Performance Food Group Company (PFGC) Q4 2007 Earnings Report, Transcript and Summary

Greetings and welcome to the Performance Food Group fourth quarter 2007 earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host John Austin, Senior Vice President and Chief Financial Officer of Performance Food Group. Thank you. Mr. Austin, you may begin.

Thank you, Ryan. Good morning and welcome to the Performance Food Group conference call and webcast to review the company’s announcement earlier today of its financial results for the fourth quarter and full year ended December 29, 2007. This morning I’m joined by Steve Spinner, our President and CEO. Our earnings release was issued this morning and a copy of the information is available on our website at www.PFGC.com. I’ll briefly address our financial highlights for the quarter and year, and then Steve will provide more insight into our operating results and expectations. Certain of the statements we’ll make in this call may be forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements involve risks and are based upon current expectations. Actual results may differ materially. These risks are more fully described in our press release and our SEC filings. In addition, these remarks may include certain non-GAAP financial measures as defined by SEC Regulation G and a presentation of those most directly comparable GAAP measures and a reconciliation of the non-GAAP measures to the GAAP measures are available on our website. Before I begin with my financial review for the fourth quarter and full year, let me update you briefly on the status of our pending merger with VISTAR Corporation, a portfolio company of The Blackstone Group and Wellspring Capital Management. Since announcing the merger agreement on January 18 2008, we have filed our preliminary proxy statement with the SEC and we and Blackstone have each made our initial Hart-Scott-Rodino filings. A copy of the preliminary proxy statement which includes a copy of the merger agreement is available on the SEC’s website. We will not be discussing the merger in detail on this call, but reiterate that subject to the satisfaction of customary closing conditions, including shareholder approval and the expiration of the waiting period under the Hart-Scott-Rodino Act, we continue to expect the transaction to close in the second quarter of the year. In regard to our financial performance for the fourth quarter and full year 2007, net sales for the quarter were $1.6 billion, an increase of approximately 10% from the year-ago quarter. Net sales for the full year were $6.3 billion, an increase of approximately 8% over the year-ago period. Sales trends in the quarter and year were impacted by the rollout of the previously announced new business in our customized segment, increased sales to existing customers in both segments and continued growth in our Broadline street sales. A complete segment breakdown is included in our news release. On a consolidated basis, inflation remained high in the quarter and was approximately 6% for the quarter and 5% for the full year. Our gross profit increased 7.4% to $214.7 million compared to the year-ago quarter, while gross profit margins decreased 35 basis points to 13.16% from 13.51% in the prior year quarter. Gross profit for the year increased approximately 6% while gross profit margins decreased 21 basis points for the full year. The decline in gross profit margin in 2007 as compared to 2006 is primarily due to inflation and to a lesser extent by the impact of our sales mix between multi-unit business and street. Even though inflation caused our gross profit margin to decline, our gross profit dollars were not impacted as much as it relates to our gross profit margin. Operating expenses for the quarter were $188.6 million or 11.56% of sales, a decrease of 41 basis points versus the prior-year quarter. Operating expenses for the year were $737 million or 11.7% of sales, which represents a decrease of 31 basis points. The decrease in operating expense ratio during the quarter and the year was due to increased sales partly driven by inflation and improved operating efficiencies, offset in part by an increased provision for bad debts in the fourth quarter. Operating profit in the quarter was $26.1 million and our operating profit margin was 1.60%, reflecting an increase of 6 basis points versus the prior year quarter. For the year, operating profit was $87.2 million and our operating profit margin was 1.38%, reflecting an increase of 9 basis points versus the prior year. For the year, interest expense and loss on accounts receivable were $9.9 million compared to $9.1 million in the prior year, primarily as a result of the increased expense associated with a capital lease at one of our facilities and costs on the company’s receivables facility. Other income for the year was $4.3 million, consisting primarily of interest income compared to $2.5 million in the prior year, which was positively impacted by an increase in our cash balance available for investment. Our effective income tax rate was 37.3% for the full year. The decrease in the effective rate from the year-ago period was primarily due to the recognition of certain tax benefits as statute of limitations expired during the year, partially offset by an increase in our state tax rate. We expect our tax rate to be approximately 39% for 2008. Net earnings from continuing operations in the quarter were $15.1 million or $0.43 per share diluted compared to $12.9 million or $0.37 per share diluted in the prior year quarter. Excluding the impact of stock compensation expense, net earnings from continuing operations amounted to $16.2 million or $0.46 per share diluted compared to $0.39 per share diluted in the prior-year quarter. Net earnings from continuing operations for the full year were $51.1 million or $1.45 per share diluted, compared to $42.9 million or $1.23 per share diluted. Again excluding the impact of stock compensation expense, net earnings for the full year amounted to $55.3 million or $1.57 per share diluted compared to a $1.32 per share diluted in the prior year. Diluted weighted average shares outstanding for the year were $35.2 million compared to $34.8 million in the prior year. At the end of the quarter, our balance sheet remained extremely strong. Our debt as a percentage of total capital was approximately 1.1% and this excludes $130 million of interest and accounts receivable sold under our receivables purchase facility. As for working capital, our days sales outstanding in receivables remain flat at 18 days sales outstanding versus the third quarter and decreased by one day compared to the prior year fourth quarter. Inventory turns increased by one day versus the third quarter and the prior year’s fourth quarter to 17 turns. Accounts payable float was 110% of inventory, which remained constant compared to the third quarter and decreased 2% versus the prior-year fourth quarter. For the full year and continuing operations, depreciation amounted to $26.7 million and amortization was $3 million. Pre-tax stock compensation expense was $6.6 million versus $4.9 million in the prior year and capital expenditures were $74.9 million versus $53.7 million in the prior year, reflecting the capital requirements associated with construction of replacement facilities at two of our Broadline locations -- Springfield, Massachusetts and Cairo, Georgia -- and our continued investment in information technology. Free cash flow for the year was $12.8 million compared to $23.3 million in the prior year and that decrease obviously was impacted by the amount of capital expenditures versus the prior year. As we look ahead to the 2008 year, based upon current trends in our business we still expect internal sales growth on a consolidated basis to be in the mid to high single-digits for the year; depreciation to be approximately $28 million to $32 million for the year; and amortization to be in the $3 million to $4 million range. We expect capital expenditures of between $30 million and $40 million for the full year, which includes approximately $10 million of cost associated with the implementation of our current financial applications with SAP. We also expect to incur pre-tax stock compensation expense of approximately $8.5 million to $9.5 million for the full year, which represents an incremental increase versus the prior year of $2 million to $3 million. We expect adjusted net earnings per share for the full year to be in the range of $1.53 to $1.65 per share diluted, excluding the previously announced facility closing costs and unadjusted net earnings per share to be in the $1.39 to $1.49. This guidance also excludes any costs associated with our pending merger with VISTAR Corporation. With that, I’ll turn it over to Steve to give you more granular insight into our operating results.

