Core-Mark Holding Company, Inc.
Q2 2019 Earnings Call Transcript

Published: 11 Aug 2019

[Operator:]

Good morning, and welcome to the Core-Mark, 2019 Second Quarter Investor Call. My name is Brandon and I'll be your operator for today. [Operator Instructions] Please note, this conference is being recorded.And I will now turn it over to David Lawrence. David, 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.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'll now turn the call over to Scott.

[Scott McPherson:]

Thanks everyone for joining us today on our 2019 second quarter call. I will start out by providing an overview and some highlights for the quarter, then Chris will add color around our financial performance and key metrics, so let's get started.Following a good first quarter performance, I'm pleased with our continued progress in the second quarter, including improved growth in non-cigarette sales, continued strength in our non-cigarette remaining gross profit margin and the benefit of operating expense leverage that drove adjusted EBITDA growth of 26%.Our results this quarter reflect continued success, executing on our three key strategic priorities

[Christopher Miller:]

Thank you Scott and good morning everyone. To kick things off I'll review our profitability metrics, provide some additional details and insights on our strong financial results for the quarter and then wrap up with an update on our outlook for the remainder of the year.Net income increased to $17.7 million or $0.38 per share compared to net income of $11 million or $0.24 per share last year. LIFO expense was $7.4 million or $0.12 per share compared with $0.11 last year. Earnings per share excluding LIFO expense, increased to $0.50 compared with $0.35 in the same quarter last year, and adjusted EBITDA increased 26% to $53.5 million. Consistent with the first quarter, our results for Q2 reflect the benefit of higher gross profit margins due to a favorable product mix shift and operating expense leverage.Total sales increased 2.7% for the second quarter, driven by an 8.8% increase in food and non-food sales, offset by a slight decrease in overall cigarette sales. In the food and non-food category we saw strong year-over-year increases in both categories, driven by same-store sales growth and the addition of new customers.Our health, beauty and general category led with a 35% year-over-year increase, driven by alternative nicotine products, which are included in this category. The food, fresh and beverage categories exhibited stronger growth this quarter, with each category increasing approximately 7% year-over-year. The other tobacco category which grew 2% for the quarter was impacted by significant product shortages by cigar manufacturers. Excluding cigars, OTP sales increased 6.6% for the quarter and overall food and non-food sales increased over 10%.As Scott mentioned, gross profit and remaining gross profit increased 10% in the quarter as compared to the same period last year. Remaining gross profit margin expanded 38 basis points, 5.6%, reflecting the benefit of the favorable mix shift towards higher-margin food and non-food products, as well as higher overall margins in the food and non-food category.We were pleased with the margins for the quarter that included the benefits of a strong year-over-year growth in higher-margin alternative nicotine products and margin expansion in our food, fresh, beverages and OTP category. While we expect to continue to drive higher year-over-year remaining gross profit margins in the second half of 2019, we face a more difficult comparison to the rest of the year given the strong sales growth we experienced in the second half of last year in higher-margin alternative nicotine products.Total operating expenses increased to $210.5 million compared to $198.6 million last year. As a percentage of remaining gross profit, operating expenses decreased to 86.8% compared to 90.1% last year, due primarily to the increase in remaining gross profit and leverage in warehouse and SG&A expenses.Warehouse and delivery expenses as a percentage of remaining gross profit improved 190 basis points to 59.1%, driven primarily by leverage of warehousing costs. SG&A expenses which increased $2.9 million or 4.7% in the second quarter, included approximately $1.6 million in costs associated with our headquarters relocation.For the year we incurred approximately $2.4 million related to the move, which is below what we expected, and we do not expect any significant costs related to the relocation going forward. SG&A expenses as a percentage of remaining gross profit improved to 140 basis points to 26.6%.I also want to briefly touch on the impact of cigarette and candy price increases for the year. On the cigarette front, a second 2019 cigarette price increase of $0.60 per carton was announced in mid-June that impacted most of our significant cigarette brands, resulting in an inventory holding gain of $3.8 million that was recognized in full in the second quarter. This compares to cigarette holding gains of $3.5 million in the second quarter of 2018.For additional context to 2018, a second cigarette price increase occurred in late September that resulted in $1 per carton increase on most major brands and brought the total cigarette price increase to $1.90 per carton last year. Through June this year, we've seen a total increase of $1.70 per carton.Given the year-to-date price increase per carton is below the prior year level and the timing of price increases has accelerated, it seems likely that the cigarette manufacturers will announce a third price increase on major brands before the end of the year. We are taking steps to maximize our holding gain in the event there is another increase this year. However, we cannot be certain of the timing or the amounts of a potential third price increase.Regarding candy, in July, Mars, Wrigley and Hershey announced price increases of approximately 9%, impacting a variety of their products. We estimate that our holding gain from these price increases will be in the range of $5 million in the third quarter.Turning to our balance sheet, the amount drawn on our revolver increased by $149 million on a sequential quarter basis to $310.7 million, reflecting the normal seasonal build in our working capital, most notably an increase in our cigarette inventory as we build for a potential price increase, and an increase in accounts receivable. The increase in accounts receivable is due to a normal seasonality and the timing of payment on certain large accounts. The seasonal and other working capital fluctuations do not change our outlook with regard to our full year free cash flow expectations of approximately $100 million, assuming no significant year-end inventory purchases.As we outlined in our earnings release this morning, we are reaffirming our financial guidance for the full year, which we announced on March 1. We are pleased with the results for the first half of the year, which are slightly ahead of our expectations. While we've had a good start to the third quarter from a sales perspective, we will need to continue to grow market share and drive strong same-store sales through the balance of the year.On the earnings front, we remain confident in our ability to deliver earnings within our guidance range.To summarize, we are pleased with our start to the year and we are focused on continued strong execution through the back half of the year. We are very optimistic about our future, and we remain highly focused on growing faster and more properly than the industry, being the leader in category management and leveraging our fixed cost structure.Operator, you can now open the line for questions. Thank you.

