Primo Water Corporation
Primo Water Corp (Form: 10-Q, Received: 08/09/2017 16:35:48)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10- Q

 

(Mark One)

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2017

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

                                                   

COMMISSION FILE NUMBER 001-34850

PRIMO WATER CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Delaware

30-0278688

 

 

(State of incorporation)

(I.R.S. Employer Identification No.)

 

       
  101 North Cherry Street, Suite 501, Winston-Salem, NC 27101  
  (Address of principal executive office) (Zip code)  

 

(336) 331-4000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☑     No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☑     No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  ☐

Accelerated filer  ☑

 

 

Non-accelerated filer ☐ (Do not check if smaller reporting company) Smaller reporting company  ☐
   

Emerging growth company ☐

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes ☐          No 

 

As of August 4, 2017, there were 29,868,131 shares of our Common Stock, par value $0.001 per share, outstanding.

 

 
 

 

 

PRIMO WATER CORPORATION

FORM 10-Q

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2017

 

INDEX

 

PART 1. Financial Information

Page number

   

Item 1. Financial Statements (Unaudited)

3

   

Condensed Consolidated Balance Sheets

3

   

Condensed Consolidated Statements of Operations

4

   

Condensed Consolidated Statements of Comprehensive Income (Loss)

5

   

Condensed Consolidated Statements of Cash Flows

6

   

Notes to Condensed Consolidated Financial Statements

7

   

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

17

   

Item 3. Quantitative and Qualitative Disclosures About Market Risk

24

   

Item 4. Controls and Procedures

25

   

PART II. Other Information

 
   

Item 1. Legal Proceedings

25

   

Item 1A. Risk Factors

25

   

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

26

   

Item 3. Defaults Upon Senior Securities

26

   

Item 4. Mine Safety Disclosures

26

   

Item 5. Other Information

26

   

Item 6. Exhibits

27

   

Signatures

28

 

 
 

 

 

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

PRIMO WATER CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value information)

 

   

June 30,

   

December 31,

 
   

2017

   

2016

 
   

(unaudited)

         

ASSETS

               

Current assets:

               

Cash and cash equivalents

  $ 4,502     $ 15,586  

Accounts receivable, net

    17,891       14,121  

Inventories

    7,487       6,182  

Prepaid expenses and other current assets

    3,396       3,086  

Total current assets

    33,276       38,975  
                 

Bottles, net

    4,468       4,152  

Property and equipment, net

    104,499       100,331  

Intangible assets, net

    147,075       149,457  

Goodwill

    91,994       91,709  

Investment in Glacier securities ($3,800 available-for-sale, at fair value)

    6,429       6,408  

Other assets

    553       353  

Total assets

  $ 388,294     $ 391,385  
                 

LIABILITIES AND STOCKHOLDERS' EQUITY

               

Current liabilities:

               

Accounts payable

  $ 21,440     $ 13,788  

Accrued expenses and other current liabilities

    14,661       16,922  

Current portion of long-term debt and capital leases

    4,008       2,183  

Total current liabilities

    40,109       32,893  
                 

Long-term debt and capital leases, net of current portion and debt issuance costs

    270,620       270,264  

Deferred tax liability, net

    13,979       13,607  

Warrant liability

          8,180  

Other long-term liabilities

    2,051       2,069  

Total liabilities

    326,759       327,013  
                 

Commitments and contingencies

               
                 

Stockholders’ equity:

               

Preferred stock, $0.001 par value - 10,000 shares authorized, none issued and outstanding

           

Common stock, $0.001 par value - 70,000 shares authorized, 29,845 and 29,305 shares issued and outstanding at June 30, 2017 and December 31, 2016, respectively

    30       29  

Additional paid-in capital

    325,521       325,779  

Common stock warrants

    18,892       7,492  

Accumulated deficit

    (281,731 )     (267,393 )

Accumulated other comprehensive loss

    (1,177 )     (1,535 )

Total stockholders’ equity

    61,535       64,372  

Total liabilities and stockholders’ equity

  $ 388,294     $ 391,385  

 

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 

 
3

 

 

PRIMO WATER CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share amounts)

 

   

Three months ended June 30,

   

Six months ended June 30,

 
   

2017

   

2016

   

2017

   

2016

 
                                 

Net sales

  $ 74,817     $ 34,385     $ 135,554     $ 66,681  

Operating costs and expenses:

                               

Cost of sales

    54,079       23,968       96,892       46,915  

Selling, general and administrative expenses

    8,219       4,778       18,764       9,807  

Non-recurring and acquisition-related costs

    2,977       232       7,425       438  

Depreciation and amortization

    6,820       2,421       13,211       4,829  

(Gain) loss on disposal and impairment of property and equipment

    (11 )     219       (18 )     412  

Total operating costs and expenses

    72,084       31,618       136,274       62,401  

Income (loss) from operations

    2,733       2,767       (720 )     4,280  

Interest expense, net

    5,022       489       10,024       959  

Change in fair value of warrant liability

                3,220        

(Loss) income from continuing operations before income taxes

    (2,289 )     2,278       (13,964 )     3,321  

Provision for income taxes

    186             373        

(Loss) income from continuing operations

    (2,475 )     2,278       (14,337 )     3,321  

Loss from discontinued operations

          (13 )           (25 )

Net (loss) income

  $ (2,475 )   $ 2,265     $ (14,337 )   $ 3,296  
                                 

Basic (loss) earnings per common share:

                               

(Loss) income from continuing operations

  $ (0.07 )   $ 0.08     $ (0.44 )   $ 0.12  

Loss from discontinued operations

                       

Net (loss) income

  $ (0.07 )   $ 0.08     $ (0.44 )   $ 0.12  
                                 

Diluted (loss) earnings per common share:

                               

(Loss) income from continuing operations

  $ (0.07 )   $ 0.08     $ (0.44 )   $ 0.11  

Loss from discontinued operations

                       

Net (loss) income

  $ (0.07 )   $ 0.08     $ (0.44 )   $ 0.11  
                                 

Weighted average shares used in computing (loss) earnings per share:

                               

Basic

    33,463       28,826       32,865       27,644  

Diluted

    33,463       30,101       32,865       29,656  

 

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 

 
4

 

   

PRIMO WATER CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)

(In thousands)

 

   

Three months ended

   

Six months ended

 
   

June 30,

   

June 30,

 
   

2017

   

2016

   

2017

   

2016

 
                                 

Net (loss) income

  $ (2,475 )   $ 2,265     $ (14,337 )   $ 3,296  

Other comprehensive income:

                               

Unrealized (loss) gain on investment in Glacier securities

    (17 )           21        

Foreign currency translation adjustments, net

    247       2       337       187  

Total other comprehensive income

    230       2       358       187  

Comprehensive (loss) income

  $ (2,245 )   $ 2,267     $ (13,979 )   $ 3,483  

   

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 

 
5

 

   

PRIMO WATER CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

   

Six Months Ended June 30,

 
   

2017

   

2016

 

Cash flows from operating activities:

               

Net (loss) income

  $ (14,337 )   $ 3,296  

Less: Loss from discontinued operations

          (25 )

(Loss) income from continuing operations

    (14,337 )     3,321  

Adjustments to reconcile net (loss) income to net cash provided by operating activities:

               

Depreciation and amortization

    13,211       4,829  

(Gain) loss on disposal and impairment of property and equipment

    (18 )     412  

Stock-based compensation expense

    3,678       1,046  

Non-cash interest (income) expense

    (34 )     55  

Change in fair value of warrant liability

    3,220        

Deferred income tax expense

    373        

Realized foreign currency exchange loss (gain) and other, net

    112       (172 )

