Q4 2021 Primo Water Corporation Earnings Call

February 24, 2022

Operator: Good morning. My name is Pam, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Primo Water Corporation's Q4 and fiscal year 2021 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you'd like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, please press star followed by two. Thank you. I would now like to turn the conference over to Mr. Jon Kathol, Vice President of Investor Relations. Please go ahead.

Ladies and gentlemen, please standby your conference will begin shortly.

[music].

Good morning, My name is Pam and I will be your conference operator today at this time I would like to welcome everyone to the Primo water Corporation fourth quarter and fiscal year 2021 earnings conference call.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you'd like to ask a question. During this time simply press Star then the number one on your telephone keypad. If you would like to withdraw your question. Please press star followed by two thank you.

I would now.

Jon Kathol: Welcome to Primo Water Corporation's Q4 2021 Earnings Conference Call. All participants are currently in listen-only mode. This call will end no later than 11:00AM Eastern Time. The call is being webcast live on Primo's website at www.primowatercorp.com and will be available for playback there for 2 weeks. This conference call contains forward-looking statements, including statements concerning the company's future financial and operational performance. These statements should be considered in connection with cautionary statements and disclaimers contained in the safe harbor statements in this morning's press release and the company's annual report on Form 10-K, quarterly reports on Form 10-Q, and other filings with securities regulators. The company's actual performance could differ materially from these statements, and the company undertakes no duty to update these forward-looking statements, except as expressly required by applicable law.

Jon Kathol: A reconciliation of any non-GAAP financial measures discussed during the call with the most comparable measures in accordance with GAAP, when the data is capable of being estimated, is included in the company's full year and Q4 earnings announcement released earlier this morning, or on the investor relations section of the company's website at www.primowatercorp.com. I am accompanied by Tom Harrington, Primo's Chief Executive Officer, and Jay Wells, Primo's Chief Financial Officer. As a part of this conference call, we have included a deck online at www.primowatercorp.com that was designed to assist you throughout our discussion. Tom will start today's call by providing a high-level review of Q4 and our progress on Primo's strategic initiatives.

Jon Kathol: Jay will review our segment-level performance, and we'll discuss our Q4 performance in greater detail and offer our outlook on the Q1 and full year 2022 before handing the call back to Tom to provide a long-term view ahead of Q&A. With that, I will now turn the call over to Tom.

Tom Harrington: Thank you, John, and good morning, everyone. Before I review our performance for Q4, I want to share how proud I am of the efforts of the team and pleased with everyone's continued commitment to safety and customer service, as our teams have once again responded to the challenges presented by the pandemic. Our teams remain focused on inspiring healthier lives by providing water your way. Turning to Q4, we achieved higher revenue driven by strong customer demand, particularly in our Water Direct and Water Exchange businesses, and implemented several pricing actions. We continued to deliver growth on Mountain Valley, America's premium spring and sparkling water brand. Our water customer base increased organically and our customer retention rates improved. We did experience challenges like most companies, where inflationary cost pressures dominated the landscape. To address the higher costs, we implemented a series of pricing actions across our customer base.

Tom Harrington: To address the higher costs, we implemented a series of pricing actions across our customer base.

Tom Harrington: These pricing actions were insufficient to fully offset higher than forecasted costs for raw materials in our North American single-use plastic bottled water business, ocean freight container rates, and tariffs incurred during the quarter. As a result, further pricing actions have been implemented in Q1, which should allow us to offset costs with pricing. Despite the cost headwinds, we continued to invest in the customer experience, which resulted in improved service levels and higher customer retention rates. Our global customer retention rate improved by 60 basis points to 86.4% compared to the prior year, which compares favorably to other subscription-based companies.

Tom Harrington: As Jay will outline later in his remarks, the combination of improved pricing, continued demand for our products and services, and improvement in customer retention gives us confidence in guiding to our full year 2022 adjusted EBITDA of between $410 and $420 million. During the quarter, revenue increased 7% to $518 million, and adjusted EBITDA increased 5% to $98 million after normalizing for the 53rd week in 2020, driven by higher demand for our products and services and improved pricing led by our Water Direct and Exchange businesses. Water Direct and Exchange grew 7% even as B2B customer volume was softer than forecasted due to a slower B2B recovery, which we attribute to the effect of Omicron variant of COVID later in the quarter.

Tom Harrington: The Water Dispenser segment declined as a result of higher retail price points and less promotional activity driven by tariffs and the substantial increase in ocean freight experienced during the quarter. We expected to see relief from the tariff in Q4 as well as a refund. Unfortunately, that did not happen. Despite these headwinds, we sold approximately 900,000 dispensers in 2021 and are optimistic regarding the potential for tariff relief and refund of last year's tariffs at some point in 2022. Ocean freight container rates have begun to stabilize, and we believe these costs will moderate over time, which we expect to support our return to growth in our dispenser business. Our water dispenser sales provide an important entry point for consumers to enter the water category, where we can capitalize on our recurring razor and razor blade revenue model.

Tom Harrington: The attractiveness of recurring purchase behavior is the ability to continually generate water sales as part of our customer for life strategy. As a reminder, our internal research indicates that approximately 60% of respondents surveyed are new to the water category. Of those likely to become a future dispenser customer, research indicates their water purchasing preference as 45% for Water Direct, 30% for Water Exchange, and 25% prefer Water Refill. We should continue to capture our fair share of this growth as a razor and razor blade model remains one of our strategic advantages. Turning to operating expenses. Overall profitability was adversely affected by higher operating costs during the quarter. As I mentioned earlier, the impact of higher costs outpaced our internal forecast.

