Core-Mark Holding Company, Inc.
Q3 2017 Earnings Call Transcript

Published: 7 Nov 2017

[Operator:]

Welcome to the Core-Mark 2017 Third Quarter Investor Call. My name is Allie, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Ms. Milton Draper. Ms. Milton Draper, you may begin.

[Milton Draper:]

Thank you, Allie, and welcome, everyone. I would now like to read the statements about the use of forward-looking statements and non-GAAP financial measures during this call. Non-GAAP financial measures will be used in this presentation. Reconciliations to the most comparable GAAP measures are included in the most recent earnings press release available on the Investor Relations portion of the Core-Mark website. Statements made in the course of this call that state the Company's or Management's hopes, beliefs, expectations or prediction of the future are forward-looking statements. Actual results may differ materially from those projections. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in our SEC filings, including our Form 10-Ks, our 10-Qs and our press releases. We undertake no obligation to update these forward looking statements. We are holding this call to review our third quarter results and to answer any questions you might have. If you have additional follow-up questions after the call, please call me at 650-589-9445. Joining me today is the Chief Executive Officer of Core-Mark, Thomas Perkins; and the Chief Financial Officer, Chris Miller. Also in the room is Matt Tachouet, our Corporate Controller; and Theo Castro, our VP of Finance and Treasurer. Our lineup for the call today is as follows

[Thomas Perkins:]