Changes in operating assets and liabilities:

               

Accounts receivable

    (3,845 )     (4,708 )

Inventories

    (1,301 )     (1,290 )

Prepaid expenses and other assets

    (587 )     (337 )

Accounts payable

    7,686       5,305  

Accrued expenses and other liabilities

    (3,155 )     (675 )

Net cash provided by operating activities

    5,003       7,786  
                 

Cash flows from investing activities:

               

Purchases of property and equipment

    (9,089 )     (5,423 )

Purchases of bottles, net of disposals

    (1,373 )     (1,329 )

Proceeds from the sale of property and equipment

    27       8  

Additions to intangible assets

    (100 )     (36 )

Net cash used in investing activities

    (10,535 )     (6,780 )
                 

Cash flows from financing activities:

               

Borrowings under prior Revolving Credit Facility

          20,900  

Payments under prior Revolving Credit Facility

          (20,900 )

Borrowings under Revolving Credit Facility

    1,000        

Payments under Revolving Credit Facility

    (1,000 )      

Term loan and capital lease payments

    (2,012 )     (143 )

Stock option and employee stock purchase activity and other, net

    (3,290 )     (1,177 )

Debt issuance costs and other

    (249 )      

Net cash used in financing activities

    (5,551 )     (1,320 )
                 

Cash used in operating activities of discontinued operations

          (52 )
                 

Effect of exchange rate changes on cash and cash equivalents

    (1 )     97  

Net decrease in cash and cash equivalents

    (11,084 )     (269 )

Cash and cash equivalents, beginning of year

    15,586       1,826  

Cash and cash equivalents, end of period

  $ 4,502     $ 1,557  

 

The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.

 

 
6

 

 

PRIMO WATER CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(In thousands, except per share amounts)

 

1.

Description of Business and Significant Accounting Policies

 

Business

 

Primo Water Corporation (together with its consolidated subsidiaries, “Primo,” “we,” “our,” “us,” or “the Company”) is North America’s leading single source provider of multi-gallon purified bottled water, self-service refill water and water dispensers sold through major retailers in the United States and Canada.

 

Unaudited Interim Financial Information

 

The accompanying interim condensed consolidated financial statements and notes have been prepared in accordance with our accounting practices described in our audited consolidated financial statements as of and for the year ended December 31, 2016. In the opinion of management, the unaudited interim condensed consolidated financial statements included herein contain all adjustments necessary to present fairly our financial position, results of operations and cash flows for the periods indicated. Such adjustments, other than nonrecurring adjustments that have been separately disclosed, are of a normal, recurring nature. The operating results for interim periods are not necessarily indicative of results to be expected for a full year or future interim periods. The unaudited interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes as of and for the year ended December 31, 2016 as filed on Form 10-K. The accompanying interim condensed consolidated financial statements are presented in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”) and, accordingly, do not include all the disclosures required by generally accepted accounting principles in the United States (“U.S. GAAP”) with respect to annual audited financial statements. Significant accounting policies are summarized in our 2016 Form 10-K.

 

Recent Accounting Pronouncements

 

In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350) Simplifying the Test for Goodwill Impairment . The updated guidance eliminates step two of the goodwill impairment test and specifies that goodwill impairment should be measured by comparing the fair value of a reporting unit with its carrying amount. Additionally, the amount of goodwill allocated to each reporting unit with a zero or negative carrying amount of net assets should be disclosed. The update is effective for annual or interim goodwill impairment tests performed in fiscal years beginning after December 15, 2019; early adoption is permitted. We currently anticipate that adoption of the new standard will not have a material impact to our consolidated financial statements.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) requiring lessees to recognize all leases (with the exception of short-term leases) at the commencement date as: (1) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis, and (2) a right-of-use (“ROU”) asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. The update is effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. We currently anticipate that upon adoption of the new standard, ROU assets and lease liabilities will be recognized in amounts that will be material to the consolidated balance sheets.

 

In September 2015, the FASB issued ASU 2015-16, Simplifying the Accounting for Measurement-Period Adjustments (Topic 805) which eliminates the requirement that an acquirer in a business combination account for measurement-period adjustments retrospectively. Instead, an acquirer will recognize measurement period adjustments during the period in which it determines the amount of the adjustment. The update was effective for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. We adopted the ASU effective January 1, 2017 as there were no measurement period adjustments during fiscal year 2016, and the adoption did not have a material impact on our consolidated financial statements.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers ( Topic 606 ) which supersedes existing revenue recognition requirements in U.S. GAAP. The updated guidance requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, the guidance establishes a five-step approach for the recognition of revenue. In March, April, May and December 2016, the FASB issued further guidance to provide clarity regarding principal versus agent considerations, the identification of performance obligations and certain other matters. The updates are currently effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. We are currently evaluating the provisions of the new standard and its potential impact on the Company’s revenue contracts by comparing our current accounting policies and practices to the requirements of the new standard, and identifying potential differences that would result from applying the new standard to our contracts.

 

 
7

 

 

2.

Glacier Acquisition

 

On December 12, 2016, we completed the acquisition by merger (the “Acquisition”) of Glacier Water Services, Inc. (“Glacier”), the leading provider of high-quality drinking water dispensed to consumers through self-service water machines located at supermarkets and other retail locations. We believe that the Acquisition will diversify our retailer and financial concentration, create operational and shared services synergies and create cross-selling opportunities with retailers and consumers.

 

Aggregate consideration in connection with the Acquisition was $200,220, consisting of a combination of cash, Primo common stock, the retirement or assumption of indebtedness and minority interests, and warrants to purchase shares of Primo common stock as outlined below. We financed the transaction through a combination of cash-on-hand and borrowings under the Goldman Credit Facility (see “Note 3 – Debt and Capital Leases, net of Debt Issuance Costs”). Operations of the acquired entity are included in the condensed consolidated statement of operations from the acquisition date. We incurred fees and expenses related to the Acquisition of $2,037 and $3,865 during the three and six months ended June 30, 2017, respectively, as recorded within non-recurring and acquisition-related costs.

 

A summary of the consideration paid is as follows:

 

Aggregate consideration:

       

Cash consideration

  $ 49,397  

Common stock issued

    36,767  

Warrants issued

    8,420  

Extinguishment of debt

    64,658  

Noncontrolling interest retired

    40,978  

Purchase price

  $ 200,220  

 

During the six months ended June 30, 2017, we obtained additional information regarding the fair value of certain acquired property and equipment, capital leases, and accrued expenses based on facts that existed at the date of acquisition. We have recast the fair value of certain acquired property and equipment, and accrued expenses via a measurement period adjustment as follows:

 

   

Purchase Price

Allocation

   

Measurement

Period

Adjustment

   

Recast

Purchase Price

Allocation

 

Cash acquired

  $ 4,294     $     $ 4,294  

Property and equipment

    65,605       3,916       69,521  

Identifiable intangible assets

    142,330             142,330  

Investments and other assets

    11,765       (340 )     11,425  

Goodwill

    91,822       115       91,937  

Deferred tax liability

    (13,607 )           (13,607 )

Net liabilities assumed

    (101,989 )     (3,691 )     (105,680 )

Aggregate purchase price

  $ 200,220     $     $ 200,220  

 

The estimated fair values are subject to refinement during the measurement period (which is no longer than one year after the closing date of the acquisition), as additional information regarding closing date fair value becomes available. During the measurement period, the causes of any changes in cash flow estimates are considered to determine whether the change results from circumstances that existed at the acquisition date or if the change results from an event that occurred after the date of acquisition. The primary area of the purchase price allocation that is not yet finalized is property and equipment.

