Performance Food Group Company (PFGC) Q2 2015 Earnings Report, Transcript and Summary

Welcome to the 2015 Second Quarter Investor Call. My name is Alex, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] Please note that this call is being recorded. I will now turn the call over to Ms. Milton Draper. Ms. Draper, you may begin.

Thank you, Alex, 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 projects. 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 second 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 second 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. Thanks for joining us on our call. I hope you noticed we have raised all aspects of our guidance reflecting the good year we are having through the first six months of the year and the momentum we continue to see in the markets in which we compete. All of our hard work over the year seems to have reached an inflection point and I feel very optimistic about where we are going both in the near term and the long term. There are number of factors driving our confidence. First, this year, we have taken market share both in gaining new categories and existing stores and adding stores. Secondly, we have renewed a number of our significant large customer contracts securing a good foundation for the future and lastly, we have tremendous opportunity for meaningful market share wins in the near future. The size and the scope of the bids we are participating in represents very significant opportunities. I really have not seen anything like this in my career at Core-Mark. We do hope to have additional good news before the year is over so stay tuned. I would also like to update you on the Rite Aid business. We continue to partner with Rite Aid and expand the products that we are delivering to their stores. We recently began servicing an important traditional category. We expect this additional volume will take cost out of their supply chain and add greater efficiencies to our delivery of product to their stores. We are excited by this development with such an important retailer. We look forward to growing our partnership with Rite Aid and are exploring ways to expand their fresh and good for you product selection. For example, we are delivering dairy and organic dairy products in some markets and fresh sandwiches for the remodeled stores that have reach and refrigeration units. We have successfully the integration of the new customers for our most recent acquisition of Karrys Bros. in Ontario, Canada. It is our intent to partner with these retailers to help them enhance their offering overtime thereby increasing their profitability and relevancy in the marketplace. These 1,500 new customers are now being serviced by our Toronto division. Prior to that, we were operating duplicate infrastructures which the integration was taking place. With the integration complete, our Toronto division will begin to leverage their fixed cost and improve their profits by handling this incremental volume out of one division. Core-Mark had a solid quarter and a very good first half of the year and we remain very optimistic about our business. For the quarter, our sales increased 8.7% adjusted for foreign currency fluctuations and we continue to see same store sales increasing both the cigarette and non-cigarette categories. Same store sales for non-cigarettes increased 4.9% and fresh sales grew at a robust 22%. These are the metrics we rely on to measure how well our core strategies are performing and to ensure we are providing the right food that consumers want to eat. This also confirms recent consumer trends towards healthy and good for you options and supports our core strategies which are focused on helping the retailer fulfill these needs. All-in, our non-cigarette sales increased 8.5% for the second quarter after adjusting for the impact from foreign currency fluctuations. In addition, we saw same store carton sales increase for the third straight quarter in a row, up 1.2% this quarter. We continue to suspect that this is a result of some combination of lower fuel prices, a recovering economy and the exit of CVS from the tobacco business. As a reminder, CVS sold approximately $2 billion of the $3.7 billion in cigarettes sold in the U.S. drug channel in 2014. We have not seen the normal historical decline in cigarette consumption in our same store sales in recent quarters. Right now, we do not know that this positive trend will continue. What we do know is that we expect to grow our carton sales by taking market share as we have in the past. We have started seeing an increase in excise taxes and in some cases we have meaningful hold and gain opportunities associated with the increases. All-in, cigarette sales increased 7.2% and this growth is expected to accelerate as we add the tobacco volume from new contracts. Also, we are expecting approximately $9 million in exercise tax holding gains in the second half of the year. So we are feeling pretty good about this line of business. Operating expenses in the quarter reflects an increase in our investment spending which included the addition of the new Ohio division and the absorption of the Karrys business. As a percentage of sales, total OpEx increased 18 basis points driven by warehouse and delivery expenses which increased 17 basis points. We did see a 6.1% increase in cubes and a 10% increase in deliveries which contributed to some of the higher operating expenses. I was not pleased with the increase in our warehouse cost as we did not adequately prepare for the rapid increase in our summer sales