[Operator:]

[Operator Instructions] And from Stephens Inc., we have Ben Bienvenu.

[Ben Bienvenu:]

Yeah, thanks. Good morning guys. I wanted to ask about the guidance for this year. You guys, as you said are putting up pretty good numbers through the first half of the year, both solid, seen in quarters 1Q and 2Q. You've now got the benefit of a candy pricing increase holding gain in 3Q. It sounds like it might not be incorporated yet into your guidance, but if there's possibility of cigarette holding gains being higher than previously anticipated.Just curious around the decision to maintain guidance versus increased guidance halfway through the year. Is it a reflection of just a more measured approach to guidance for the full year or is there anything from a trend perspective into the second half of the year that we should be confident enough?

[Scott McPherson:]

Sure Ben. I think let's take the EBITDA side first. I think you called out a couple of the key considerations there. One of them is, we did have a candy price increase. We're still getting kind of the final tabulation on that, so that's definitely going to be a benefit, but there's no certainty that there's going to be a cigarette price increase. We're anticipating that, but there's definitely been a break in the cadence from the cigarette manufacturers, so that's a key element of our thinking.And then the last thing is just we're going into third quarter. It's the biggest revenue and profit quarter of the year. We feel really good about our positioning, but I think it was prudent for us to revisit at the end of the third quarter on the EBITDA side.On the revenue side, we feel really strong about how our same-store sales performance has come in. We've seen some traction in the second quarter, but we're going to have to continue to grow share in Q3 and Q4, you know and in light of some of the recent stuff with Altria coming out and saying, you know that they may see an acceleration in carton decline. You know we're going to have to perform. We see a path to get there, but we're going to have to perform really well in the second half on a revenue side.

[Ben Bienvenu:]

Okay, thanks. And then Chris looking at the balance sheet, you talked about the working capital increases, some of which is associated with the potential to the maximize cigarette holding gains. But if you would just revisit your expectation around year-end debt balance and the implied leverage associated with that that would be helpful.

[Christopher Miller:]

Sure. I feel pretty good that by the end of the year we'll be, let's say 1.5x from a leverage standpoint. Again, that kind of assumes a more normal level of buying inventory at the end of the year, but I think we'll be in the 1.5x range.

[Ben Bienvenu:]

Okay, and then last question for me on the food and fresh revenue category, really strong results and a nice sequential improvement from 1Q to 2Q. Can you talk about what contributed to that, and was the improvement driven disproportionately by independents or larger chains? Any detail you could provide there would be great.

[Scott McPherson:]

Sure. You know I think Ben, we've worked really hard to work with our customer base on really understanding the complexities of being in the food and fresh business. I'd say it's fairly balanced. We've had a couple of pretty sizable chains really embrace food programs, so maybe a little slanted towards the chains.But really it's just us working with our customers, executing on our category management strategies, and I think if you look at what we're seeing from the millennial and Gen Z consumer, which is I think very encouraging to convenience, they are frequent snackers. They consider convenience outlets as an optimal location for food snacking. I think the industry is starting to capitalize on that and I think that's benefited us as well.

[Ben Bienvenu:]

Okay, thanks. Good luck going forward.

[Scott McPherson:]

Thanks Ben.

