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PRMW > SEC Filings for PRMW > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for PRIMO WATER CORP

Form 10-Q for PRIMO WATER CORP


8-Nov-2012

Quarterly Report


Item 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 Annual Report on Form 10-K for the year ended December 31, 2011. The discussion below contains forward-looking statements that are based upon our current expectations and 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, 2011.

Overview

Primo Water Corporation (together with its consolidated subsidiaries, "Primo", "we", "our," "us") is a rapidly growing provider of multi-gallon purified bottled water, self-serve filtered drinking water and water dispensers sold through major retailers in the United States and Canada. We believe the market for purified water is growing 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.

Our business is designed to generate recurring demand for our purified bottled water or self-serve filtered 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 water dispenser creates a base of users who frequently purchase complementary water services. We believe dispenser owners consume an average of 35 multi-gallon bottles of water annually. 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 (exchange) or they are refilled at a self-serve filtered drinking water location (refill). Each of our multi-gallon 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, 2012, our dispensers and water services were offered in each of the contiguous United States and in Canada at approximately 24,600 combined retail locations, including Lowe's Home Improvement, Walmart, Kroger, Safeway, Winn Dixie, H-E-B Grocery and Walgreens.

We provide major retailers throughout the United States and Canada with single-vendor solutions for water bottle exchange and refill vending services, addressing a market demand that we believe was previously unmet. Our solutions are easy for retailers to implement, require minimal management supervision and store-based labor, and provide centralized billing and detailed performance reports. Our exchange solution offers retailers attractive financial margins and the ability to optimize typically unused retail space with our displays. Our refill solution provides filtered water through the installation and servicing of reverse osmosis water filtration systems in the back room of the retailer's store location, which minimizes the usage of the customer's retail space. The refill vending machine, which is typically accompanied by a sales display containing empty reusable bottles, is located within the retailer customer's floor space. Additionally, due to the recurring nature of water consumption, retailers benefit from year-round customer traffic and highly predictable revenue.

Business Segments

At September 30, 2012, we had three operating segments and three reportable segments: Primo Water ("Water"), Primo Dispensers ("Dispensers") and Other.

Our Water segment sales consist of the sale of multi-gallon purified bottled water (exchange services), which includes the Canada Exchange Business acquired in March 2011, and our self-serve filtered drinking water vending service (refill services) offered through retailers in each of the contiguous United States and Canada. Our Water services are offered through point of purchase display racks or self-serve filtered water vending displays 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 U.S. retailers and are sold primarily through a direct-import model, where we recognize revenues for the sale of the water dispensers when title is transferred. We support retail sell-through with domestic inventory. We design, market and arrange for certification and inspection of our water dispensers.


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The Other segment includes the income and expenses associated with the sale of CO2 cylinders for use in Flavorstation appliances, which during the first and second quarter of 2012 were included in the results of the Flavorstation segment.

During the third quarter of 2012, we committed to a plan to sell the assets related to the Flavorstation home beverage appliances, flavor concentrates and accessories, which included the Omnifrio Single-Serve Business acquired in April 2011 (the "Disposal Group") and as a result, current and prior year amounts and disclosures reflect these operations as discontinued operations. During the first and second quarters of 2012, the income and expenses associated with the sale of our Flavorstation home beverage appliances, flavor concentrates and accessories were reported as the Flavorstation segment. Prior to 2012, Flavorstation-related financial information was reported in "Other."

We evaluate the financial results of these segments focusing primarily on segment net sales and segment income (loss) from operations before depreciation and amortization ("segment income (loss) from operations"). We utilize segment net sales and segment income (loss) 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 Water consists primarily of costs for distribution, bottles and related packaging materials for our exchange services and servicing and material costs for our refill services. Cost of sales for Dispensers and Other consist primarily of contract manufacturing, fulfillment, freight and duty costs.

Selling, general and administrative expenses for all segments 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, sales, marketing, and human resources 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" for our Water segment, we are comparing retail locations at which our services 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.

Recent Transactions

Goodwill Impairment

Effective June 30, 2012, we performed a step one interim impairment test of our goodwill and other identifiable intangible assets due to events and changes in circumstances that indicated impairment might have occurred. This test was performed for each of our reporting units that have goodwill: Water and Flavorstation. The Flavorstation reporting unit is now part of the Disposal Group and reported as discontinued operations. See below under "Discontinued Operations" for further discussion of the impairment recorded for the Disposal Group. The factor deemed by management to have constituted a potential impairment triggering event was the sustained decrease in our stock price relative to our book value. The first step involves a comparison of the fair value of a reporting unit to its carrying value. The fair value is estimated based on a number of factors including operating results, business plans and future cash flows.