 

 
8

 

 

Unaudited pro forma results of operations are presented below for the three and six months ended June 30, 2017 and 2016, assuming that the Acquisition occurred on January 1, 2016. The pro forma information does not necessarily reflect the results of operations that would have occurred had we acquired Glacier at the beginning of 2016 as cost saving synergies are not reflected in the unaudited pro forma amounts.

 

   

Three months ended June 30,

   

Six months ended June 30,

 
   

2017

   

2016

   

2017

   

2016

 

Net sales

  $ 74,817     $ 69,874     $ 135,554     $ 134,053  

Pro forma net (loss) income

  $ (2,475 )   $ 1,023     $ (14,337 )   $ (720 )
                                 

Basic (loss) earnings per common share:

                               

Net (loss) earnings attributable to common shareholders

  $ (0.07 )   $ 0.03     $ (0.44 )   $ (0.02 )
                                 

Diluted (loss) earnings per common share:

                               

Net (loss) earnings attributable to common shareholders

  $ (0.07 )   $ 0.03     $ (0.44 )   $ (0.02 )

 

3.

D ebt and Capital Leases, net of Debt Issuance Costs

 

Debt and capital leases, net of debt issuance costs are summarized as follows:

   

   

June 30,

   

December 31,

 
   

2017

   

2016

 
                 

Term loans

  $ 185,070     $ 186,000  

Debt issuance costs

    (3,401 )     (3,794 )

Total Credit Facilities

    181,669       182,206  

Junior Subordinated Debentures

    89,054       89,529  

Capital leases

    3,905       712  
      274,628       272,447  

Less current portion

    (4,008 )     (2,183 )

Long-term debt and capital leases, net of current portion and debt issuance costs

  $ 270,620     $ 270,264  

 

Goldman Credit Facility

 

On December 12, 2016, we entered into the Goldman Credit Facility that provides for a $186,000 term loan facility (the “Term Loan”) and a $10,000 revolving loan facility (the “Revolving Facility”). The Goldman Credit Facility matures on December 12, 2021. The Term Loan requires annual principal payments (payable in quarterly installments beginning March 31, 2017) equal to 1% per annum, or $1,860, with the remaining indebtedness due at maturity. The Goldman Credit Facility is secured on a first priority basis by substantially all of our assets but no more than 65% of the voting equity of non-U.S. subsidiaries.

 

Interest on outstanding borrowings under the Goldman Credit Facility will be calculated at our option at either a base rate (which may be derived from the federal funds effective rate) or a London Interbank Offered Rate (“LIBOR”), subject to floors of 4.0% for the base rate and 1.0% per annum for LIBOR, respectively, plus, in each case, a margin, initially set at 5.50% per annum with respect to LIBOR loans and 4.50% per annum for base rate loans. Interest rate margins for the loans will step down upon the achievement of consolidated leverage ratios. A commitment fee of 0.50% per annum will be payable quarterly on the average undrawn portion of the Revolving Credit Facility. Total costs associated with the Goldman Credit Facility were $4,291, which have been presented either as a direct deduction from the carrying amount of the debt within long-term debt and capital leases, net of current portion and debt issuance costs, with respect to costs attributable to the Term Loan, or within other assets, with respect to costs attributable to the Revolving Facility. The costs are being amortized as part of interest expense over the term of the Goldman Credit Facility. As of June 30, 2017, we had no outstanding borrowings and our availability was $2,958 under the Revolving Facility.

 

The Goldman Credit Facility contains a number of affirmative and negative covenants that use consolidated adjusted EBITDA (“Adjusted EBITDA”). Adjusted EBITDA is a non-U.S. GAAP financial measure that is calculated as income (loss) from continuing operations before depreciation and amortization; interest expense, net; change in fair value of warrant liability; non-cash stock-based compensation expense; non-recurring and acquisition-related costs; and loss on disposal and impairment of property and equipment and other.

 

 
9

 

 

The primary operational covenants included in the Goldman Credit Facility are as follows: (i) a maximum fixed charge coverage ratio of 1.20:1.00, (ii) a maximum total leverage ratio of 4.25:1.00, declining to 4.00:1.00 on December 31, 2017, and (iii) a minimum consolidated liquidity of $3,500, with the financial ratios to be tested as of the last day of each fiscal quarter and the minimum liquidity to be required at all times. The required financial ratios will step down further to lower levels in future periods as provided in the Goldman Credit Facility. At June 30, 2017 we were in compliance with all operational covenants, including (i) a fixed charge coverage ratio of 1.25:1.00 and (ii) a total leverage ratio of 3.74:1.00.

 

Junior Subordinated Debentures

 

In connection with the Acquisition, we assumed $89,529 of Junior Subordinated Debentures (the “Subordinated Debentures”) issued to Glacier Water Trust I, a wholly owned subsidiary of Primo. Interest on the Subordinated Debentures accrues at an annual rate of 9.0625% payable monthly in arrears. The Subordinated Debentures mature on January 31, 2028 but may be redeemed at our option at any time at 100% of the principal amount plus any accrued but unpaid interest.

 

4.

Glacier Warrants

 

On December 12, 2016, we issued warrants to purchase 2,000 shares of our common stock in connection with the Acquisition (the “Glacier Warrants”). The Glacier Warrants are exercisable as follows: 33% exercisable on and after June 10, 2017, an additional 33% become exercisable on and after September 8, 2017 and the final 34% become exercisable on and after December 12, 2017. The Glacier Warrants are exercisable at an exercise price of $11.88 per share and expire on December 12, 2021.

 

The Glacier Warrants’ fair value at the date of issuance of $8,420 was recorded as a liability on our condensed consolidated balance sheets as part of consideration for the Acquisition.

 

On March 13, 2017, we entered into Amendment No. 1 to the Glacier Warrant Agreement (the “Amendment”). The Amendment provides, among other things, that under no circumstances may a Glacier Warrant holder exercise any Glacier Warrants and receive a cash payment as a net cash settlement. Thus, effective March 13, 2017, the Glacier Warrants were no longer reported as a liability on the condensed consolidated balance sheet with changes in the fair value of the warrant liability reported within the condensed consolidated statements of operations. Instead, the Glacier Warrants were reported as equity instruments on the consolidated statements of stockholders’ equity. The change in the estimated fair value of the warrant liability for the period of January 1, 2017 through March 13, 2017 resulted in non-cash expense of $3,220 as presented on the condensed consolidated statements of operations for the six months ended June 30, 2017. The Glacier Warrants’ estimated fair value as recorded on our condensed consolidated balance sheet was $0 and $8,180 as of June 30, 2017 and December 31, 2016, respectively.

 

The estimated fair value of these Warrants was determined using Level 3 inputs and assumptions within the Black- Scholes pricing model. The key assumptions used in the Black-Scholes model were as follows:

 

   

March 13,

2017

   

December 31,

2016

 

Expected life in years

    4.75       4.95  

Risk-free interest rate

    2.08 %     1.92 %

Expected volatility

    33.0 %     33.0 %

Dividend yield

    0.0 %     0.0 %

 

The risk-free interest rate was based on the U.S. Treasury rate for the expected remaining life of common stock warrants. Our expected volatility was based on the average long-term historical volatilities of peer companies. The dividend yield assumption was based on our current intent not to issue dividends.

 

 
10

 

 

5.

