Good afternoon, and welcome to the Performance Food Group First Quarter Fiscal 2017 Earnings Conference Call. Today's call is scheduled to last about 1 hour, including remarks by PFG's management and the question-and-answer session. I would now like to turn the call over to Mr. Michael Neese, Vice President, Investor Relations for PFG. Please go ahead, sir.

Thank you, Stephanie. And good evening, and thank you for joining us. We're here this evening with George Holm, Performance Food Group's CEO; and Tom Ondrof, PFG’s Chief Financial Officer. During our call this evening, unless otherwise stated, we are comparing first quarter fiscal 2017 results versus the same period in fiscal 2016. We issued a press release regarding the results after the close of the market today. You can find our earnings release on the Investor Relations section on our website at pfgc.com. Our remarks and the earnings release contain forward-looking and cautionary statements and projections of future results. Please review the forward-looking statements section in today's earnings release and in our SEC filings for various factors that could cause actual results to differ materially from forward-looking projections. On today's call, we may reference certain non-GAAP financial measures. Descriptions of these non-GAAP financial measures and reconciliations to the most closely comparable financial measures calculated in accordance with GAAP are included in today's earnings release and in our presentation slides. Now let’s turn the call over to George.

Thanks, Michael. Good evening, everyone, and thank you for joining us today. I'm pleased to announce PFG's results for the first quarter of fiscal 2017. Our underlying business performed well in the quarter, however, we experienced many challenges during the first quarter. We grew our total sales cases by 6.5% with incremental market share gain. This is at the high-end of our 4% to 7% guidance. The 6.5% total case growth is one of our best growth quarters since fiscal 2015, despite our national account business softening during the quarter. Our Performance Foodservice segment reported strong independent case growth of 8.0%, and double-digit independent Performance Brands case growth, all of which were organic. We made planned strategic growth investments in PFG Customized and Vistar in the first quarter and these investments will continue through our fiscal second quarter as we enhance our diverse business model to further provide us significant growth opportunities in fiscal 2017 and over the next several years. We experienced higher-than-expected new business transition costs and corporate expenses during the quarter, leading to adjusted EBITDA coming in below last year and below our expectations. Tom will discuss this in greater detail in his remarks. We remain focused on improving sales, productivity and increasing gross profits. We continue to expect to grow our overall cases in the 4% to 7% range in fiscal 2017, and grow our independent cases in the 6% to 10% range. We are focused on managing our corporate expenses, but at the same time, we'll continue to add talented sales associates as we enhance and strengthen our foundation for growth. In addition, our pipeline for future M&A continues to be attractive. Before we get into the financial details, I would like to continue our practice of highlighting one of our associates this time for…

Thank you, George. It's great to be a part of the PFG team, and I'll look forward to contributing to the continued growth and success of the company. I'll briefly go through our detailed first quarter financial results, discuss our cash flow and balance sheet and wrap up with our fiscal 2017 outlook. As George mentioned, case volume growth was very strong at 6.5%, while net sales for the quarter increased 3% over prior year to $4 billion. The difference between the sales and case growth rate was primarily a result of ongoing deflation. It was also impacted by case pack size changes from some of our suppliers. Gross profit dollars also showed solid improvement increasing 6.3% in the quarter compared to prior year. The increase was the result of growth in cases as well as selling and improved mix of products in customer channels, specifically, through the independent channel. Operating expenses increased 9.7% to just under $480 million during the first quarter versus the prior year period. While we planned for our operating expenses to increase in the quarter due to the strategic growth investments in Vistar and Customized, significant additions in our sales force and incremental expenses with being a public company, we were further impacted by higher-than-expected new business transition costs and corporate expenses during the period. Let me take a moment to expand on each of those starting with new business transition costs. The rollout of sizable new customer accounts at Customized and Vistar was in full swing during the period. In order to ensure we provided a seamless transition with complete product availability and outstanding customer service at each location, we opted to incur higher-than-planned labor, facility and transportation costs. Along with the startup costs to bring our new automated retail center online, these short-term…

[Operator Instructions] Your first question comes from Vincent Sinisi of Morgan Stanley.