Thank you, John. Good morning, everyone. I would like to add some comments regarding our fourth quarter and year-end performance. Three years ago we set out on a core strategy for Performance Food Group that focused on three areas of our business: Growing our street sales; Operational excellence; Category management. We believed these initiatives would drive growth in the most profitable areas of our business, improve the efficiency of our operations, and enhance our financial performance. We have continued to make progress in these initiatives and this progress is reflected in our strong financial performance in both the fourth quarter and the full year. We are also dealing with the challenge of increasing food inflation, growing concerns about the economy, slower industry growth and the need to grow larger as we seek to better leverage our scale and infrastructure. PFG made significant progress in 2007, thanks to the hard work and dedication of our associates in further developing and implementing our core strategies. We continued to realize significant progress in the transformation of our company toward a more standardized, efficient and disciplined organization. Our expanded technologies further improved customer service levels and operational efficiencies. Our sales force continued to drive higher margin sales growth and we have been undertaking additional opportunities to leverage our scale and aggressively manage costs. We have been pleased with our company’s steady progress in real sales growth, which continues to outpace our industry. However, we have not seen any moderation in inflation and we are continuing to watch economic and consumer spending indicators closely. We remain committed to our focus on operational excellence and to improving our levels of service across every part of our company. To support this process, we have made major investments in new systems including the continued rollout of voice selection technology in our warehouses, which we believe will further enhance our service to customers by increasing accuracy and efficiency. We have been successful in achieving industry-leading standards throughout our business and we have done so efficiently and with an eye on long-term returns. We took a disciplined approach to sales rep growth, given the industry and economic environment. Since 2005 when we undertook an initiative to increase our sales force, we’ve added 26% more associates, brining our total street sales force to more than 1,100 at 2007 year end. We have supported this growth with the addition of a common training curriculum designed to provide our sales force with the added expertise to support our customers and grow their businesses. We will continue to be opportunistic in developing profitable new business opportunities that focus on street sales growth as well as multi-unit customers that meet our profitability objectives. We completed 28 supplier reviews during the year and we continue to focus on improving negotiated programs with suppliers, owning efficiencies in our procurement practices and further leveraging our national supply chain. Our objective remains focused on enhancing our operating margins as well as enhancing the value we bring to our customers. For 2007, PFG brand sales increased to 27% of our street sales and we expect to continue the expansion and penetration of our private label products including new products like the recently introduced PFG Naturals and Organic product line. Our goal is to increase our brand penetration to 30% of street sales by the end of 2008. In 2007, we focused on building capacity through renovations and construction of new facilities to expand our distribution system. In 2007 and early 2008, we opened Broadline replacement facilities in Cairo, Georgia and Springfield, Massachusetts and we completed an expansion of St. Louis, Missouri location. This increased capacity will support growth with new customers, provide enhanced services for existing customers and make us more operationally efficient. In customized distribution, we added a significant new customer, O’Charley's, and in 2008 we added Joe’s Crab Shacks; together this will add approximately $270 million in annualized sales. The rollout of O’Charley's was completed in the fourth quarter, and we have now completed the rollout for Joe’s. Customized Distribution remains the industry’s leading perishable experts, and we continue to excel in the delivery of fresh products from seafood and meats to produce and dairy to further support our growing footprint and our customers’ needs. We continue to anticipate construction of a ninth Customized Distribution facility west of the Mississippi River, beginning late in the year. We have invested in information technology, and are well underway with a significant initiative to standardize our core financial systems, including applications for vendor receivables, accounts payable and general ledger. This information technology platform is enabling our shared services center in Columbia, South Carolina which will be operational in mid-2008. We believe that the standardization and centralization of these financial processes will drive greater cost efficiencies, support certain long-term category management initiatives and serve as our platform for future growth. To support this effort, we have expanded our training efforts and we remain committed to the continued development of our associates in other areas throughout the company. Throughout our business, PFG is driving results, despite challenging macro-economic conditions. During the last several years, PFG invested heavily in building improvements and technology. In 2008, as we expect CapEx spending to moderate, we will focus heavily on return on capital, free cash flow, and driving appropriate returns from our prior year’s investments. As we execute our core initiatives, we are positioning PFG for the future. It’s a future that rests on the shoulders of our associates whose skills, hard work and commitment to serving customers are the backbone of our success. As you know, we announced in early 2008 that PFG’s Board of Directors has signed a merger agreement with the Blackstone Group and Wellspring Capital Management. We filed our preliminary proxy with the SEC on February 15 and filed our Hart-Scott-Rodino filing with DOJ and SEC last week. We are continuing to work toward closing, which we expect to occur late in the second quarter. If you would like more information, you can access our preliminary proxy publicly filed with the SEC. In closing, I would like to thank you for joining us today and your interest in our company. We’re ready to take questions.