Stock-Based Compensation

 

Overview

 

Total non-cash stock-based compensation expense by award type for all of our plans, all of which is included in selling, general and administrative expenses on our condensed consolidated statements of operations, was as follows:

 

   

Three months ended June 30,

   

Six months ended June 30,

 
   

2017

   

2016

   

2017

   

2016

 

Stock options

  $ 145     $ 182     $ 299     $ 329  

Restricted stock

    861       289       1,448       434  

Value Creation Plan

                1,482       254  

Long-Term Performance Plan

    301             401        

Employee Stock Purchase Plan

    35       15       48       29  
    $ 1,342     $ 486     $ 3,678     $ 1,046  

 

Value Creation Plan

 

On May 7, 2012, we established the Value Creation Plan (the “VCP”), which was subsequently amended on May 14, 2013 and amended and restated on March 3, 2016. The VCP provided awards comprised of cash or equity grants for eligible employees as determined by the Compensation Committee, based on the attainment of certain performance-based targets. The VCP provided for the issuance of up to three separate awards to eligible employees based on our attainment of financial targets of at least $15,000, $24,000 and $28,000 in Adjusted EBITDA for any fiscal year between 2014 and 2019. On December 22, 2016, the Compensation Committee of our Board of Directors approved the termination of the VCP, effective December 31, 2016, eliminating the third award related to the $28,000 Adjusted EBITDA target.

 

The award pool for the second issuance based on the achievement of the $24,000 Adjusted EBITDA target equaled 17.5% of the market capital appreciation of our stock from March 11, 2016 to March 20, 2017, the market close on the third full trading day after public announcement of financial results for 2016. On March 20, 2017, 1,370 shares were issued or deferred into the Primo Water Corporation Executive Deferred Compensation Plan (the “Deferred Compensation Plan”) as a result of the achievement of the $24,000 Adjusted EBITDA target. The deferral of certain shares did not alter the existing vesting conditions, number of awards vested or the form of the awards issued under the VCP.

 

Long-Term Performance Plan

 

On February 28, 2017, we established the Long-Term Performance Plan (the “LTPP”). The LTPP provides equity grants for eligible employees based on the attainment of certain performance-based targets. Our intention is that all awards under the LTPP will be in the form of equity grants. The LTPP provides for the issuance of awards based on our attainment of financial targets for the period of January 1, 2017 through December 31, 2019. Awards earned vary based on achievement of the established financial targets of Adjusted EBITDA and free cash flow on a cumulative basis for fiscal years 2017 through 2019.

 

 
11

 

 

6.

Commitments and Contingencies

 

Omnifrio Single-Serve Beverage Business

 

Deferred purchase price payments totaling $1,901 were included within accrued expenses and other current liabilities on the condensed consolidated balance sheets as of December 31, 2016. These payments were related to the April 11, 2011 acquisition of certain intellectual property and other assets from the seller, Omnifrio Beverage Company LLC (“Omnifrio”).

 

On March 31, 2017, we entered into a settlement and release agreement with Omnifrio in which we agreed to a cash payment of $710 to Omnifrio and to transfer all intellectual property and other assets purchased from Omnifrio in April 2011 back to Omnifrio. The settlement resulted in a gain of $1,191, reported within non-recurring and acquisition-related costs on the condensed consolidated statement of operations for the six months ended June 30, 2017.  

 

Texas Regional Operator Litigation/Arbitration

 

On August 8, 2014, a lawsuit was commenced against us by our regional operators Artesia Springs, LLC, HOD Enterprises, L.P., and BBB Water, Inc. (the “ROs”) in the State of Texas. DS Services of America, Inc. was also named as a defendant in the lawsuit. The claims alleged against us in the lawsuit were breach of contract, conspiracy and fraud, and the ROs sought unspecified monetary damages as well as injunctive relief. On April 10, 2015, the ROs initiated an arbitration proceeding with the American Arbitration Association (the “AAA”). We resolved the claims asserted by BBB Water, Inc. as of December 31, 2015, and BBB Water, Inc. is no longer a party to the arbitration proceedings.

 

We entered into a settlement and mutual release agreement with Artesia Springs, LLC and HOD Enterprises, L.P. on April 5, 2017, pursuant to which we agreed to make payments including interest in April, July and October 2017 totaling $3,783. A liability of $2,467 is included within accrued expenses and other liabilities on the condensed consolidated balance sheet as of June 30, 2017. The settlement resulted in other expense $3,701, reported within non-recurring and acquisition-related costs on the condensed consolidated statement of operations for the six months ended June 30, 2017. The settlement also resulted in interest expense of $61 for the three and six months ended June 30, 2017.

 

Prism Arbitration

 

On August 5, 2014, Primo Distribution, LLC (also known as Prism Distribution) initiated an arbitration proceeding against us, claiming less than $1,000 in damages for alleged breach of contract.  The arbitration was filed with the AAA, and was amended on December 19, 2014 to include additional claims for conversion, unfair and deceptive trade practices, fraud, and unjust enrichment. 

 

On July 24, 2017, we entered into a settlement and mutual release agreement with Prism Distribution pursuant to which we agreed to make a payment to Prism of $825. A liability of $825 was recorded within accrued expenses and other liabilities on the condensed consolidated balance sheet as of June 30, 2017. The settlement resulted in expense of $825, reported within non-recurring and acquisition-related costs on the condensed consolidated statement of operations for the three and six months ended June 30, 2017.

 

Sales Tax

 

We routinely purchase equipment for use in operations from various vendors.  These purchases are subject to sales tax depending on the equipment type and local sales tax regulations; however, we believe certain vendors have not assessed the appropriate sales tax.  For purchases that are subject to sales tax in which we believe the vendor did not assess the appropriate amount, we accrue an estimate of the sales tax liability we ultimately expect to pay.

 

Other Contingencies

 

From time to time, we are involved in various claims and legal actions that arise in the normal course of business. Management believes that the outcome of such claims and legal actions will not have a significant adverse effect on our financial position, results of operations or cash flows.

 

 
12

 

 

7.

Income Taxes

 

We have established a full valuation allowance to offset the net deferred tax assets that are not expected to be realized. For the three months ended June 30, 2017 and 2016, there was $186 and $0 income tax expense recognized, respectively, and for the six months ended June 30, 2017 and 2016, there was $373 and $0 income tax expense recognized respectively, related to goodwill and intangibles.

 

Section 382 of the U.S. Internal Revenue Code imposes an annual limitation on the amount of net operating loss carryforwards that might be used to offset taxable income when a corporation has undergone significant changes in stock ownership. We believe our prior ownership changes have created an annual limit, imposed by Section 382, on the amount of net operating loss we can utilize in a given year. Realization of the loss carryforwards is dependent upon generating sufficient taxable income prior to the expiration of the loss carryforwards, subject to the Section 382 limitation.

 

8.

Fair Value Measurements

 

Fair value rules currently apply to all financial assets and liabilities and for certain nonfinancial assets and liabilities that are required to be recognized or disclosed at fair value. For this purpose, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs.

 

U.S. GAAP establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include:

 

 

Level 1 — quoted prices in active markets for identical assets and liabilities.

 

 

Level 2 — observable inputs other than quoted prices in active markets for identical assets and liabilities.

 

 

Level 3 — unobservable inputs in which there is little or no market data available, which require the reporting entity to develop its own assumptions.