Tom Harrington: After averaging roughly a 4% increase in costs over Q1, Q2, and Q3 of the year, we saw input costs increase more than 9% in Q4 when compared to the prior year in the US. To address the higher costs, we implemented a series of pricing actions across our customer base. These pricing actions were insufficient to fully offset higher than forecasted costs during the quarter, and further pricing actions have been implemented in Q1, which should allow us to offset costs with pricing. As we worked our way through Q4, we started to see an increase in the number of COVID cases across our operations. Similar to the Delta variant in Q3, we saw hundreds of routes affected by Omicron. Fortunately, COVID case rates appear to have peaked and have dropped significantly as we move through Q1.

Tom Harrington: We continue to work diligently to meet the current levels of demand, especially in our North America Water Direct and Exchange businesses. Despite these challenges, we were able to improve our service metrics as we worked our way through the quarter. The improvement of the customer experience and a push to get close to the full staffing levels were a key focus and the result of conscious investment choices during the quarter. Although these actions cost more in the short term, we believe the long-term benefits of improving the customer experience will outweigh the short-term costs, supported by our continued improvement in customer retention rates. Globally, our water customer base grew 2% to nearly 2.3 million customers in 2021.

Tom Harrington: As I mentioned last quarter, the addressable three- and five-gallon water category of US residential households alone is estimated to be between 22 and 29 million and continues to grow. The residential opportunity for increased sales of three- and five-gallon returnable water remains a top priority as the category has 2 to 3 times the market potential versus today's installed base, and we are focused on increasing household penetration through execution of our razor-blade model. As it relates to our efforts in ESG, we remain focused on elevating our position on environmental responsibility and finding new ways to honor our commitment to protect the environment, provide quality drinking water, and manage sustainability. In December, we achieved carbon neutrality across our global operations.

Tom Harrington: Major projects funded as a part of our carbon offset strategy include funding water infrastructure improvements in sub-Saharan Africa, repairing, and drilling new boreholes in small rural communities. By providing clean water, communities no longer need to purify water through boiling. This alleviates pressure on local forests, the predominant source of firewood, and reduces greenhouse gas emissions. We've also funded water filtration improvements in Guatemala. Waterborne disease has been identified as a national priority in Guatemala, given the high incidence of disease and chronic malnutrition. This project distributes water filters and stoves that enable access to clean water and improve cooking conditions by increasing fuel efficiency and reducing harmful indoor air pollution. It is the first Gold Standard water treatment or cook stove project in the country. The project so far has benefited over 500,000 people.

Tom Harrington: In December 2020, we became the first company to certify a spring water source under the Alliance for Water Stewardship Standards and certified 3 additional spring water sources in 2021. We will continue to transition more trucks within our fleet away from diesel-powered vehicles to more environmentally-friendly propane-powered vehicles. During our Q3 earnings call, and again at our investor day, we discussed the next phase of our transformation as a pure play water company and leader in ESG, and that we've begun the process of exiting the small format, single-use bottled water retail business in North America. Although it is a relatively small part of our overall business, exiting this category will make us a higher margin and more environmentally friendly business.

Tom Harrington: The increasing effect of one-way single-use plastic bottles in our landfills and waterways have driven us to focus on our more environmentally friendly returnable bottle business. Our 3-gallon and 5-gallon bottle provides an attractive alternative to combat this challenge. Adjusting for the exit of the category, we expect revenue growth in 2022 of 9% to 10%. In addition, during 2022, we expect to achieve our targeted $40 million to $60 million range of M&A tuck-ins. As I mentioned earlier, our pure play water model gives us the confidence to set our full year adjusted EBITDA outlook between $410 million and $420 million. I'd like to turn the call over to Jay to review our Q4 and full year financial results in greater detail.

Jay Wells: Thank you, Tom, and good morning, everyone. Starting with our Q4 consolidated results. Revenue increased 3% to $518 million compared to $505 million. Excluding the impact of foreign exchange, and the 53rd week, revenue increased by 6%. The gains were largely driven by growth in our Water Direct and Water Exchange businesses, partially offset by declines in our Water Refill and Water Dispenser businesses. Adjusted EBITDA was flat to last year at $98 million. Excluding the effect of the 53rd week in the prior year, adjusted EBITDA was up 5% in the quarter. As Tom discussed, the effect of higher costs coupled with softer B2B volume drove lower than expected profitability. In the later stages of the quarter, we saw the effects of the Omicron variant, which caused B2B volume to come in lower than expected.

Jay Wells: The higher COVID rates also affected our route drivers and caused us to increase spending to deliver our goods and services to customers. These costs, along with a push to get to full staffing levels, were partially offset by increased pricing taken during Q4. The major buckets of higher costs include material costs associated with our North America single-use water retail business, ocean freight, and labor. As Tom mentioned, we had forecasted and priced for higher costs. However, these costs came in considerably higher than expected. The additional pricing taken in Q4 and again in Q1 should allow us to now offset these increased costs. Turning to our segment-level performance for the quarter. North America revenue increased 1% to $387 million compared to $385 million.

Jay Wells: Excluding the impact of foreign exchange and the fifty-third week, revenue increased by 6%, driven by growth in our Water Direct and Water Exchange businesses, partially offset by lower revenue from our Water Refill and Water Dispenser businesses. Adjusted EBITDA in North America increased 4% to $85 million. Excluding the impact of the fifty-third week, adjusted EBITDA was up 10% in the quarter. Turning to our Rest of World segment, revenue increased by 9% to $131 million. Excluding the impact of foreign exchange and the fifty-third week, revenue increased by 9%. The increase was driven by growth in residential customers, with revenue from residential customers being up 15%.