Wanted to just ask, regarding the investments around Customized and Vistar, sounds like kind of maybe a bit higher-than-expected, but so far things are going at least relatively well. Can you maybe just give us a little bit more color around kind of the different steps, and how we should kind of think of the investment path as we go forward? I think you mentioned for at least one of the items kind of normalize as we get into the second half. But if you could just give us a little more color around kind of the basics of the process and how you see that as we progress through this year, that would be great?

Yes, I'll start with Customized. This is George, and I'll move into in the Vistar. With Customized, we thought we had things planned out fairly well as to when we'd exit business and when the new business would come in, and we had a couple of the chains that did leave early, which was fine. We still decided that, we obviously aren't going to lay off employees for a short period of time and then try and bring them back and risk losing them. So we held on to all those employees with less business than we expected, so that we could on-board the new business properly. It has gone very well. We haven't had any issues. Great help from our people and from theirs. And we now have all that business in place starting this week. So we expect to have some impact in November, obviously, not anywhere near what we had in the first quarter. And then as we go into December forward, then we'll be in very good shape there with good growth. We will have less customers, actually less concepts, less SKUs, we'll have more scale per concept. Obviously, higher dollar sales, higher gross profit dollars, fewer stops and bigger drops. So that situation is now behind us, and we feel very good there. When you get to Vistar, not quite as simple. The additional distribution center that we put in New York until we find the right facility to put the 2 together, and it's not something that we want to rush and make a mistake. We need some significant excess capacity there for some things that we have in the future. So that's going to continue. It does get better each month. I think we'll be able to give much better guidance coming up. Our productivity has gotten close to what we are in our other Metro New York Center, but we lose a lot in density because we're only doing one piece of business out of that distribution center. Then, if you move to -- by the way, we also brought that into our Connecticut, our Mid-Atlantic and our Carolinas distribution center with a little bit of pain there, too, but that's all behind us, and those centers are back to normal productivity and have the additional business. If you move to our retail automation facility, what we call Retail Central, that's in Memphis, once again, getting better all the time. We are adding business into there each week. We're taking it slow, and we're taking it carefully. But once again, better productivity all the time. We're at a point now, we are more productive in that automated facility than we are in our existing pick-and-pack facilities, which are entirely manual. So good news there. It's just going to take us a little time to get that consolidated from 2 down to 1.

Okay. That's very helpful, George. And just a quick follow-up, if I may. Your 2 main competitors, of course, have reported this week as well. And I think there's maybe just a little bit of confusion on kind of some -- what you're seeing either in results and/or commentaries by some of the managements, in terms of, just kind of the overall health of the restaurant, in particular, industry. So if you guys could just kind of give us your take and by customer segment within that, that would be great?

Yes. This will just be obviously my take and what we see. We're in a little different world than them. I think they both had real good quarters, and we had better growth, but certainly not as good quarters as they had. If you look at our Performance Foodservice business, we were -- in the month of August, we're right at 9.0, the same independent growth that we had run the previous quarter. As soon as we hit the conventions -- we hit the political conventions, we saw a little softening. We were like mid-7s for case growth in the month of August, a little softening during the Olympics as well. As we got into September, we perked back up again, a little under 8. And then in the last weeks, we've been actually better again. So whatever that means, I'm not sure. I think it means that the independent restaurant continues to do well, and we're doing well in that area. And Performance Foodservice, our national account business, did weaken throughout the quarter, and that's continued into October. We go to our Customized business and we saw continued weakness in casual dining, that has continued into the month of October. We don't expect it to continue from here. Fortunately, we'll still have sales growth because of our additional new business. But we think a lot of it has to do with, I guess, the election, maybe this disconnect between the price of food at home and the price of food eaten out. Our Vistar business has been extremely strong. Every channel that we're in, we are seeing sales growth, and we're actually growing that business organically better than we've grown that business, I would probably say, in its history since at least -- since we've owned it, which was 2002, so kind of 3 different worlds there, but that's what we see today.

Your next question is John Heinbockel of Guggenheim Securities.

George, I was going to ask, when you look at Vistar, it looks like there was a sequential pickup, right, if I back out the extra week from the fourth quarter. So is that primarily organic? And what channels -- I know it's broad-based, but what channels would drive the bulk of that? Is there 1 or 2 that stand out?

