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PRMW > SEC Filings for PRMW > Form 10-K on 22-Mar-2013All Recent SEC Filings

Show all filings for PRIMO WATER CORP | Request a Trial to NEW EDGAR Online Pro

Form 10-K for PRIMO WATER CORP


22-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and notes thereto included elsewhere in this report.

Overview

Primo Water Corporation (together with its consolidated subsidiaries, "Primo", "we", "our," "us") is a leading 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. We are a Delaware corporation that was founded in 2004 and is headquartered in Winston-Salem, North Carolina.

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 product creates a base of users who frequently purchase complementary consumable products. 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 December 31, 2012, our products and services were offered in each of the contiguous United States and in Canada at approximately 24,500 combined retail locations, including Lowe's Home Improvement, Walmart, Kmart, Meijer, Kroger, Food Lion, H-E-B Grocery, Sobeys and Walgreens.

We provide major retailers throughout the United States and Canada with single-vendor solutions for Exchange and Refill 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 December 31, 2012, we had two operating segments and two reportable segments:
Primo Water ("Water") and Primo Dispensers ("Dispensers").

Our Water segment sales consist of our Exchange and Refill services, which are 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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During 2012, we committed to a plan to sell the assets related to the sparkling beverage appliances, flavor concentrates, CO2 cylinders and accessories sold under the Flavorstation brand (the "Disposal Group") and as a result, we are no longer reporting Flavorstation as a separate business segment and current and prior year amounts and disclosures reflect these operations as discontinued operations. In 2011, the income and expenses associated with the sale of our Flavorstation home beverage appliances, flavor concentrates, CO2 cylinders and accessories as well as the results of the Omnifrio Single-Serve Beverage Business acquired in 2011 were reported in "Other".

The 2011 amounts included in Other include the sale of inventory that does not relate to Water or Dispensers.

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 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 consists of contract manufacturing, freight and duties.

Selling, general and administrative expenses for Water and Dispensers consist primarily of personnel costs for sales, marketing, operations support and customer service, 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" for our Water segment, we are comparing retail locations at which our Exchange 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 Developments

Goodwill Impairment

Effective October 1, 2012, we performed the annual impairment test of our goodwill. The first step of the impairment test involves a comparison of the fair value of each reporting unit that carries goodwill to its carrying value. As of our impairment testing date, the Water reporting unit was the only reporting unit carrying goodwill. The fair value is estimated based on a number of factors including operating results, business plans, future cash flows and the market approach. Based on the results of step one of the impairment 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. 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 $67.5 million for the Water reporting unit, representing a full impairment. The impairment was primarily the result of placing greater weight on the market valuation approach. The sustained decrease in our stock price relative to our book value resulted in placing a greater weight on the market approach in determining the fair value of the Water reporting unit compared to our annual 2011 and interim 2012 impairment tests.


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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. 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. This test was performed for each of our reporting units that carried goodwill as of the testing date: Water and the Disposal Group. The Disposal Group is now reported as discontinued operations. See below under "Discontinued Operations" for further discussion of the impairment recorded for the Disposal Group. 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 the impairment test following the same approach described for our annual test and recorded an $11.5 million non-cash goodwill impairment charge.

The results of our impairment test for the other identifiable intangible assets of the Disposal Group are described below under "Discontinued Operations."

Discontinued Operations

During 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.

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 the 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 are included in the results of discontinued operations.


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Results of Operations

The following table sets forth our results of operations:

                                                                 Years ended December 31,
                                                                    2012             2011

Net sales                                                      $       91,479      $  83,062
Operating costs and expenses:
Cost of sales                                                          70,081         63,201
Selling, general and administrative expenses                           17,708         18,206
Non-recurring and acquisition-related costs                               743          2,091
Depreciation and amortization                                          11,102          8,863
Goodwill and other impairment                                          82,013              -
Total operating costs and expenses                                    181,647         92,361
Loss from operations                                                  (90,168 )       (9,299 )
Interest expense and other, net                                         4,043          1,690
Loss from continuing operations before income taxes                   (94,211 )      (10,989 )
Income tax (benefit) provision                                           (961 )          961
Loss from continuing operations                                       (93,250 )      (11,950 )
Loss from discontinued operations, net of income taxes                (17,779 )       (2,429 )
Net loss                                                       $     (111,029 )    $ (14,379 )