Jay Wells: Revenue from B2B customers up 5% for the quarter as the performance of our Water Direct B2B customer base remains tied to the relative level of the return to office in each of the countries we serve. We continue to work toward an efficient and low-cost rollout of our products and services for residential customers in Europe to further diversify our customer base and better balance the customer mix. Adjusted EBITDA in the Rest of World segment decreased 9% to $20 million as government-subsidized furlough programs are ending in many European markets, and we're investing in sales and marketing to drive volume and revenue growth. Turning to our liquidity position and balance sheet.

Jay Wells: We ended the quarter with a cash balance of $128 million and available net borrowing capacity on our cash flow revolver of $80 million for a combined total liquidity position of $208 million. Our net leverage ratio is 3.8x, and as a reminder, we are now targeting a net leverage ratio of less than 2.5x by 2024. Looking to Q1, based on the information we have available to us as of today, we currently expect consolidated revenue from continuing operations to be between $510 million and $530 million. We also expect that our Q1-adjusted EBITDA will be in the range of $80 million to $90 million.

Jay Wells: For the full year of 2022, organic revenue growth is projected to be 7% to 8%, and overall revenue growth is projected to be 9% to 10%, adjusted for the exit of the North America single-use retail water business and including the revenue from the tuck-in acquisitions made during 2021. As Tom mentioned, the exit of the North America single-use retail water business is moving quickly. In 2021, these products accounted for revenue of approximately $142 million. We now expect that 2022 revenue for this product line to be about $40 million with minimal effect on adjusted EBITDA. We still expect to be out of this category by mid-year. We are forecasting our annual adjusted EBITDA to be between $410 and $420 million.

Jay Wells: We also expect around $10 million of cash taxes, $60 million of interest, as well as capital expenditures of approximately $200 million. The capital expenditure figures include incremental spending as we discussed during our recent Investor Day, which is being used to support our growth outlook and EBITDA margin expansion. The multiyear incremental spending will begin in 2022 and will show returns in subsequent years. Key initiatives to be funded from the incremental CapEx include driving digital growth, leading dispenser innovation, building a more environmentally friendly delivery and service fleet, installing more efficient water production lines, which will reduce water usage and increase productivity. Driving growth and refill with simple on-the-go units and new filtration innovations like Bevi. Earlier this week, our board of directors authorized a quarterly dividend of $0.07 per common share.

Jay Wells: This dividend represents a 17% increase over previous quarterly dividends. As discussed during our November investor day, our growth outlook and increased free cash flow generation can fund our growth and an increase in our annual dividend. Our path to a multiyear dividend step-up includes an increase in our quarterly dividend per share by $0.01 in 2022, another in 2023, and another in 2024. Other aspects of capital deployment include continuing our tuck-in M&A. During the Q4, we announced the acquisition of Clear Mountain Refreshment Services in Little Rock, Arkansas, Water Event, which operates 5 locations in the Dallas-Fort Worth Metroplex, and the purchase of SipWell in Belgium.

Jay Wells: The addition of SipWell makes Primo the leading provider of sustainable drinking water solutions in Belgium, expanding the Primo footprint and furthering our vision of providing sustainable water solutions whenever, wherever, and however our customers want them. For 2022, we are again targeting $40 to 60 million of tuck-ins and remain focused on executing the robust pipeline of tuck-in opportunities in front of us. Our long-term organic growth outlook has not changed. In terms of our outlook for 2024, we are forecasting high single-digit organic revenue growth. Targeted annualized adjusted EBITDA approaching $525 million. Adjusted EBITDA margins of 21% to 22%. Adjusted earnings per share of $1.10 to $1.20 per share. Net leverage of less than 2.5 times and return on invested capital greater than 12%.

Jay Wells: I will now turn the call back to Tom.

Tom Harrington: Thanks, Jay. Looking ahead, we remain focused on executing our differentiated Water Your Way platform, and we will leverage our pure play water model to drive revenue growth of 9% to 10% in 2022, adjusting for the exit of the North America single-use plastic retail water business and including the revenue from the tuck-in acquisitions made during 2021. We will continue to enhance the customer experience by building out more diverse e-commerce solutions and improving the customer experience through flawless delivery execution. We have two important global initiatives that we believe will make a difference in customer experience and revenue. The new refreshed North America mobile app will be launching in Q2 with an easier experience for our customers and most importantly, with new features that provide easy access for support with more channels such as live chat.

Tom Harrington: The second initiative is the launch of a global direct-to-consumer webshop later this year that will accelerate our dispenser sales and introduce an on-demand approach for all things water. By taking a global approach in the launch of these two digital platforms, we see efficiencies in developmental costs, accelerated learning, and further enhancing our Primo brand and global platform. We will continue to execute our razor-razor blade model with growth in the number of dispensers sold, driving top-line growth through the sale of water products. Earlier this month, we announced the launch of a new alkaline water brand, Primo Plus. Primo Plus alkaline water will complement our existing portfolio as alkaline water is a growing trend globally. Primo Plus alkaline water has a pH level of 9.5 at the time of bottling and is an ideal hydration solution sold in 3-gallon bottles.

Tom Harrington: Primo Plus alkaline water has a pH level of 9.5 at the time of bottling and is an ideal hydration solution sold in 3-gallon bottles.

Tom Harrington: It is currently available for Water Direct customers in limited US geographies and will be expanding to select grocery and retail locations through our Water Exchange program during 2022. Supporting our growth are more structural and thematic tailwinds that are driving consumers toward healthy hydration solutions. The growth in the health and wellness category continues to support our prospects of gaining share of the broader beverage category. COVID and its variants continue to elevate the health and wellness conversation, and consumers are increasingly conscious of their overall health and well-being. In addition, the perception of the declining quality of municipal tap water is well documented, which supports the growth of our products and services. Tap water as a primary drinking source is expected to continue to decline in all parts of the world for the foreseeable future.

