Performance Food Group Company (PFGC) Q4 2014 Earnings Report, Transcript and Summary

Welcome to the 2014 Fourth Quarter Investor Call. My name is Laura, and I will be operator for today’s call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Ms. Milton Draper. Ms. Draper, you may begin.

Thank you, Laura, and welcome, everyone. I would now like to read the statements about the use of forward-looking statements and non-GAAP financial measures during this call. Statements made in the course of this call that state the company’s or management’s hopes, beliefs, expectations or predictions of the future are forward-looking statements. Actual results may differ materially from those projections. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in our SEC filings, including our Form 10-K, our 10-Qs and our press releases. We undertake no obligation to update these forward-looking statements. We are holding this call to review our fourth quarter results and to answer any questions you might have. If you have additional follow-up questions after the call, please call me at 650-589-9445. Joining me today is the Chief Executive Officer of Core-Mark, Thomas Perkins; and the Chief Financial Officer, Stacy Loretz Congdon. Also in the room is Chris Miller, our Chief Accounting Officer; and Greg Antholzner, our Vice President of Finance and Treasurer. Our lineup for the call today is as follows: Tom will discuss the state of our business and our strategy going forward, followed by Stacy, who will review the financial results for the fourth quarter. We will then open up the call for your questions. Now I would like to turn the call over to our CEO, Tom Perkins.

