The abrupt, but not unexpected, firing of Primo Water Corp.’s chief executive and a further lowering of the company’s fiscal 2019 guidance spurred a negative reaction from investors in trading Wednesday.

Primo’s share price fell as much as 18.3% in early trading to a 52-week low of $10.07. It recovered to close at $11.26, down $1.07 or 8.7%.

By comparison, the 52-week share price high is $17.84.

The company fired Matt Sheehan, effective immediately, amid intense pressure from a major shareholder group to shake up the management team and board of directors.

Billy Prim, the Winston-Salem company’s founder and executive chairman, will resume his chief executive duties on an interim basis while the board conducts a search for Sheehan’s replacement. Sheehan succeeded Prim as chief executive in May 2017.

Susan Cates, Primo's lead independent board member, told analysts that Prim would not be a candidate to remain as chief executive.

"We do not have a definitive time-frame for identifying and hiring a new CEO, but the process is well under way and we're committed to moving swiftly or deliberately," Cates said.

Activist hedge-fund group Legion Partners LP, of Beverly Hills, Calif., submitted letters on Sept. 17 and Oct. 29 to shareholders that were harshly critical of Sheehan, Prim and several board members.

Cates told analysts that the firing of Sheehan was "about the company not performing to expectations that the board had for operating performance."

"As Billy has referenced some of the controllable aspects of that, we had not made a decision to make a change until this quarter and the performance in this quarter."

Investors also reacted negatively to two Primo financial developments in the third quarter. Both announcements were released after the stock market closed Tuesday.

Primo posted a $2.62 million profit and 6.3% increase in sales to $87 million, which met the upper range of its third-quarter estimate.

However, adjusted EBITDA was down 5.4% to $15.3 million. Primo had projected a range of $17 million to $18 million.

EBITDA stands for earnings before interest, taxes, depreciation and amortization. Many analysts put their financial focus on EBITDA when evaluating the performance of a company that has yet to make a profit or is newly profitable.

The company reported diluted earnings of 6 cents and adjusted earnings of 10 cents.

The average earnings forecast was 17 cents by three analysts surveyed by Zacks Investment Research. Analysts typically do not include one-time gains and charges in their forecasts.

Reduced earnings forecast

Investors also responded to Primo whittling its fiscal 2019 guidance from a range of $312 million to $320 million in net sales to a range of $312 million to $316 million.

By comparison, Primo projected in March that fiscal 2019 net sales would be in the range of $315 million to $325 million. Fiscal 2018 sales were $302.1 million.

Primo lowered again its forecast for fiscal 2019 adjusted EBITDA from a range of $56 million to $58 million to a range of $50 million to $52 million. The initial projection was a range of $60 million to $63 million after having adjusted EBITDA of $55.4 million in fiscal 2018.

Prim touted in a statement with the third-quarter report that “consistent sales growth in both dispensers and exchange, along with an improving refill business, gives us confidence in future sales growth.”

Primo reported an 8% decline in refill sales to $44.5 million; a 12.6% increase in exchange sales to $24.2 million; and a 53.1% gain in dispenser sales to $18.3 million.

However, Prim said that “our adjusted EBITDA miss is unacceptable, especially in light of this top-line performance.”

“We are re-committing ourselves to better management of the controllable aspects of our business to drive sustainable and profitable growth and value for our shareholders.”

The missed financial targets did not deter at least one analyst from his big-picture view of Primo.

Barrington Research analyst Michael Petusky concentrated on the financial aspects of Primo in Wednesday’s analysis.

“Refill lagged our expectations meaningfully, while dispensers and exchange both easily exceeded our modeling,” Petusky said.

“Unfortunately, refill is the company’s largest revenue generator and the source of the company’s highest margins. Therefore, when this segment underperforms materially — as it did this quarter — it becomes very difficult to mitigate the impact.”

