Core-Mark Holding Company, Inc.
Q4 2017 Earnings Call Transcript

Published: 3 Mar 2018

[Operator:]

Welcome to the Core-Mark 2017 Fourth Quarter Investor Call. My name is Collet, 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. You may begin.

[Milton Draper:]

Thank you, Operator, and welcome, everyone. I would now like to read the statements about the use of forward-looking statements and non-GAAP financial measures during the 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 Web site. 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 fourth 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 our Chief Operating Officer, Scott McPherson; and our Chief Financial Officer, Chris Miller. Also in the room is Matt Tachouet, our Corporate Controller. Our lineup for the call today is as follows

[Tom Perkins:]

Good morning, and thank you for joining us on our fourth quarter and year end 2017 conference call. I would like to begin by discussing my retirement at the end of June and transitioning the leadership of the company into the capable hands of Scott McPherson. I've enjoyed my many years t Core-Mark and have enjoyed leading and working with the outstanding individuals that make up this great company over the last five plus years. My retirement plans have been in the works for a while and they do not detract from either my love of Core-Mark or my strong belief in the Company's future, rather that stem from commitments I’ve made to my family and my desire to honor those commitments after nearly 25 year career here at this great company. I have worked side-by-side with Scott for nearly 20 years and have complete confidence that he will lead Core-Mark with distinction. In our prepared remarks, I will provide a summary of our 2017 results. Scott will address what we are focused on in order to reach our 2018 goals, and then Chris will walk through the financial results in greater detail. After that, we will take your questions. We executed well on many of our core strategies in 2017. We closed the largest acquisition in our history and we added important customers like Walmart and others. All of these achievements bode well for our future. However, 2017 was a very disappointing year from a profitability perspective, finishing well below our standards. The on boarding and off boarding of major customers caused significant disruption to a large percentage of our divisions in 2017, and took our focus away from the fundamentals. We also struggle to ramp up and effectively manage the added volume the two divisions have experience the greatest growth. This resulted in significant cost overruns and unanticipated cost to remediate. We have made meaningful changes to the management teams at these two divisions. These changes, combined with other operational improvements, give us the high degree of confidence that we are on the right track to get these divisions back to expected profitability levels in 2018. One of our key accomplishments in 2017 was the acquisition of Farner-Bocken, which we now refer to as our Iowa division. The Iowa division has been a leader in the all-important food service category selling a vast array of these products to the convenience channel and another food service outlets in their market. Their expertise in this area will provide our other divisions with valuable insight and resources for expanding our food offering and improving the menu in our customer stores. I have high expectations on the contributions this new member of our family will bring to our company. We also performed well in our other core strategies. Our VCI and fresh incremental sales totaled about $90 million despite having to replace fresh and VCI volume, resulting from Circle K East and Kroger transition. These two strategic initiatives are a great importance to our C store retailers as their profits to the pressure of continuing cigarette carton declines. It is vital to our customers that they take cost out of their supply chain, while also providing the consumer with the products they want. There is clear and growing evidence that C-Store consumers are demanding these fresh and better for you products. We must partner with our customers to design creative and effective solutions to ensure these products are in their stores while also meeting our profit margin objectives. Turning to our Core Solutions Group, whose role continues to grow as data analytics becomes more critical on our go to market strategy. In 2017, we delivered FMI marketing plans to over 4,300 retail partners with a greater than 65% acceptance rate. We expect to see positive impacts from this accelerated growth in FMI marketing plans in our 2018 results. In addition, our goal for 2018 is to target another 4,600 stores. This is consistent with our re-focus on growing our existing customer’s same-store sales, a critical element in growing the Company's profitability. We will leverage our CRM to gain market share among the important independency C-Store retailers. We believe our core strategies can assist the independent operator to be more relevant and profitable. The Core Solutions Group has also enhanced our visibility to collect operational data more quickly, improving our abilities for achieving our productivity targets. Now let's turn the full year financial highlights. Sales for 2017 increased 8% to $15.7 billion. This includes approximately six months of sales contribution from Farner-Bocken, offset by net customer wins and losses. The important non-cigarette categories grew at 15% for the year and over 17% in the fourth quarter. These results reflect a sequential increase in same-store non-cigarette sales. So we are encouraged by that trend. Same-store non-cigarette sales growth was 8% in the fourth quarter compared to 5% in the third quarter. The driver to this growth were fresh, including dairy as well as e-cigs and vapors in our general merchandise category and OTP. We mentioned in the last call that two of our customers are rolling out the fresh categories in the fourth quarter, so that help resolved. With that being said, we expect greater growth in our fresh category sales in 2018. Unfortunately in the fourth quarter, we saw dramatic drop off in carton sales in November and December that resulted in a approximate 6% same-store sales carton decline for the quarter. The impact from a reduction in carton sales is being offset slightly by the growth in other tobacco products in e-cigs and vapors. Manufacturers have total that they are seeing more traditional smokers migrating to these products or at least mixing them in and this trend might be having some impact on the carton decline we are seeing. The good news is that these other nicotine products are having a position impact on our remaining gross profit. Certainly, not enough to make us whole in the declining cartons, but helpful nonetheless. The fourth quarter carton trends have continued into January. We have begun implementing strategies to help offset the loss profit associated with a greater than average carton decline. We do not realize the full benefits of the warehouse and delivery expense and issues in the fourth quarter. We did see an improvement in our warehouse pieces per hour, but have not reached our target of 5% improvement. Our true trouble divisions did see incremental improvements in reducing operating expenses from the third quarter to the fourth quarter, but this too is the lower expectations. I am pleased to say that one of these divisions was in the black for the fourth quarter, so these two divisions are trending in a positive direction. We were also unable to leverage the reduction in our SG&A cost in the fourth quarter due to lower than planned sales growth as we lap 7-Eleven business and we saw an acceleration in carton decline. We have put in place a number of cost reduction efficiency improvement initiatives in 2017 that will continue to provide benefits and be a focus throughout 2018. The bottom line is our EBITDA for the year came in at 135.7 and that excludes the one-time cost of selling our pension plan compared to 152.3 in the previous year, significantly below our expectations. However, we believe the initiatives we put in place in 2017 will assist in driving improved performance in 2018. Now, I will hand over hand it over to Scott to talk about our 2018 plans and outlook.