[Operator:]

From BMO Capital we have Kelly Bania. Please go ahead.

[Kelly Bania:]

Hi, good morning. Thanks for taking my questions.I also just you know wanted to dive in a little bit on the first half margin performance relative to what the guidance implies for the second half. Can you maybe just isolate the last couple of quarters, just the impact of alternative nicotine and the mix shift there on the margins, and maybe just how much that impacts the margin outlook? And then also, what is embedded in your guidance with respect to a third cigarette price increase?

[Scott McPherson:]

So, let me take the last one first, because that's the easiest Kelly. We have $19 million in cigarette price increase in our guidance and I think year-to-date we're at 12.6%. So definitely we anticipated to be on a much higher level, but they've certainly changed the cadence and the amount, so you know still anticipating to see that third one and to be close to our guidance range on cigarette price increase income.On the margin front, as I've called out you know a number of times, in the long range I think 10 to 20 basis points is a good range for you to think about from our standpoint, but obviously we had two really strong quarters. We were at 28 and 38 basis points of growth.Now if I break those into buckets you know, big buckets would be alternative nicotine is about a third of that, and obviously we're going to run into much stronger comps in the second half of the year, and then you've got mix is another bucket and then we've also made a really strong progress in our strategic pricing gains, and that's something that we've worked on now for at least 12 months, and we're definitely getting some traction there as well. So I think about us definitely being in the higher end of that 10 to 20 range, if not exceeding a little bit this year.

[Kelly Bania:]

And you mean 10 to 20 for the full year?

[Scott McPherson:]

Yes, 10 to 20 basis points for the full year. And like I said, we'll be at the higher end of that range or slightly higher than that.

[Kelly Bania:]

Okay, that's helpful. And I guess with respect to Altria's comments that you just mentioned and the cigarette declines may be accelerating. Just curious what you guys think on that? Are you seeing that? Do you agree with that? Do you have a view if that comes at the expense of growth in alternative nicotine and just how that could be a positive or negative for you as that plays out?

[Scott McPherson:]

Sure. I mean you know right now we have outperformed the market, so on a same-store sales basis our decline is not quite as strong as what the market is seeing. I think a lot of that is we worked really hard, not just on alternative nicotine, but in combustibles to make sure our customers have the right product mix to satisfy the consumer.That said, I certainly, and I just sat with Altria recently, there is certainly a shift from combustible users using you know vape as an alternative and there's even a shift where combustible users are completely leaving combustibles for vape, primarily Juul.For us, it's definitely a revenue headwind, but as I called out total nicotine for us was actually up and from a profit standpoint, quality of earnings standpoint, so far it's been good. So you know there is definitely some trade off from combustible to alternative nicotine, which is a revenue headwind, but I think is generally profit neutral at this point.

[Kelly Bania:]

Okay, that's helpful. And then just last one for me, just can you help us think about what may be organic sales growth was for this quarter, you know excluding any kind of chunky customer wins or losses?

[Scott McPherson:]

Yes, we had lapped most of our historic losses in the first quarter. So if you look at you know Q2, with the exception of a little bit with – we had a little bit of Rite-Aid departure which we had called out a number of times. I think we started the year with a 1,000 Rite-Aid stores give or take and we're down to about 500. But outside of that I would say that the growth for the quarter was a combination of market share and same-store sales growth and was pretty clean.

[Kelly Bania:]

Okay, and then sorry, really last one. Are you seeing anything competitively, I guess maybe from McLane, specifically just curious on how things are trending on the RFP cycle and competitive bidding cycle.

[Scott McPherson:]

Yes, we're – we have a couple coming up next year and the year after and we're in the process of working on a couple right now. I think McLane's a very rational competitor as I believe we are, and I think the market has also been very rational in the bids that we've been a part of recently.

[Kelly Bania:]

Thank you.

[Operator:]

And from Raymond James we have Bobby Griffin. Please go ahead.

[Bobby Griffin:]

Good morning. Thank you for taking my questions; just two quick ones for me. First on the impressive food and beverage growth, was that pretty much all volume-driven or is there some price running through there, also benefiting that year-over-year growth?

[Scott McPherson:]

Are you talking about just revenue growth or margin growth?

[Bobby Griffin:]

Revenue growth, sorry.

[Scott McPherson:]

Yes, most of it is market share gain. We did have you know specifically around beverage some pricing initiatives that would have helped revenues a little bit, but most of that is just share gain and same-store sales growth.

[Bobby Griffin:]

Okay, I appreciate it. And then just quickly a modeling question. Should we assume any other relocation expense in 3Q, about $1 million or $2 million was called out in the 10-Q this quarter. Is there anything left on that?