Good morning, everyone. I would like to go over the state of our business and briefly review the financial results for the year, and then discuss our core strategies. I’m sure most of you saw our press release this morning announcing the completion of an asset deal in Canada to acquire Karrys Bros, a distributor in Ontario. Like Core-Mark, Karrys has been in business for more than a century and has a reputation for providing excellent customer service. They also deliver fresh, frozen and refrigerated products, so this business should be a nice fit for us. We paid approximately $10 million for most of the assets and expect to spend about $1 million on start-up and transition costs in 2015. While this is not a large acquisition, it is an important one for our Canadian division. It should generate approximately $100 million in annual sales and will contribute to leveraging our Toronto division’s fixed cost and help generate higher profits. We look forward to servicing their customers and welcoming many of their employees into the Corel-Mark family as we fold this business into our Toronto division in the spring. Speaking of Canada, you may have noticed in our 10-K that our Canadian division’s profits have improved considerably in 2014. We picked up a large customer, maximized holding gains and a keen focus on our operational efficiencies all drove the results. The addition of the Karrys business should continue the momentum in this important segment of our business. Our partnership with Rite Aid is going well, we continue to focus on the chilled, fresh, frozen and bakery items in the approximately 4200 stores added this year. These items are selling at very healthy rates, indicating to us and our partners at Rite Aid an improvement in their fresh and food offerings. We want to help Rite Aid continue to expand their fresh food offerings, their customers and the streamlining of their supply chain, but this will be a gradual process. I do want to be clear that this is a profitable account with very significant opportunities for future growth. Our Ohio division is now up and running servicing about 1400 stores with plans to transfer an additional 200 stores before the end of this year. Construction is completed and we are covering a territory from Rochester, New York, Chicago, Illinois and from West Virginia to the Upper Peninsula. There are significant market share opportunities in this region, we have just won a new customer with 44 stores and are in discussions with a number of other potential new customers in the area, so I’m very encouraged by these prospects and the overall performance of this division so far. I know many of you want to know how we’re feeling about or partial conversion to CNG trucks given the recent decline in fuel prices, including diesel fuel. These declines have lowered the spread between CNG and diesel from 2 to 1 to now 3 to 2, but the transition still makes financial sense, assuming the current spread among fuel prices remain about where it is today. Not only will we save money in transportation costs, but we will reduce our carbon footprint. In the fourth quarter, we saved over $1 million in fuel cost and a percentage of that was due to the CNG trucks we have in our fleet. We now have 141 CNG trucks on the road and still anticipate about 30% of our fleet to be running on CNG by the middle of the year. In addition, we own two CNG stations, one in Wilkes Barre, PA and the other in Corona, California. Three additional CNG stations were opened in partnership with U.S. Oil GAIN and are located in Aurora, Colorado, Forrest City, Arkansas and Sanford, North Carolina. GAIN is breaking ground on our fourth station in Atlanta with the fifth one planned in Tampa later this year. Core-Mark had a good year in 2014. I’m very pleased with our 12.1% growth in adjusted EBITDA, which exceeded our guidance. I’m also pleased with the growth trends we saw in our comparable same-store non-cigarette sales as the year progressed. These results continue to strengthen my confidence in the fundamentals of our company and the industry we service. Non-cigarette sales grew 6.8% for the year or 7.7% adjusting for the foreign currency impact. Comparable same-store sales for non-cigarettes improved to 5.5% in the fourth quarter, showing improvement over both the second and third quarters. This metric confirms for me the direction we’re taking the company is the right one. Our core strategies VCI, Fresh and FMI are significant drivers to the continued growth in our non-cigarette sales. Non-cigarette remaining gross profits grew almost 8% for the year, while margins increased 13 basis points or 20 basis points if you exclude the compressing effect of the two large customers we won in the second half of 2013. In the cigarette business, we saw a 4.5% increase in sales on a 1.2% increase in cartons sold and a 3.3% increase in the average cigarette price. We believe cartons are up due primarily to market share gains and vendor promotional activities in 2014. Same-store carton sales for the fourth quarter were up almost 1%, which is a fairly rare statistic in our industry and might support the theory that the C-store industry is benefiting from the CVS exit from the cigarette business. Warehouse and distribution expenses increased about 7%. This increase was driven by a 7% increase in cubic feet of product handled and sold, in addition miles driven increased 6% and we had a 7.4% increase in deliveries. We are beginning to see some improvement in transportation costs, which spiked earlier in the year. We believe that overall the driver pool across North America will remain