Core-Mark Holding Company, Inc.
Q1 2019 Earnings Call Transcript

Published: 9 May 2019

[Operator:]

Welcome to the Core-Mark 2019 First Quarter Investor Call. My name is Sylvia, and I'll 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 conference is being recorded. I will now turn the call over to Mr. David Lawrence, Vice President of Treasury and Investor Relations. Sir, you may begin.

[David Lawrence:]

Thank you. Today's call will be led by Scott McPherson, our President and Chief Executive Officer; and Chris Miller our Chief Financial Officer. Also in the room is Matt Tachouet, our Chief Accounting Officer; and Milton Draper, Director of Investor Relations. Before turning the call over to Scott, I will point out that Core-Mark intends to take advantage of the Safe Harbor provisions of the Private Securities Litigation Reform Act as noted in the earnings release we filed this morning. Please remember that our comments today may include forward-looking statements, which are subject to risks and uncertainties and actual results may differ materially from those indicated or implied by such statements. Some of these risks are described in detail in the company's SEC filings including our Annual Report on Form 10-K. The company does not undertake any duty to update such forward-looking statements. Additionally, we will refer to certain non-GAAP financial measures during this call. You can find a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measure and other related information including a discussion of why we consider these measures useful to investors in our earnings release and our quarterly report on Form 10-Q. I will now turn the call over to Scott.

[Scott McPherson:]

Welcome to Core-Mark's 2019 first quarter call and thanks for joining us. We are pleased to be hosting this morning's call from our new corporate office in Westlake, Texas. Before we begin I would like to welcome David Lawrence, who joined Core-Mark recently as the VP of Treasury and Investor Relations. I also want to sincerely thank Milton Draper, our Director of Investor Relations who will be retiring soon. Milton has made significant contributions to Core-Mark for over a decade through her hard work and dedication. On behalf of all of us at Core-Mark, we wish her all the best in her retirement. Now turning to our results. We're off to a good start in 2019 that puts us on track with our financial objectives for the year. I'm especially pleased with the continued progress we're making on the profitability front with adjusted EBITDA up 22% on the benefit of higher remaining gross profit and improved operating expense leverage. Net sales declined by 1.4%, which is obviously not where we'd like to be. But keep in mind that we faced tough first quarter comparables with the loss of Kum & Go and the Rite Aid store transitions along with one less selling day in the quarter. Adjusted for those items, net sales would have increased 3.2%. On the whole it was a good quarter in which we continued to make progress on our strategic priorities. Taking a closer look at our results, the 3.2% adjusted sales growth was driven by a 7.4% increase in non-cigarette sales and a 1.1% increase in cigarette sales impacted by a 4% decline in same-store carton sales. Overall, same-store non-cig sales were up 6.7% showing growth in each of our key reported categories. Remaining gross profit increased in both our cigarette and non-cigarette categories and operating expenses as a percent of remaining gross profit improved by 150 basis points on the benefit of operational efficiency improvements that helped us to drive a $5.4 million increase in adjusted EBITDA. We also delivered good progress this quarter executing on our three key strategic priorities; growing sales and margins faster than the industry, leading the industry in providing category management solutions, and leveraging cost to drive profitable growth. Despite the expected sales headwinds in the quarter, we managed to make solid gains in non-cigarette sales and gross profit margins, which benefited from better mix and traction from our strategic pricing initiatives. Our favorable same-store sales metrics reflect the benefit of a continued focus on our category management solutions. We also delivered improvement in our key operational metrics driven by higher warehouse throughput and a continued focus on leveraging technology. And lastly, we made great progress in our employee engagement and retention metrics which positions us well as we head toward the busy summer season. While overall execution this quarter was good, we are of course focused on growing the top line in 2019 consistent with our guidance. We continue to take a very strategic approach to customer targeting across the country including both independents and chains. We are using data visualization software tools to quickly identify stores that align with our existing routes and distribution hubs to maximize our profitability and present a compelling value proposition to our customers. Our efforts are gaining traction and support our outlook for the year with over 250 new independent accounts gained year-to-date, as well as the recently-announced new partnership with TravelCenters of America and expanded partnership with GPM. For clarification, TravelCenters was one of the two mid-sized chain additions that we mentioned on our fourth quarter call. As we have talked about in the past, we will continue to evaluate potential acquisitions and have the right capital structure in place to execute on those opportunities as they arise. As we pursue these strategies, it's important to understand the broader industry backdrop. So before I hand the call over to Chris I want to provide a few reflections coming out of the recent NACS State of the Industry Summit. The headlines for 2018 focused on continued sales growth driven by food and alternative nicotine with headwinds coming from store count and store visits. Our view is that, industry trends and challenges reinforce our conviction in both our strategy and the significant opportunity to drive growth in sales and profitability at Core-Mark. Consumer expectations have evolved with an increasing focus on quality, product diversity and ease of experience. While enhanced technology and alternative store formats have increased the options available to the consumer. C-stores remain the largest channel of trade with over 165 million transactions per day serving the entire mobile population of America every two days. In-store transactions today remain less than half of the transactions at the pump and represent an incredible opportunity to drive in-store sales growth. Additionally trends amongst the millennial and Gen Z consumers point to a continued focus on food and snacking with the most encouraging data point being their size of basket and frequency of visit. We are uniquely positioned to help retailers establish a point of differentiation through actionable solutions whether it be around Food and Fresh, the emerging nicotine space or the leveraging of consumer data to help drive in-store sales growth. On our last call I talked about the Core-Mark Center of Excellence that is focused on helping our customers to deliver the next-level experience that consumers are seeking. This facility is the next-level evolution of our long-standing focus of providing industry-leading category management and will be open by the end of 2019. I will now hand the call over to Chris to provide more details on our financial results.