 

At June 30, 2017 and December 31, 2016, we held financial assets and liabilities that are required to be measured at fair value on a recurring basis. The financial assets and liabilities held by the Company and the fair value hierarchy used to determine their fair values are as follows:

 

   

June 30, 2017

Fair Value

   

Level 1

   

Level 2

   

Level 3

 

Assets:

                               
Investment in money market funds (1)   $ 1     $ 1     $     $  

Investment in Glacier securities

  $ 3,800     $     $ 3,800     $  

Total assets

  $ 3,800     $     $ 3,800     $  

Liabilities:

                               

Contingent consideration

  $ 1,486     $     $     $ 1,486  

Total liabilities

  $ 1,486     $     $     $ 1,486  

 

   

December 31, 2016

Fair Value

   

Level 1

   

Level 2

   

Level 3

 

Assets:

                               

Investment in money market funds (1)

  $ 675     $ 675     $     $  

Investment in Glacier securities

    3,779             3,779        

Total assets

  $ 4,454     $ 675     $ 3,779     $  

Liabilities:

                               

Warrant liability

  $ 8,180     $     $     $ 8,180  

Contingent consideration

    1,513                   1,513  

Total liabilities

  $ 9,693     $     $     $ 9,693  

   

 

(1)

Included in cash and cash equivalents in accompanying condensed consolidated balance sheets.

 

 
13

 

   

The carrying amounts of cash and cash equivalents, accounts receivable, net, accounts payable, and accrued expenses and other current liabilities, approximate their fair values due to their short maturities.  Liabilities of the Disposal Group classified as held for sale and reported within accrued expenses and other current liabilities, and other long-term liabilities on our condensed consolidated balance sheets are presented at their carrying value, which approximates their fair value.  Based on borrowing rates currently available to us for loans with similar terms, the variable interest rate for borrowings under our Goldman Credit Facility and the fact that the Junior Subordinated Debentures were recorded at fair value at the time of the Acquisition, the carrying value of debt and capital leases approximates fair value.

 

The following table provides a rollforward of the Company’s Level 3 fair value measurements:

 

   

Warrant

Liability

   

Contingent

Consideration

 

Balance at December 31, 2016

  $ 8,180     $ 1,513  

Change in fair value

    3,220       (27 )

Reclass Glacier warrant to equity

    (11,400 )      

Balance at June 30, 2017

  $     $ 1,486  

 

9.

Earnings Per Share

 

The following table sets forth the calculations of basic and diluted earnings per share:

 

   

Three months ended

June 30,

   

Six months ended

June 30,

 
   

2017

   

2016

   

2017

   

2016

 

Basic:

                               

(Loss) income from continuing operations

  $ (2,475 )   $ 2,278     $ (14,337 )   $ 3,321  

Loss from discontinued operations

          (13 )           (25 )

Net (loss) income

  $ (2,475 )   $ 2,265     $ (14,337 )   $ 3,296  
                                 

Weighted average shares

    33,463       28,826       32,865       27,644  
                                 

Basic (loss) earnings per share from continuing operations

  $ (0.07 )   $ 0.08     $ (0.44 )   $ 0.12  

Basic loss per share from discontinued operations

                       

Basic (loss) earnings per share

  $ (0.07 )   $ 0.08     $ (0.44 )   $ 0.12  
                                 

Diluted:

                               

(Loss) income from continuing operations

  $ (2,475 )   $ 2,278     $ (14,337 )   $ 3,321  

Loss from discontinued operations

          (13 )           (25 )

Net (loss) income

  $ (2,475 )   $ 2,265     $ (14,337 )   $ 3,296  
                                 

Weighted average shares

    33,463       28,826       32,865       27,644  

Potential shares arising from stock options, restricted stock, warrants and contingently issuable shares under the VCP

          1,275             2,012  

Weighted average shares - diluted

    33,463       30,101       32,865       29,656  
                                 

Diluted (loss) earnings per share from continuing operations

  $ (0.07 )   $ 0.08     $ (0.44 )   $ 0.11  

Diluted loss per share from discontinued operations

                       

Diluted (loss) earnings per share

  $ (0.07 )   $ 0.08     $ (0.44 )   $ 0.11  

 

For the three and six months ended June 30, 2017, stock options, warrants and unvested shares of restricted stock with respect to an aggregate of 1,236 and 1,417 shares, respectively, were excluded from the computation of the number of shares used in the diluted (loss) earnings per share. These shares have been excluded because we incurred a net loss for the respective periods and their inclusion would be anti-dilutive.

 

For the three and six months ended June 30, 2016, stock options, warrants and unvested shares of restricted stock with respect to an aggregate of 685 and 893 shares, respectively, have been excluded from the computation of the number of shares used in the diluted earnings per share because the exercise or grant prices of the awards were greater than the average market price of the underlying common stock and the effect of their inclusion would have been anti-dilutive.

 

 
14

 

 

For the six months ended June 30, 2016, contingently issuable shares related to the first award under the VCP were included in the computation of the number of shares used in the diluted earnings per share through the March 11, 2016 issuance or deferral into the Deferred Compensation Plan. Subsequent to March 11, 2016, such shares were used in the computation of the number of shares used in basic earnings per share.

 

10.

Segments

 

We have three operating segments and three reportable segments: Primo Refill (“Refill”), Primo Exchange (“Exchange”) and Primo Dispensers (“Dispensers”).

 

Our Refill segment sales consists of the sale of filtered drinking water dispensed directly to consumers through technologically advanced, self-service machines located at major retailers throughout the United States and Canada.

 

Our Exchange segment sales consist of the sale of multi-gallon purified bottled water offered through retailers in the United States and Canada. Our Exchange products are offered through point of purchase display racks and recycling centers that are prominently located at major retailers in space that is often underutilized.

 

Our Dispensers segment sells water dispensers that are designed to dispense Primo and other dispenser-compatible bottled water. Our Dispensers sales are primarily generated through major U.S. retailers, where we recognize revenues for the sale of the water dispensers when title is transferred. We support retail sell-through with domestic inventory.

 

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 Refill consists primarily of costs associated with routine maintenance of reverse osmosis water filtration systems and filtered water displays as well as costs associated with obtaining meter readings to determine water usage, and collecting coins from our coin-operated machines. Cost of sales for Exchange consists primarily of costs for bottling, distribution and bottles. Cost of sales for Dispensers consists of contract manufacturing, freight and duties.

 

Selling, general and administrative expenses for Refill, Exchange, and Dispensers consist primarily of personnel costs for operations support as well as other supporting costs for operating each segment.

 

Expenses not specifically related to operating segments are shown separately as Corporate. Corporate expenses are comprised mainly of compensation and other related expenses for corporate support, information systems and administration. Corporate expenses also include certain professional fees and expenses and compensation of our Board of Directors.

 

Effective May 31, 2017 Billy D. Prim transitioned from his position as Chief Executive Officer to the Executive Chairman of the Board of Directors. At that time, Matthew T. Sheehan, President and Chief Operating Officer, assumed the role of Chief Executive Officer. Following this change, we determined that we now have three reportable segments, Refill, Exchange, and Dispensers. These segments are reflective of how the Company’s Chief Operating Decision Maker (“CODM”) reviews operating results for the purposes of allocating resources and assessing performance. Prior periods have been recast to reflect the change in reportable segments.