Good morning, and thank you for joining us on our third quarter 2017 conference call. I will provide a summary of the quarter and recent events, and then Chris will walk through the quarter in greater detail. After that, we will take your questions. Our third quarter showed solid improvement in many respects. We were able to grow our EBITDA 22% with sales growth at 8% in the third quarter. This is while facing unusual issues including major hurricanes and wildfires in the Northwestern California as well as working through the operational challenges that we have talked about on prior calls. While EBITDA benefited from cigarette holding gains, we still grew 6% for the quarter without that impact. We saw good results from our Farner-Bocken acquisition, our new Iowa division, and secured the long-awaited renewable with Rite Aid. So clearly some good things are happening, but there is much more to do. Our focus continues to be on improving our operational execution and leveraging our core strategies, which puts us in good position to achieve at least our low end of our guidance. Our operations in Texas and Florida were impacted by Hurricanes, Harvey, and Irma. Our highest priority was to make sure our employees were safe and then to support the first responders and our customers. Hurricane Harvey impacted our Fort Worth division the most as we were unable to deliver products into some affected areas for many days. We were able to support the first responders with necessary supplies such as water, snacks, and sandwiches so they could continue their important work. We started to deliver to our accessible customers within days of the storm despite some challenging issues that required our employees to think outside of the box to make sure we maximize everyone's safety and customer service. Irma affected our Tampa operations, but not to the same degree we saw in Fort Worth. Fewer employees were personally impacted by the storm and the damage to Tampa and surrounding areas was not as pervasive. Irma also had some effect on our Atlanta and Carolina divisions as related storms moved up to East Coast. While it is difficult to quantify the total impacts of events such as this given their complexity it did cause some level of business interruption for which we expect to be reimbursed through our insurance carriers. Turning back to the business, we remain exceedingly pleased with our new Iowa division. The division is preferring very well and has made positive contributions to our growth in the third quarter. I recently visited the team in Iowa and I was very impressed by their go-to-market strategy and customer focus. We are also very happy to have renewed our contract to continuing servicing the 4,500 Rite Aid Stores. We view this as an important partnership for Core-Mark. Our business continues to grow as we expand the number of stores where we deliver milk. We also continue to discuss with them other category expansion opportunities. Turning to Walmart, we are currently delivering to 550 Wal-Mart Stores today and it’s going very well. We are excited to have this partnership with such a marquee name performing so well and we continue discussions about additional items we could deliver and other ways to partner with the world's largest retailer. Now let's dive a little deeper in the financials. Sales in the third quarter grew 8% with one last selling day. The primary drivers to our growth were our Farner-Bocken acquisition, a full quarter Walmart sales and incremental sales from 7-Eleven. The sales increases were offset by the loss of the Kroger and Circle East contracts. The total revenue growth of 8% and the non-cigarette growth of 19% was healthy. I am also encouraged by the improvements we are seen as a California car declines in the center of the store items are showing slight increases. Warehouse and delivery expenses continue to be a challenge particularly at our two fastest growing divisions that have experienced cost overruns. I am pleased to report that service levels are vastly improved, so at a higher than normal cost, which had an impact on third quarter expenses. As we look forward, we are finally starting to see expense reductions at these two divisions and are hopeful that we will see a significant reduction in Q4, setting us up for improved results in 2018. To update you on our cost savings initiatives, we have seen a 5% decline in weekly miles this quarter compared to the run rate in Q2 2017. We estimate the cost savings from this to be $1.5 million, so we are on pace to achieve our second half 2017 goals. Throughput, which is total pieces pick per hour are also showing some improvement. We saw 1.4% improvement in the third quarter and in October improvement of 4%. So we are still on pace to reach our goal of $1 million to $3 million from each of these initiatives. In my experience there is a lag time from when these metrics start to improve and when we see can see them generate tangible financial benefits. We will need to see these improvements accelerate in order to reach our goals. We are seeing good progress on our SG&A expenses as our general costs are down 7% and selling costs are down 9% from our first quarter run rates. Our estimated impact of these initiatives for the quarter is about $3 million in savings that we are seeing some good progress in these areas. Taking all of this into account, adjusted EBITDA grew to $47.9 million compared to $39.2 million last year, which was a significant improvement compared to our Q2 performance. Now an update on our core growth strategies, Our VCI and Fresh incremental sales totaled about $20 million despite having to replace Fresh and VCI volume from Circle K East and Kroger. Even with these losses, we are on track to reach our $100 million incremental target. These core strategies continue to help our customers take cost out of their supply chain, while also providing the consumer the products that are in demand. There is clear evidence that same-store consumers are demanding these fresh and better for you products and it is our job to partner with our customers and to make sure these are available while also meeting our profit margin objects. In fact, we are in the early stages of two or large customers in assisting them in rolling out major fresh programs to their stores. Our sales organization has doubled down our efforts to sell to higher margin products particularly fresh products. Turning to our Core Solutions Group, it was relevance is growing as data analysis plays an even more critical role in a modern organization. This group is also responsible for the FMI surveys that we conduct. In the first nine months of 2017, we have printed over 3,000 FMI surveys with a greater than 60% acceptance rate. We increased our target mid-way through year from 3,000 to 4,500, so this benchmark puts us on pace to reach our elevated goals. We have seen the stores grow their non-cigarettes at an accelerating rate compared stores that have not participate, particularly in the recent soft sales environment. Before wrapping up my comments, I wanted to touch on the recently announced promotion of Scott McPherson to President and Chief Operating Officer, as well as the promotion of Chris Hobson to the Senior Vice President of the Western divisions from his prior role as a Senior Vice President of Sales and Marketing. Having all three of our graphic regions report directly to Scott along with the IT, corporate office and training groups will help drive the operational efficiencies we need to grow the profitability of our Company. Congratulations to both Chris and Scott. I am confident that these two changes will serve the Company very well and support our growth going forward. In closing, we have begun to see some of our initiatives gain traction. We continue to focus on accelerating the rate of that traction of these initiatives. We are seeing slight improvement in consumer demand and some of our initiatives are aiding that growth. The cost overruns at two of our divisions that have impacted 2017 are decelerating and that needs to continue as well. I am confident that we will get those divisions back to profitability in the near-term. And I am confident our initiatives are driving improvement in our operations. Overall, with the improvements that we've seen in Q3 coupled with executing on our initiatives, I am confident we can deliver our revised outlook for the year and put us on a path for profitable 2018. I will now turn the call to Chris Miller, our CFO.

[Christopher Miller:]