Tom Harrington: As Jay noted, we expect our consolidated first quarter revenue to be between $510 and $530 million and for our adjusted EBITDA to be between $80 and $90 million. For full year 2022, we're forecasting revenue growth of 9% to 10%, adjusting for the exit of the North America single-use retail water business and including the revenue from the tuck-in acquisitions made during 2021, and are forecasting our adjusted EBITDA to be between $410 and $420 million. We continue to see the elevated demand in the residential sector as the return to work aspect of the B2B sector has once again been delayed with the emergence of the Omicron variant of COVID. Fortunately, COVID case rates appear to have peaked and have dropped significantly as we move through Q1.

Tom Harrington: We're also maintaining a strong pipeline of M&A targets, which we expect to execute during the remainder of the year. Once again, I'd like to thank the Primo Water associates across the business for their tireless efforts to serve our customers. With that, I'll turn the call back over to John to move us to Q&A.

Jay Wells: Thanks, Tom. During the Q&A, to ensure we can hear from as many of you as possible, we would ask for a limit of one question and one follow-up per person. Thank you. Operator, please open the line for questions.

Jon Kathol: Thanks, Tom. During the Q&A, to ensure we can hear from as many of you as possible, we would ask for a limit of one question and one follow-up per person. Thank you. Operator, please open the line for questions.

Operator: Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Should you have a question, please press star followed by one on your touchtone phone. You will hear a three-tone prompt acknowledging your request, and your questions will be pulled in the order they are received. Should you wish to decline from the polling process, please press star followed by two. If you're using a speakerphone, please lift your handset before pressing any keys. One moment for your first question. Your first question comes from Derek Lessard with TD Securities. Please go ahead.

Derek Lessard: Yeah, good morning, gentlemen, and hope you're all well.

Tom Harrington: Good morning, Derek. How are you?

Derek Lessard: I'm very good, thanks. You guys held your Investor Day last November, which, you know, in these, indeed, times feels like a really long time ago now. If I go back to that period, you sounded really confident, almost excited in the outlook. I guess my question really is, you know, do you think that these results in any way temper or impact that longer 2024 outlook that you have?

Tom Harrington: Yeah, Derek, this is Tom. The short answer is no. You know, if you look over the last two quarters, the Delta variant and the Omicron variant have provided us with unexpected short-term headwinds. The company, you know, we decided to continue to invest in service because we think that's in long-term best interest of everyone, our customers, and our stakeholders. We chose to keep that investment and try and service through these, I'll call them anomalies, I hope, so they have not been our friend. I'm actually more bullish today than I was back in Investor Day. We still have positive tailwinds. Consumers are gonna look for our brands, they're gonna look for our products, they're gonna look for our services more in the future than they have in the past.

Tom Harrington: We think that's a positive place for the company to be. We continue to grow our market share. We continue to grow profitability. I'm confident in, you know, over the last few years, as you know, Derek, this is the first time I've said 9% to 10% growth. We've become a growth company, and we're confident in our ability to achieve those numbers. We also continue to make appropriate investments. We're investing in assets to improve efficiency and effectiveness. We continue to invest in CX. We'll continue to make investments in ESG, which we believe matters and will become a tailwind for us. We have the capital structure to continue to accelerate growth and execute against our tuck-ins. You know, as I said, I'm more confident about what our outlook is for 2024 than I was when we did this in November.

Tom Harrington: You know, as I said, I'm more confident about what our outlook is for 2024 than I was when we did this in November. You know, Omicron has not been my friend. Neither was Delta, but that's now in your rearview mirror, I hope.

Tom Harrington: You know, Omicron has not been my friend. Neither was Delta, but that's now in your rearview mirror, I hope.

Derek Lessard: Okay. Just maybe one follow-up for me, and that's very helpful. Thanks. You know, again

Tom Harrington: Thanks

Tom Harrington: Thanks.

Derek Lessard: ... as it relates to everything that you do consider transitory, so Omicron, inflation, and supply chain, just wondering how these pressures have been trending almost now that we're two-thirds the way through Q1?

Derek Lessard: As it relates to everything that you do consider transitory, so Omicron, inflation, and supply chain, just wondering how these pressures have been trending almost now that we're two-thirds the way through Q1?

Tom Harrington: Well, I'll pass it to Jay, but you know, our forecasting assumes status quo. We didn't anticipate Omicron in Q4. It created challenges that we've articulated to you from the labor perspective, servicing our customers. It also had a negative impact on the B2B commercial volume recovery, that frankly, we didn't anticipate that we'd get another spike. Jay, anything to add?

Jay Wells: Yeah. You know, the other thing that Tom didn't mention was within the forecast and guidance that we provided, it was the end of tariffs on our water dispensers that we're importing from China. If you look at last year, we spent about $13 million in tariffs. Now, keep in mind, $8 million was in CapEx. Those are the coolers that we buy to lease to our customers, and about $5 million was in COGS. Those are our resale coolers. Within my forecast was getting that refunded. That's on me. That's part of the miss. I assure you it's not in my current guidance either, because, you know, the government has moved slow. We're still optimistic we're gonna get it back.

Jay Wells: I view that now as upside on my forecast and guidance versus the risk I had when I expected it last quarter. That's once on me, shame on me type forecasting, let's put it that way. The same with recovery. We were trending really good on recovery from COVID. We thought that trend would continue, and it didn't. It actually reversed a bit in Q4. Those are the two of the main things that was, you know, assumption of my forecast that weren't accurate. I'm not going to forecast a significant recovery throughout this year. I'll take it as it comes, but I would view that more as opportunity than risk if it doesn't come.

Tom Harrington: The key points on the tariffs, if we get it, terrific, but we're not creating a hurdle for ourselves here.

Daniel Moore: Okay.

Tom Harrington: Once was enough.

Daniel Moore: Okay. Thanks for all that.

