. GAAP financial measure that is calculated as net (loss) income before depreciation and amortization; interest expense, net; income taxes; change in fair value of warrant liability; non-cash stock-based compensation expense; non-recurring and acquisition-related costs; and impairment charges and other. Our SunTrust Credit Facility contains financial covenants that use Adjusted EBITDA. We believe Adjusted EBITDA provides useful information to management, investors and financial analysts regarding certain financial and business trends relating to our financial condition and results of operations. Adjusted EBITDA is used by management to compare our performance to that of prior periods for trend analyses and planning purposes and is presented to our Board of Directors.
Non-U.S. GAAP measures should not be considered a substitute for, or superior to, financial measures calculated in accordance with U.S. GAAP. Adjusted EBITDA excludes significant expenses that are required by U.S. GAAP to be recorded in our financial statements and is subject to inherent limitations. In addition, other companies in our industry may calculate this non-U.S. GAAP measure differently than we do or may not calculate it at all, limiting its usefulness as a comparative measure. The table below provides a reconciliation between net loss and Adjusted EBITDA (dollars in thousands).
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Net (loss) income
|
|
$
|
(58,238
|
)
|
|
$
|
4,947
|
|
|
$
|
(56,577
|
)
|
|
$
|
(9,391
|
)
|
Depreciation and amortization
|
|
|
6,194
|
|
|
|
6,358
|
|
|
|
18,365
|
|
|
|
19,571
|
|
Interest expense, net
|
|
|
2,465
|
|
|
|
5,153
|
|
|
|
18,909
|
|
|
|
15,177
|
|
Income tax (benefit) provision
|
|
|
(2,411
|
)
|
|
|
451
|
|
|
|
(8,907
|
)
|
|
|
823
|
|
EBITDA
|
|
|
(51,990
|
)
|
|
|
16,909
|
|
|
|
(28,210
|
)
|
|
|
26,180
|
|
Change in fair value of warrant liability
|
|
|
–
|
|
|
|
–
|
|
|
|
–
|
|
|
|
3,220
|
|
Non-cash, stock-based compensation expense
|
|
|
31
|
|
|
|
933
|
|
|
|
2,710
|
|
|
|
4,611
|
|
Non-recurring and acquisition-related costs
(1)
|
|
|
139
|
|
|
|
158
|
|
|
|
626
|
|
|
|
7,583
|
|
Impairment charges and other
|
|
|
68,044
|
|
|
|
25
|
|
|
|
68,444
|
|
|
|
174
|
|
Adjusted EBITDA
|
|
$
|
16,224
|
|
|
$
|
18,025
|
|
|
$
|
43,570
|
|
|
$
|
41,768
|
|
|
(1)
|
For the three months ended September 30, 2018, “Non-recurring and acquisition-related costs” consisted of approximately $0.2 million of acquisition-related expenses related to the Acquisition, partially offset by approximately $0.1 million of non-recurring gains related to various other income and expenses. For the nine months ended September 30, 2018, “Non-recurring and acquisition-related costs” consisted of approximately $0.6 million of acquisition-related expenses related to the Acquisition. For the three months ended September 30, 2017, “Non-recurring and acquisition-related costs” consisted of approximately $0.2 million of acquisition-related expenses related to the Acquisition. For the nine months ended September 30, 2017, “Non-recurring and acquisition related costs” consisted of approximately $4.0 million of acquisition-related expenses related to the Acquisition and approximately $3.6 million of non-recurring costs related to the strategic alliance agreement with DS Services of America, Inc., including transition payments and legal expenses associated with litigation and arbitration proceedings against certain former regional operators, the settlement reached with Omnifrio Beverage Company LLC and various other income and expenses associated with severance and restructuring costs. See “Note 7 – Commitments and Contingencies” in the notes to the condensed consolidated financial statements.
|
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements, investments in special purpose entities or undisclosed borrowings or debt. Additionally, we are not a party to any derivative contracts or synthetic leases.
Inflation
and Changing Prices
In the three most recent fiscal years, inflation and changing prices have not had a material effect on our business and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future.
Seasonality; Fluctuations of Results
We have experienced and expect to continue to experience seasonal fluctuations in our sales and operating income. Our sales and operating income have been highest in the spring and summer and lowest in the fall and winter. Our Refill and Exchange segments, which generally enjoy higher margins than our Dispensers segment, experience higher sales and operating income in the spring and summer. We have historically experienced higher sales and operating income from our Dispensers segment in spring and summer; however, we believe the seasonality of dispenser sales are more dependent on retailer inventory management and purchasing cycles and not correlated to weather. Sustained periods of poor weather, particularly in the spring and summer, can negatively impact our sales in our higher margin Refill and Exchange segments. Accordingly, our results of operations in any quarter will not necessarily be indicative of the results that we may achieve for a fiscal year or any future quarter.
Critical Accounting Policies and Estimates
Other than the adoption of Topic 606 on January 1, 2018, as described in “Note 2 - Revenue Recognition” in the condensed consolidated financial statements, there have been no material changes to our critical accounting policies and estimates from the information provided in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in our Annual Report on Form 10-K for the year ended December 31, 2017.
Cautionary Note Regarding Forward-Looking Statements
This document includes and other information we make public from time to time may include “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include statements about our estimates, expectations, projections, beliefs, intentions or strategies for the future, and the assumptions underlying such statements. We use the words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “forecasts,” “may,” “will,” “should,” “could,” “seek,” “plan,” and similar expressions to identify our forward-looking statements. These forward-looking statements are subject to uncertainty and changes in circumstances. Actual results may differ materially from these expectations due to inaccurate assumptions and known and unknown risks, including those factors set forth in Part I, Item 1A, “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2017. We caution readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made. Except as otherwise required by federal securities laws, we disclaim any obligation or undertaking to publicly release any updates or revisions to any forward-looking statement contained herein (or elsewhere) to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.