Thank you, Tom, and good morning. I would like to start by bridging the 22% growth in EBITDA of the quarter compared with earnings per share, which was flat at $0.29. Now I will discuss the results in more detail and touch on the revisions to our guidance. LIFO expense was $0.08 per share this year versus $0.05 in the third quarter last year. So excluding LIFO, EPS grew approximately 9% to $0.37 compared to $0.34 last year. Higher interest expense from the purchase of Farner-Bocken and cigarette inventory purchases as well as a higher income tax rate in the third quarter of this year decreased EPS by $0.03 per share and $0.02 per share respectively. Adjusting for these items, EPS increased approximate 24% for the quarter compared to last year. Now turning to the results for the quarter. Total sales for the third quarter grew 7.9% to $4.3 billion compared to last year. Our growth was driven by several factors including the Farner-Bocken acquisition which we now refer to as our Iowa division, a full quarter of sales with Walmart, significant incremental sales from 7-Eleven and an increase in sales to existing customers. This is despite one less selling day in the quarter this year, which decreased sales by approximately 1.7% and loss of Circle K and Kroger earlier this year. Sales for the non-cigarette categories increased 18.8%, again reflecting contributions from our new Iowa division, Walmart and 7-Eleven and an increase in same-store sales of 4.7%. We saw a robust sales increase of 50% in the candy category, driven primarily by Walmart sales as well as additional volume from the Iowa division. We also saw healthy sales in food and fresh, which each grew approximately 15% and in our health, beauty and general category which grew about 12%. Non-cigarette sales increased to 31.4% of our total sales for the third quarter of this year compared with 28.5% last year. Sales in the cigarette category grew 3.6% to $3 billion on the addition of the volume from the Iowa vision and to a lesser extent increases in cigarette prices and excise taxes. Cigarette carton sales declined by 4.8% on a same-store sales basis in Q3 driven by 19% decrease in California volumes. Excluding California, the same-store carton sales decrease was 2.8%. As you recall, we along with our industry peers have seen Californian carton volumes declined significantly following the $20 per carton excise tax increase in the spring. We did see the decline in the rate in California cartons improve in Q3 compared with Q2. While this is encouraging the overall decline in cartons continues to present a challenge in 2017. Gross profit increased $23.3 million or approximately 12% in the third quarter compared to last year, driven primarily by the addition of the Iowa division and a $6.2 million increase in cigarette holding gains year-over-year. Cigarette manufacturers increased prices in September this year compared with November in 2016. In addition, gross profit was negatively affected by LIFO expense of $6 million compared to $3.7 million last year. Remaining gross profit, which excludes holding gains and LIFO expense increased $19.4 million or 9.6% for the quarter. Looking at remaining gross profit by category, non-cigarette remaining gross profit increased $19.7 million or approximately 14%, while cigarette remaining gross profit decreased $0.3 million or 0.5% compared with the third quarter last year. Although remaining gross profit per carton increased 3.5% this was offset by the decline in carton sales. Remaining gross profit margin was up 8 basis points for the quarter, margin gains from the shift and sales mix for the quarter were driven primarily by the addition of the Iowa division which has a higher in non-cigarette volumes than our traditional customer and the increase in non-cigarette same-store sales. These gains are offset by higher cigarette manufacturer prices and excise taxes which compressed remaining gross profit margin by approximately 20 points. Cigarette remaining gross profit margins decreased 8 basis points due mainly to manufacture price increases and increases in various states excise taxes. Non-cigarette remaining gross profit margins decreased 53 basis points during the quarter driven primarily by a net sales increase in large chain business and a higher sales mix of OTP which carries much lower gross profit margins relative to other food and non-food products. These decreases were partially offset by the addition of the Iowa division. Just a reminder that although large chain businesses may negatively impact our gross profit margins. They generally require less working capital, this allows us in most cases to offer lower prices to achieve a favorable return on our investment. Total operating expenses increased $20.1 million or 11.4% to $296.8 million for the quarter, as a percent of sales OpEx increased 15 basis points. Excluding the new Iowa division OpEx increased $1.2 million or 0.7%. As Tom mentioned we did see positive impacts of our cost savings initiatives during the quarter. Although we still have work to do around these initiatives we are encouraged by the results we have seen thus far. Warehouse and delivery expenses increased $20 million or 17% during the third quarter. Excluding Iowa of increase in warehouse and delivery costs was $6.5 million or 5.5%. Although we still have higher costs at two of our divisions servicing 7-Eleven the overruns did state improve during the quarter. As a percent of sales warehouse and delivery expenses increased 25 basis points. SG&A expenses decreased $0.6 million or 1% to $57 million compared with the third quarter last year. Excluding Iowa SG&A expenses decreased $6 million or $10.4 largely due to our cost savings initiatives. As a percent of sales SG&A expenses declined 12 basis points. Now turning to cash flows. Our free cash flow which is calculated by taking net cash flow from operations less net CapEx and capitalized software totaled approximately $62 million for the first nine months of 2017 compared to a net usage of cash of $108 million for the same period in 2016. We are trending toward the higher end of our free cash flow projections for the year and currently expect approximately $60 million in free cash flow for 2017 subject to year-end LIFO and other inventory buys. Our total long-term debt as of September 30 increased $500 million compared to approximately $348 million at the end of 2016. However, our debt is back down to approximately $400 million as of the end of October as we have since sold through excess cigarette inventory purchase during the third quarter. The net increase in the debt position reflects the asset purchase of Farner-Bocken. Capital spending total $47.4 million for the first nine months of 2017 compared to $49.6 million for the same period last year. Some of the larger ticket items included our investments in a new consolidation center in the northeast and investments needed to service the new Walmart business including leasehold improvements and additional tractors and trailers. We still expect CapEx to be approximately $50 million for the year. We announced an 11% increase in our dividend up to $0.10 per share quarterly or $0.40 annually. The next quarterly dividend will be paid on December 22 the shareholders of record on November 28. Now turning to our guidance, based on trends to-date and what we expect through the end of the year, we have made a few changes to our guidance as outlined in our press release. First, we've tightened the range for full-year sales by increasing the low end from $15.6 billion to $15.7 billion and we've kept the high-end at $15.8 billion. For adjusted EBITDA, we've lowered the top-end from $159 million to $156 million and kept the low-end at $152 million. The estimates for GAAP EPS have changed to $0.93 from $0.96 on the low-end and to $0.79 from $1.3 on the high-end. The decrease is due primarily the higher LIFO expense, which we now expect to approximate $20 million rather than $18 million for the year. We still expect LIFO EPS to be $1.20 per share on the low side and have reduced the top end to $1.24 versus $1.27 per share previously. In addition, we expect interest expense to be $10.5 million for the year and our tax rate to be approximately 36% for the year rather than 37.5%, which we had expected previously. Lastly, I'd like to remind everyone that our guidance does not include the expected non-cash expenses related to the planned termination of our defined-benefit pension plan. We do expect to settle and terminate the plan in Q4 and incur non-cash charges in the range of $17 million to $19 million, which represents unamortized actuarial losses that have accumulated over the life of the plan. Terminating the pension plan will lower future expenses and eliminate the risk of rising premiums. We will update you on our next call on the status of the termination. To summarize, we had a respectable quarter where we saw some improvements in the fundamentals, but we still have much to accomplish before the end of the year. We are progressing toward overcoming their operational challenges we have faced this year and believe we have the right plan in place to reach our targets. We remain very confident about the long-term course we are on to drive sales growth and improve 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 over time and to help our customers succeed. And with that, operator, you may now open the line for questions.