Derek Lessard: Okay. Thanks for all that.

Tom Harrington: Thanks, Derek.

Operator: Your next question comes from Nik Modi with RBC Capital Markets. Please go ahead.

Filippo Falorni: Hey, good morning, this is Filippo Falorni for Nick. How are you guys?

Filippo Falorni: Hey, good morning, this is Filippo Falorni for Nik. How are you guys?

Tom Harrington: Very good. Good morning.

Filippo Falorni: Morning. So first, on the cost front, can you remind us, after the exit of the North America single-use business, how much of your cost is in commodities and what are the biggest commodity exposure for your business? More broadly, in terms of cost inflation, I guess, what are you assuming for 2022 in terms of labor or cost inflation?

Tom Harrington: Yeah, I'll take a piece of that, and then this is Tom, and then give it to Jay. On our retail bottled water business, the commodity issue was resin for the high density polyethylene bottles. Also impacted us on corrugated, the box, shrink wrap. You name it, all of the components of that business, which I'm happily on schedule to exit in the next two months, were negatively impacted by cost inflation. Jay, I don't know if you have some numbers to-

Jay Wells: Yeah, no, I mean, you really look at year over year, our, you know, main cost buckets that we said were up 9% versus the trend of 4% to 5%. I'd say almost half the bucket were the first items that Tom mentioned. It was material costs for, thankfully, the single-use plastic retail business that we're exiting. So that's one of the many reasons we are getting out of that business. I would say when you look at the other half, it was really two tranches. It was ocean freight and tariffs, and then it was labor. I mean, we are going to see having to give our folks, you know, higher raises. Also, please keep in mind our RSRs, especially in North America, are predominantly commission-based.

Jay Wells: As we take price, we are gonna pay more in commission. Part of it, you know, we get the majority of it, be sure, but, you know, we will see labor. I would say, assuming we are, and we will be by mid-year, fully out of the retail business discussed, that will take the main material cost type inflation. Tom and I already talked, you know, tariffs. We are seeing ocean freight start to moderate and improve a bit as we go into this year. You know, that's the other cost I look at. Then the last is really labor. We're, you know, a delivery company. We have our RSRs delivering, providing our customers good service, and we wanna make sure we provide our customers the best service we can.

Jay Wells: Retaining and developing those associates is key as part of our associate experience that we focus on.

Tom Harrington: While we anticipated inflation rolling into Q4, we didn't anticipate it frankly would be 2x. We had taken pricing across the customer base based on what we saw when we were in Q3 and executed that at, you know, the end of August. We've taken another action that has been implemented during January based on the realities of what we saw in Q4. You know, we-

Filippo Falorni: Got it.

Tom Harrington: We got the 2x and then we've taken the action to address it, go forward.

Filippo Falorni: Got it. That makes sense. That's very helpful. I guess probably can you comment a bit on, you know, taking another action, like, would you feel like you're in a good position now? Would you consider incremental actions if the commodity or-

Tom Harrington: Yeah.

Filippo Falorni: The cost environment were to stay elevated?

Tom Harrington: Yeah. We think we've covered as we sit here today. As you can imagine, we're like many other companies, we're watching costs like a hawk. If we're required to act, we will. The good news is our customer retention rates continue to improve, which is partially because of our decision to not cut those costs and focus on the customer experience, which is ultimately the key driver of our success on 9% to 10% growth and our ability and confidence in the multi-year 2024 outlook.

Filippo Falorni: Great. That's very helpful, guys. Appreciate it.

Tom Harrington: Thank you.

Jay Wells: Thank you.

Operator: Your next question comes from Daniel Moore with CJS Securities. Please go ahead.

Daniel Moore: Thank you, Tom. Thank you, Jay.

Tom Harrington: Hey, Dan, how are you?

Daniel Moore: I'm good. Great color, by the way, in terms of the impact of the tariffs. That helps clarify things quite a bit. In terms of the growth expectation, 8% to 9% organic, how much of that is volume and how much of that is price, roughly, given all the price you've had to and been able to take?

Tom Harrington: Yeah, just a point of clarity and then I'll pass it over to Jay. Organic, I believe it's 7 to 8.

Daniel Moore: Mm-hmm.

Tom Harrington: If you factor.

Daniel Moore: Yes, my apologies. Yes. Mm-hmm.

Tom Harrington: Yeah, no worries. Just so we're clear. The 9 to 10 has the exit of that-

Daniel Moore: Overall, yes.

Tom Harrington: Yeah, retail, jazz, and then the benefits of some tuck-ins. So-

Jay Wells: Yep.

Tom Harrington: Just to be clear. Jay, some color?

Jay Wells: No, I mean, we, you know, we've talked about it before, and Tom mentioned it on the call that, you know, our water customer base is up 2%. You know, that is driving the growth, and a key focus is to continue on the customer experience. Improved ads reduced our quit rate. So, you know, customers are generating a very good part of that. I would say, when you look on the volume side on top of that, I think you heard a little bit of a tone. I think we've moved a little bit on a conservative side on the B2B side to more run current trends, but we're continuing to sit within our forecast to be very bullish on the residential side. So the residential side should continue to drive about another 1+% on volume.

Jay Wells: you know, commercial will give us an upside if we don't have another variant of COVID, and then pricing would be the remainder of it, Dan.

Jay Wells: You know, commercial will give us an upside if we don't have another variant of COVID, and then pricing would be the remainder of it, Dan.

Tom Harrington: The other piece I'd add is, so last year, 2021, we sold, you know, approximately 900,000 dispensers. They create what we call water-only customers, which is a terrific customer, largely residential. As the ocean freights have begun to, I won't say normalize, but ease, and hopefully we have a resolution on the tariffs, we expect to accelerate that dispenser business, which will give us growth in that customer base, you know, that buys three and five gallon containers from us. You know, that's part of the growth story. People love our brands, and we're just finding different ways to give them water their way.