Well, the bulk of it is organic. Our acquisition wasn't real big. As far as the channels that are driving it, one is maybe not necessarily a channel, but we call it good-to-go, and it's like protein bars and energy bars and energy drinks and things like that, where we've put a great focus on. That would be the fastest-growing part of our business even though it goes across several different channels. Our business in hospitality has grown well as more people put pantries into their kind of mid-scale hotels, it's where that's been good. Theater business has been okay. Our retail business in spite of retail being soft, but our retail, what we call our big box business, has been very strong. And then, vending has been an industry that has lived for a long time. And for the first time, we are seeing -- well, we've grown each year, but it's just been through adding share, and it's been fairly small growth. We're seeing good growth there today. We think it's got a lot to do with micro markets, a lot to do with a free vend, which is something that started on the West Coast, and it's really spreading, so that's been good for us. But really it's just across every business that they're in, we're seeing good growth and double-digit in some of the channels.

And then secondly, so when I look at the Performance Foodservice segment, I know you're up against a big gain a year ago, but mid-single-digit, probably one of your slower rates of growth in the past couple of years, was there any investment in that business [indiscernible]?

We invested -- yes, we invested fairly heavily in sales people. We have 3 large additions that we're doing to facilities, but that would not have impacted us to any real degree. What it was really is, we've been building that business, we've been building people, we've been adding a lot of drivers, we've been adding sales people. We actually are at the highest level of increase from a percentage standpoint in sales people that we've been in many years. What really impacted us there the most, I would say, as far as not leveraging as well as we would like to have been, would just be the softest that we experienced in national accounts. If you think about our Performance Foodservice business, and you compare that to our competitors, we do so little in health care and contract feeding and lodging, the restaurant industry, especially the chain world was slower, at least that's what we read everywhere and that's what our business is, when you get outside of our independent restaurant business. So I think that probably had something to do with it, but we're very confident moving forward in our Performance Foodservice business that, that we'll do a much better job of leveraging the growth that we have the rest of the year, and we'll be up against slightly softer comps.

Your next question is from Kelly Bania of BMO Capital.

I was just curious, what was the dollar amount of incremental transition costs that you experienced in Q1 above your expectation, and how should we think about that in Q2? And I guess, on top of that is, is that something that you expect to cycle and not incur in next year when we get to Q1 and Q2?

Kelly, this is Tom. Just to answer the second question first. Yes, unless there are additional investment opportunities that we come across later in the year, but none of those are sort of right in front of us at the moment. I think the best way to look at that transition costs is the operating expenses are up about 970 basis points. About 250 of those are what we would say, would be -- were higher-than-expected, 250 basis points in 2 buckets. The corporate cost, I talked about, medical, worker's comp, were about 60% of that and the other 40% were the transition costs -- or sorry, yes, the other 40%. So of the 250 basis points, 60% of it was corporate costs higher-than-expected and 40% were transition costs higher-than-expected.

Yes, this is George. I think I'll add a couple of comments to that. We operate with quite low expense ratios, and we're used to leveraging growth when we have growth. But these were somewhat unusual circumstances. We'll get our arms around each one of these. And I think, I'll put it to you this way, what I tell our people today is, let's not let this quarter bother us very much, we've got a lot of great things going on, but don't be patting yourself on the back when we get to this time next year either because we'll have some easy comparisons. But we don't see anything here in the near future that would be any big investment. We got plenty to kind of get on track right now, and we've got some good built-in growth. So that's our biggest emphasis right now is to get back to leveraging this growth that we have.

Okay, that's very helpful. And then, I guess, your guidance for the second half is now for, I think, you said mid- to high-teens EBITDA growth. And I think it was mid-single-digit to low-double-digit prior. So I guess, just the delta there, are you expecting these investments to kind of drive some incremental EBITDA in the second half or what is the difference in the guidance there in the second half?

Yes. Obviously, number one is, we leverage this growth that we have. That's the number one of this as far as kind of importance going. We have some additional business that's coming in just after the first of the year, which will also help us. And I think another thing to remember, some of this investment started in May of last year, it was very heavy in June. So we're going to have some fairly easy comparisons as we get towards the end of the fiscal year. So that's part of it as well.