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Chris Mandeville from Jefferies. Please go ahead.

[Chris Mandeville:]

Hey. Thanks for taking the questions. Tom, first off I appreciate you providing color on the loss of the selling day as well as the impact from California, but maybe just to the best of your ability is there any way to quantify the impact of the hurricanes on either the cartons or non-cigarette comps?

[Thomas Perkins:]

The thing, Chris, in that's what we're struggling with right now is so what we saw prior to the hurricanes making landfall. We saw an uptick in our volume correct, as people were preparing for the hurricane. And then, again in Fort Worth in particular we went dark and we served about 400 stores in the Houston area. So that was the most impacted area. So the impact to our business was mostly the cost, so we're paying our employees, we were running our business, but we couldn’t make those deliveries. And then as soon as those customers in the areas got up, we were delivering those and then again after the fact we had a huge spike in our business. And so that's where we're struggling with right now is trying to assess is there long-term impact to our sales going forward. We saw the same thing in Tampa. Huge spike before it went down, and then in Tampa we came up – got back up pretty quickly and then we saw a huge demand for product. And so it's almost like those will offset each other and so that's why we're really struggling right now is trying to assess is there long-term impact on our volume and I can't tell you that right now because it's a little too early to understand that.

[Chris Mandeville:]

Got it. And did those big spikes post-hurricane persist in the month of October?

[Thomas Perkins:]

Yes. And definitely in Tampa, which were later in the year, so we definitely saw an uptick in October after those hurricanes hit now. The one thing is interesting if you talk to customers, especially in Houston, right, and our good customers there. They believe and hopefully time will tell is because of the reconstruction that has to take place that will be good for our business in those areas, right because the people are going to be doing that work are convenience stores shoppers. And so hopefully long-term, we actually see a bigger benefit on a long-term basis from that.

[Chris Mandeville:]

Okay. And then I guess with respect to the sales environment and maybe some of the prospect that you just discussed there, but also you having referenced an overall soft sales backdrop. Can you maybe just update us on customer traffic trends and how they progress like or it maybe difficult? But just generally speaking what you're thinking of as it relates to independent versus chain, and what you're seeing with non-c store customers?