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

                                                                  Years ended December 31,
                                                                   2012               2011
Consolidated statements of operations data:
Net sales                                                               100 %            100.0 %
Operating costs and expenses:
Cost of sales                                                          76.6               76.1
Selling, general and administrative expenses                           19.4               21.9
Non-recurring and acquisition-related costs                             0.8                2.5
Depreciation and amortization                                          12.1               10.7
Goodwill and other impairment                                          89.7                  -
Total operating costs and expenses                                    198.6              111.2
Loss from operations                                                  (98.6 )            (11.2 )
Interest expense and other, net                                         4.4                2.0
Loss from continuing operations before income taxes                  (103.0 )            (13.2 )
Income tax (benefit) provision                                         (1.1 )              1.2
Loss from continuing operations                                      (101.9 )            (14.4 )
Loss from discontinued operations, net of income taxes                (19.4 )             (2.9 )
Net loss                                                             (121.3 %)           (17.3 %)


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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.

                                                      Year ended December 31,
                                                        2012             2011
      Segment net sales
      Water                                         $     62,667       $  58,696
      Dispensers                                          28,812          23,595
      Other                                                    -             771
      Total net sales                               $     91,479       $  83,062

      Segment income (loss) from operations
      Water                                         $     15,942       $  13,563
      Dispensers                                          (1,319 )        (1,021 )
      Corporate                                          (10,933 )       (10,887 )
      Non-recurring and acquisition-related costs           (743 )        (2,091 )
      Depreciation and amortization                      (11,102 )        (8,863 )
      Goodwill and other impairment                      (82,013 )             -
      Loss from operations                          $    (90,168 )     $  (9,299 )

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

Net Sales. Net sales increased 10.1%, or $8.4 million, to $91.5 million for the year ended December 31, 2012 from $83.1 million for the year ended December 31, 2011. The increase in net sales resulted from a $5.2 million increase in Dispenser sales and a $4.0 million increase in Water sales.

Water. Water net sales increased 6.8% to $62.7 million, representing 68.5% of our total net sales for 2012. Five-gallon equivalent units for Water increased 3.8% to 27.6 million units for 2012 from 26.6 million units for 2011. The increase in Water net sales was primarily due to a 15.8% increase in U.S. Exchange sales, driven by same-store unit growth of 6.5% during 2012. The increase in U.S. Exchange sales was partially offset by a reduction of 5.2% in Refill sales, primarily due to lower empty bottles sales due to distributor transitions.

Dispensers. Dispensers net sales increased 22.1% to $28.8 million, representing 31.5% of our total net sales for 2012. The increase is due primarily to growth in the number of retail locations offering our dispensers. Our dispenser unit sales to retailers increased by 5.5% for 2012 compared to 2011. Sales increased at a greater level than unit sales due to the increase in sales mix for higher value dispensers.

Other. Other consists of a one-time sale of inventory in 2011 that is not included in Water or Dispensers. No such transactions occurred in 2012.

Gross Margin Percentage. While our gross margins improved in Dispensers and remained consistent in Water, our overall gross margin percentage decreased to 23.4% for 2012 from 23.9% for 2011 due to the lower-margin Dispensers segment representing a larger portion of our total net sales.

Water. Gross margin as a percentage of net sales in our Water segment remained consistent with 2011 at 32.5%.

Dispensers. Gross margin as a percentage of net sales in our Dispensers segment increased to 3.7% for 2012 from 3.5% for 2011. The increase in gross margin was primarily due to price increases to our retail customers initiated during the second and third quarters of 2012, partially offset by increased third-party manufacturing costs initiated during the fourth quarter of 2011.


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Selling, General and Administrative Expenses ("SG&A"). SG&A decreased 2.7% to $17.7 million for 2012 from $18.2 million for 2011. As a percentage of net sales, SG&A decreased to 19.4% for 2012 from 21.9% for 2011. The decrease in SG&A was primarily a result of a reduction in duplicate costs related to recent acquisitions.

Water. SG&A for our Water segment decreased 19.9% to $4.4 million for 2012 from $5.5 million for 2011. Water SG&A as a percentage of Water net sales decreased to 7.0% for 2012 compared to 9.3% for 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 29.9% to $2.4 million for 2012 from $1.8 million for 2011. SG&A as a percentage of Dispensers segment net sales increased to 8.3% for 2012 from 7.8% for 2011. The increase was primarily due to a one-time expense of $0.35 million related to the rollout of new dispenser locations for 2012.

Corporate. Corporate SG&A remained consistent with 2011 at $10.9 million. Corporate SG&A as a percentage of consolidated net sales decreased to 12.0% for 2012 from 13.1% for 2011.

