CORE
#Good morning, and thank you for joining us on our First Quarter 2017 Conference Call.
Our top line growth trajectory continued at a healthy pace in the first quarter, both in revenues and store count and we continue to make good progress on our core strategies.
However, our profit results did not meet our goals.
While some of the factors were outside our control, we need to continue improving our execution, especially hitting our productivity targets in 2 of our divisions that are involved with the integration of the 7-Eleven business.
I am confident we will get there and that is why we have reaffirmed our guidance today for 2017.
We have a strong organization, the right strategies to improve our profitability and continue our momentum in the marketplace.
I will provide a summary of the quarter and recent events and then Chris will walk through the quarter in details and discuss our outlook.
After that, we will take your questions.
I would like to start with a quick update on Rite Aid.
We are in deep discussions ---+ deep into discussions on a renewal of our contract.
As we discussed in our last quarterly earnings call, we expanded our product categories with Rite Aid and added dairy at their locations in Southern California and Northern California.
We will also be starting the planning process for delivering fluid dairy to approximately 700 stores in the Southeast.
We believe we will reach a mutually beneficial agreement in the near future and look forward to updating you at that time.
Now turning to the first quarter, we grew sales at a strong pace of over 16% and continue to gain market share with our net store count ending the quarter at approximately 42,000, which is up 8.5% year-over-year.
Despite this growth, we, along with other food distributors and retailers in our industry, face macro headwinds and challenges across our divisions.
These included bad weather in certain regions, higher fuel costs in the quarter, as well as continued overall weakness in consumer market demand.
These market dynamics are occurring at a time when we are scaling the company for growth.
Operating costs for the quarter were $30 million higher than last year's first quarter, including increases in cubic feet handle, higher fuel prices and miles driven, the addition of Pine State and infrastructure investment to support a larger company.
Our first quarter results also reflect the off-boarding of the 1,100 Circle K stores in the Southeastern region, that we previously announced.
Finally, the integration 7-Eleven stores continues to experience some challenges from a productivity and execution standpoint, particularly in 2 of our divisions where volumes have doubled.
The good news is we are making progress, although we know we have more work to do to get the execution and service levels improved and the cost right.
Taking all of this into account, adjusted EBITDA came in at $19.6 million compared to $24.1 million in the last year, which was one of the most profitable first quarters in the company's history.
As we look out over the rest of 2017, we see some real opportunity to better leverage our operating costs and refocus on the higher margin products to reach the financial goals that we have set.
We have some puts and takes in terms of off-boarding the Kroger stores, on-boarding the Walmart stores this month and absorbing the impact of the $2 per pack cigarette price hike in California.
Overall, we see significant growth potential and better bottom line performance ahead.
Bear in mind that the first quarter is historically our lowest EBITDA quarter of the year, typically under 15% of annual EBITDA.
As we move through the year, we are focused on leveraging our warehouse and delivery expenses through a number of initiatives.
We have plans to eliminate some inefficient stops and have mandated rerouting for all divisions to ensure our goal to reduce miles be achieved.
We also plan to leverage our largely fixed SG&A expenses to a greater degree, as volumes increase throughout the year and production levels and new hires increase.
As we improve the execution and new customer wins take hold, we have an excellent growth runway ahead of us.
As a result, we are reiterating full-year guidance for 2017 and we are fully committed to achieve our target of 9% to 14% adjusted EBITDA growth on a mid-single-digit sales increase.
Moving deeper into the quarter's results, sales of $3.5 billion included solid double-digit growth in cigarette and non-cigarette, and the strategically important food and fresh categories.
The strong sales volume is driven primarily by market share wins and additional volume from the Pine State acquisition.
Sales for the center of store categories and higher-margin items were softer than expected due to weaker-than-normal consumer demand.
We were able to rebound somewhat from a rough start in the first 2 months of the year and had improved performance in March that we are seeing continuing in April.