[Thomas Perkins:]

Yes. I think that I had an opportunity when I was at NACS in October to spend some time with our chain customers and independent customers. And I think it was a tale of two cities, one certain areas of that are definitely continuing to see depressed sales environment whereas other sales are starting to see some slight increases. I think we decided upon and really as it pretense to independence is take matters into our own hands. And so that's really where we accelerated the pace of play with our FMIs which we're on pace to do 4,500 and those and then our other programs like SmartStock, Fresh and really focus on our fresh categories. And really we saw the impact in our customers on those that acceleration as we saw. Finally, we saw improvement in our same-store sales in snacks, in fresh, in retail beverages, sweet sauce, and also fast food. I was really pleased that we certainly have to control our own destiny sometimes and I think if I focus on those strategies and helping our customers be relevant to increase their in store sales, I think we're seeing some progress in those initiatives.

[Chris Mandeville:]

Okay. And then the last one for me before I hop back to the queue. In regards to the future M&A and I guess quarter end your leverage ratio is that 3.1 times, but presumably that’s improved in October as Chris referenced on debt paid down. How do you guys feel about your ability to acquire something that will actually move the needle for you in the near to intermediate term? And is there anything out there today that you see as available and then what do you consider your market share of your addressable fee store industry today again excluding maybe major GST that you wouldn’t be able to displace?

[Thomas Perkins:]

Yes. I could. So to think about it is that over the last since the end of 2012, we've acquired probably the three top independent wholesalers right with Farner-Bocken been in the last Pine State and then J. T. Davenport, so those have been an incremental and invaluable to our growth going forward and so we've been able to really leverage those and Iowa being the most current one that leverage those on a go forward bases, and really as you say they will move the needle on those. The one thing is if there is large M&A activity out there that definitely equity would have to be a piece of that. But we feel confident that as our profitability gets stronger that will be – it will be in a better debt position and down the road M&A as it those become available we’ll always take a serious look at those.

[Chris Mandeville:]

Okay. And just your market share as it relates to your overall addressable industry today?

[Thomas Perkins:]

So we are probably – if you include the total inside store sales of the industry in the U.S., we're probably about 15% to 16%.

[Chris Mandeville:]

All right. Thanks, guys.

[Thomas Perkins:]

Thanks.

[Operator:]

Our next question comes from Ben Bienvenu from Stephens, Inc. Please go ahead.

[Benjamin Bienvenu:]

Yes. Thanks. Good morning. I want to first ask about operating expenses in particular warehouse and distribution expenses, the guidance for the year seems to imply a sequential reduction in the absolute dollar amount for warehouse distribution expenses. I am curious what gives you the confidence a) is that right and then b) what gives you the confidence around sequential reduction and warehouse distribution expenses and what's kind of a baseline number that we should expect to grow off of going into next year with some more normalized dollar amount for that line item?

[Thomas Perkins:]

All right. So what we are seeing, Ben, so really the impact to our operating expenses especially warehouse and delivery that near the significant impact is come from those two divisions we've talked about. So what we are seeing is we are seeing improvement in those expenses as we left September and going into October coming into the fourth quarter. So that definitely will - our spend will go down because of just because of that. So that's a big piece of lower expenses anticipated for the fourth quarter. From an overall expense are you asking as a percentage of sales are you asking our dollar I'm just not sure what…

[Benjamin Bienvenu:]

Yes, as a percentage of sales maybe an easier way to think about it as you guys continue to…

[Thomas Perkins:]

Yes, it is interesting. So as our non-cigarette mix grows and becomes a bigger piece of our business and right now I think for the third quarter we grew to 31.6% versus 29%. Our operating expense as a percentage sales has got to go up. Right, I know in the past we've run about 3% I would say especially with Iowa they were going to probably be 3.1% to 3.2% and definitely we can provide that information when we issue 2018 guidance but that's what I'm thinking on the warehouse and delivery costs.

[Benjamin Bienvenu:]

Okay. Fair enough. And maybe as an extension of that question. Do you think you can get back to that historical cadence you had operating margin leverage on LIFO basis or 100 percentage sale basis.

[Thomas Perkins:]

Yes, I believe while we absolutely I think you know again I look at the business is the and I think I've talked about it before is there's if I was to withdraw right the two divisions that we've had the most serious cost overruns this year. We are seeing improvement in operating margins, but those two had such an impact that it clouds all that. So we're going to be back to closer to normal next year. So I think you'll see that next year.

[Benjamin Bienvenu:]

Okay. Great. And then one last one as it relates to the balance sheet. Chris you already cited the reduced debt balance in October. What’s your expectation for the pace of the deleverage over the course of the next year. Where would you like to be in terms of the leverage the carton in the next two to four quarters?