Based on the results of the step one test we determined that our Water reporting unit had a carrying value higher than its estimated fair value. We performed the second step of impairment test which required us to compare the implied value of the reporting unit goodwill to its carrying value. If the carrying value of the goodwill of a reporting unit exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. We had to determine the implied fair value of goodwill in the same manner as if we had acquired the reporting unit in an arm's length transaction as of the testing date of June 30, 2012. We performed this analysis by deducting the estimated fair value of all tangible and identifiable intangible net assets of the reporting unit from the estimated fair value of the reporting unit. Because the recorded amount of goodwill exceeded the amount of goodwill that would have been recorded under the second step as of the impairment testing date, we recorded a non-cash goodwill impairment charge of $11.5 million for the Water reporting unit. The impairment was the result of lower projected growth in store locations due to capital restraints related to the Term Loan and the Senior Revolving Credit Facility (see Note 6 of the Notes to the Condensed Consolidated Financial Statements). The results of our impairment test for the other identifiable intangible assets of the Disposal Group are described below under "Discontinued Operations."


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We perform our annual impairment test as of the first day of the fourth quarter (October 1) and have not yet completed our analysis.

Discontinued Operations

During the third quarter of 2012, we committed to a plan to sell the assets of the Disposal Group and initiated an active program to execute this plan. In addition, we determined that the Disposal Group met all of the criteria for classification as discontinued operations. As a result, current and prior year amounts and disclosures reflect these operations as discontinued operations. The CO2 exchange portion of the Flavorstation business is not included in the Disposal Group and is now part of the "Other" segment (see Note 11).

As described in Note 2, effective June 30, 2012, we performed goodwill and other intangible asset impairment tests. In addition to the sustained decrease in our stock price relative to our book value, we noted that delays in product development and manufacturing of the Omnifrio Single-Serve Business appliance created an indication of impairment in the related goodwill and developed technology definite-lived intangible asset. As a result of the delays, we determined that the appliance would not be available for this 2012 holiday season. We recorded a non-cash goodwill impairment of $6.4 million. The developed technology intangible asset was also considered impaired as its carrying value exceeded its undiscounted cash flows. We recorded a non-cash impairment charge of $7.0 million for the developed technology intangible asset. These impairment charges were previously reported in the Flavorstation segment and are now included in the results of discontinued operations.

Results of Operations

The following table sets forth our results of operations:

                                                  Three months ended September 30,           Nine months ended September 30,
                                                     2012                  2011                 2012                  2011
Consolidated statements of operations data:
Net sales                                       $        26,185       $        24,110     $         70,710       $       61,950
Operating costs and expenses:
Cost of sales                                            19,897                18,727               54,145               45,925
Selling, general and administrative expenses              4,783                 4,952               13,667               13,210
Non-recurring and acquisition-related costs                 170                   249                  565                1,167
Depreciation and amortization                             2,898                 2,349                7,929                6,406
Goodwill impairment                                           -                     -               11,488                    -
Total operating costs and expenses                       27,748                26,277               87,794               66,708
Loss from operations                                     (1,563 )              (2,167 )            (17,084 )             (4,758 )
Interest expense and other, net                             905                   190                3,082                  956
Loss from continuing operations before income
taxes                                                    (2,468 )              (2,357 )            (20,166 )             (5,714 )
Income tax (benefit) provision                                -                   166                 (960 )                509
Loss from continuing operations                          (2,468 )              (2,523 )            (19,206 )             (6,223 )
Loss from discontinued operations, net of
income taxes                                             (1,367 )                (774 )            (14,799 )             (1,163 )
Net loss                                        $        (3,835 )     $        (3,297 )   $        (34,005 )     $       (7,386 )


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The following table sets forth our results of operations expressed as a percentage of net sales:

                                                             Three months ended September 30,               Nine months ended September 30,
                                                               2012                     2011                 2012                     2011
Consolidated statements of operations data:
Net sales                                                           100.0 %                  100.0 %              100.0 %                  100.0 %
Operating costs and expenses:
Cost of sales                                                        76.0                     77.7                 76.6                     74.1
Selling, general and administrative expenses                         18.3                     20.5                 19.3                     21.3
Non-recurring and acquisition-related costs                           0.6                      1.0                  0.8                      1.9
Depreciation and amortization                                        11.1                      9.8                 11.3                     10.4
Goodwill impairment                                                     -                        -                 16.2                        -
Total operating costs and expenses                                  106.0                    109.0                124.2                    107.7
Loss from operations                                                 (6.0 )                   (9.0 )              (24.2 )                   (7.7 )
Interest expense and other, net                                       3.4                      0.8                  4.4                      1.5
Loss from continuing operations before income taxes                  (9.4 )                   (9.8 )              (28.6 )                   (9.2 )
Income tax (benefit) provision                                          -                      0.7                 (1.4 )                    0.8
Loss from continuing operations                                      (9.4 )                  (10.5 )              (27.2 )                  (10.0 )
Loss from discontinued operations, net of income taxes               (5.2 )                   (3.2 )              (20.9 )                   (1.9 )
Net loss                                                            -14.6 %                  -13.7 %              -48.1 %                  -11.9 %

The following table sets forth our segment net sales and segment income (loss) from operations presented on a segment basis and reconciled to our consolidated loss from operations.