volume. This is an area my team and the division management teams are focused on improving. These improvements will consist of better recruiting, training and staffing plans. We did have success in reducing our transportation cost this quarter. The driver pool has improved and we have expanded our in-house driver training program which now includes in excess of 50 participants. We also benefited from the lower fuel cost including the savings from our CNG trucks and decreasing miles driven for the customers we transfer to our new Ohio division. We also announced with our partner again the opening of the fourth CNG station in Smyrna, Georgia where we are the anchor customer. We expect again to open one more CNG in partnership with us this year. Bottom line EBITDA was up 10% for the second quarter and is up 21% year-to-date. My confidence in the fundamentals of our company and the industries we service continues to strengthen. The raising of our 2015 guidance reflects this confidence. The sales guidance increase of $200 million is being driven primarily by market share wins particularly in the cigarette and tobacco categories. In addition, our EBITDA and EPS will benefit from profit generated from the increase in our sales along with a $9 million excise tax holding gain which will be partially offset by a number of items that Stacy will discuss. All-in, our EBITDA guidance was increased by 5% and our EPS by 9%. As to our core strategies, these continue to perform well. VCI and fresh incremental sales in the quarter were up over $33 million and $55 million year-to-date with the stronger half of the year still to come. We continue to focus on expanding the categories we serviced in our stores through vendor consolidation. We have expanded our private label products with our core essentials program and are now getting products with our core gear program. We believe for the more product categories on our trucks helps to increase the profitability of our customers and the relevancy in the market. Our recently launched farm to market program is doing well with over 1,200 racks out in the field and we have began the roll out of our new Boyd's Coffee program. Both of these innovative food programs help us improve our customers financial performance and grow our market share. FMI is also doing well with nearly 1,500 store surveys completed year-to-date and we are in target to complete our goal of 3,000 this year. The average profit improvement in our surveys stores remains in the range of $20,000 to $25,000 per year and we see the non-cigarette purchases grow more than two times faster than the stores that have not participated. The acceptance rate of our recommendations is currently at 65% so we are making incremental improvements each year. In addition, we are gaining traction to using this program in an abbreviate fashion to close the deal on some new customers. The convenience store industry remains healthy today and no small part due to its proven ability to adjust to the ever changing consumer demands. This is one of the core strengths of the c-store industry. In addition, the consumers desire for convenience is accelerating. Today’s convenience shoppers want fresh, healthy and good for you items and there is a growing need for snacks. I am very confident that our core strategies, vendor consolidation, fresh and FMI are exactly what our customers need to meet the challenges they faced to attract and serve the ever-changing needs of their consumers. In summary, business is good and our future looks bright. We are executing well and our approach is resonating in the marketplace. We continue to invest in our people, technology, systems and assets in order to support the future long term growth of the company. It is my responsibility to make sure this organization as tools and resources it needs to support our continued growth and to ensure we adequately leverage these investments to return value to you, our shareholders. 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 an overview of our revised EPS and adjusted EBITDA guidance and then move into our second quarter results. We are raising EPS estimates by $0.16 on the low end and $0.19 on the high end or approximately 9%. For adjusted EBITDA, we are raising guidance by $6.5 million on the low end and $7 million on the high end and now expect to achieve between $133 million and $136 million for EBITDA. The primary driver to the increases in EPS and EBITDA guidance is a $9 million excise tax holding gain resulting from two taxing jurisdictions that raised excise tax rate from July 01 and allowed us an opportunity to recognize a holding gain for inventories on hand. Our division and purchasing team did an excellent job maximizing this opportunity and we expect to realize this holding gain as we sell through the related inventory. The majority of the tax holding gain will be recognized in the third quarter, but we may see some of the tax gain trickle into the fourth quarter. In addition, we expect to see an increase in our operating income associated with the recent market share sales gains predominantly in our cigarette and tobacco categories. Both of these income opportunities will be offset partially by pension settlement charges resulting from lump sum payments and other pension activities we have undertaken to reduce our pension liability. Current estimates forecast pension expense of $2.2 million to $2.5 million, which could ultimately be higher or lower depending on acceptance rates and discount rates. You should note that this is a non-cash charge and essentially