Non-Recurring and Acquisition-Related Costs. Non-recurring and acquisition-related costs decreased to $0.7 million for 2012 from $2.1 million for 2011. Non-recurring and acquisition-related costs for 2012 were primarily related to employee severance costs associated with the elimination of duplicate management roles related to the Refill services business, the restructuring and consolidation of Water operations and 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 25.3% to $11.1 million for 2012 from $8.9 million for 2011. The increase was primarily due to depreciation on additional property and equipment from new locations and amortization for identifiable intangible assets related to our 2011 business acquisition.

Impairment. We recorded non-cash goodwill impairment charges of $79.1 million for the Water reporting unit for 2012. We also recorded non-cash impairment charges of $2.9 million related to other current assets for 2012.

Interest Expense and Other, net. Interest expense increased to $4.0 million for 2012 from $1.7 million for 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 and to increased amortization of deferred loan costs as a result of the accelerated maturity of our prior senior revolving credit facility.

Income Tax (Benefit) Provision. We recorded an income tax benefit for 2012 compared to a provision for 2011. In 2011 the income tax provision was a result of the recognition of a deferred tax liability related to tax deductible goodwill. In 2012 the impairment of the goodwill (see Note 2 of the Notes to the 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 December 31, 2012.

Discontinued Operations. Loss from discontinued operations was $17.8 million for 2012 compared to $2.4 million for 2011. As we did not begin selling Flavorstation products until the fourth quarter of 2011, loss from discontinued operations for 2011 does not reflect a full year of income and expenses. Additionally, loss from discontinued operations for 2012 reflects non-cash impairment of $13.4 million for the goodwill and developed technology intangibles associated with the Disposal Group.


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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 and borrowings under credit facilities. While we had no material commitments for capital expenditures as of December 31, 2012, we anticipate capital expenditures to range between $5.0 million and $6.0 million for 2013. Anticipated capital expenditures are related primarily to growth in Water locations.

At December 31, 2012, our cash totaled $0.2 million and we had approximately $0.8 million in additional availability under the Senior Revolving Credit Facility. This availability is subject to borrowing base requirements related to our eligible accounts receivable and inventory. We anticipate that our current cash and cash equivalents, availability under the Senior Revolving Credit Facility and cash flow from operations will be sufficient to meet our needs for general corporate purposes for the foreseeable future.

Our future capital requirements may vary materially from those now anticipated and will depend on many factors including: the rate of growth in new Water locations and related display and rack 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 acquisitions of other businesses. Historically, we have experienced increases in our capital expenditures consistent with the growth in our operations and personnel, and we anticipate that our expenditures will continue to increase as we grow our business, subject to limits related to our Term Loan and Senior Revolving Credit Facility.

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 additional equity or debt financing.

Changes in Cash Flows

The following table shows the components of our cash flows for the periods
presented (in thousands):

                                                         Year Ended December 31,
                                                         2012               2011
Net cash provided by (used in) operating activities   $       5.9       $       (8.2 )
Net cash used in investing activities                 $      (5.9 )     $      (21.2 )
Net cash provided by financing activities             $       5.1       $       35.6


Table of Contents

Net Cash Flows from Operating Activities

Net cash provided by operating activities was $5.9 million for 2012 compared to net cash used in operating activities of $8.2 million for 2011. The increase in cash flow from operations is primarily due to an $11.6 decrease in cash used to fund net working capital components.

For 2012, cash flows from operating activities include $82.0 million in goodwill and other impairment charges that have no current or expected future impact on cash flows and are shown as reconciling items to net cash used in operating activities.

Net Cash Flows from Investing Activities

Net cash used in investing activities decreased to $5.9 million for 2012 from $21.2 million for 2011, caused by decreases in cash used in capital expenditures.

Our primary investing activities are typically capital expenditures for business acquisitions, property, equipment and bottles and include expenditures related to the installation of our recycle centers, display racks and reverse osmosis filtration systems at new Water locations.

Net Cash Flows from Financing Activities

Net cash provided by financing activities decreased to $5.1 million for 2012 from $35.6 million for 2011. During 2012, cash provided by financing activities was primarily related to net borrowings on our credit facilities and term loan of $7.7 million, which were partially offset by debt issuance costs of $2.2 million.

During 2011, cash provided by financing activities was primarily from our issuance of common stock in connection with our secondary public offering. Net proceeds from the secondary public offering were $39.4 million. During 2011, we had $3.4 million in net borrowings under our credit facilities.

Senior Revolving Credit Facility

We entered into the Senior Revolving Credit Facility on April 30, 2012, as amended on February 21, 2013, that replaced our prior senior credit . . .

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