We remain very encouraged by our performance in our growth categories, which include food, up 11% and fresh, which increased 14% despite the macro pressure space.
Food and fresh are key elements of our core growth strategies and we believe they will help drive strong earnings growth going forward.
The largest challenge to earnings for the quarter were warehouse and delivery expenses, which increased 25% during the quarter.
The higher expense levels represent a significant amount of effort required on the part of our operations team to absorb the large increase in volume and execute with a high number of new employees.
We also increased comparable cubic feet of products shipped by 2.9%, increased deliveries by almost 7% and increased miles driven by 4.4% in the quarter.
SG&A expense grew 12%, but as a percentage of sales, declined 6 basis points.
We believe the investments we have made are prudent and will certainly pay off during the balance of the year, and in the longer term, as we observe these additional cost and volume increases.
I would like to provide an update on our core growth strategies.
Recently, several of our senior leaders attended and participated in a NCA State of the Industry Conference.
There was good discussion at the event of the current state of our industry and it aligns well with our core strategies.
A few important trends I wanted to highlight: first is the demand for fresh.
It's becoming clear that consumers are favoring products that have the appearance of being less prepared and are both fresh and convenient.
Secondly, is understanding consumers' growing focus on health and wellness.
C-Stores can no longer just replace product offerings, they must stay ahead of the curve in thinking about consumer trends and Good For You offerings.
Third is continuing innovation of the store experience, both in-store and out.
Competition is intensifying and broadening.
Other retail formats are emerging as warehouse stores, traditional drug stores, dollar stores, offer many of the products found in convenience stores.
Some retailers, like Walmart are even exploring the C-Store format themselves.
C-Stores continue to fare well competitively, but as operators, they need to think about their offerings.
They must understand that all types of retailers are looking to offer convenience and scale into smaller footprints.
Fourth, the growing dominance of e-commerce and the emergence of home delivery, both are driving new competition, while also creating opportunities for those who figure out how to harness digital solutions to drive greater convenience for customers.
And finally, trends in digital marketing.
The industry's traditional promotional awareness programs and campaigns have lost their effectiveness, especially with the millennial and future generations who have very distinct and different purchasing habits than C-Store core customers.
Helping our customers stay in front of these trends is critical to their success and our ability to anticipate and provide innovative solutions to these evolving trends is key to successful partnerships with our customers.
These are the primary drivers to our focus on our core strategies.
We continue to make good progress with our strategies and further differentiate ourselves in the market in which we compete and drive incremental financial returns as well.
Our vendor consolidation initiative and fresh food strategy both performed well in the quarter and generated $34 million in incremental sales.
The fresh category was led by dairy and bread product, which grew 21% and 13% over last year's first quarter and were the largest contributor to the growth of the fresh category.
We are committed to focusing on these opportunities that offer our customers fresh, healthy food that meets their changing demands.
We have several new programs and products to advance our strategy that I will touch on.
We have been working on a new pizza program to serve our customers that will feature crust made from scratch, 100% California vine-ripened tomatoes for the sauce, 100% mozzarella cheese with no preservatives and packaging made from recycled materials to offer a more sustainable footprint.
We anticipate the pizza program to be complete by late June and ready for launch in July.
We are also in the exploratory stages of looking at kiosk sandwich programs whereby sandwiches are made fresh in store for customers.
This is on trend with what consumers perceive as fresh, meaning they can see the product actually being assembled to order while they are in the retail location.
We are exploring for both national branded and private branded, as potential solutions.
We see this as a late 2017 to 2018 opportunity for Core-Mark.
Turning briefly to our Core Solutions Group, this is a critical part of our strategy to help customers gain a competitive edge and face the industry's challenges.
In the first quarter, we conducted over 800 FMI surveys with a greater than 60% acceptance rate.
We continue to see these stores grow their nonsurrogates at a higher rate compared to stores that have not participated and we continue to see a significant reduction in turn rates for these independent retailers.