[Christopher Miller:]

Yes, so likely end the year I'd say little bit higher than where we are in terms of debt just because of year-end buys LIFO or whatnot so maybe 450 to or so but then it should come down after year end as usually does. I think we generated $100 million or so in free cash flow in the first quarter. So I would expect something like that again. To bring it down to below 400 or mid 300. So but in terms of leverage definitely when it gets up to three were that's kind of where the comfort starts to such get little on comfortable I guess for me, but will be below that we should definitely we will below that next year as we generate free cash flow and paydown the debt.

[Benjamin Bienvenu:]

Okay. Fair enough. Thanks a lot.

[Thomas Perkins:]

Thanks, Ben.

[Christopher Miller:]

Thank you.

[Operator:]

And our next question comes from Andrew Wolf from Loop Capital Markets. Please go ahead.

[Andrew Wolf:]

Hi, thanks.

[Thomas Perkins:]

Hi, Andrew.

[Andrew Wolf:]

Hello. With Farner-Bocken I met to miss this did you call out either any integration costs that were either in the quarter or are sort of in the guidance that would cycle out?

[Christopher Miller:]

We didn't call it out Andy, because in the third quarter it wasn't as significant we'd incur a $300,000 during the quarter a lot of it was in the U.S. in the second quarter of prior to the actual acquisition occurring.

[Thomas Perkins:]

I think the total is that one point…

[Christopher Miller:]

Total is about $1.7 million year-to-date.

[Andrew Wolf:]

And how about in reference to guidance? Is there more to come or how should we think about it?

[Christopher Miller:]

No, no we’re not converting them to our system or any of that until…

[Thomas Perkins:]

We don't know yet.

[Christopher Miller:]

For a while, yes, so there should not be any significant costs going forward for this year.

[Andrew Wolf:]

Okay, another sort of housekeeping question around guidance. On the business interruption, estimates that – is that in your guidance or is that something that you settle out later?

[Thomas Perkins:]

Yes, we made an estimate for what it is at this point and that's in our guidance.

[Andrew Wolf:]

Okay. But it sounds like it's not a big type of number you should [indiscernible]?

[Thomas Perkins:]

That's right

[Andrew Wolf:]

Okay, and then I'm not sure I've heard you right. So I know the tone of your in-store business is still pretty subdued, but did you say that you saw some signs of changes that it’s in behavior and if you did was that because of things that Walmart is doing for the customers or is that kind of more of a macro?

[Thomas Perkins:]

No Andy, that's a good question. But that's what we're doing. What we can do is help our customers be relevant and drive the profitability in their stores and so really that's what we've done with accelerating FMI. We really focus on our smart stock programs. We focus on fresh categories sales and that's really I think we're seeing improvement in our stores because of the strategies that we’re executing in our stores.

[Andrew Wolf:]

Okay, and last thing is some of the food service distributors stocks are being affected partly because of the driver shortages, for in-bound freight in these hurricane affected areas and are you seeing that kind of thing in your cost structure or…?

[Thomas Perkins:]

Well yes, it's a good question. So the suppliers we buy products from really cover the cost of freight. Now we have seen a degradation of service from our suppliers because of the driver shortages within the trucking companies. So it does impact our fill rate to our customers from a product perspective, but since all of our drivers are about – 99% of our drivers are employed by Core-Mark. We still see shortages in different areas, but we try to offset that with in-house driver programs et cetera. So but from a trucking company that's more I think on our suppliers, who definitely have there's been difficulty in and we definitely are been having a lot of serious discussions with some of our major suppliers because of their inability to get our product to our warehouses when they do.

[Andrew Wolf:]

Okay, are they – do they have a sense of when it’s going to leave? When it could get better or is it sort of…?

[Thomas Perkins:]

I don't know I haven't had that question to say what do you guys doing about it. But so far it has been improved, I mean it was fine and then the last couple months it's gotten worse, and maybe the summer et cetera so hopefully by the end of the year and I'll be talking to certain suppliers is that we're seeing some improvement in their trucking ability to get their trucks and product to our warehouses?

[Andrew Wolf:]

And last one for me is, you've also seen sort of in commodity-based, again with the food service distributors are selling so much commodity products, fair amount of inflation and you guys are much different mix, but maybe – what are you seeing with inflation if anything obviously more in the food side and the non-cigarette side.