tight, though some slight loosening is being seen in regions dependent on the oil industry. On a more positive note, we expect to see cost savings in 2015 related to the relocation of customers now serviced by our new Ohio division. Also, if fuel prices continue to remain at current levels, we should continue to benefit, but some of these savings maybe diminished as we reduce the fuel surcharge we have in place for many of our customers. SG&A expenses increased 9.6% or about 7 basis points when measuring these expenses as a percentage of sales. We had some spending in 2014 representing investments in our future, particularly in our people. We will continue to invest in our company in 2015 to ensure we are supporting our future growth. The bottom line is our adjusted EBITDA increased 15.3% to $36.1 million in the fourth quarter and 12.1% or $122.7 million for the year. I am very pleased with these results. This organization was able to complete a number of major projects, execute on the fundamentals and maximize income opportunities such as the candy price increase, holding gain and tax refunds. We know that candy holding gains and tax refunds will probably not recur in 2015, but when these opportunities present themselves we take advantage of them and generate cash and profits for our business. For those of you that have been following our industry for a number of years, you understand we have a sizeable number of one-time events. Most of these are good, but not all. Historically, we have been successful at maximizing these opportunities and on the opposite end minimizing our risks. We had a very good year executing our core strategies and we’re focused on repeating this performance in 2015. VCI and Fresh had a record year, generating over $113 million in incremental sales dollars. Innovation continues to drive these results in these key categories. We continue to develop new programs and products to advance this important strategy. For example, we have launched an organic and plant-based dairy program. This is being included in our largely vendor-funded fresh food cooler program. We believe this will do very well in the stores in more affluent neighborhoods. Our recently launched Farm to Market program is also doing well with over 1000 merchandising racks placed in our customers’ stores during 2014. FMI also had an excellent year as we performed over 3000 surveys which are an integral part of making our independent retailers more relevant and profitable. Surveys were prepared for new stores, re-dos of existing stores and for potential new Core-Mark customers. We are planning on performing an additional 3000 surveys in 2015. Our acceptance rate continues to be above 60% and we are seeing purchases from FMI stores growing three times faster than non-FMI stores. Our Core Solutions Group is focused on mining data to help our sales force help our customers grow their sales and profits as well as our own. We use this data to identify gaps in our existing stores where key products are not being purchased and sold. In addition, we are capturing market share and competitive data using our customer relationship management software. In 2014, this tool helped us identify and prioritize accounts that should be purchasing from Core-Mark. This tool assists our field sales force in targeting their efforts to gain market share and should assist us in growing ourselves in 2015. Bottom line, our core strategies continue to resonate with our customers and we plan to further refine and expand these creative solutions for the markets we serve. For 2015, we are targeting the revenues of $10.7 billion to $11 billion and adjusted EBITDA of $125 million to $129 million. At first glance, it may appear we are being ultraconservative on the low end and more modest in our expectations on the high end. However, there are several factors to consider as we move into 2015 in addition to our general approach being a conservative one. First, we have not included any large customer wins and no acquisitions other than that carries asset deal in our revenue guidance. The growth rate implies the 4% to 7% range led by a continued shift to higher margin non-cigarette categories and continued cigarette consumption declines offset in part by market share gains. On the profit side, we have approximately $14 million related to candy holding gains and OTP tax refunds offset by approximately $5 million for certain transitional and non-recurring expenses that are not included in our 2015 EBITDA guidance. Excluding these items, the anticipated EBITDA growth is at the 9% to 13% range. In addition, we will be investing in our company, mostly in our people, to ensure our infrastructure supports our future growth. We will update you on our expectations as the year progresses. In summary, business is good. I am very pleased with the fourth quarter and year-end results and feel even more optimistic about 2015. We continue to outpace the growth of a pretty healthy industry with saw an approximate 1% store count growth in 2014 and we’re ensuring through innovation that we are providing the products and solutions to our customers’ need to be more relevant and more profitable. We must also continue to invest in the future growth of the company and technology, people, systems and assets. We’re very excited to welcome the Karrys organization into our family and are very pleased about the partnerships we have developed with our customers. I believe our core strategies are working and are a key contributor to our improved financial performance. With that, I will now turn things over to our CFO, Stacy Loretz Congdon. Stacy?