recognizes deferred pension valuation losses sitting in our equity accounts. We have also contemplated in our revised guidance a $2.2 million increase in bonus and stock comp for the year. Certain key assumptions for EPS remain unchanged that include $16 million for LIFO expense, $8 million for cigarette inventory holding gains, a 38% tax rate and 23.4 million dilutive shares outstanding. We have not contemplated any increase in operating profits related to the current robust RSP landscape nor any CapEx or startup costs related to any large customer account wins that maybe in our future. We will adjust guidance accordingly or build into our 2016 guidance that some of these larger opportunities come to fruition. For 2015, we are now expecting an EPS range between $2.03 and $2.10; excluding LIFO expenses equates to an EPS range of $2.45 to $2.52 and compares to $2.26 in 2014, a 10% increase at the mid-point. Remember that our 2014 results included approximately $0.16 per share of candy holding gains and $0.20 per share for net OTP tax items. As a reminder, guidance for 2015 also includes $6 million to $7 million of investment spending related to infrastructure, technology and people needed to support future growth. This investment spending does not include the expansion activities for Ohio and Karrys. Despite all of these investments, our expected earnings reflect solid execution and healthy growth. Moving on to second quarter results, diluted EPS for the second quarter was $0.57 compared to $0.52 last year. For those of you who model EPS, excluding LIFO expense this translates to $0.66 for the quarter compared to $0.63 last year, nearly a 5% increase. For the first half of 2015, EPS excluding LIFO expense was $0.97 versus $0.80, a 21% improvement. Sales increased 7.1% to $2.8 billion, compared to $2.6 billion last year. Excluding the impact of foreign currency, sales increased 8.7%. The weakness in the Canadian dollar reduced Canada’s contribution to sales by about $42 million for the quarter. Cigarette sales increased 7.2% to $1.9 billion, compared to $1.8 billion last year, driven by a 6.1% increase in carton sales and a 1.1% increase in the average selling price per carton, including FX impact. The largest drivers to carton sales growth were market share gains, the Karrys acquisition and a 1.2% increase in same-store sales. This compares to industry carton shipments adjusted for trade loading, which were modestly down for the quarter. Our food/non-food category sales increased 6.9% in Q2 to $911 million compared to $852 million in the same period last year. This $59 million increase was led by our food categories, which increased 9.6% or $36 million, compared to the prior year. Fresh foods in particular were up 22% and now represent approximately 21% of our food category for the quarter, up from a little over 18% last year. One other category stands out, snacks, which increased about 14%. Fresh & snack growth also reflect U.S. consumer trends where snacking represents over 50% of all evening occasion and 91% of Americans are snacking daily. Gross profit increased $15.6 million to $158.9 million, an increase of 10.9% for the second quarter of 2015. We recorded $0.9 million in net OTP tax refunds, $0.5 million in incremental cigarette holding gains and LIFO expense decreased $0.8 million compared to the prior year. Remaining gross profit, which excludes the aforementioned items increased $13.4 million or 9.3% to $157.7 million. Remaining gross profit margin increased about 11 basis points for the quarter or 17 basis points if you adjust for the 6 basis point compressing effect of cigarette manufacturer price increases. Cigarette remaining gross profit increased $2.7 million or 6.7% to $43.2 million, benefiting primarily from the 6.1% increase in carton sales. For the quarter, remaining gross profit per carton was up slightly. Non-cigarette remaining gross profit increased $10.6 million or 10.2% to $114.5 million for the second quarter of 2015. Remaining gross profit margins for non-cigarettes increased 37 basis points, which is coincidentally the same basis point increase year-to-date. Our strategy is focused on improving the non-cigarette margins by 20 basis points per year, excluding any compression events, which we normally call out. We are quite pleased with the strength of our food programs, particularly fresh which is contributing meaningfully to this margin growth. Candy also generated some lift in the overall food/non-food margins this quarter, due to some new vendor agreements, trade show income and other sourcing activities. Moving on, operating expenses were $136.7 million in the second quarter this year compared to $122.8 million for the same period last year. Operating expenses as a percent of sales were 4.9% compared to 4.7% in the second quarter of 2014. Operating expenses included $5.2 million in incremental costs for Ohio and Karrys Bros, as well as 0.8 for the integration of Karrys’ customers into our transfer division. Excluding these items, operating expenses as a percent of sales increased only 3 basis point and included approximately $2 million of investment spending impacting primarily SG&A. Warehouse and delivery expenses increased $10.5 million or approximately 13.4% to $88.6 million during the second quarter of 2015. Excluding the incremental operating expenses for Ohio and Karrys, warehouse and delivery expenses increased $6.7 million or 8.6%. This increase was driven by a 6.1% increase in cubic feet handled and a 10.1% increase in the numbered deliveries on a comparable