[Scott McPherson:]

Yes, Chris called out in the script that we're pretty much anything material is behind us.

[Christopher Miller:]

Yes.

[Bobby Griffin:]

Okay, that's perfect. I appreciate it.

[Christopher Miller:]

That's the bulk of it.

[Bobby Griffin:]

Alright, well best of luck going forward. Thanks for the time.

[Scott McPherson:]

Thanks Bobby

[Operator:]

From Jefferies we have Christopher Mandeville. Please go ahead.

[Christopher Mandeville:]

Hey, good morning. Scott, can we start off just with the monthly cadence on non-cigs in the quarter itself and then maybe if you'd be willing to offer up some quarter-to-date color. In particular, I guess I'm kind of curious on health and beauty that's been performing quarter-to-date, just given the considerable contribution that vaping has had to both the health and gross profit dollars.

[Scott McPherson:]

So when you say the monthly cadence, are you talking about month-by-month in this quarter?

[Christopher Mandeville:]

Correct.

[Scott McPherson:]

Yes, I think we had a really strong April and I'd say May and June were probably kind of at par with each other, so a pretty good balance from a non-cigarette same-store sales growth and really even from a general merchandise growth through the quarter. But I think like we mentioned, when you're thinking about general merchandise and vape in particular, the real significant ramp-up was in the back half of last year, in Q3 and Q4. There was a significant jump from Q2 to Q3.That said, you know we still feel like there's a pretty strong runway with Juul. We're continuing to penetrate new accounts. The Canadian market really didn't get going until this year, so we've seen good growth there. And Juul frankly is you know continuing to grow in same store. So I think there's definitely a lot of momentum, even into Q3 and Q4, but maybe not quite as much as we saw in the first half of the year.

[Christopher Mandeville:]

Okay, and then just to be clear, the guidance being maintained or reiterated, that does or does not now include the price increase for candy?

[Scott McPherson:]

Right now, it does. We called out that we got $5 million, but I think we also as I said earlier, right now we haven't gotten a second cigarette price increase, which is a similar amount. So that's the main reason that and we're headed into Q3, which is our biggest quarter and why we didn't make any adjustments to guidance at this point.

[Christopher Mandeville:]

Okay, so there's nothing that’s necessarily changed to guidance to incorporate candy. It's just your conservative in going into the summer driving season for Q3.

[Scott McPherson:]

You can call it conservatism. I think we're just being prudent and seeing – making sure we get that next price increase and then we have a strong third quarter.

[Christopher Mandeville:]

Okay, and then the last one for me and I'll hop back in the queue. Just on warehousing and distribution you guys are really showing great progress there. I think its running, call it 4% or so year-to-date. If I look back at historicals, generally speaking you've never really shown growth below like 7%. So just as we look to the back half of the year, can you just kind of remind us a little bit on why or if we should be expecting an acceleration in growth or if maybe there's a new mindset surrounding expense control and the ability to be below that?

[Scott McPherson:]

Well, I'm always – I think you know I'm very focused on expense control and if I look at the first half of the year and really the quarter, it was really primarily driven in warehouse. Transportation, we did have an increase in cubes per load, but it was kind of offset by labor, but we had good leverage in Q2, and I would expect that leverage to generally continue through the balance of the year. I think we're well positioned you know for the next two quarters from a leverage standpoint and warehousing trends.

[Christopher Mandeville:]

Great, thanks.

[Operator:]

[Operator Instructions] And from Loop Capital Markets we have Andrew Wolf. Please go ahead.

[Andrew Wolf:]

Thanks, good morning. So I still on the guidance want to clarify. Were you expecting, when you set guidance or last quarter when you – did you contemplate the candy or did that come this quarter as a surprise?

[Scott McPherson:]

Yes, candy came as a surprise. The one thing that I would maybe clarify to everybody on the candy price increase is we anticipate it will be in the $5 million range, but the other thing that happens when we get one of those is that kind of – it kind of supersedes all other increases that we get through the balance of the year. So we definitely anticipated some candy income over the course of the year and we kind of got it all at one time, but it will definitely be upside for us for this year when we think about guidance.

[Andrew Wolf:]

Oh, I see. So the net would be a little less than that, but since it's a big number you call it out? Is that how we should think about it?

[Scott McPherson:]

Yes, exactly right sir.

[Andrew Wolf:]

Okay. Alright, so then that would be like $3 million or something and you just don't usually would be shown in gross margin but not big enough to call out? I'm just trying to – if you don't feel comfortable quantifying it.