[Chris Miller:]

Thank you Scott and good morning everyone. I'll start with a quick summary of our results for the quarter. Net income increased to $1.3 million or $0.03 per share compared to a net loss of $1.3 million or $0.03 per share last year. LIFO expense was $7 million or $0.11 per share in the quarter compared with $0.10 last year. Earnings per share excluding LIFO expense doubled to $0.14 compared with $0.07 in the same quarter last year. And adjusted EBITDA increased 22% to $29.7 million. Our results this quarter reflect the benefit of higher gross profits due to a favorable product mix shift and increased operating expense leverage. Scott touched on many of the key sales levers, but I wanted to provide some additional color. As you would suspect our Health Beauty & General Merchandise category led our non-cigarette same-store sales growth. However this was also a quarter where we saw growth in every category we report. We've now had over 30 consecutive quarters of non-cigarette same-store sales growth which continues to validate that our efforts around category management are resonating. We should also see some added benefit moving forward from the TravelCenters and GPM stores which came online during the later half of Q1. Overall, we came in about where we expected on revenues for the quarter and we are focused on executing on our sales growth initiatives through the balance of the year. Gross profit increased 4.2% to $208.2 million from $199.8 million in Q1 last year. Remaining gross profit increased 3.9% to $206.4 million and remaining gross profit margin expanded by 28 basis points to 5.5%, primarily due to the sales mix shift to higher-margin non-cigarette products. Remaining gross profit margin for non-cigarettes increased 47 basis points to 12.3% due to sales growth in alternative nicotine products, favorable quarterly incentives, product mix and margin enhancement across other categories. Total operating expenses increased to $202.8 million compared to $198.2 million in last year's first quarter. As a percentage of remaining gross profit, operating expenses decreased to 98.3% from 99.8% in last year's first quarter. This was driven primarily by the increase in remaining gross profit and continued improvements in warehouse productivity. You may have noticed that we added operating expense as a percentage of remaining gross profit as an additional non-GAAP metric in our earnings release and 10-Q that we filed this morning. While we mentioned this metric in the past, we added this to our earnings materials, because we believe it is a meaningful metric in benchmarking our operating expenses given the continued shift in sales mix to non-cigarettes and other factors. Warehousing and distribution costs decreased to 65% of remaining gross profit compared to 66.6% in the same quarter last year, reflecting the benefit of higher remaining gross profit and increased warehouse throughput gained through technology leverage and increased employee retention. Transportation continues to be a leverage challenge, but we did see modest improvement in the number of queues per route during the quarter and we also saw improvements in employee retention similar to warehouse. SG&A costs increased $2.5 million or 3.9% to $65.9 million. The increase was due primarily to $2.5 million in bad debt expense and incremental costs associated with the relocation of our corporate headquarters. As a percentage of remaining gross profit, SG&A costs were flat year-over-year at 31.9%. The majority of the increase in bad debt expense relates to a couple of legacy accounts recently found to be uncollectible. We are now 100% reserved for these customers, but continue to pursue recovery. Otherwise, we've seen a decent reduction in our past due receivables and our DSO metric. Turning to our balance sheet. We reduced our long-term debt by $158.5 million to $187.7 million on the benefit of $175.2 million in net cash flow from operating activities generated in the first quarter this year. Our operating cash flow improved by $74.1 million as compared to the same quarter last year due primarily to the decline in cigarette inventory, related to the timing of cigarette price increases and the associated buy-ins of inventory. In 2018, cigarette price increases occurred late in the quarter compared to mid-quarter in 2019. As a result, we sold through more of our 2019 buy-in resulting in working capital improvement over the comparable period. The operating cash flow results in the first quarter do not change our previously-communicated outlook for the full year of approximately $100 million in free cash flow. I also wanted to briefly comment on our adoption of a new accounting guidance pertaining to leases, which was effective January 1, 2019. This resulted in the establishment of approximately $248 million of operating lease liabilities with a similar amount recorded for operating lease assets. There was no immediate change to our consolidated statement of operations as the expenses associated with these leases continue to be reflected on a consistent basis with how they were historically reported. As outlined in our earnings release issued this morning, we are reaffirming our financial guidance for the full-year, which we previously announced on March 1. We remain focused on adding new customers and growing same-store sales through our category management solutions as well as gaining additional leverage of our costs. We are off to a good start in the first quarter and we look forward to sharing further progress in subsequent quarters. Operator, you can now open the call for questions.