[Scott McPherson:]

Thanks, Tom. I would like to begin by thanking you for your great leadership, mentorship and friendship over the past 20 years. I have the utmost respect for you and wish you nothing but the best in your retirement. As to our plans for 2018, we are focused on returning to the fundamentals that brought our company and shareholders a track record of success. From a customer perspective, we are returning our focus to expanding our independent customer base, which has been the catalyst of our long term growth. As Tom mentioned, we will continue the initiatives we kicked off in 2017 around leveraging warehouse throughput and transportation efficiency in an effort to improve our cost structure. We will not have the magnitude of disruptions in 2018 that we experienced last year with all of the on-boarding and off-boarding activities allowing us to focus on the fundamentals. With the focus on our core strategies and operating expense leverage, I am confident we will return to our historical track record of growing our earnings faster than revenues. Based on our guidance, we expect to grow our top line by at least 6%, driven by incremental sales from Farner-Bocken and Walmart, as well as contributions from new independent customers and same-store sales growth from existing customers. We expect EBITDA to grow in a minimum of 16% to $157 million compared to our 2017 performance of approximately $136 million. Our EBITDA guidance assumes the two underperforming divisions return to breakeven for the year. Given the new management teams we have put in place those two divisions and based on what we've seen so far, we think this is a good assumption. We also assume continued productivity improvements in the warehouse as we continue to drive higher throughput, a measure that is critical to your cost leverage. For delivery expenses, we are focused on leveraging our cost per delivery, which we achieved by increasing our cubes and stops per route and reducing the number of trucks we have on the road. In addition to our cost-containment activities, our efforts on growing sales will also play a major part in achieving our guidance targets. Based on how we are positioned entering 2018, we believe we have aligned the organization to achieve our guidance and return to our track record of steady EBITDA growth.

[Tom Perkins:]

Thank Scott. The high growth we experienced in 2016 caught to us in 2017. However, we are determined to get back to our fundamental steady-eddy state and we have a long history of performing well even under difficult circumstances. While the industry is facing evolving consumer habits and stiff competition for share of the stomach, this is a very large and three with a very resilient history going back decades. Given the challenges facing the C-Store space, our core strategies are more important than they have ever been for our customers. I am confident that we can partner with our customers to help them succeed while also reaching our financial goals. By refocusing on the higher margin items and by driving productivity and efficiencies in our operations, we expect significant improvement in our profitability in 2018. I am very optimistic about this Company's future. I will now turn the call over to Chris Miller, our CFO.