We are accelerating the number of FMI surveys to be completed this year, which will assist us in reaching our financial goals for the year.
At the same time, we know that these surveys will assist our customers to grow their profits in a soft retail environment.
In closing, I would like to reiterate that we are focused on operational execution and the growth of the higher-margin products, as well as continued market share gains.
This means we must accelerate our core strategies in order to deliver the margin enhancement that will drive profitable growth.
We have the right approach in place, but we also have more work to do to better leverage our fixed costs and drive the productivity gains that we expect as we increase scale.
I am confident that we will get there.
The investments we have made to expand our business, build our infrastructure and innovate in our operations give us the tools to achieve our margin goals and deliver strong healthy returns over time.
With Walmart coming on board and our momentum in the marketplace being strong, our future is bright and we have tremendous opportunity to create shareholder value in the years ahead.
I will now turn the call over to Chris <UNK>, our CFO.
Thank you, Tom, and good morning.
We generated solid top line growth in the quarter, with total sales increasing 16.4% to $3.5 billion.
Our GAAP EPS for the first quarter was $0.05 compared to $0.12 last year.
Excluding the LIFO expense, EPS was $0.11 for the quarter compared to $0.17 last year.
The disappointing bottom line was due primarily to soft comparable store sales in the first 2 months of the quarter, combined with higher warehouse and delivery expenses related primarily to the absorption of the 7-Eleven volume.
Although EPS was below our expectations for the quarter, it is important to remember that Q1 is typically our weakest quarter.
At this point, we still expect to reach our previously announced sales and EBITDA guidance for the year.
I will touch on more ---+ I'll touch more on that later.
The healthy increase in sales for the quarter was driven mostly by market share gains in the Northern New England division we acquired last year.
Excluding the acquisition, our sales increased approximately 9%.
Sales to Murphy USA, combined with other market share gains including 7-Eleven, accounted for the lion's share of the remaining increase in sales for the quarter.
We saw strong growth in most categories and are especially encouraged by continued strength in strategic categories, even in the soft economic environment.
Starting with cigarettes, sales increased approximately 18%, driven by a 10.6% increase in carton sales.
Our same-store cigarette carton sales were down 3.8%, also reflecting a sequential decline from the fourth quarter of 2016.
This was slightly more severe than the decline reported by cigarette manufacturers for the quarter and mainly driven by significant tax increases in certain states.
Non-cigarette sales increased 13.5% during the first quarter, led by OTP sales, which grew over 17%.
The increase in OTP was driven by market share gains, the Pine State acquisition and the continued shift from cigarettes to smokeless moist tobacco products, which is a continuing industry trend.
We saw healthy growth rates in food, our largest volume commodity, which grew almost 11%, and fresh, which grew 14%.
Our same-store non-cigarette sales in both January and February increased less than 1%, but we're much stronger in March with an increase over 5%.
Same-store sales for the month of April were consistent with March, especially in the U.S. Further strengthening of consumer spending, coupled with our strategies, could provide a significant tailwind for the remainder of the year.
Gross profit increased $22.9 million or approximately 15% in the first quarter of this year compared to last year's first quarter.
We recorded $6.6 million of cigarette holding gains in the first quarter compared to $1 million in Q1 of 2016.
Cigarette manufacturers in the U.S. increased carton prices much earlier this year than last.
As this was expected for us, we were not able to build our cigarette inventories ahead of the price increase as much as we normally would.
However, we were still able to capture meaningful holding gain.
We do still expect the cigarette price increase from U.S. manufacturers in the second half of this year consistent with prior years.
In addition to the holding gains, gross profit for the quarter included LIFO expense of $4.2 million compared to an expense of $3.4 million last year.
Remaining gross profit, which excludes holding gains and LIFO expense, increased $18.1 million or 11.8% for the quarter.