Daniel Moore: Helpful. Clearly, you know, impressive customer retention in the face of that, those, you know, multiple price increases. The growth in terms of Rest of World versus North America, you just gave us some inkling, but you expect to continue to drive retail penetration in Rest of World and, you know, what are the kind of relative growth rates embedded in the guide? Thanks again.

Tom Harrington: Yeah, I think that we were quite pleased in 2021 with our residential performance in Rest of World. It is unfortunately, as you know, with Delta and Omicron as a spike in North America. There were more than two spikes depending on the country you're in in Europe. But we think that, you know, the markets are accelerating their return, if you will, and easing mask guidance offset by whatever happens in the Ukraine, right? We think we're in a good spot. We're confident about our ability to grow the residential business, where we will develop the solution that we call Sip On The Go, which we think is a real solution to grow our revenue and volume in the continent, and we'll go there first, you know, later in 2022.

Jay Wells: Yeah, I'm very excited on the quarter. I mean, 15% residential growth, 5% B2B growth. I mean, that is great that, you know, as we've talked before, Europe has been a flattish to declining business. Through all of the efforts we're making, we've turned the top line in growth. Now, we did have some bottom line pressures, and we will, as we lap the furlough programs, as we get the employees back in, and then and only then can you right size the organization, because you cannot right size organizations while individuals are on furlough programs. Be assured that we'll adjust our cost base to, you know, to the right level.

Jay Wells: The exciting part is that type of top line growth out of Europe is something, you know, we did not see when we diligenced even many years ago, and we haven't seen since we bought them. I think, Europe's in a very good space going forward.

Tom Harrington: Become a tailwind.

Jay Wells: Yeah.

Daniel Moore: All right. The tariffs, if you did get them back, would be up to a $13 million potential benefit? Or is that the right way to think about it? You know that's a fair question, sorry.

Jay Wells: Yeah. Remember, $8 million was CapEx. If we get that back, that's not an EBITDA benefit. $5 million did go through COGS, as a cost of goods sold of the dispensers that we sell in retail. That would be a benefit, flowing through.

Daniel Moore: Very helpful. Thank you.

Tom Harrington: Thanks, Dan. Appreciate it.

Operator: Your next question comes from John Zamparo with CIBC. Please go ahead.

Tom Harrington: Morning, John.

John Zamparo: Good morning, guys.

Tom Harrington: Hello, John. Good morning.

John Zamparo: Good morning. I wanted to follow up on revenue in the quarter and appreciate the commentary so far. You mentioned some headwinds from Omicron, of course. Can you add some color, particularly on the refill and filtration segment and the other segment? Seems like you saw some softness in those. I wonder if that was impacted by Omicron or the furlough programs you're talking about. I know there was a customer loss on the refill side, but any commentary you can add on those two segments would be helpful.

Tom Harrington: Yeah. I think on refill, there's a couple of things that were a headwind in the quarter, and there is a direct correlation to Omicron and/or the Delta variant, frankly, at the end of Q3. It has to get to retail store traffic, right? If foot traffic is down in retail, then the number of customers that pass our outdoor refill machine will be lower, and the number of customers that go through the aisle for the indoor machine is lower. Naturally, we're gonna be negatively impacted from a revenue perspective.

Tom Harrington: We're cautiously optimistic, but we're not baking in any, you know, we're taking the appropriate approach that says we're gonna take steady state in terms of those businesses, as opposed to, you know, expecting that it gets better because, which was a bit of our problem in Q4, thinking that, you know, Delta was good, things look great, and then Omicron hit us again. Filtration was also gonna be related to Omicron if you think about traffic and how many commercial opportunities don't exist today, partially because of work from home. That business segment is still either in decline or not yet stable because of the variant, our ability to attract new customers is negatively impacted short term, which has a direct impact on the top line.

Jay Wells: Yeah. On, I think you mentioned other water also, John. You're gonna see that decline in North America. That's the exit of our single-use plastic water business. That is what that decline that you see in the other water.

Tom Harrington: That declined faster than we anticipated.

Jay Wells: And it-

Tom Harrington: post our announcement. Which gets us out of the business, you know.

Tom Harrington: Post our announcement. Which gets us out of the business, you know.

Jay Wells: It was, I mean, that business, as I mentioned, was $142 million last year. It's gonna be $40 this year, about $20 million each quarter. You know, on revenue since we're on it, we posted a supplemental deck on our website, and if you look at slide 23, that'll give you a good view of our quarterly revenue last year. It minuses out the revenue associated with this single-use plastic water business that we're exiting. It's really 9% to 10% growth on that number each quarter. I'd add another $20 million in Q1 and $20 million in Q2 to add back the little bit of revenue we will still have in that channel for H1 this year.

Jay Wells: That's how we look at it, but it really is the exit of the retail business we've discussed.

John Zamparo: Okay. That's very helpful. Thank you for that. Then my follow-up is on the CapEx guidance of $200 million. Just thinking about the investor day or maybe it was Q3, but I think you'd said 7% of sales is the rough guide and then $50 million of additional projects to be spread over the next 3 years. If you do that math, you get a bit below the 200. I'm wondering have you front loaded some of those projects? Does the 200 now reflect paying the tariffs or the CapEx portion of it? Any other color there you can add would be helpful.

Tom Harrington: Yeah. I'll give you kind of the way I think about the phasing, is that we will make investments in 2022, both on efficiency projects as well as growth projects. We won't see that benefit until later on in, you know, as you think about, frankly, 2023 and 2024. You have to, you know, execute those projects and do work in plants and build a simple machine that works globally. We'll make those investments this year. We'll see future benefit in 2023 and 2024. The CapEx, Jay, I'll flip to you on.