Your next question is from Edward Kelly of Crédit Suisse.

So could I just -- I want to start with a follow-up on the transition costs. George, it sounds to me like taking a step back and listening to you guys that the issue on this side is more timing-oriented than, I guess, execution-oriented, and I just wanted your thoughts as to -- around whether that's fair or not. Why is it harder to forecast some of this stuff? And then as it relates to all of this, is there anything that's going on here that would impact the customer and what the customer sees from you?

No. I think that's part of what caused some additional expenses. We wanted to make sure that the customer didn't. And I would have to tell you that our initial performance in the dollar segment in Metro New York was not something we were proud of, but we got that handled fairly quickly. And other than that, and I would have to say, other than that, I don't think our customers have seen any difference in us.

All right. And also just a follow-up on the guidance, and I'm just going to ask the question in a very straightforward way. And the question really is, is it conservative enough? And the reason I ask that is because, obviously, you were just asked about the back half and the guidance is now higher than what it was before. But could you just maybe give us a little bit more color to give us some comfort on what's changed today versus the end of last year that gives you more confidence in the back half of the year?

Well, I guess, so we have some additional business coming on. We typically, through the year, we build payroll and we don't see that really happening. We've already made those investments early in the year. The only thing I would say where it could be -- we might be conservative or not conservative, I guess, I should put it, is that we really don't expect to see the national account business as, I guess, I would use the term weak as it's been the last couple of months. We're kind of through the kind of the political stage here. We also are through the Olympics and some of the things that just seem to put some slowness into that business, and we just don't believe that people's eating habits change that quickly. The other thing that was impactful was that people didn't promote, some of these larger chains didn't promote much through that period of time. TV advertising was very expensive to get because of the political season. Radio time was very expensive to get. So there wasn't the advertising to support heavy promotional activity. So it's just a combination of many things, and we just feel we're not going to experience that degree of softness.

Okay. And just last question for you is related to M&A. George, you mentioned an attractive pipeline, could you just remind us of the types of opportunities you're looking for? Does the current -- the challenges of the business currently in the first half of this year impact in any way the way you would think about timing of all of this given that you kind of have a lot going on, I guess, as it stands?

No, not at all. We don't really announce acquisitions that aren't material, but we have done 2 in the last couple weeks. They're both center-of-the-plate companies, which is something we want to build on -- very important, obviously, broadline food service distributors, which we have a pipeline there. And then Vistar, we're always looking at the right opportunities, and we have confidence that we'll have more of those. From an operating standpoint, right now, the issues that we're dealing with are so isolated, particularly with Customized back on track, and we have no desire to make any acquisitions in that business. So I think that it really -- it won't have any impact at all.

Your next question is from Karen Short of Barclays.

Just a couple of follow-ups in general. So first starting with Vistar. I guess, I'm wondering why there was a disconnect on gross profit dollar growth versus sales growth given that there was about a 300 basis point spread on that, so that's my first question and then I had a couple others?

Okay, on the difference between sales growth and gross profit dollar growth, we had a fairly good increase in sales in that dollar channel and a big customer involved with that has increased their SKU-base. So in other words, they're offering a wider variety of product. They don't operate with storage, the stuff is delivered and goes to the shelf. So they're using smaller pack sizes. And so it almost makes it appear like it's kind of deflation, if that's how you're looking at it, and that's not the case, it's just that our average case price in our Vistar channel was affected by that.

Okay. That makes sense. And then, I guess, just to understand OpEx increase, and I feel like you've been asked this, but I guess I still am not clear in the answer. But I feel like in 4Q, you indicated that you felt that you'd kind of resolved or smoothed out the OpEx lumpiness post fourth quarter for the new business. So I guess, I'm wondering what kind of caught you by surprise.

Well, the things that caught us by surprise were, it took us longer to get the automated pick-and-pack facility up and going. We had problems at one of the stations, took us a while to resolve that. We found that we didn't have the capacity in New York and didn't realize that it would take us -- it's probably going to take us a while to find the distribution center there. Like I said, these things are improving month to month. But -- so we're still dealing with that. And then we had Customized planned out pretty well, and then we had business that left earlier than expected. So it left us with more employees and a reduced the amount of gross profit dollars to a net period of time, which had a pretty significant impact on CapEx -- I'm sorry, on OpEx.