Non-cigarette remaining gross profit increased $12.1 million or approximately 11%, while cigarette remaining gross profit increased $6 million or 13.5%.
Remaining gross profit margin decreased approximately 20 basis points to 4.9%, driven primarily by the addition of Murphy USA, given its substantially higher sales mix of tobacco products that have significantly lower margins.
We have now lapped this business so beginning in the second quarter, our gross profit margin will be more comparable.
Cigarette remaining gross profit margins declined 7 basis points due mainly to the additional volume generated by the net new market share wins.
Non-cigarette remaining gross profit margins decreased 26 basis points during the quarter.
Excluding the impact of the net market share gains and our acquisition, remaining gross profit margins for non-cigarettes were down 10 basis points.
Margins were also compressed by approximately 12 basis points due to the higher OTP sales volumes.
The sales weakness in January and February, which affected certain of our higher-margin food commodities, resulted in a reduction of our overall non-cigarette margins.
Because of this, we did not see the 20 to 25 basis point increase we normally expect each quarter.
However, we are encouraged by higher sales levels in March and April.
If these trends continue, we expect to see the impact in our margins.
Total operating expenses increased approximately $30 million or 21% for the quarter ---+ (technical difficulty) On sales growth of 16.4%.
As a percent of sales, OpEx increased 18 basis points in the first quarter of 2017.
Warehouse and delivery expenses increased approximately $23 million or 25% during the first quarter.
The increase in these expenses includes $6.6 million of operating expenses from our Northern New England division acquired in June last year.
As a percent of sales, warehouse and delivery expenses increased 22 basis points due primarily to significant cost overruns at 2 of the 3 divisions involved in on-boarding 7-Eleven and increases in fuel and employee health care costs.
SG&A expenses increased $5.9 million or 12% compared with the first quarter last year, including $4.3 million of expenses generated by the Northern New England division.
SG&A in the first quarter of 2016 included a gain of $2 million related to the settlement of a legacy lawsuit.
As a percent of sales, SG&A expenses decreased 6 basis points, or 11 basis points, adjusting for the legal settlement last year.
You may have noticed we had an income tax benefit of $1.2 million for the first quarter this year.
New accounting guidance went into effect at the beginning of the year.
In general terms, the new guidance requires us to recognize a tax benefit or tax expense, depending on the difference between our stock price at the time shares vest versus the price of the corresponding shares when initially granted.
If the price has risen, which was the case here, we recognize the tax benefit.
Conversely, if the price declines, we will have higher tax expense.
The benefit was $1.5 million in the first quarter of this year.
We will likely see the largest impact of this change in the first quarter each year because this is when the majority of our internal stock grants vest.
We still anticipate our full-year tax rate in 2017 to approximate 37.5%.
Our free cash flow, which is calculated by taking net cash from operations less net CapEx and capitalized software, generated cash of approximately $144 million for the first quarter of 2017 compared to net cash provided at $38 million for the same period in 2016.
The primary driver of this improvement was the sell-through of our cigarette inventory from the end of 2016, in both the U.S. and Canada.
We increased our purchases of inventory at the end of last year in order to maximize incentives.
In addition, we saw a reduction in non-cigarette inventory, driven primarily by the impact of the market share gains and losses and some year-end buys across several non-cigarette categories.
Our total long-term debt was $233.4 million at the end of the quarter, compared to $347.7 million at the end of 2016.
The free cash flow we generated in the first quarter was used to pay down our credit facility.
Capital spending totals $14.4 million for the quarter compared to $11 million for the same quarter last year.
The increase is due primarily to investments in the new consolidation Center in the Northeast.
We announced our quarterly dividend of $0.09 per share to be paid on June 22 to shareholders of record on May 25.
To summarize, a soft sales start to the year, combined with higher warehouse and delivery expenses, led to a disappointing bottom line in the first quarter.
But as Tom mentioned, the first quarter is a small contributor to our annualized EBITDA goal.