[Operator:]

Thank you. [Operator Instructions] And our first question comes from Ben Brownlow from Raymond James.

[Ben Brownlow:]

Hi, good morning.

[Scott McPherson:]

Good morning, Ben.

[Ben Brownlow:]

Congrats on the quarter. I guess just talking about your recent account wins. The two mid-sized chains that included TA, does it also include GPM? Or is that expansion separate?

[Scott McPherson:]

Yeah. So that was separate. I know I called out two account wins on the last call. One of those was TravelCenters. One of those – we've talked to the customer and we're not going to disclose that, but I would say it's similar in scope to TravelCenters and then GPM was additional to that.

[Ben Brownlow:]

Okay. That's helpful. And how should we think about sort of the aggregate revenue size of those recent deals? Is it enough to offset the Kum & Go and the fewer Rite-Aid stores that impacted the first quarter?

[Scott McPherson:]

Yeah. Ben, we don't normally talk about specific revenues for customers of that size but I think we gave the store counts in both of those releases that came out. And the one we didn't talk about like I said is similar in size to those.

[Ben Brownlow:]

Okay. Great. And just one last one for me. On the warehouse throughput you called out as improving and that was up a solid 5% 2018. Is that sort of the same run rate that you're seeing? And kind of what is the trend into the second quarter?

[Scott McPherson:]

Yeah. So we've seen, I'd say fairly consistent run rate in the first quarter. That's not usually where you knock throughput out of the park and we were in the 3% to 4% range first quarter, which was fairly consistent with where we were last year in the first quarter. So yes warehouse continues to be probably the biggest driver of cost leverage right now.

[Ben Brownlow:]

Great. Thanks.

[Operator:]

Our following question comes from Christopher Mandeville from Jefferies.

[Blake Anderson:]

Hi. Good morning. This is Blake on for Chris. Thanks for taking my questions. I was wondering if you could give us any commentary on the margin expansion cadence. It was pretty good in the quarter. I know you mentioned, some efforts on the warehouse side in technology, employee retention, anything you can call out specifically that might have helped you on the margin in the quarter? And then maybe any initiatives that might hit more or less in the remaining quarters, and maybe if you could also mention the transportation headwinds. Do those get less in the back half of the year?

[Scott McPherson:]

Yeah. Sure. I'll start with the margins for the quarter. We had a great quarter from a margins perspective. There were really a few things that contributed to that. One of them obviously was mix. And I've also talked about our strategic pricing initiatives. Both of those had good traction in the quarter. In addition to that, we saw some product inflation. So we had nice floor stock gain in the quarter which for the last couple of years has been pretty low. And then, finally, every quarter we have quarterly incentives and we really had a good quarter around capitalizing on those. So we had really kind of four things that fell into alignment. I'd say as you look at the balance of the year, I wouldn't expect that to be the continuous run rate. We've talked historically about that 10 to 20 basis points of growth and I think that's what I'd be thinking about as we move forward. But yes definitely we had a good quarter from a margin standpoint.