Our first question comes from the line of Chris Routhe - Piper Jaffray.

On prior calls you talked about food inflation and how embedded in that there’s this trade off between sales growth rates and percentage margin, as inflation numbers rise and fall against your expectations. But inflation has been abnormally high now for quite some time. Are you saying that, given the nature of your business, your profit dollars are basically immune from a 6% inflation number on a long-term basis? And if commodity prices don’t cooperate and inflation remains sticky in the back half, you are not concerned about earnings pressure?

First of all, I would not characterize it as immune from inflation pressures by any means. We’ve talked about this actually on the last couple of calls as we are continuing to see inflation up in the mid single-digit range, which is as you’d mentioned, very high historically. We’ve had three plus quarters of that kind of inflation. The comment we were trying to make on the gross profit dollars was more along the lines of given our mix of business and the fact that a lot of multi-unit business is priced on a fee per case, the escalation in the actual food cost, while it will depress your percentage margin, doesn’t have a significant impact on what your gross profit dollars are. So I would definitely not characterize it as immune, but certainly that helps mitigate any of that significant inflation but it is absolutely a challenging environment especially as things are continuing to ramp up.

I think that high inflation just causes a lot of difficulty in looking at your percentage rates. So we tend to look at our actual dollars as well as our per case statistics as opposed to using the percentage rates, because they just get so distorted...

Sometimes, they get distorted, right.

Okay, do you still expect, from what you’ve been reading, some sort of price inflation alleviation in the back half?

The industry is certainly indicating that’s going to happen, we have not seen any indication of any fall off in the inflation.

Have you hedged your fuel for ’08? I think in the last call you suggested that might be done sometime soon?

We’ve been working hard on that issue, to date we’ve hedged approximately 13%, 14% of our fuel and we’re still kind of waiting to see where the price ultimately ends, so to date about 13%, 14%.

Your next question comes from Meredith Adler - Lehman Brothers.