We feel comfortable reiterating our full-year guidance.
As a reminder, we are expecting revenue growth of between 5% and 7% for 2017 and adjusted EBITDA improvement between 9% and 14%.
The faster growth in adjusted EBITDA compared to revenue is due primarily to a favorable shift in sales mix to non-cigarettes, driven primarily by our core strategies and the leveraging of our operating expenses.
This financial performance will not be easy but we see enough opportunities out there at this point that allow us to believe our financial goals are attainable.
Some other more significant opportunities are: sales momentum, including market share wins; execution of our core strategies including BTI, fresh and FMI; and most importantly, leveraging our OpEx during a soft retail environment.
Additionally, if we see further strengthening of consumer spending as we are seeing in early spring, that could provide a strong tailwind for the remainder of the year.
At a high level, we are confident about the long-term course we are on to drive growth and improving profitability.
We believe the execution of our core strategies, coupled with our flexible go-to-market approach, uniquely positions us to continue to capture market share and to help our customers succeed.
And with that, operator, you may now open the line for questions.
Yes, no.
Again, to think how our guidance was created, we took into account definitely the start up for Walmart, the off-boarding from ---+ the off-boarding of the Circle K business.
But really our 2 main components of our business in the first quarter was 1 with soft same-store sales.
So for existing customers, we benefited from market wins that carried over into the quarter but we definitely had soft sales.
And then we definitely had severe cost overruns in 2 of our divisions that were servicing the 7-Eleven stores.
At the same time though, as our sales softened, our divisions needed to react much quicker to that softening and we have the thing called the iron bar where basically, if our sales and profit declines, gross margin declines, we have to reduce our OpEx in line with that fall off and so we just didn't react as quick enough.
So right now, we're really geared towards improving that execution.
And so really, those were the 3 components.
Yes, did we have off-boarding costs with Circle K.
Yes, we did, and that impacted it.
Higher fuel cost, health and welfare but really, the 2 divisions caught ---+ the 2 divisions' operating costs were much higher than we anticipated and that's our #1 goal, is to get those back in line.
Yes.
Definitely the first 5 months of the year have a lot of ups and downs, right.
Because we talked about the Circle K off-boarding, we talked about the difficulty with 7-Eleven absorption, we had the $2 per pack increase in California, Kroger coming off and Walmart coming on.
So all mixed together, once we get it all rolled out, we should see our margins get back to that basic of growing our non-cigarettes 20 to 25 basis points.
Once all that activity is flushed out, June will be the first clean month when all that activity is done and so I anticipate that to happen.
I think the, again, our focus is we have to be very focused on our 2 divisions with 7-Eleven and that's critical that we get them right as quickly as possible.
And so, that's really a high priority for us and we need to do that.
And so I think that the other divisions will get their expenses where we want them.
But the 2 ---+ 7-Eleven divisions are probably our most pressing issue right now.
Definitely, there are opportunities.
Definitely, there ---+ it's not as robust of an RFP environment.
2018 will probably be a little bit stronger than we're seeing in 2017.
But right now, we're pretty well set ---+ almost set from our own customers, so we really haven't had to go into any competitive bidding environment with any of our customers.
And I think time will tell, as we get into some RFPs for non-Core-Mark customers, we'll see how that is.
But again, our whole focus is financial discipline and we have to make sure that the decisions we make from a pricing perspective are in the best interest of the company and our shareholders.
And so that will always be, sort of the discipline we have to hold, as we look at potential opportunities.
I think one of them will be, but in a very narrow way.
So what we've done, because of the large number of items that are specific to Walmart, we've set up satellite warehouses to handle probably 70% to 80% of the volume.
So those are standalone operations.
So the nice thing is, those are really going to be operated by themselves.
So it should not have a material impact on any of our divisions that have the satellite warehouses close by.
So I think we've sheltered that and we definitely are very mindful in those 2 divisions, that our focus is on their core business with 7-Eleven and ---+ but ---+ and with the other group, to be able to handle the rollout of the Walmart stores.