Thanks, Tom, and good morning, everyone. I'd like to start my comments with a brief discussion of our earnings per share for the quarter and the year. Diluted EPS for the fourth quarter was $0.62 compared to $0.65 last year. For those of you that model EPS excluding LIFO expense, this translates to $0.69 for the quarter compared to $0.65 last year, a 6.2% improvement. For the year, diluted EPS was $1.83 in 2014 compared to $1.79 for 2013. We had guided to a range of $1.68 to $1.76 and beat that expectation due primarily to our LIFO expense coming in a bit lower and a better tax rate than expected. As a reminder, our LIFO expense is tied to the Producer Price Index and reflects estimates in the various product categories. Excluding LIFO expense, we earned $2.26 in 2014 compared to $2.02 last year, an 11.9% increase. This result was above the higher end of our guidance which targeted $2.17 to $2.25 per share. For 2015, we’re guiding to an EPS range between $1.84 and $1.91. This includes estimates of $16 million for LIFO expense, $8 million for cigarette holding gains, a 38% tax rate and 23.4 million dilutive shares outstanding. Excluding LIFO expense, we are guidance to an EPS range of $2.26 to $2.33. The candy gain and the net OTP tax items represented approximately $0.36 per share for 2014 and are not expected to recur in 2015. In addition, integration, acquisition, legal settlement and legacy insurance claim costs compressed 2014 EPS by approximately $0.13 per share. Normalized for just these items, guidance for 2015 EPS excluding LIFO expense indicates a range of growth between 10% to 14%. Moving on to our fourth quarter results, sales increased 4.7% to $2.6 billion compared to $2.5 billion last year. Excluding the impact of foreign currency, sales increased 5.8%. The weakness in the Canadian dollar reduced Canada’s contribution to sales by about $26 million for the quarter and nearly $90 million year-to-date. Sales in the fourth quarter were comparable for acquisitions and large account wins that were consistent in both periods. Fourth quarter cigarette sales increased 4.3% to $1.8 billion compared to $1.7 billion last year. Excluding the impact of foreign currency, cigarette sales increased 5.4% driven by a 1.3% increase in carton sales and a 3% increase in the average sales price of carton. Same-store carton sales increased 0.6% during the fourth quarter, with over half of the US divisions showing growth in this category. In contrast, industry carton shipments were down a modest 2% with carton manufacturers citing stronger consumer demand and lower gas prices. The future expectations for industry carton declines remain in the 3% to 4% range. Our non-cigarette sales increased 5.6% in Q4 to $844 million compared to $799 million in the same period last year. Excluding the impact of foreign currency, sales increased 6.6%. Food products contributed over 55% of this growth, increasing 7.2% during the quarter including foreign exchange impact. Meat and healthy snacks as well as nuts, seeds and dried fruits drove the snack category up 12%. Our fresh categories which include dairy, bread, fresh products and meat increased nearly 16% during Q4, benefiting from the Rite Aid expansion and the execution of our core strategies. Gross profit increased $11.3 million to $154.6 million, an increase of 7.9% for the fourth quarter of 2014. We recorded $7 million in net OTP tax items and the remaining holding gain associated with the candy price increase. This was offset partially by $2.7 million in LIFO expense. Cigarette holding gains in Q4 was slightly above prior year. The remaining gross profit which excludes the aforementioned items increased $7 million or 5% to $146.1 million. Remaining gross profit margins increased about 8 basis points for the quarter, but were compressed by 6 basis points due to the increase in cigarette manufacturer prices. Cigarette remaining gross profit increased 1.5% to $39.8 million, benefitting primarily from the 1.3% increase in carton sales. Remaining gross profit per carton was essentially flat for the quarter. Non-cigarette remaining gross profit increased 6.5% to $106.3 million for Q4 2014. Remaining gross profit margins for non-cigarettes increased 11 basis points. The comps for inventory shrink which was slightly higher than historical norms this quarter compared to a favorable inventory adjustment during the same period last year had a 9 basis point compressing effect. Excluding this, remaining gross profit margins increased 20 basis points, much closer to what we’ve seen in recent quarters. Moving on, operating expenses were $131.6 million in the fourth quarter this year compared to $119.5 million for the same period last year, a 10.1% increase. Operating expense as a percentage of sales increased approximately 20 basis points, driven largely by SG&A costs which I will discuss in a minute. Warehouse and delivery expenses increased $4.2 million or approximately 5.4% to $81.4 million during the fourth quarter 2014. This increase supported a comparable 5.2% increase in cubic feet handled. In addition, miles driven were up 7.6% and deliveries increased 12.6% driven by the new Rite Aid business. The increase in operating costs was offset by lower fuel costs. CNG units drove nearly 15% of total miles, up from 12% in Q3, contributing to fuel cost reduction. As a percentage to sales, warehouse and delivery was essentially flat compared to prior year. SG&A grew $7.9 million or 19% during the fourth quarter and as a percentage of sales, increased 23 basis points. Fourth quarter can often be impacted by a number of year-end adjustments and non-recurring activities, so I will point out the larger items. We saw higher stock comp versus last year’s fourth quarter when