Could you talk about whether this kind of environment -- high inflation and maybe slowing traffic, especially for the casual dining chains that you service -- does this encourage them to stay put with a supplier, or are they more likely to make changes during this environment to find ways to become more efficient? It seems to me those would be conflicts -- don’t mess things up, but on the other hand maybe you need to do something more aggressive?

Meredith, I think that it’s not so much a supplier-based question in terms of the distribution, as much as it is a supplier-based question in terms of the product that they are ultimately serving in the restaurant. So I think when you get high periods of inflation, it causes restaurants to look at the pricing on the menu, it causes them to look at the mix of products on the menu, it causes them to look at the value structure within specific geographies. Obviously we’re on the distribution side but I think what you see is a lot of the restaurant operators very carefully looking at the products that they offer throughout their system, and not so much the means that the products are getting to the restaurants themselves.

Are they indicating that they have some flexibility in terms of their menus? Some of them have very specific images for their customers and they wouldn’t have that much flexibility?

I’m not sure we can really comment on that, because we don’t have enough visibility into that question. Obviously, the restaurants can’t randomly change their menu prices. That takes a long period of time. So, not sure I can give you much more color than that.

Your category management efforts, I think you talked about your own brand penetration going up, but can you talk about whether you are continuing to progress with the rest of your category management effort?

Absolutely. What I said in my comments is we completed about 28 supplier reviews for the year, which was right on target with where we wanted to be. We think that the completion of our financial systems rollout will significantly help move that project along at a much faster clip, but it’s very much a focal point for us and continues to be. We’re making a lot of progress, a lot more of the products that are purchased by our field operating companies fall within our umbrella of national programs, so yes, it’s still a very, very big part of who we are. Quite frankly, it is the single biggest contributor to our gross margin initiatives over the next couple of years.

Thank you. Personally I am sorry you are going private because I was looking for to watching that improvement. Thanks, guys.

Our next question comes from Ajay Jain - UBS.

I really just have one main question, which is related to timing of the merger agreement. At what point do you expect to file an updated version of the proxy statement? When will the final version of the proxy be sent out for shareholder approval? Is that something you can comment on at all at this time?

Thanks, Ajay. That is not something we could comment on. Obviously the preliminary proxy was filed on the 15th of February and we’ll work through that process and you will be the first to see it, I think, but we’ll do that as expeditiously as possible.

So to the extent that there is any update on the status of the financing or anything else, we should assume that will be communicated some point after March 9th?

Again, we won’t comment anywhere in the process, but we’ll file all our public documents as timely as possible.

Your next question comes from Andy Wolf - BB&T. Andy Wolf - BB&T: On the slower street sales growth last couple of quarters, is that more internal? I mean you touched on that you managed the hiring of the sales force down this year. Or is it really just more external, there is just less business out there? Could you actually point to competition?

Andy, I think it’s mostly a trade down that we’re seeing out in the restaurants. I don’t think it’s a factor of our hiring practices as much as it is the general economic condition in the industry. The traffic and therefore the revenue, through each customer that we sell, has struggled. And that’s as a result of a lot of factors. But I think the biggest one is just the trading down effect in terms of frequency and the amount that the average consumer spends each time they go out to eat.

That was something we noticed in the third quarter, I know we talked about it on our third quarter call was that was the first quarter that our multi-unit business had actually grown faster than our street business in 2007, we saw that same trend in the fourth quarter. Andy Wolf - BB&T: On the deal, I just want to check with you, it’s more using the calendar and math. There was a provision in there for 50 days to market the company, I guess for a better bid or different bid. Using the calendar, that would leave about nine days left. First is it a calendar or business day? Nothing about business days was mentioned so I assumed it was calendar. Is there about nine or ten days left to that?

It talks about it in the proxy and I would refer you to that, it expires on March 9th. Andy Wolf - BB&T: That’s what I was looking for. Lastly, other income I noticed a decent amount almost $900,000. Could you mention what that was derived from?

We actually had a small investment in a B2B network. That company was sold and we recognized the gain. That was about $800,000 in other income.

Your next question comes from Ajay Jain - UBS.

Can you give any comment on current sales trends for the first six weeks through this quarter, what you are seeing in both Broadline and Customized? Any comment on the inflation mix as well?

I think generally speaking we are seeing more of the same.

Well thanks, everybody. Performance Food Group has been a company in motion, delivering results, enhancing our core business, and investing in technology and people with an eye toward growth and profitability and I’m proud of what we have accomplished. As we look to the future of PFG, I’m confident that our legacy of success will continue. Thank you and have a great day.