Yes.
Really, our focus is to get it done in the next 2 months.
It is interesting, Ben is, we have been so focused on expansion and growth, right.
And now, as we've sort of seen a softening of our customer sales, same-store sales, we now had to get back to the basics of saying, now we need to, right, leverage our operating cross and really implement the iron bar.
And so we've been a little slow on that and so now we've sped up the process.
And so everyone has opportunity, right, to reroute, even those divisions in the Southeast that already did a reroute.
Now that we're, that was based on a ---+ expected sales performance from our customers, but now that, that's not where it should be, then we still have to go back and tighten those routes.
And so there is a lot of opportunity in that and so over the next 2 months, really, is our focus to get those implemented and start seeing the savings from reducing the miles we're driving.
Yes, so Ben, I would say that given where we ended the quarter ---+ and first of all, we will end the year with debt.
And I think it depends on ---+ if no other, I guess, transaction or new customers is added, I think we ---+ you could expect to see our debt level to come down a little bit by year end but maybe close to the $100 million, $150 million area.
It's a little bit higher.
So what we did see is, we saw sort of a buildup of purchases by our customers in the last 2 week of March and then we definitely saw a severe fall off in the first 3 or 4 weeks of April.
So right now, it's tracking a little bit worse.
The manufacturers estimate about an 18% to 20% decline immediately, and then get back to some normal cadence, 12% or 13% decline once all that shakes out.
But we're a little bit north of that 20% right now.
And so really, it's going to take a little bit of time to shake out.
That was a massive increase but we'd still anticipate that ---+ getting back to that normalized maybe a 12% or 13% decline, once all the noise and people ---+ the sticker shock is over with the smokers in California.
So we have ---+ so the 9-month trend, we'll go first to that.
So we really were fully rolled out in November for all the stores.
So our focus is to get the execution and the improvement or service levels where we need to be, and from a cost perspective, by the end of the second quarter.
So that's sort of in that 9-month trend there.
And definitely, we've seen ---+ you see a higher level of turnover in those divisions because of the large number of new employees.
So it's a sort of breeds upon itself.
As you get new employees, less productivity, people work long hours and then you ---+ and maybe people that aren't right for the jobs.
So as you stabilize, which we're seeing stabilization in several of the departments within our operations, you start seeing better productivity and less turnover.
And so that's really than 9-month trend.
But the second thing I think, and so, you put those 2 aside, which definitely had a significant impact on our expenses.
But in the other divisions, is we again, focused on off-boarding Circle K.
But we didn't react, right, as the sales stop.
In 1 month, okay, January is down, and you say okay, well it's going to come back.
And then the second month, it didn't come back in February, then that's when we need to be rerouting, right.
Focus on efficiency savings, et cetera.
And so we were very slow on the uptake on that, and I think, again, like I say, we sort of got, with all the expansion and growth is ---+ we've got sort of get back to the mode of running our business as we normally run it which is ratcheting down expenses and growing our profitable categories.
So that ---+ so significant cost, but not enough leverage in our other divisions and ---+ which would've definitely helped the quarter if we would've done a better job on that.
Not really.
Here's our focus, right.
Where our focus is to do more with less, but that is to just be more efficient because we definitely have inefficiencies within our selling organizations, that we can take some of the dollars that we're spending and really focus really on our FMI strategy.
Because what we know today is FMI is our ---+ really the strategy is our way that we open up the doors to vendor consolidation and price with our customers.
And our customers that have an FMI survey are much more profitable and successful and we are much more profitable.
So definitely, we want to accelerate the pace.
Annually we've been doing about 3,000 but our intent is to do more than that.
In fact, I think we're shooting for 4,500 new surveys, 4,500 surveys this year versus 3,000.
And so I think that's really our goal, and it's really just about reassigning resources to that key strategy.