basis. Higher healthcare and workers’ comp expenses contributed $1.9 million of the warehouse and delivery increase driven by the severity of certain plants and higher headcount. Mileage also increased approximately 10%, but was leveraged by lower fuel cost, a conversation to CNG fuel and stem mile reduction. SG&A expenses increased $3.5 million or 8% during the second quarter, excluding incremental costs related to Ohio and Karrys comparable SG&A increased approximately 3% and as a percentage of sales decreased 5 basis points. This includes investment spending of approximately $2 million in the quarter. In recent calls, we’ve mentioned our estimate of between $6 million to $7 million of investment spend. So far, we’ve spent approximately $3 million year-to-date. These investments support longer-term value creation and are necessary to maintain our continued growth. Moving to cash flows, cash generated from operations before working capital changes increased 19% from $48.1 million for first half of the year compared to $40.4 million for the same period last year. Changes in working capital which measures two single points in time resulted in the use of $59 million in cash year-to-date 2015 compared to the generation of nearly $27 million in cash for the first half of 2014. The $86 million swing in cash use for working capital related primarily to inventory levels on hand at the end of June 2015 as we maximize our excise tax holding gain opportunity. As we said in the past, our peak inventory levels are generally June 30 before the July 4 holiday and December 31, when we are building inventories to preserve our LIFO position. We've also indicated that one of our uses of free cash flow is focused on maximizing inventory speculative opportunity as such in addition to the normal high levels of inventory at June 30. We also purchased additional excise tax stamps and cigarette cartons in order to maximize the holding gain opportunities in two of the taxing jurisdictions. Without getting overly complicated with the details to leverage this opportunity, we purchased approximately 20 weeks of additional inventory resulting in $9 million of holding gain that will be recognized in the second half of this year. My hats-off to the division and corporate teams who created and executed on this strategy given short notice and logistic hurdle a major win for the company and our shareholders. As a result of this temporary spike in inventories occurring in the last couple of weeks of June, free cash flow is negative year-to-date by approximately $21 million. However, as we flush excess inventories, I expect free cash flow will return to normal levels and we still expect full-year free cash flow will be in the range of $65 million to $70 million subject to any unusual spikes at year-end. We have spent over $14 million of CapEx for the year and have $3.4 million committed through June. We continue to believe that we will spend approximately $35 million by the end of the year. Average debt for the quarter was $37 million compared to $6.9 million is 2014, and our peak debt position was $121 million on June 29. Again our inventory strategy related to the excise tax holding gains was the driver to this increase. We have spent $6 million on share repurchases and paid $6 million in cash dividends through June 30. We have also announced our third quarter dividend in our press release this morning. Our capital allocation decisions support our core strategies and focus on ensuring we have sufficient capital to support initiatives that will ultimately return value to you our shareholders. Our investments in CapEx and related infrastructure and our acquisition in the expansion activities are all focused on the long-term value creation. Opportunistic inventory buyers may be shorter term, but are an integral part of the wholesale business and helps us maximize free cash flow that allows us defend our dividend and share repurchase programs. To summarize, we are having a good year and are very optimistic about our future. At the same time, we continue to focus on infrastructure, cost control, and leverage opportunities that drive earnings. As we have said before, the best predictor of the future is our past performance. Our revenues have grown 8% to 10%, including expansion activities and where EBITDA performance has improved over the years from 10% to 12% both metrics on a compounded basis. We’ve also said that our results in growth may not be linear and of course cannot be guaranteed, but over the long term we view our selves as a steady company and believe these bench marks should be a reasonable expectation. And with that I would like to thank all of our employees, our vendors, our customers and you are shareholders for your continued support. Operator you can now open the line for questions.

Thank you and we will now begin the question and answer session. [Operator Instructions] Our first question comes from [indiscernible] from Stephens, please go ahead.

And our next question comes from Mark Wiltamuth from Jefferies, please go ahead.

[Operator Instructions] And we have a question from Chris McGinnis from Sidoti & Company. Please go ahead.

And we have no further questions at this time.

Thank you for your participating in our conference call and for your interest in Core-Mark. We are very pleased with the first half of the year and believe the momentum we have in our business will enable us to have an even better second half. If you have any follow-up questions, please give me a call at 650-589-9445. Thank you and thank you operator.