[Thomas Perkins:]

That's one of the issues we've faced really over the last two years is since where our majority of our pricing is cost plus and so when we see inflation, we’re able to sort of offset the wage inflation right we have. But really last two years has been very, very small definitely cigarette manufacturer continue to increase carton prices and tobacco prices, other tobacco products. We haven't seen the increase in other categories. And so that's one that's not good for us because we're seeing wage increases and unfortunately in our business you just can't go out and raise prices because we have some competitors out there that would take advantage of that. So and again third year of the three-year cycle for candy was to get price increases every three years and they haven't done that this year. So I think they're holding off also. So it's been very – the price inflation at least for the categories we carry has been nominal, and we hope that inflation gets stronger. I am sort of with fed on that is why as an inflation increased.

[Andrew Wolf:]

Well I guess we'll find out later. Thanks.

[Thomas Perkins:]

Thanks.

[Operator:]

And our next question comes from John Lawrence from Coker Palmer. Please go ahead.

[John Lawrence:]

Thanks. Good morning, guys.

[Thomas Perkins:]

Good morning, John.

[John Lawrence:]

Yes. Tom would you – you commented a little bit on what you've seen in October with some of the initiatives. Can you just remind us a little bit as far as going through the process, after the second quarter you told us some of the issues that are still? I guess walk us through that process and what’s improved, what’s still needed to improve and how important is this? Does this 4% productivity in October, does that get you to the run rate where you need to be for the fourth?

[Thomas Perkins:]

Yes. So definitely we set a goal of reducing miles by 5% from a transportation perspective. We saw that in the third quarter. And in fact we've actually increased the pace to play and actually looking for a larger increase in the balance of the years, so we've increased the pace of play, so hopefully that will generate even more savings. Productivity was sort of the last thing we put out there. Our goal is to improve productivity by 5%. And so think about this for every one piece throughput improvement for the company on an annual basis that’s a $1 million savings. So we definitely have – we are seeing traction on that. We were in our plan review process right now with our divisions where we visit all the divisions. And Scott and his new role is sort of talking the role of that, going out to the divisions, but definitely his comments to the divisions as we got it, we got to increase the pace of improvement in our throughput, in our miles. And really that's a short-term, but it's also a long-term and I think those benefits will continue throughout this year and into next year. From a selling in general, John I think we're doing exactly what we said we're going to do and those will continue into the fourth quarter, so I'm really pleased by the divisions really focusing on those fixed expenses and reducing those. So I'm really pleased by that. So definitely we need to continue and we need to hit these targets to hit our guidance for the year.

[John Lawrence:]

Great. Thanks. Second question as you mentioned some of the – obviously Walmart et cetera, usually when Walmart looks at things in certain divisions there's also things and you mentioned that other programs are being discussed. Is it fair to assume that some of the more matured divisions maybe in the southeast or certainly in some of those locations or dealing with the same difficulties they had before they came to you?

[Thomas Perkins:]

I don't know that to be honest with you. So we focused on the stores that we service and we focus on there as we all are is the importance of in stock levels at store level and I do know that our in stock levels are on par with their other supplier, and so I think they were very pleased by that because anytime you make a change they don't know. So what I try to do is let's focus on what we're doing with our stores today, and I think if we do that that as the contract progresses that there's a point in time when they say hey, listen we need you in certain other parts of the country, but right now it's all about just doing the best for them in the stores we service.

[John Lawrence:]

Great. Thanks. Good luck.

[Thomas Perkins:]

Thanks, John.

[Operator:]

And our next question comes from Ben Brownlow from Raymond James. Please go ahead.

[Benjamin Brownlow:]

Hey. Thanks for taking the question. Tom you’ve talked quite a bit around the guidance and the OpEx reductions, I'm just hoping you can help out a little bit just trying to further get my arms around the guidance. The implied fourth quarter EBITDA guidance being I guess around $56 million. How should we think about the Farner-Bocken contribution in the fourth quarter relative to the third quarter? And just given the year-over-year and sequential increase when you take out the inventory holding gains, it's a huge kind of $14 million, $15 million uptick in EBITDA. Is that you know some of that coming from better gross profit, better sales or is there is a majority in that expense reduction.

[Thomas Perkins:]

Yes, so I couple of things are going to happen when we will have them carryover CPI’s about to $2 million to $3 million in the fourth quarter because of the timing so we weren't able to recognize all of the CPI we earn, so we'll have that in the fourth quarter. Definitely what's driving the higher performance in the fourth quarter of our EBITDA is a full quarter contribution from Farner-Bocken. So that definitely is going to drive the performance. And then coupled with the initiatives we have going on that that's really what's driving that higher EBITDA expectation.