Yes, the Customized made sense on the OpEx, but I was kind of wondering on Vistar. But since you bring up Customized, just to clarify, so the top line miss then was entirely a function of the planned exits happening earlier than expected, meaning Red Lobster is contributing at the run rate you expected, I know you gave us a pretty detailed...

That's correct. But Karen, we did have a softer sales environment than we expected with our existing customer base. And we did talk about this on the last call, it hadn't happened yet, but we had one concept that it closed 98 stores. We had another concept that closed 27 stores. So those were rather unexpected for us as well.

Okay. And then just last question on deflation. One retailer earlier this or last week, I guess, mentioned that, salmon, in particular had turned inflationary, but I'm wondering if you could give some color on, given that your exposure to seafood is obviously higher now -- but what your deflation or inflation outlook might be for fiscal '17?

Yes, we've seen the deflation pretty much go away in seafood right now. The shrimp pricing has come back. And as you mentioned with salmon -- those are the 2 really big items. The areas that we're still seeing fairly significant deflation are in beef and then in cheese, and of course, eggs. That's somewhat deflation, but it's more about them being so high-priced last year.

And what are your thoughts for the year for deflation?

Well, we can only go with what, I guess, the supposed experts tell us. But it appears as if beef is going to stay down in price for quite a while just because of the availability unless something would happen in the export markets. Cheese was really going down last year. So from now until the end of calendar year, last year, it softened. So we don't expect to see a big reduction in -- we don't expect to see as much deflation as we've had over last year in cheese coming up from now until the end of the year and then probably not into next fiscal year should we see any deflation either. Our customer mix is -- our ideal mix is not the same for every company in this business, but I think, what was ours? 1.5%, I think, we have for deflation. Yes, so it's moderated for us some.

So maybe flat is possible for the year or...

I don't think it would be staying deflated that it would be flat. But I've perceived that it should continue to go down a little bit, and heavily impacted by cheese for us.

Your next question is from Bryan Hunt of Wells Fargo.

Just to touch on 2 topics that have been touched on already. One, when you look at acquisitions, I know you're always looking, you've done a couple, how would you describe the pipeline? Is it maybe more robust than it was a year ago or less? Is there any way you can kind of give it some quantification?

We haven't been as acquisitive in the last few years. But we would call it much, much more robust than it was then. And we feel better, probably today, I would say, than we have ever felt about the possibilities that we have in an acquisition area.

And is that because just numerically the number of companies that are for sale or is it because of the multiples are more reasonable or a combination of both?

No. I would say it's more so just people that are willing to sell today. Just a bigger pool.

And when I think about acquisitions, I think you all touched on this in the past, but where do you feel comfortable running the leverage up to on the balance sheet?

Well, we're going to be opportunistic, and it just depends on the quality of what's out there. But for us to lever back up, we've been a size 5.7 before, we don't -- certainly don't want to do that. But we could easily lever up a couple of more turns if the right acquisition was available.

Great. And then my last question is, when you look at all the projects you have, and it seems like you've got some duplicative facilities you're kind of exit. Automation, that you're getting to that project as well, kind of what's your outlook for CapEx? Last time we talked, it was $140 million to $160 million, has that changed at all in terms of tempo?

Our budget this year is for $150 million, so right in the middle of what you just described as the range. Once again, there, I mean, we're going to be opportunistic with it. We've got some great additions that we're doing now in our Performance Foodservice, and that's certainly where we most want to spend our money. The opportunity was great in Vistar to do this new facility. We did a large one. We have a very robust pick-and-pack business. We have a B2C business where we do fulfillment that we feel can be a big category for us, so that's why we did that. And then we've got a lot of OpEx that we can take out in Vistar just by going to one facility and 3 markets where we have 2. So those obviously will be something that we'll look to do when the right facilities are available.

And then my last question is, when you looked at the Customized division, and you pull out the locations that were closed and the roll-up of Red Lobster, is there any way you can gauge what maybe same-store case volume was in Q1, and do you feel like it has actually troughed, now that you've seen October numbers?