Petusky said that retail store location attrition “has significantly and negatively impacted results. The company communicated that stemming this trend and delivering location growth will be the biggest key in driving overall growth and margin expansion within this business.”

“We are maintaining our outperform investment rating, but are reducing our price target to $15 from $18.

“Though we continue to believe in the exceptional value that can be created at Primo over time, the past five to six quarters of execution at Primo has been well below the line of acceptability.”

Legion influence

Legion owns 9.1% of Primo, or 3.57 million shares. Legion trails just Capital Research Global Investors of Los Angeles, which held a 10.6% stake, or 4.16 million shares, as of July 31.

Prim held just under 1.9 million shares of Primo, which represented a 4.7% stake as of March 28. Prim also has 762,236 deferred stock units that he could acquire over the next three years.

The essence of Legion’s appeal has been that “we contend Primo is an incredible business with significant scale, but is being held back by a lack of critical expertise on the board and an inability or unwillingness to objectively evaluate the performance of management and directors.”

Ted White, a Legion co-founder and managing director, said in a statement Tuesday that “we fully support Mr. Sheehan’s termination, as his performance was completely unacceptable.”

“However, we are deeply concerned about Billy Prim’s appointment as interim CEO and his plans to remain on the board as chairman given that he is as much a part of the problem at Primo as Mr. Sheehan was.”

Cates did not mention Legion’s criticism in her comments about Sheehan’s firing.

“The board of directors is committed to enhancing stockholder value,” Cates said. “When execution fell short of our expectations, we concluded it was time for a leadership change.”

Cates told analysts that "we are working with a leading board recruiting firm to evaluate the composition of our board and help us identify potential director candidate."

"Our process has included outreach to many of our large shareholders."

Prim said the company’s focus “will be on continuing to grow our exchange and dispenser businesses, improving our refill business and driving operational execution and organizational development, while positioning Primo Water to achieve long-term profitable growth and improved value for shareholders.”

Prim was asked by an analyst whether "you think or the board thinks it makes sense to also pursue or look into strategic alternatives for the business. Should this be a dual track kind of process?"

Prim answered by saying "we've got to get our cost and unexpected surprises under control from a cost standpoint, then our business will be stabilized and we think the shareholders will be rewarded for it in that way."

Since making its first investment in March 2018 at 1.6 million shares, Legion has steadily added to its stake, including serving as the top shareholder for a period in 2018 and 2019.

White continued Legion’s call for replacing board members Richard Brenner, Malcolm McQuilkin and David Warnock.

Legion says the three members are too closely linked to Prim to properly oversee the company from their previous relationship with Prim with Blue Rhino Corp., which was sold to Ferrellgas Partners LP for $343 million in April 2004.

“Legion is still evaluating next steps to address the pressing issues at Primo,” White said.

Legion claims that Primo has had “significant operational and financial under-performance” under Prim.

“With quarter after quarter of earnings misses and lowered forward guidance, I imagine that there was tension between the board and the administration,” said Bowman Gray IV, a local independent stockbroker.

“While this was an appropriate decision given the above, it will remain to be seen if Mr. Prim can turn things around or find someone who can. I do not see a quick fix here.”

The hedge-fund group also cited Primo paying $35.6 million in what Legion termed “excessive pay packages” in 2015-16 to Prim, Sheehan and former chief financial officer Mark Castaneda involving deferred stock units after the share price fell from $12 to $1.39.

Primo has declined to comment about the executive compensation claims by Legion.

Following the Oct. 29 shareholder letter, Primo issued a statement in which it said it has been “proactively engaged with Legion in meetings, discussions and correspondence regarding Primo Water’s board composition, governance enhancements and business performance.”

“Most recently, we have asked Legion and our other large shareholders for substantive feedback and input on our board and on skills or experience that may be enhanced or complemented through the addition of new directors.

“Several of our shareholders have already provided us with constructive feedback on these matters. Legion has yet to do so, but we continue to welcome Legion’s input.”

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