[Chris Miller:]

Thank you, Tom, and good morning, everyone. I'd like to start by discussing a couple of significant one-time items impacting our earnings per share in the fourth quarter and full year. These items are included in the supplemental long gap EPS schedule, which is part of our press release. Our diluted EPS for the fourth quarter this year was $0.23 compared to $0.41 for the same quarter last year or $0.33 versus $0.45, excluding LIFO expense. For the year, diluted EPS was $0.72 compared to $1.17 last year or $1 per share versus the $1.35, excluding LIFO expense. The first item I like to discuss is the termination of our legacy defined-benefit pension plan, which resulted in a non-cash settlement charge $17.2 million, included in fourth quarter SG&A expenses. As a result of the termination, the company has no further obligations or financial risk associated with the pension plan. The non-cash settlement charge equates to $0.25 on a diluted EPS basis for the fourth quarter and $0.22 for the year. The second item impacting EPS is related to the passage of the Tax Cuts and Jobs Act legislation. The passage of the legislation required us to revalue our deferred tax balances using the lower tax rate under this new law. As a result, we recognize the one-time tax benefit of $14.6 million in the fourth quarter, which translates to approximately $0.32 per share for the quarter. I’ll now cover the financial highlights for the quarter. Total sales for the fourth quarter increased 6.1% to $4.1 billion compared to $3.8 billion last year. This growth was driven primarily by the acquisition of the Iowa division, the addition of Walmart and incremental sales from 7-Eleven. These sales contributions were offset by expiration of the Kroger and Circle K East contracts earlier in 2017. Sales for the non-cigarette categories increased 17.6%, again reflecting contributions from the Iowa division, Walmart and 7-Eleven and an increase in same-store sales of approximately 8%. We continue to see very robust sales in the candy category growing at approximately 50% due primarily to the Walmart accounts. We saw 13% increase in fresh and over 11% growth in food all-in. In addition, we’re seeing strong growth in nicotine products with OTP increasing approximately 14% and general merchandise where vapor and our e-cig products are included, growing over 20%. Non-cigarette sales increased to 31.8% of our total sales for the fourth quarter this year compared with 28.7% last year. Sales in the cigarette category grew 1.5% to $2.8 billion on the additional volume from the Iowa division and increases in cigarette prices and excise taxes, particularly California. These increases were offset by 5.6% decline in same-store carton sales in the loss of Circle K East and Kroger. The overall decline in same-store cartons was challenged to 2017. And as Tom mentioned, we’re taking steps to offset the lost profit from this strength. Gross profit increased $10.4 million or 5.2% in the fourth quarter compared to last year. Gross profit in Q4 2017 benefited from $2.7 million of OTP tax refunds offset by a decrease in inventory holding gains of $4.9 million and incremental LIFO expense of $3.5. Remaining gross profit, which excludes inventory holding gains, LIFO expense and OTP tax refunds, increased $16.1 million or 8.2% for the quarter. The increase in remaining gross profit was driven primarily by the addition of the Iowa division, the new business from Walmart and incremental sales from 7-Eleven and the increase in non-cigarette same-store sales offset by the loss of Kroger and Circle K East earlier in the year. Looking at remaining gross profit by category, non-cigarette remaining gross profit increased $20.7 million or approximately 15%, while cigarette remaining gross profit decreased $4.6 million or 8% compared with the fourth quarter last year. The decrease in cigarette remaining gross profit was driven primarily by the declining carton sales. Remaining gross profit margin was up 10 basis points for the quarter. The increase was driven primarily by a shift in sales mix to non-cigarettes attributable to the addition of Iowa and the 8% increase in same-store non-cigarette sales. Cigarette remaining gross profit margins decreased 20 basis points due mainly to inflation and manufacturer prices and increases in various states excise taxes. Non-cigarette remaining gross profit margin decreased 27 basis points during the quarter, driven primarily by the compressing effects of Walmart business and a shift in sales mix to OTP, which has significantly lower margins than our other non-cigarette commodities. Offsetting these decreases and remaining gross profit were the positive margin contributions from the Iowa division, higher sales of e-cigarette products and the expiration of the Kroger and Circle K East agreements, which had lower margin relative to the rest of our business. As a reminder, we typically earn lower gross profit margins from large chain customers. However, large chain customers generally require less working capital, allowing us in most cases to offer lower prices to achieve a favorable return on our investments. Our focus is to strike a balance between large chain business and independently owned convenience stores, which comprise approximately 66% of the overall convenience store market and generally have higher gross profit margins. Total operating expenses increased $43.5 million to $211.5 million in the fourth quarter. In addition to the $17.2 million pension charge, the new Iowa division contributed approximate $20 million of incremental operating expenses. Warehouse and delivery expenses increased approximate $18 million or 15% during the fourth quarter compared to Q4 last year. The increase in warehouse and delivery expenses was driven by approximately six months of Iowa expenses and an overall lack of efficiencies as the improvements from our productivity and cost reduction initiatives were not fully realized. As a percent of sales, warehouse and delivery expenses increased 26 basis points. SG&A expenses increased $25 million in the fourth quarter compared to the same period last year. Excluding the one-time pension charge and incremental expenses from Iowa, SG&A increased $1.5 million or 8 basis points as a percent of sales due primarily to de-leveraging from lower carton sales. 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 $40 million for 2017 compared to a net cash usage of $160 million in 2016. Our total long-term debt as of December 31st was $513 million compared to $348 million at the end of 2016. The increase in the debt position was due primarily to the asset purchase of Farner-Bocken and incremental year-end inventory buys to maximize manufacturer incentives and maintain our inventory -- our likely inventory layers. Our debt decreased approximately $350 million in January as we sold through a lot of is inventory. A key focus for us this year is maximizing our free cash flow and reducing our debt level. Capital spending totaled $48.2 million for 2017 compared to $54.3 million for 2016. Some of the larger ticket items in 2017 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 trailers. We announced an increase in our dividend to $0.10 per share quarterly or $0.40 annually in our third quarter earnings release. The next quarterly dividend of $0.10 per share will be paid on March 29th to shareholders of record on March 12th. Now turning to our guidance. Revenue guidance is to grow from $15.7 billion in 2017 to between $16.6 billion and $16.8 billion in 2018. This represents a growth rate of approximately 6% to 7%. Adjusted EBITDA is expected to grow from $135.7 million in 2017 to between $157 million and $167 million in 2018, and represents a growth rate of approximately 16% to 23%. Earnings per share, excluding LIFO expense, is expected to grow to between $1.13 and $1.29 per share in 2018 from $1 per share all in for 2017. This represents a growth rate of 13% to 29%. We expect free cash flow for 2018 to be between $50 million and $60 million depending on the degree of year-end inventory buys. Also our free cash flow forecast assumes CapEx spending of approximately $30 million for the year. In addition to the business assumption Scott already provided our guidance for 2018 also assumes cigarette -- inventory holding gains of $16 million, which assumes to price increases during the year consistent with the last several years. We have not included any other significant holding gains in our guidance. LIFO expense is expected to be $18 million for the year. We've assumed an effective tax rate of 25% for 2018, which reflects the impact of the Tax Cuts and Jobs Act. Incremental interest of between $4 million and $5 million over 2017 subject to the pace of interest rate hikes this year, and diluted shares outstanding of $46.4 million. We view 2018 as a real opportunity to generate solid returns as we drive our core strategies to gain independent market share and help our customers grow. At the same time execute on our operational fundamentals in order to leverage our bottom line. 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:]