[Blake Anderson:]

All right. And then just my last question was Nestle announced they're no longer being a DSD. I was wondering, if you could share any conversations you might have had about how this could be an opportunity for you. And maybe any thoughts on why they changed. Is – there maybe something that would imply other DSDs will make the switch as well.

[Scott McPherson:]

Yeah. We've seen a number of DSD folks the cost of distribution and the fragmentation especially in the convenience store channel. I think there's definite benefits to them going to the warehouse distribution model. We've talked to them a little bit. I don't see a tremendous upside with them specifically in our channel. Most of the product we sell with Nestle is around candy and foodservice so we may see some potential benefit. But I definitely do think that moving forward we'll see more and more DSDs evaluating their model and seeing if it makes sense especially in the convenience store channel where their drops tend to be a little smaller. Did I catch all your questions?

[Blake Anderson:]

Yes. That's it. I appreciate it. Thank you.

[Scott McPherson:]

You bet. You bet.

[Operator:]

Our following question comes from Ben Bienvenu from Stephens Inc.

[Ben Bienvenu:]

Hey, good morning.

[Scott McPherson:]

Good morning, Ben.

[Ben Bienvenu:]

I wanted to ask on two fronts. Obviously, there was some challenging weather during the quarter that a number of other retailers had pointed to. Curious to what degree that factored into your results in the quarter. Any commentary you could provide on quarterly cadence of sales? And then to the extent that you can talk about it just quarter-to-date trends and how you're feeling about volumes for the balance of the first half and into the back half of the year.

[Scott McPherson:]

Sure. Yeah. So, definitely, especially in the Midwest and even -- we had some challenges in the Carolinas. We definitely had some weather challenges and had a couple of our distribution centers that were locked down for one day or two. So, yeah, I think there was some impact of that. I think I called out in my script that the other headwind we had obviously was the loss of a couple customers the Rite Aid transitions and Kum & Go. So net of that we were up 3.2%. We were up 7.4% in non-cigs and also up in cigs. So, when I think about the year that 3.2% kind of puts in the middle of our guidance range and then obviously picking up a few of these mid-sized chains and we added kind of most of that kind of fell middle to late in the first quarter. So, we're definitely going to have to continue to gain traction and picking up new stores throughout the balance of the year. But, right now, as I look forward to the second quarter and we see how April kind of came in, I feel pretty good about our trends and pretty good about our chances to hit guidance, both top and bottom.

[Ben Bienvenu:]

Okay. Thanks. And then Chris, you commented on the timing of the cigarette pricing increases that we saw and the resulting holding gains. There were some residual impacts or benefit from cigarette holding gains that flowed into 2Q of last year. Sounded like the holding gains hit a little bit earlier in 1Q this year. Would you still expect to have any residual impact or benefit from holding gains in 2Q of 2019?

[Chris Miller:]

So, you're right, the -- we won't see the same level as we did in Q2. There will be a little bit that flows into April. But, yeah, it won't be as much.

[Ben Bienvenu:]

Okay. Great. And you guys continue to work on paying down debt and putting yourselves in a position to be flexible. Given where your balance sheet has moved to from a leverage perspective, could you talk about your interests on the M&A front, the extent to which there is seller interest and then the extent to which you guys are finding reasonable valuations such that a deal could potentially transpire this year?

[Scott McPherson:]

Yeah. I mean, we definitely as we called out on the last call are interested in acquisitions. That's definitely been part of our continuous strategy. And we think from a balance sheet standpoint, we're in a great position. I do think that there are going to be willing sellers and I think that the prices in our market have stayed fairly consistent. We haven't seen a big fluctuation at -- in wholesale pricing as you've seen it in a retail and retail transaction. So, we are definitely actively out there looking at opportunities. And so, if we find the right -- we're very disciplined about our approach though, so we've got to find the right seller in the right geography and it's the right fit for us. So -- but we're definitely active in that arena.