the performance shares were cancelled and bonus expense increased on good results which contributed $1.7 million collectively to this increase. In addition, we accrued $1.2 million during Q4 for settlement, litigation and related fees and another $1.9 million for legacy insurance claims, professional fees associated with the OTP tax refunds and bad debt exposure. Our health care costs were slightly higher during Q4 this year, offset by higher comparable integration costs this year versus 2013. Lastly, we reported a pension curtailment gain in SG&A last year that did not recur this year. All of these items represented a little over 70% of the increase, meaning everything else increased about 5%. The remaining increase was driven by SG&A salaries, excluding benefit. Those were up about 9%, meaning we did leverage some of the other SG&A line items. This increase in salaries was due primarily to Ohio and an investment in bench strength primary in sales, IT and some back-office functions. Moving further down the income statement, our effective tax rate for the quarter was 35.1% versus 35.3% for the fourth quarter last year. For the year, our effective tax rate was 35.7% compared to 37% last year. The decrease for the year was driven primarily by larger positive adjustments of prior year estimates and by the expiration of statutes of limitations for certain tax provisions. Moving to cash flow, cash generated from operations before working capital changes was $96 million for 2014 compared to $88 million last year, an 8.8% increase. Changes in working capital which measures two single points in resulted in a use of cash in both 2014 and 2013 of just over $29 million. The largest increase in our working capital was for cigarette inventory purchases related to our LIFO buy-in at the end of the year, which ran about $20 million higher this year compared to 2013. Free cash flow, which we measure as adjusted EBITDA plus or minus changes in working capital, less CapEx, cash taxes and cash interest, was slightly over $23 million for 2014. However, if you add back the $20 million temporary spike in inventory, we came in slightly above our expectation. Our capital investments were $54 million this year compared to $18 million in 2013. Our new Ohio division represented approximately $16 million of our total spend this year. For 2015, we are guiding back to a more normal level of $35 million for CapEx. Free cash flow per diluted share was $1.01 this year or $1.87 excluding the incremental year-end inventory buy-in. In addition, the $4 million additional CapEx spend over the $50 million we guided to represents another $0.17 a share. For 2015, we expect free cash flow to be between $65 million and $70 million, depending of course on any unusual year-end activities which I normally call out. On a per share basis, we’re expecting a range of $2.75 to $2.95 for free cash flow. Average debt for the year was $14.8 million compared to $35.3 million in 2013. Average inter-month working capital swings were approximately $55 million for the year, with our peak debt position at about $80 million in December when we started buying inventory in anticipation of the cigarette price increase. Our current ratio continues to be strong at 2 to 1 and average monthly cash conversion cycle was stable at 14 days compared to 14.3 days last year. We were able to generate sufficient excess cash in 2014 to return value to our shareholders consisting of $10.7 million in dividends and $8 million of share repurchases. And you may have noticed our first-quarter dividend announcement of $0.13 per share in our press release this morning. In addition, we continue to invest in our infrastructure and human capital to support our long-term growth strategies. As many of you know, our return on net asset standard is 20%, which means we focus on meeting or approaching that standard when making our investment decisions. The net assets we monitor include inventory, accounts receivable and fixed assets less accounts payable, tobacco taxes payable and accrued liabilities, all major components to our working capital management and monitored on a daily basis. For 2014, our RONA was just above 19% compared to 18% in 2013. Our capital allocation decisions support our core strategies and focus on ensuring we have sufficient capital to fund CapEx and related investments in our infrastructure, enable us to focus on acquisition and expansion activities, take advantage of opportunistic inventory buys and return value to you, our shareholders, through our dividend and share repurchase programs. To summarize, we had a good fourth third and a very good year in 2014, delivering record top line and EBITDA results. We’re very optimistic about 2015 in leveraging the foundation we are building for the future. And with that, I’d like to thank all of our employees, our vendors, our customers and you, our shareholders, for your continued support. Operator, you can now open the line for questions.

[Operator Instructions] And our first question comes from Mark Wiltamuth.

And our next question comes from Andrew Wolf.

And our next question comes from Chris McGinnis.

And our next question comes from John Lawrence.

[Operator Instructions] And we do have Andrew Wolf back in the queue.

[Operator Instructions] We do have Chris McGinnis back in queue with a question.

And we have no further questions at this time.

Thank you for your participation in our conference call and for your interest in Core-Mark. We are pleased with the results for the year and believe that 2015 will be another terrific year for the company as we execute on our core strategies and take market share. If you have any additional questions, please feel free to call me at 650-589-9445. Thanks operator.