 

 
15

 

 

The following table presents segment information for the following periods:

 

   

Three months ended June 30,

   

Six months ended June 30,

 
   

2017

   

2016

   

2017

   

2016

 

Segment net sales:

                               

Refill

  $ 44,163     $ 6,748     $ 80,528     $ 13,157  

Exchange

    18,121       17,533       34,866       33,502  

Dispensers

    12,533       10,104       20,160       20,022  
    $ 74,817     $ 34,385     $ 135,554     $ 66,681  
                                 

Segment (loss) income from operations:

                               

Refill

  $ 11,497     $ 3,311     $ 20,206     $ 6,317  

Exchange

    5,381       5,404       10,533       10,128  

Dispensers

    1,108       785       1,686       1,483  

Corporate

    (5,467 )     (3,861 )     (12,527 )     (7,969 )

Non-recurring and acquisition-related costs

    (2,977 )     (232 )     (7,425 )     (438 )

Depreciation and amortization

    (6,820 )     (2,421 )     (13,211 )     (4,829 )

Gain (loss) on disposal and impairment of property and equipment

    11       (219 )     18       (412 )
    $ 2,733     $ 2,767     $ (720 )   $ 4,280  
                                 

Depreciation and amortization expense:

                               

Refill

  $ 5,444     $ 1,077     $ 10,456     $ 2,134  

Exchange

    1,232       1,211       2,437       2,437  

Dispensers

    47       39       92       78  

Corporate

    97       94       226       180  
    $ 6,820     $ 2,421     $ 13,211     $ 4,829  
                                 

Capital expenditures:

                               

Refill

                  $ 8,167     $ 4,617  

Exchange

                    1,697       1,894  

Dispensers

                    57         

Corporate

                    541       241  
                    $ 10,462     $ 6,752  

 

Identifiable assets:                  

June 30,

2017

   

December 31,

2016

 

Refill

                  $ 345,711     $ 344,796  

Exchange

                    23,835       19,669  

Dispensers

                    12,636       11,202  

Corporate

                    6,112       15,718  
                    $ 388,294     $ 391,385  

 

As of June 30, 2017 we had goodwill of $91,994 as a result of the Acquisition. All goodwill is reported within our Refill segment.

 

 
16

 

 

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 A nnual Report on Form 10-K for the year ended December 31, 2016 . This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and S ection 21E of the Securities Exchange Act of 1934, as amended, that are intended to be covered by the “safe harbor” created by those sections. Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, can generally be identified by the use of forward-looking terms such as “believe,” “expect,” “may,” “will,” “should,” “could,” “seek,” “intend,” “plan,” “estimate,” “anticipate” or other comparable terms. These forward-looking statements are subject to uncertainty and changes in circumstances. Actual results may differ materially from these expectations due to inaccurate assumptions and known or unknown risks and uncertainties, including those identified in “Cautionary Note Regarding Forward-Looking Statements” in this Item 2 and in “Risk Factors” in Item 1A of Part I of our Annual Report on Form 10-K for the year ended December 31, 2016. We urge you to consider those risks and uncertainties in evaluating our forward-looking statements. We caution readers not to place undue reliance upon any such forward-looking statements, which speak only as of the date made. Except as otherwise required by the federal securities laws, we disclaim any obligation or undertaking to publicly release any updates or revisions to any forward-looking statement contained herein (or elsewhere) to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

 

Overview

 

Primo Water Corporation (together with its consolidated subsidiaries, “Primo,” “we,” “our,” or “us,” or “the Company”) is North America’s leading single source provider of multi-gallon purified bottled water, self-service refill water and water dispensers sold through major retailers in the United States and Canada.  We believe the market for purified water continues to grow due to evolving taste preferences, perceived health benefits and concerns regarding the quality of municipal tap water. Our products provide an environmentally friendly, economical, convenient and healthy solution for consuming purified and filtered water.  We are a Delaware corporation that was founded in 2004 and is headquartered in Winston-Salem, North Carolina.

 

On December 12, 2016, we completed the acquisition by merger (the “Acquisition”) of Glacier Water Services, Inc. (“Glacier”), the leading provider of high-quality drinking water dispensed to consumers through self-service water machines located at supermarkets and other retail locations. The Acquisition was consummated pursuant to the terms of the Agreement and Plan of Merger (the “Merger Agreement”), dated October 9, 2016. Aggregate consideration was approximately $200.2 million consisting of cash, Primo common stock and warrants, plus the assumption of approximately $78.8 million of debt, net of cash. The Acquisition diversifies retailer concentration and offers cross-selling opportunities, while creating operational and shared service synergies. We financed the transaction through a combination of cash-on-hand and borrowings under the $196.0 million credit agreement with Goldman Sachs Bank USA (the “Goldman Credit Facility”).

 

Our business is designed to generate recurring demand for our purified bottled water or self-service 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. 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-service filtered drinking water location (“Refill”). Each of our multi-gallon Exchange water bottles can be sanitized and reused up to 40 times before being taken out of use, crushed and recycled, substantially reducing landfill waste compared to consumption of equivalent volumes of single-serve bottled water. As of June 30, 2017, our products were offered in the United States and in Canada at over 46,000 combined retail locations, including Lowe’s Home Improvement, Walmart, The Home Depot, Meijer, Kroger, Food Lion, H-E-B Grocery, Sobeys, Circle K, Family Dollar, Walgreens, Albertsons, Publix, and CVS. We believe the market for purified water continues to grow due to evolving taste preferences, perceived health benefits and concerns regarding the quality of municipal tap water. Our products provide an environmentally friendly, economical, convenient and healthy solution for consuming purified and filtered water.

 

 
17

 

 

We provide major retailers throughout the United States and Canada with a single-vendor solution for our three reporting segments, Refill, Exchange, and Dispensers, 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. Exchange offers retailers attractive financial margins and the ability to optimize typically unused retail space with our displays.  Refill provides filtered water for consumer purchase through the installation of self-service vending displays at retail locations. The Refill business model eliminates the bottling and distribution infrastructure required to deliver traditional bottled water, thereby allowing us to provide filtered water at a value price. Additionally, due to the recurring nature of water consumption, retailers benefit from year-round customer traffic and highly predictable revenue. We believe the Acquisition will help us build out and expand our Refill operations in particular, given Glacier’s extensive Refill network.

 

Business Segments

 

We have three operating segments and three reportable segments: Refill, Exchange, and Dispensers.

 

Our Refill segment sales consists of the sale of filtered drinking water dispensed directly to consumers through technologically advanced, self-service machines located at major retailers throughout the United States and Canada.

 

Our Exchange segment sales consist of the sale of multi-gallon purified bottled water offered through retailers in the United States and Canada. Our Exchange products are offered through point of purchase display racks and recycling centers that are prominently located at major retailers in space that is often underutilized.

 

Our Dispensers segment sells water dispensers that are designed to dispense Primo and other dispenser-compatible bottled water. Our Dispensers sales are primarily generated through major retailers in the U.S. and Canada, where we recognize revenues for the sale of the water dispensers when title is transferred. We support retail sell-through with domestic inventory.

 

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 Exchange consists primarily of costs for bottling, distribution and bottles. Cost of sales for Refill consists primarily of costs associated with routine maintenance of reverse osmosis water filtration systems and filtered water displays, as well as costs associated with obtaining meter readings to determine water usage and collecting coins from our coin-operated machines. Cost of sales for Dispensers consists of contract manufacturing, freight and duties.

 

Selling, general and administrative expenses for Refill, Exchange, and Dispensers consist primarily of personnel costs for operations support as well as other supporting costs for operating each segment.

 

Expenses not specifically related to operating segments are shown separately as Corporate. Corporate expenses are comprised mainly of compensation and other related expenses for corporate support, information systems and administration. Corporate expenses also include certain professional fees and expenses and compensation of our Board of Directors.

 

In this Management’s Discussion and Analysis of Financial Condition and Results of Operations, when we refer to “same-store unit growth”, we are comparing retail locations at which our products have been available for at least 12 months at the beginning of the relevant period. In addition, “gross margin percentage” is defined as net sales less cost of sales, as a percentage of net sales.