Tom, thinking the cigarette volumes. Can you share your assumptions on that metric for the full year? You noted that quarter to-date trends in that negative 6% decline range. And then as we think about that progressing throughout the year if or maybe if you think that we should be seeing improvement throughout the year, but yet it doesn’t show up. How prepared or how quickly can you move to flex that iron bar and show that profitability as it materially impacted?

[TomPerkins:]

Definitely, the fourth quarter was a surprise especially November and December and for a variety of reasons. I think California definitely had a higher carton decline and then we saw in the third quarter. And really that impacted and looking at all three that impacted their results, because Marlboro is a big brand in California. As I look at in 2018 definitely as I said January had the consistent trends, a little bit improvement in February. But I do believe that one, the cigarette manufacturers will be implementing new programs to get the volume up as they should. And also the retail customers have to get probably more competitive. Definitely dollar stores are having an impact, especially if a C-Store is mild proximity of the convenient store. So we think that that growth or that decline will get back to more of a normal 3.5% to 4%. But we’re ready to move and we’re doing it already and really in spite specific customers and don't want to share too much of what those plans are. But really the overall goal is we have to help our customers offset the loss profits in their stores because of the cigarette carton declines and really it’s about having the right product, the fresh categories. It’s about getting the customers in the stores for food service, et cetera. And so really we have a lot of leverage we can push. I think the last thing we want to do is raise prices, but we really want to help our customers grow profits in other categories, that’s our first goal.