Jay Wells: I think the difference you're trying to work to is probably the tariff that I referred to. If it goes away, we would get closer to the number you're referring to, not the refund, but just the pure in your CapEx on dispensers, that's probably the difference. That's above and beyond the 7% of revenue. When that goes away, we'll get back to about the 7%. I would say that the tariffs on the dispensers that we rent to our customers, that CapEx is really probably the difference that you're looking for.

Derek Dley: Okay. Understood. Thank you very much.

John Zamparo: Okay. Understood. Thank you very much.

Tom Harrington: Thanks, John. Appreciate it.

Operator: Ladies and gentlemen, as a reminder, if you do have a question, please press star one. Your next question comes from Derek Dley with Canaccord. Please go ahead.

Derek Dley: Yeah. Hi, good morning.

Tom Harrington: Morning, Derek.

Jay Wells: Hello, Derek.

Derek Dley: Just on the price increase that you expect, Jay, did I hear you correct? It's gonna be about 5% to 6% for 2022?

Jay Wells: I think you're roughly correct. If you think and you look at inflationary numbers right now, and you ignore what happened in Q4, that's, you know, that's not far off of inflation and that's what we're pricing to cover the cost increase plus a little bit more. You've got it about right, Derek.

Derek Dley: Okay. How does that compare to the price increase that you took in Q4?

Jay Wells: Well, it's kind of more of a combo that I'm doing the rollover benefit on the full year and what we've taken. Just point of information, we have taken it. It's gone through. It's gone to our customers, so it's in place. We've pocketed that. Keep in mind, we're still gonna do our regular pricing on top of that too. This was more just acceleration of certain others. You know, it's a combination of rollover benefit, the pricing that we took right at the end of January, beginning of February, and then our normal pricing that we take, you know, throughout the year. It gets you to that number, Derek.

Derek Dley: Okay. No, got it. That's helpful. Then maybe Tom, just your comment on freight. Can you quantify that a little bit for us? I get it's, you know, still elevated but normalizing, but how does that compare to what you've seen over the last two quarters?

Tom Harrington: Yeah. I'll give you a couple of numbers, you know, to put it in context. I paid as high as $25,000 a container. Pre all of this, it would be something closer to $5,000 if you went back to, you know, before the spike. That's the order of magnitude of the change. We paid, you know, down under $20,000 or less now, right? It's beginning to work its way closer to $15,000 than $25,000. We haven't built all that benefit in because we need it to be more than, you know, 10 containers of trend, right? Jay said it before, you can accuse me of being conservative. I'm just being thoughtful about, I don't wanna make a tariff mistake again, and I'm complicit with Jay on that.

Tom Harrington: We wanna make sure that it's trendable and bankable, right? So that's really how we think about it. Now, you may also ask, it's still if you're in Long Beach. I think the last numbers I looked at was 80 days. We've built that into our demand plan, so we think we have the appropriate flow of assets. It doesn't impact our ability to acquire customers. You know, the pricing offsets it, and we've baked in that 80 days into that demand planning model, which, you know, frankly, last year was a catch-up, right? You went from whatever it was, less than 30 to 80 practically overnight. All that's now we kind of modeled into our go-forward operating plan.

Derek Dley: Okay, that's great. Just, can you just maybe talk about the business that's coming through your website and your e-commerce business? You know, how has that been growing over the last year? You know, can you provide like what percentage of revenue it represents?

Tom Harrington: I can do some of that. Let's go with Europe, right? You remember we stood up websites if you go back in May 2020. We now have websites up in all markets in Rest of World, and it led to something on the order of 25,000+ net new customers on the residential side in Europe, right? Which was a positive tailwind for us as we dealt with the high percentage of our customer base in Europe that was commercial business. That has worked quite nicely. Our residential mix is higher in North America. We are generating more customers from digital. We're rolling out a new app in North America early Q2, which we expect to help us drive customers.

Tom Harrington: We are building in process of global portal to e-commerce web shops, Derek, that will enable us to accelerate dispenser sales through this dispenser and water sales through this platform, you know, as we go forward. We haven't stood them up everywhere. We're still in the learning stages, but we are selling dispensers, and we actually sell water on those sites. We think it'll be a good component of that ultimately 9% to 10% growth model.

Derek Dley: Okay, great. Thank you very much.

Tom Harrington: Thanks, Derek.

Operator: Your next question comes from Andrea Teixeira with J.P. Morgan. Please go ahead.

Operator: Your next question comes from Andrea Teixeira with JPMorgan. Please go ahead.

Andrea Teixeira: Thank you. I wanted to just follow up on the organic growth guidance and on the commentary about the 1% volume guide for residential embedded in the total top-line growth. I'm a bit surprised, maybe I'm understanding it the wrong way. You had 900,000 new dispensers sold last year. I'm not sure if it's more exchange related and within the razor blade model that those jugs that go into there they will be accounted for in these residential customers. In other words, are you being just conservative because of the tough comparisons for residential, or you're assuming that reopening, the commentary about commercial customers, that you're being more conservative on those and/or the frequency of purchases?

Andrea Teixeira: Related to that, what we saw in Q4 as we enter Q1, did the Omicron impact subside during the beginning of the year? Was there any major customer that you lost during these logistics issues? Perhaps, you know, comment also on the churn rate after you took pricing.

Tom Harrington: Okay, Andrea, good morning. I'm gonna

Operator: Morning.

Tom Harrington: I may take these backwards, right? Customer churn and our retention in Q4 was 60 basis points better, 86.4%. Our 2021 pricing was initiated, implemented, let's call it 1 September 2021. That number did not spike. I know it's part of our investment, you know, with the route associates in terms of servicing the customer investments in our call center to make sure that we gave continued service despite the Delta and Omicron variants. That's a pretty good indicator for us that we're getting the price we need, and we see it flow through, and we haven't chased off customers. We're not seeing any material change early in Q1. In terms of where we are with the Omicron, it's like other things I've read, is the number of cases has dropped off markedly.