[Scott McPherson:]

No, I would say normally we get between $1 million and $2 million of inflation in candy categories overall, somewhere in that range.

[Christopher Miller:]

Over the course of the year.

[Scott McPherson:]

So your thinking is not far off.

[Andrew Wolf:]

Okay, got it. And then on the cigarette like Chris was asking, and I apologize, maybe I was just not listening well. So you haven't got a second price increase, which would be also I think you said around $5 million if it comes in. Is that in the guidance and was that expected or… sorry.

[Scott McPherson:]

Yes. No, we were expecting this year two price increases that generated $19 million, and to be fair that includes some price increases in Canada, but primarily that's all driven by U.S. manufacturer increases.So far this year we did get two price increases. They both came earlier than expected or earlier than we had seen historically, and they were less than we had gotten historically. So that's why there's a delta in the price increase income, and based on you know Altria's activity and investments in everything that they've done this year, we believe that there's a strong probability that they will have a third price increase.

[Andrew Wolf:]

Okay, and that is the guidance as well?

[Scott McPherson:]

Well, the $19 million is in the guidance, and so far this year we've only been at...

[Christopher Miller:]

$12 million or $13 million.

[Scott McPherson:]

$13 million. So the $19 million of cigarette price income is definitely in there.

[Andrew Wolf:]

Okay, and then in the first quarter you called out some new customers. Could you just – is there much of a profit cycle with new customers like onboarding them cost you money, and then you start making money or is it – like could you just sort of talk about how new customer wins cycle into the income statement?

[Scott McPherson:]

Sure. Yes, I think – when I think about that Andy, I think about independent customers, very very low incremental start-up costs. The larger the customer, the larger the start-up cost.In the cases, you know the customers that we've called out this year, we’ve called out three different customers. All of them had 300 stores or in that range. I would say you know it ranged – a couple of them I’d say were fairly low start-up costs. One of them was fairly significant because it incurred a lot of divisions, but I would say the start-up cost is all behind us in this quarter. We don't have anything going forward from a start-up cost standpoint, and really all those transitions went fairly smoothly.

[Andrew Wolf:]

Okay, back in last year, third quarter with Juul or just those type of products, what caused that to ramp so quickly last year that you're now facing a challenging comparison?

[Scott McPherson:]

Well, I think alternative nicotine had been around for a while, but nobody had kind of hit the magic formula and I think Juul did. Juul came out with a device that was user-friendly, it delivered nicotine at levels and very easily, and it became – I'd call it kind of a social media phenomenon. I mean, it was – became very popular very quick. Like I said, we had a big jump from Q2 to Q3, and that's continued on.I think the good thing about what's taken place there is I think that Altria and Juul and others from a social responsibility standpoint have done a great job of moving this away from you know under age users and making this a viable alternative for combustible cigarette users. And they are starting to see that turn out in the data fairly quickly. So I think that's positive for the industry and so far has been positive for us.

[Andrew Wolf:]

Okay, and just one last question is on the pretty longer term is on the CBD outlook. I mean obviously it's to be determined what's going to happen at the federal level and so on, but where – what are you and the board sort of looking at two to five years for that product type and specifically for Core-Mark and convenience stores? What could you see there?

[Scott McPherson:]

Andy, we're selling very select few manufacturers and a very select product mix today in a select number of states, and I would say that the customer acceptance has been very high. I think that all the numbers I see around CBD point to – it's going to be a multibillion-dollar category over the next five years.I think convenience is extremely well positioned to be the primary distribution channel for that, and I think we've picked really good partners. Recently Altria made some moves with Cronos that positions them to be doing that in the CBD game. So I think there's a long runway for CBD in the convenience space.

[Andrew Wolf:]

Okay, and why do you think convenience? Is it compliant, making sure minors don't get it or is it – or are there other reasons?

[Scott McPherson:]

Yes. No Andy, I think convenience is in my mind the number one age verification channel that exists in retail today and I think they've proven that from a social responsibility standpoint, selling alcohol and cigarettes and other products and doing it at a high level of accuracy. I think it's pretty clear to me that, that's – that would be the channel that if I were the FDA or anybody else, that I'd want it to go in.

[Andrew Wolf:]

Alright, thank you. I appreciate it.

[Scott McPherson:]

You got it.

[Operator:]

No further questions at this time. We'll now turn it back to David Lawrence for closing remarks.

[David Lawrence:]

Thank you all for joining our call this morning. We greatly appreciate your interest in Core-Mark. If you have any questions you can contact me directly. My contact information is available in the earnings release we filed this morning, as well as on our website. Thanks so much.

[Operator:]

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for joining. You may now disconnect.