Well, I say this all the time. We're real careful that we don't talk about any of our customers, that's their job. But in its entirety, definitely soft at the same-store sales level. And I think they're all working hard at their business and they're improving their business, and we'll find out, I guess, coming up how much it had to do with the political season and the Olympics and just a soft environment. And we just feel like we're going to see some sequential improvement in that business.

Your next question is from Ajay Jain of Pivotal Research.

My question was actually mainly guidance related and about your conviction about the back half of the year. But I think you already got a couple of questions along those lines. So I wanted to ask you about the outlook for Q2 specifically. And I wanted to ask if you're expecting any stabilization in EBITDA trends? Or are you looking for similar decline to last quarter?

Well, at this point, we would expect it to be better than the first quarter. We're not projecting to be ahead of the previous year for that 26-week period of time. It's a little different quarter too from the standpoint that holidays affect our business a good bit. Last year, we did not have a holiday in November, this year, we will. Last year, we had 2 holidays, Thanksgiving, and Christmas in December. We will have -- I mean, and this year, we will have 2 holidays in December, but then in January last year, we had the New Year's holiday fell in January from a fiscal standpoint. It will -- I mean last year, it fell in December; this year, it will fall -- last year fell in January, this year it will fall in December, so we're going to have an easier comparison as we get into the third quarter.

Okay. I guess, just the commentary on the first half of the year gives a lot of room for interpretation for Q2. So maybe I'll just ask it slightly differently. I mean, do you expect directionally EBITDA's going to be up or down in the second quarter?

Slightly down.

Your next question is from Zach Fadem of Wells Fargo.

Just to clarify, can you help me bridge the gap to get to your 3% top line growth number? So if organic growth was -- organic volume was 5.3% and deflation was down 1.5%, can you help me just size the impact of the pack size mix change? And then what was the sales impact of M&A to get to that 3%?

Well, the M&A was very marginal, it's just one small acquisition in Vistar. I'd have to do the math. Do you have an idea on that, Tom?

I don't know. We can follow back up with you.

Okay, that's fine. We can do this offline.

Primarily, yes. We should -- they'll get that number to you, but in our Vistar business, we did grow our cases a good bit more than we grew our sales, so that's where it's going to be. It's not [indiscernible].

Yes, I mean, that's what I'm trying to get at is just a specific impact to bridge that gap. But just moving on, I want to follow up on an earlier comment. Just, George, with respect to your overall business mix, you're under indexed in some of the larger institutional verticals like health care, hospitality, et cetera, I'm curious how you think about the opportunity to expand there. Is it a matter of national scale? Are there any particular hurdles that prevent you from being more involved in those channels over time?

No. We do some business in those channels, where we have the kind of scale to do that and the kind of product line to be in health care. Not having national scale, we're certainly not going to be able to do a national program with all those -- with those type of channels. But for us, I mean, we're doing a significant job growing our independent business, and we'd rather focus on that today. I think we can only do so many things at one time and that's the growth that is the most important to us. And then to properly leverage our business, we want some growth in our national account channel, and that, we weren't able to get in this first quarter. We should have a little bit of it in the second quarter, and it will be better in the back half of the year. So we have several things that are just better in the back half of the year.

[Operator Instructions] And we do have a follow-up from Kelly Bania of BMO Capital.

I was wondering if you could talk a little bit about gross margin and the impact, if any, that Red Lobster has -- had on gross margin in the quarter. And I guess, how you think about gross margin for the next couple of quarters?

Yes. Well, our gross margin is improving in Performance Foodservice. It's fairly flat in Vistar. Our gross profit per case in Customized is slightly up. Our gross profit as a percent of sales is about flat. And as far as the impact of Red Lobster would have, I think a lot of that's got to do with how their mix of business settles in as they have some very, very expensive product, and we don't have a good enough feel for that yet as to what that will do from a margin standpoint. We do those programs where we do in great detail what our cost is to move the case of product and those are the fee-based, not margin-based. So we really don't look at it that close. But that is something we'll make sure that as we get through this quarter and into the next call that we'll give some real color on that.

There are no further questions.

Thanks, everyone.

I'd like to thank everyone for their participation on today's call. We look forward to presenting at the Morgan Stanley conference next week in New York City. Thank you.

Thank you. That does conclude today's conference call. You may now disconnect.