Tom Harrington: You know, in October, at the end of the quarter, we had some discussions. I was really probably too bullish about how that turned out and Delta became Omicron. Yes, I would be conservative about that. We're expecting steady state, no meaningful positive from that benefit of, let's hope, another variant. On the dispensers, the way to think about it is we get customer acquisitions in Water Direct from people who rent coolers from us. You can relate that to Jay's comments about the $8 million in CapEx. Then we separately sell 900,000 coolers through a number of large retailers and through e-commerce. In our script, we talk about roughly 60% of the customers who buy a dispenser is new to the category.

Tom Harrington: I think it's the number. We can validate that. 45% of them prefer Water Direct. 25% prefer Water Exchange and 30% prefer Water Refill. We get our fair share of that, right, in terms of our market share. We would expect those water dispenser purchases to come into our family of products, brands and products, either in Water Direct, in Water Exchange or in Water Refill. That was really around the water only that I talked about, and that's how we categorize them, and they would be part of our growth story, largely residential. I think I got it.

Jay Wells: You got it.

Tom Harrington: I think I got all three, Andrea, but I'm not sure. Hopefully that helps.

Operator: No, this is super helpful. Yeah, no, absolutely. Just on double-clicking on that, the 1% that you're assuming for residential in 2022, how did that number compare? How much did you grow in volume for residential consumers in 2021 and in 2020? If you can give us that, you know, kind of progression of household penetration and growth in residential.

Andrea Teixeira: No, this is super helpful. Yeah, no, absolutely. Just on double-clicking on that, the 1% that you're assuming for residential in 2022, how did that number compare? How much did you grow in volume for residential consumers in 2021 and in 2020? If you can give us that, you know, kind of progression of household penetration and growth in residential.

Jay Wells: I don't have that number at hand, my apologies. Let me you know, just give you kind of repeat what I said earlier. It might have been missed a little bit. We, you know, we mentioned that our customer base within water is up 2%. We're bringing that tailwind in. You know, Tom's talked about our retention rates improving, our focus on the customer experience, bringing that. You know, that will give us that organic growth. What we see in volume growth is another 1+, maybe getting up to 2%, and that's really being led by residential. That's pretty typical, pretty standard. Let's ignore the unusual fluctuations during a pandemic, but that's normal. What we're not factoring in is much more recovery on the commercial side.

Jay Wells: Not to say that it's not gonna be there, but I'm just not gonna include in my forecast because I'm not gonna forecast COVID recovery anymore. The remaining is really the price increases that we're taking.

Operator: That's perfect. Thank you so much for reiterating that. Appreciate it. Pass it on.

Andrea Teixeira: That's perfect. Thank you so much for reiterating that. Appreciate it. Pass it on.

Tom Harrington: Thank you.

Jay Wells: Thank you.

Operator: Your next question comes from Graham Price with Raymond James. Please go ahead.

Graham Price: Hi.

Tom Harrington: Morning.

Graham Price: Good morning. Thanks for

Tom Harrington: Good morning.

Graham Price: ... for fitting me. You previously gave the color around the revenue outlook for the single-use divestiture asset. Just wanted to double-check that $40 million. Does that assume that the asset would be divested maybe sometime next quarter? Was also wondering on the impact of that divestiture on margins and profitability in your 2022 outlook.

Graham Price: For fitting me. You previously gave the color around the revenue outlook for the single-use divestiture asset. Just wanted to double-check that $40 million. Does that assume that the asset would be divested maybe sometime next quarter? Was also wondering on the impact of that divestiture on margins and profitability in your 2022 outlook.

Tom Harrington: It's our expectation that we will be completely out of this business by the end of Q2. Jay's referenced the numbers that it was $142 million in prior year. We expect roughly $40 million this year, which is an update to Investor Day because we've exited it. It's begun to exit a little bit quicker than we originally expected. On the margin, Jay, we can give some insight earlier.

Jay Wells: No, no. Again, I did add specifically for these types of questions, a slide to our supplemental deck. It's in the appendix, slide 23, and it does show our revenue by quarter last year, minusing out the benefit of this specific. So you can see, you know, it runs, you know, about somewhere in the 30s every quarter to get to the $142. Then how I'm modeling it in my projection. What we've got left, kinda like what I'm doing with the depreciation on these assets. If you see a little spike in depreciation, I'm kinda like just straight lining the $40 million out until the end of Q2. So $20 million this current quarter, $20 million next on top of the growth we'd get off of the net numbers shown on slide 23. Does that make sense?

Graham Price: That does. Thank you for that. Just a quick housekeeping follow-up. Saw a spike in D&A expense for Q4.

Jay Wells: Yep.

Graham Price: And, and-

Jay Wells: I just tried to answer that question as part of the prior answer, 'cause I knew you probably would have that question too. Yeah, what you're really seeing, you know, once we decided to get out of the business by the end of Q2, every asset within this business under the GAAP accounting rules, you accelerate the depreciation and you depreciate or amortize it over the remaining terms. You're seeing the accelerated D&A associated with the business that we're exiting.

Graham Price: Okay. Sure. Understood. Thank you.

Jay Wells: Thank you.

Tom Harrington: Thank you very much.

Operator: There are no further questions at this time. Please proceed.

Jay Wells: This concludes Primo's Q4 results call. Thank you all for attending.

Jon Kathol: This concludes Primo's Q4 results call. Thank you all for attending.

Operator: Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day.

Q4 2021 Primo Water Corporation Earnings Call

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