 

 
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Results of Operations  

 

The following table sets forth our results of operations (dollars in thousands):

 

   

Three months ended June 30,

   

Six months ended June 30,

 
   

2017

   

2016

   

2017

   

2016

 

Consolidated statements of operations data:

                               

Net sales

  $ 74,817     $ 34,385     $ 135,554     $ 66,681  

Operating costs and expenses:

                               

Cost of sales

    54,079       23,968       96,892       46,915  

Selling, general and administrative expenses

    8,219       4,778       18,764       9,807  

Non-recurring and acquisition-related costs

    2,977       232       7,425       438  

Depreciation and amortization

    6,820       2,421       13,211       4,829  

(Gain) loss on disposal and impairment of property and equipment

    (11 )     219       (18 )     412  

Total operating costs and expenses

    72,084       31,618       136,274       62,401  

Income (loss) from operations

    2,733       2,767       (720 )     4,280  

Interest expense, net

    5,022       489       10,024       959  

Change in fair value of warrant liability

                3,220        

(Loss) income from continuing operations before income taxes

    (2,289 )     2,278       (13,964 )     3,321  

Provision for income taxes

    186             373        

(Loss) income from continuing operations

    (2,475 )     2,278       (14,337 )     3,321  

Loss from discontinued operations

          (13 )     -       (25 )

Net (loss) income

  $ (2,475 )   $ 2,265     $ (14,337 )   $ 3,296  

 

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

   

   

Three months ended June 30,

   

Six months ended June 30,

 
   

2017

   

2016

   

2017

   

2016

 

Consolidated statements of operations data:

                               

Net sales

    100.0 %     100.0 %     100.0 %     100.0 %

Operating costs and expenses:

                               

Cost of sales

    72.3       69.7       71.5       70.4  

Selling, general and administrative expenses

    11.0       13.9       13.8       14.7  

Non-recurring and acquisition-related costs

    4.0       0.7       5.5       0.7  

Depreciation and amortization

    9.1       7.1       9.7       7.2  

(Gain) loss on disposal and impairment of property and equipment

          0.6             0.6  

Total operating costs and expenses

    96.4       92.0       100.5       93.6  

Income (loss) from operations

    3.6       8.0       (0.5 )     6.4  

Interest expense, net

    6.7       1.4       7.4       1.4  

Change in fair value of warrant liability

                2.4        

(Loss) income from continuing operations

    (3.1 )     6.6       (10.3 )     5.0  

Provision for income taxes

    0.2             0.3        

(Loss) income from continuing operations

    (3.3 )     6.6       (10.6 )     5.0  

Loss from discontinued operations

                      (0.1 )

Net (loss) income

    (3.3 )%     6.6 %     (10.6 )%     4.9 %

 

 
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The following table sets forth our segment net sales and segment income from operations presented on a segment basis and reconciled to our consolidated income from operations (dollars in thousands):

 

   

Three months ended June 30,

   

Six months ended June 30,

 
   

2017

   

2016

   

2017

   

2016

 

Segment net sales

                               

Refill

  $ 44,163     $ 6,748     $ 80,528     $ 13,157  

Exchange

    18,121       17,533       34,866       33,502  

Dispensers

    12,533       10,104       20,160       20,022  

Total net sales

  $ 74,817     $ 34,385     $ 135,554     $ 66,681  
                                 

Segment income (loss) from operations

                               

Refill

  $ 11,497     $ 3,311     $ 20,206     $ 6,317  

Exchange

    5,381       5,404       10,533       10,128  

Dispensers

    1,108       785       1,686       1,483  

Corporate

    (5,467 )     (3,861 )     (12,527 )     (7,969 )

Non-recurring and acquisition-related costs

    (2,977 )     (232 )     (7,425 )     (438 )

Depreciation and amortization

    (6,820 )     (2,421 )     (13,211 )     (4,829 )

Gain (loss) on disposal and impairment of property and equipment

    11       (219 )     18       (412 )
    $ 2,733     $ 2,767     $ (720 )   $ 4,280  

 

Three Months Ended June 30, 2017 Compared to Three Months Ended June 30, 2016

 

Net Sales . Net sales increased 117.6%, or $40.4 million, to $74.8 million for the three months ended June 30, 2017 from $34.4 million for the three months ended June 30, 2016. The change was due to increases in sales for Refill, Exchange, and Dispensers of $37.4 million, $0.6 million, and $2.4 million, respectively.

 

Refill. Refill net sales increased over six-fold to $44.2 million, representing 59.0% of our total net sales for the three months ended June 30, 2017. The increase in Refill net sales was primarily due to the Acquisition.

 

Exchange. Exchange net sales increased 3.4% to $18.1 million, representing 24.2% of our total net sales for the three months ended June 30, 2017. The Exchange sales were driven by U.S. same-store unit growth of approximately 6.2% for the three months ended June 30, 2017. Overall, five-gallon equivalent units for Exchange increased to 3.7 million units for the three months ended June 30, 2017 from 3.5 million units for the same period of the prior year.        

 

Dispensers. Dispensers net sales increased 24.0% to $12.5 million, representing 16.8% of our total net sales for the three months ended June 30, 2017. The increase in Dispensers net sales was due primarily to increased consumer demand and the timing of orders by major retail customers compared to the prior year. Consumer demand, which we measure as the dispenser unit sales by our retail customers to consumers, was a record 169,000.

 

Gross Margin Percentage. The overall gross margin percentage was 27.7% for the three months ended June 30, 2017 compared to 30.3% for the same period of the prior year primarily due to the Acquisition as well as an increase in lower margin Dispenser sales.

 

Refill . Gross margin as a percentage of net sales for our Refill segment was 30.2% for the three months ended June 30, 2017 compared to 53.5% for the three months ended June 30, 2016 due to the impact of the Acquisition. With revenue reported as the amount charged to end consumers, primarily through coin-operated machines, and cost of goods sold including a commission paid to retailers, the historical Glacier refill business had a lower gross margin percentage than historical Primo refill business.

 

Exchange. Gross margin as a percentage of net sales for our Exchange segment was 32.3% for the three months ended June 30, 2017 compared to 33.0% for the three months ended June 30, 2016. The change was primarily due to changes in product and customer mix.

 

Dispensers. Gross margin as a percentage of net sales for our Dispensers segment increased to 12.2% for the three months ended June 30, 2017 from 10.1% for the three months ended June 30, 2016. The increase in gross margin percentage was primarily due to a favorable change in sales mix towards higher-margin products and improved supply chain costs.

 

 
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Selling, General and Administrative Expenses (“SG&A”). SG&A increased to $8.2 million for the three months ended June 30, 2017 from $4.8 million for the three months ended June 30, 2016. As a percentage of net sales, SG&A decreased to 11.0% for the three months ended June 30, 2017 from 13.9% for the three months ended June 30, 2016. The increase in SG&A expense was driven by an increase in employee-related expenses of $0.8 million, as well as an increase in water quality, tax compliance, insurance, and rent expense of $1.0 million primarily related to the Acquisition. The increase was also attributable to the $0.9 million increase in non-cash stock-based compensation expense (see “Note 5 - Stock-Based Compensation” in the Notes to the Condensed Consolidated Financial Statements).

 

Non-recurring and acquisition-related costs . Non-recurring and acquisition-related costs were $3.0 million for the three months ended June 30, 2017 compared to $0.2 million for the same period in 2016. The increase was due to costs associated with the Acquisition which totaled $2.1 million for the three months ended June 30, 2017 (see “Note 2 – Glacier Acquisition” in the Notes to Condensed Consolidated Financial Statements), and the settlement amount of $0.9 million related to the settlement  with Prism Distribution (see “Note 6 – Commitments and Contingencies” in the Notes to Condensed Consolidated Financial Statements).

 

Depreciation and Amortization. Depreciation and amortization increased to $6.8 million for the three months ended June 30, 2017 from $2.4 million for the three months ended June 30, 2016. The increase was primarily due to property and equipment, and intangibles acquired in connection with the Acquisition.