[Ben Bienvenu:]

Understood. Nice start to the year. Best of luck.

[Scott McPherson:]

Thank you very much.

[Operator:]

Our next question comes from Kelly Bania from BMO Capital Markets.

[Steve Caputo:]

Hey, there. This is Steve Caputo on for Kelly. I just had a quick question on gas prices. Altria called out a 30 basis points headwind I think during the quarter, a 30 basis point impact on cigarette sales. Did you guys see something similar during the quarter? And was that something that impacted the non-cigarette portion of your business?

[Scott McPherson:]

Yeah. I think -- I mean, I think, quarter-over-quarter, if I remember Altria's call, gas prices were up 19%. So anytime you see a big jump in those numbers, you'll have some impact on store traffic. So, it's hard to quantify in real time, but I would definitely say that that may have had some impact on non-cigarette sales and cartons. But I don't -- I couldn't pin it down to an exact number.

[Steve Caputo:]

Okay. And then just looking at the 1.4% growth in non-cigarette sales, could you quantify sort of how much of that came from the alternative nicotine products and how you sort of think about that going through the rest of the year as we start to lap some of the growth there?

[Scott McPherson:]

Yeah. We'll definitely have -- quarter-over-quarter, we definitely had solid growth. About half of our same-store growth was from the general merchandise category. Now, that that does have some regular general merchandise some non-nicotine stuff in it as well and that grew as well. But it was about half of our same-store growth. So that -- is that responsive to what you're asking?

[Steve Caputo:]

Yeah. Definitely, that's helpful. And then the last one from me, sort of, we've heard from the drug stores that they're either taking proactive measures to raise the age of tobacco purchases and other nicotine products. Have you heard any commentary from that -- from some of your customers and what you guys would think would happen to your business if that was something that was to be implemented nationwide?

[Scott McPherson:]

Yeah. I think it's likely it will be implemented nationwide. Recently, I believe it was Mitch McConnell that proposed legislation on an age 21 federally. I think Altria has supported that. I mean we -- right now 38% of the volume is in states that have already moved to age 21. And in those states we haven't seen a huge impact. I think that smoking population is about 2% of the combustible smokers. I think what it does do for the channel -- there's a couple things that it does. One, is I think it provides a path for the convenience store channel to potentially see flavors come back to the channel. I think it provides a path to things like CVD and potentially marijuana down the road. And then the other thing I think from a social responsibility standpoint, I think right now teen usage of nicotine is a concern and I think moving to 21 just creates a spread on that social purchase. And so I think it's -- from a social responsibility standpoint I think it's good for the country. And I think for our channel we've been the one that has benefited from the regulation and things like that. So I think our channel will be well-positioned if it does move to 21.

[Steve Caputo:]

Okay. Thank you very much.

[Operator:]

Our next question comes from Chris McGinnis from Sidoti & Company.

[Chris McGinnis:]

Good morning. Thanks for taking my question. I was going to ask about -- it sounded like you have some new -- maybe some new technology to help target the independent base. Is that being offered in conjunction with FMI? And maybe just -- I know you cited a number earlier and it was 250 new clients. Is that growth rate where you think it is and -- versus your expectation? Thank you.

[Scott McPherson:]

Yeah. For the quarter that growth rate was almost to a customer where we thought it should be. So the technology that we're using is essentially a routing -- basically combining our routing technology and our CRM software. So instead of trying to run around the country and target the 70,000 convenience stores, independents we don't have, what we've essentially done is overlaid that base on our existing routes that are call it underdeveloped. So, routes that don't have a significant amount of cube on it. And so really it allows us to optimize the profitability of new customers that we pick up and it really allows us to focus who we're targeting in the customer arena as well.

[Chris McGinnis:]

Great. Thanks for the feedback and we’ll look in Q2.

[Scott McPherson:]

Thank you very much.

[Operator:]

We have no further questions at this time. Mr. Morris [ph], I'll turn the call over for final remarks.

[David Lawrence:]

Thank you all for joining the call. We appreciate your interest in Core-Mark. If you have any follow-up questions don't hesitate to reach out to me, David Lawrence at 1-800-622-1713 extension 7923 and my contact information is on our website in the Investors section as well.

[Milton Draper:]

Thanks.

[Scott McPherson:]

Thank you.

[Operator:]

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.