                                                 Three months ended           Nine months ended
                                                   September 30,                September 30,
                                                 2012          2011          2012          2011
Segment net sales
Water                                         $   17,265     $  16,793     $  47,624     $  44,788
Dispensers                                         8,894         7,317        22,970        17,162
Other                                                 26             -           116             -
Total net sales                               $   26,185     $  24,110     $  70,710     $  61,950

Segment income (loss) from operations
Water                                         $    4,549     $   3,733     $  12,335     $  10,913
Dispensers                                          (441 )        (458 )      (1,223 )        (402 )
Other                                                 (2 )         (12 )          42           (12 )
Corporate                                         (2,601 )      (2,832 )      (8,256 )      (7,684 )
Non-recurring and acquisition-related costs         (170 )        (249 )        (565 )      (1,167 )
Depreciation and amortization                     (2,898 )      (2,349 )      (7,929 )      (6,406 )
Goodwill impairment                                    -             -       (11,488 )           -
Loss from operations                          $   (1,563 )   $  (2,167 )   $ (17,084 )   $  (4,758 )

Three Months Ended September 30, 2012 Compared to Three Months Ended September 30, 2011

Net Sales. Net sales increased 8.6%, or $2.1 million, to $26.2 million for the three months ended September 30, 2012 from $24.1 million for the three months ended September 30, 2011. The increase in net sales resulted from a $1.6 million increase in Dispenser sales and a $0.5 million increase in Water sales.

Water. Water net sales increased 2.8% to $17.3 million, representing 65.9% of our total net sales, for the three months ended September 30, 2012. Five-gallon equivalent units for Water increased 0.2% and were 7.5 million units for both the third quarter of 2012 and 2011, respectively. The increase in Water net sales was primarily due to a 7.9% increase in exchange sales, driven by a 9.1% increase in U.S. exchange sales that resulted from same-store unit growth of 13.0% in our exchange services compared to the third quarter of 2011. The increase in U.S. exchange sales was partially offset by a reduction of 3.4% in refill sales, primarily due to the positive impact of hurricane demand in the prior year as compared to the current year third quarter.


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Dispensers. Dispensers net sales increased 21.6% to $8.9 million, representing 34.0% of our total net sales, for the three months ended September 30, 2012. Our dispenser unit sales to retailers decreased by 4.1% for the three months ended September 30, 2012 compared to the same period in the prior year. Despite the decrease in unit sales, net sales increased due to the increase in sales mix for higher value dispensers and the increase in prices to retail customers.

Gross Margin Percentage. Our overall gross margin percentage increased to 24.0% for the three months ended September 30, 2012 from 22.3% for the three months ended September 30, 2011. The increase in margin was a result of margin improvements for both the Dispensers and Water segments.

Water. Gross margin as a percentage of net sales in our Water segment increased to 32.3% for the three months ended September 30, 2012 from 31.9% for the same period in the prior year. The increase in gross margin percentage for the three months ended September 30, 2012 was primarily due to improvements in exchange margins.

Dispensers. Gross margin as a percentage of net sales in our Dispensers segment increased to 8.0% for the three months ended September 30, 2012 from 0.5% for the same period in the prior year. The increase in gross margin percentage for the three months ended September 30, 2012 was primarily due to recent price increases to our retail customers.

Selling, General and Administrative Expenses ("SG&A"). SG&A decreased 3.4% to $4.8 million for the three months ended September 30, 2012 from $5.0 million for the three months ended September 30, 2011. As a percentage of net sales, SG&A decreased to 18.3% for the three months ended September 30, 2012 from 20.5% for the three months ended September 30, 2011. We currently expect that SG&A as a percentage of net sales for the remainder of 2012 will continue to compare favorably with 2011 as we leverage costs with increased sales growth.

Water. SG&A for our Water segment decreased 36.4% to $1.0 million for the three months ended September 30, 2012 from $1.6 million for the three months ended September 30, 2011. Water SG&A as a percentage of Water net sales decreased to 5.9% for the three months ended September 30, 2012 compared to 9.6% for the three months ended September 30, 2011. The decrease in Water SG&A was primarily a result of a reduction in duplicate costs related to the refill business acquisition, which occurred in November 2010. We expect to continue to leverage costs with sales growth.