 

Interest Expense, net.  Interest expense increased to $5.0 million for the three months ended June 30, 2017 from $0.5 million for the three months ended June 30, 2016. The increase was primarily due to increased debt levels related to the Goldman Credit Facility and the Subordinated Debentures assumed in connection of the Acquisition (see “Note 3 - Debt and Capital Leases, net of Debt Issuance Costs” in the Notes to the Condensed Consolidated Financial Statements).

 

Six Months Ended June 30, 2017 Compared to Six Months Ended June 30, 2016

 

Net Sales . Net sales increased 103.3%, or $68.9 million, to $135.6 million for the six months ended June 30, 2017 from $66.7 million for the six months ended June 30, 2016. The change was due to increases in sales for Refill, Exchange, and Dispensers of $67.4 million, $1.4 million, and $0.1 million, respectively.

 

Refill. Refill net sales increased over six-fold to $80.5 million, representing 59.4% of our total net sales for the six months ended June 30, 2017. The increase in Refill net sales was primarily due to the Acquisition.

 

Exchange. Exchange net sales increased 4.1% to $34.9 million, representing 25.7% of our total net sales for the six months ended June 30, 2017. The Exchange sales were driven by U.S. same-store unit growth of approximately 6.2% for the six months ended June 30, 2017. Overall, five-gallon equivalent units for Exchange increased to 7.1 million units for the six months ended June 30, 2017 from 6.6 million units for the same period of the prior year.        

 

Dispensers. Dispensers net sales increased 0.7% to $20.2 million, representing 14.9% of our total net sales for the six months ended June 30, 2017. The increase in Dispensers net sales was primarily due to the timing of orders from major retailers compared to the prior year. Consumer demand, which we measure as the dispenser unit sales by our retail customers to consumers, was a record 312,000 for the six months ended June 30, 2017 . Our dispenser unit sales to retailers increased by 6.1% for the six months ended June 30, 2017 compared to the same period in 2016. The increase in sales units was greater than the increase in sales dollars primarily due to a shift in customer and item mix.

 

Gross Margin Percentage. The overall gross margin percentage was 28.5% for the six months ended June 30, 2017 compared to 29.6% for the six months ended June 30, 2016 due to the Acquisition.

 

Refill. Gross margin as a percentage of net sales for our Refill segment was 30.8% for the six months ended June 30, 2017 compared to 52.8% for the six months ended June 30, 2016 due to the impact of the Acquisition. With revenue reported as the amount charged to end consumers, primarily through coin-operated machines, and cost of goods sold including a commission paid to retailers, the historical Glacier refill business has a lower gross margin percentage than the historical Primo refill business.

 

Exchange. Gross margin as a percentage of net sales for our Exchange segment was 32.8% for the six months ended June 30, 2017, compared to 32.3% for the six months ended June 30, 2016.

 

 
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Dispensers. Gross margin as a percentage of net sales for our Dispensers segment increased to 11.9% for the six months ended June 30, 2017 from 10.0% for the six months ended June 30, 2016. The increase in gross margin percentage was primarily due to a favorable change in sales mix towards higher-margin products and improved supply chain costs.

 

Selling, General and Administrative Expenses (“SG&A”). SG&A increased 91.3% to $18.8 million for the six months ended June 30, 2017 from $9.8 million for the six months ended June 30, 2016. As a percentage of net sales, SG&A decreased to 13.8% for the six months ended June 30, 2017 from 14.7% for the six months ended June 30, 2016. The increase in SG&A expense was driven by an increase in employee-related expenses of $2.9 million, as well as an increase in water quality, tax compliance, insurance, and rent expense of $1.9 million primarily related to the Acquisition. The increase was also attributable to the $2.6 million increase in non-cash stock-based compensation expense, which was primarily related to the $1.2 million increase for performance-based awards granted under the VCP that were contingent on achieving certain financial targets (see “Note 5 - Stock-Based Compensation” in the Notes to the Condensed Consolidated Financial Statements).

 

Non-Recurring Costs. Non-recurring costs were $7.4 million for the six months ended June 30, 2017 compared to $0.4 million for the same period in 2016. The increase was primarily due to settlement payments and legal expenses totaling $4.6 million associated with former Texas Regional Distributors and Prism Distribution, and costs associated with the Acquisition totaling $3.9 million for the six months ended June 30, 2017 (see “Note 2 – Glacier Acquisition” in the Notes to Condensed Consolidated Financial Statements). These costs were partially offset by a settlement reached with Omnifrio resulting in a $1.2 million gain (see “Note 6 – Commitments and Contingencies” in the Notes to Condensed Consolidated Financial Statements).

 

Depreciation and Amortization. Depreciation and amortization increased to $13.2 million for the three months ended June 30, 2017 from $4.8 million for the three months ended June 30, 2016. The increase was primarily due to property and equipment, and intangibles acquired in connection with the Acquisition.

 

Interest Expense, net.  Interest expense increased to $10.0 million for the six months ended June 30, 2017 from $1.0 million for the six months ended June 30, 2016. The increase was primarily due to increased debt levels related to the Goldman Credit Facility and the Subordinated Debentures assumed in connection of the Acquisition (see “Note 3 - Debt and Capital Leases, net of Debt Issuance Costs” in the Notes to the Condensed Consolidated Financial Statements).

 

Liquidity and Capital Resources

 

Adequacy of Capital Resources

 

Since our inception, we have financed our operations primarily through the sale of stock, the issuance of debt, borrowings under credit facilities and cash provided by operations. While we had no material commitments for capital expenditures as of June 30, 2017, we anticipate net capital expenditures to range between $9.0 million and $11.0 million for the remainder of 2017. Anticipated capital expenditures are related primarily to growth and maintenance in Refill and Exchange locations. We anticipate using cash on hand and availability under the Goldman Credit Facility to meet these capital commitments.

 

At June 30, 2017, our cash and cash equivalents totaled $4.5 million and we had $7.5 million in availability under our revolving credit facility. We anticipate that our current cash, availability under our revolving credit facility and cash flow from operations will be sufficient to meet our current needs for working capital and capital expenditures in the ordinary course of business for the foreseeable future. Given our increased indebtedness incurred under the Goldman Credit Facility in connection with the Acquisition, if we do require additional debt financing, such debt financing may not be available to us on terms favorable to us, if at all.

 

Our future capital requirements may vary materially from those now anticipated and will depend on many factors including:  the rate of growth in new Refill or Exchange locations and related display, rack and reverse osmosis filtration system costs, cost to develop new Dispenser product lines, sales and marketing resources needed to further penetrate our markets, the expansion of our operations in the United States and Canada, the response of competitors to our solutions and products, as well as acquisition and integration of Glacier.  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.

 

 
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Our ability to satisfy our obligations or to fund planned capital expenditures will depend on our future performance, which to a certain extent is subject to general economic, financial, competitive, legislative, regulatory and other factors beyond our control.  We also believe that if we pursue any material acquisitions in the foreseeable future we will need to finance this activity through the issuance of equity or additional debt financing.

 

Changes in Cash Flows

 

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

 

   

Six months ended June 30,

 
   

2017

   

2016

 

Net cash provided by operating activities

  $ 5.0     $ 7.8  

Net cash used in investing activities

  $ (10.5 )   $ (6.8 )

Net cash used in financing activities

  $ (5.6 )   $ (1.3 )

 

Net Cash Flows from Operating Activities

 

Net cash provided by operating activities decreased to $5.0 million for the six months ended June 30 2017, from $7.8 million for the same period of the prior year, driven primarily by the decrease in income from continuing operations, partially offset by changes in operating assets and liabilities.

 

Ne