[Benjamin Brownlow:]

Okay. That’s helpful. And I just from a big standpoint the new role - newly create a role of the CEO. Can you just discuss any kind of primary changes around the operational approach you're taking and kind of that dynamic between the decentralized model that you've had in the past?

[Thomas Perkins:]

Yes, no change in the decentralized model but what this gives us is those Scott we'll have the three senior vice presidents who are in-charge of our divisions right. And then he also will have IT the core products group in our trained organization. So he will be able to impact the division operations on a quick basis right and get everyone aligned so and he also will be spending a majority of his time really with this senior VP isn't really driving the probability of the divisions which drives the probability of the Company. So really now that we have 33 divisions it's I think it was a necessary step in our organizational structure to really to sort of provide more focus on our division operations.

[Benjamin Brownlow:]

Great, thank you.

[Operator:]

[Operator Instructions] And our next question from Chris McGinnis from Sidoti & Company. Please go ahead.

[Chris McGinnis:]

Thanks for taking my questions. So quickly I guess just continue on the operating expenses, is there something specific you can highlight that you've done to the two facilities that you call out in terms of what are the actual I guess changes being made, just to get some confidence in that Q4 improvement?

[Thomas Perkins:]

Sure. Yes, so the biggest change we may which was probably about 3.5 months ago was – and one of the division – in both divisions we replaced and put in place experienced director of operations to run the day to day operations, right, the warehouse and delivering facility. So that was the start of the change, right. One of the divisions we actually put a new. President in that division and so the intent was one get the service stabilize and improve to our customers, which we've done that right and now the focus has been on throughput and it's been focused on rerouting the customers and stuff. And so what we've been able to do in our Sacramento division for instance is we've been able to remove about 30 people from our warehouse, headcount because our productivity is improving, our service is improving. So we don't need as many people right, and so each of those facilities are going through that process. Improving productivity, reducing headcount, reducing the hours worked, reducing the over time right, which is driving the expense reduction. Second thing is early on in particular in the third quarter, we had to bring in outside assistance from other divisions, and we just adds a terrific amount of cost to those divisions. We have not had outside assistance in the month of September, month of October and we will not have any outside assistance in either of those divisions the rest of the year and that was a big cost of not only do you have the outside people who labor cost, but you also have those travel causes associates, those are gone. So I think that those are all the things we're doing, all the right things we're doing, which is getting back to profitability.

[Chris McGinnis:]

Okay, thanks for taking the time. Appreciate it.

[Thomas Perkins:]

Sure.

[Operator:]

And our next question comes from Chris Mandeville from Jefferies. Please go ahead.

[Chris Mandeville:]

Thanks for the follow-up. Tom, I may have missed this, but in terms of your fresh growth excluding Farner-Bocken, what was the organic rate there?

[Thomas Perkins:]

So the fresh categories for the same-store sales for the quarter which would exclude Farner-Bocken was 9.6% and that was up from 8.2% in the second and 4.9% in the first.

[Chris Mandeville:]

Okay. That's helpful. And then last one circling back to your SG&A dollar reduction progress thus far and the need to accelerate things in Q4 in the guidance. It maybe a little bit early, but how should we think about potential need for any additional investment in people and/or CapEx spend on new technologies to become more automated in the coming year?

[Thomas Perkins:]

Yes. We've actually, I mean we've already invested in our handheld units for not only our customers for our sales organization and the data analytics that they can access the data analytics. We have rolled out handheld device to our drivers which is creating efficiencies with our deliveries, but again our CapEx next year will be much less than what we've spend over the last two years. I think we definitely – I guess that the other day, I'll say this as we've invested and that’s right now we we've added enough business and our goal now is really to leverage all of those and drive the profitability of our company.

[Chris Mandeville:]

It's safe to say that SG&A will likely be down year-on-year in 2018?

[Thomas Perkins:]

Yes. Of course, you'd have to cut out the Farner-Bocken in that, so we're going through that planned process right now. And again, as we talk to our divisions, listen if they want to increase selling expense so how much sales and margin right are you going to increase and then sort of you've got to have a return on investment, and so that's the way we look at the business.

[Chris Mandeville:]

All right. Thanks, guys.

[Thomas Perkins:]

Thanks. End of Q&A

[Operator:]

And as we have no further questions, I'd like to turn it back to Ms. Milton Draper for closing remarks.

[Milton Draper:]

Thank you for your participation in our conference call and for your interest in Core-Mark. We appreciate your continuing support. If you have additional questions, please feel free to give me a call 650-589-9445. Thanks.

[Operator:]

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