Dispensers. SG&A for our Dispensers segment increased 128.7% to $1.2 million for the three months ended September 30, 2012 from $0.5 million for the three months ended September 30, 2011. This increase was primarily due to a one-time expense of $0.35 million related to the rollout of new dispenser locations for the three months ended September 30, 2012. SG&A, excluding the one-time marketing related expenses, as a percentage of Dispensers segment net sales increased to 13.0% for the three months ended September 30, 2012 from 6.9% for the three months ended September 30, 2011. Going forward we expect SG&A for Dispensers to be more in line with 2011.

Corporate. Corporate SG&A decreased 8.2% to $2.6 million for the three months ended September 30, 2012 from $2.8 million for the three months ended September 30, 2011. Corporate SG&A as a percentage of consolidated net sales decreased to 9.9% for the three months ended September 30, 2012 from 11.7% for the three months ended September 30, 2011. We currently expect Corporate SG&A as a percentage of consolidated net sales to decrease for the remainder of 2012 as we leverage expenses with sales growth.

Non-Recurring and Acquisition-Related Costs. Non-recurring and acquisition-related costs were $0.2 million for the three months ended September 30, 2012 and 2011. Non-recurring and acquisition-related costs during 2012 consisted primarily of litigation-related expenses. Non-recurring and acquisition-related costs during 2011 consisted primarily of costs associated with the acquisitions of the refill business, the Canada Exchange Business and the Omnifrio Single-Serve Beverage Business.

Depreciation and Amortization. Depreciation and amortization increased 23.4% to $2.9 million for the three months ended September 30, 2012 from $2.3 million for the three months ended September 30, 2011. The increase was primarily due to depreciation on additional property and equipment.

Interest Expense and Other, net. Interest expense increased to $0.9 million for the three months ended September 30, 2012 from $0.2 million for the three months ended September 30, 2011. The increase was primarily due to increased overall debt balances and increased interest rates for our Term Loan compared to our prior senior revolving credit facility.


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Income Taxes (Benefit) Provision. We recorded an income tax provision for the three months ended September 30, 2011. In 2011 the income tax provision was a result of the recognition of a deferred tax liability related to tax deductible goodwill. In the second quarter of 2012, the impairment of the goodwill (See Notes 2 and 3 of the Notes to the Condensed Consolidated Financial Statements) resulted in a reversal of the related deferred tax liability and the recognition of a deferred tax asset. We have provided valuation allowances to fully offset the net deferred tax assets at September 30, 2012.

Discontinued Operations. As we did not begin selling Flavorstation products until the fourth quarter of 2011, loss from discontinued operations for the three months ended September 30, 2011 consisted only of selling, general and administrative costs and depreciation and amortization. Loss from discontinued operations was $1.4 million for the three months ended September 30, 2012 compared to $0.8 million for the three months ended September 30, 2011.

Nine Months Ended September 30, 2012 Compared to Nine Months Ended September 30, 2011

Net Sales. Net sales increased 14.1%, or $8.8 million, to $70.7 million for the nine months ended September 30, 2012 from $62.0 million for the nine months ended September 30, 2011. The increase in net sales resulted from a $5.8 million increase in Dispenser sales, a $2.9 million increase in Water sales and from $0.1 million in Other sales.

Water. Water net sales increased 6.3% to $47.6 million, representing 67.4% of our total net sales, for the nine months ended September 30, 2012. Five-gallon equivalent units for Water increased 3.3% to 21.0 million units for the first nine months of 2012 from 20.4 million units in the same period of the prior year. The increase in Water net sales was primarily due to a 15.0% increase in exchange sales, driven by a 14.7% increase in U.S. exchange sales that resulted from new location growth and same-store unit growth of 5.0% in our exchange services compared to the first nine months of 2011.

Dispensers. Dispensers net sales increased 33.8% to $23.0 million, representing 32.5% of our total net sales, for the nine months ended September 30, 2012. The increase was due primarily to the increase in the number of retail locations offering our dispensers. Our dispenser unit sales to retailers increased by 18.6% for the nine months ended September 30, 2012 compared to the same period in the prior year. Sales increased at a greater level than unit sales due to the increase in sales mix for higher value dispensers.

Other. Other net sales were $0.1 million for the nine months ended September 30, 2012.

Gross Margin Percentage. Our overall gross margin percentage decreased to 23.4% for the nine months ended September 30, 2012 from 25.9% for the nine months ended September 30, 2011.

Water. Gross margin as a percentage of net sales in our Water segment decreased to 32.9% for the nine months ended September 30, 2012 from 34.2% for the same . . .

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