[Chris Mandeville:]

And just quickly as a follow up to that as you mentioned dollar stores. I know they’re putting up very robust unit growth but just curious on an apples-to-apples basis. What type of volume does a dollar store get the preview versus your traditional…

[TomPerkins:]

About a third of the C-Store average, so let’s say if it’s 130 or if it’s 75, it’s 25 or so 20. It’s just that they have a lot of stores too.

[Chris Mandeville:]

And then you also mentioned fresh and I believe you said that two of your customers just recently rolled back category out before. So thinking about the long 8% comp in Q4 is that effectively how we should think about things over the next several quarters for the non-cigarette category?

[TomPerkins:]

I think so. I think that's what the intent is. I think it really is interesting and I think that in our non-cigarettes we have OTP and e-cigs vapors. And in California in particular, as we’ve seen the carton decline in California, we've also seen a commensurate increase in OTP and e-cig. So definitely there is a shift in nicotine purchases but definitely that 8% percent, I'm hoping that that continues the trend and we're doing everything in our power with the core strategies to drive that.

[Chris Mandeville:]

And then on the cash flow and balance sheet. Can you just help us think about your use of the tax reform proceedings maybe where leverage could end up by year-end. Since you did have some pretty violent working capital swings in most recent quarters. And I think you called out $40 million to $50 million in free cash expectations, but you did $40 million this year CapEx comes down roughly $20 million in EBITDA or roughly 25-ish midpoint. Why shouldn't we be expecting greater free cash flow generation in the coming year?

[Chris Miller:]

Chris, I said 50 to 60 for the year and that assumes there will be some level of inventory buys at the end of the year and that’s really why it's probably lower than maybe what you're thinking. So I think it’s probably towards the higher end of that range but again subject to what we're going to purchase at the end of the year.

[TomPerkins:]

And I think our goal as a company with the reduction in our tax rates is really is that free cash flow or that cash flows going to be going against the debt reduction. So really our goal is to use that. We believe is the right purposes to use to pay down our debt as we go out throughout the year.

[Operator:]

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

[Daniel Imbro:]

I want to start on the operational progress on the West Coast. In terms of profitability, you guys mentioned that one with profitable last quarter. Where are they currently and then what is the glide path to think of as it move towards breakeven this year?

[Scott McPherson:]

I think currently as Tom mentioned, we had one in the fourth quarter that was a breakeven. I think both the divisions are performing currently where we expected them to be. So as far as that contributes to our overall guidance, I think they are on a good glide path right now and we're very pleased with the management teams that we have in both of those divisions right now and the operational metrics that they’re generating. So right now I would say they are on track.

[Daniel Imbro:]

And then continuing on that, given the past 12 months. How the operational challenges you’ve experienced changed how you pursue new business. Can you guys maybe talk about any changes that you’ve made either operationally or philosophically as you approach new business given what you learn this year?

[Scott McPherson:]

I think, I guess I would say this. I think 2018 is a breather year, so we take a breath. We've had a lot of activity affecting a lot of divisions over the last two years. I think going forward, I think we’re much smarter. When we bring on sophisticated and complex chains and I refer to you maybe 7-Eleven or Walmart, I think we did a really good job in Walmart and we’ve already talked enough about 7-Eleven. But again, I think where our bread-and-butter is really those regional pocket chains, those 20 stores chains, those 30 store chains that we really bring tremendous amount of value too. And those we do really well, and it’s not spread over a multitude of divisions, it's a division-by-division strategic plan. So I think that’s really where we want to be focused on is really those kind of chains. And then again, we will be opportunistic if other chain business comes up. But again at the end of the day, it comes down to we have to make the right amount of return on those investments for those customers. And so that's how I look at potential changes in our customer acquisitions.

[Daniel Imbro:]

And then last one from me, little bit of housekeeping question. We’re hearing a lot of commentary around the tightening labor market. Are you guys feeling any impact of that? And if so, are there any regional discrepancy of where you’re feeling it more or less?

[Scott McPherson:]

I think there is always regional pressures across our company. But last year we worked really hard on our seasonal staffing plan. We’ve done the same thing this year. And so far we feel like we’re in a pretty good position from a hiring standpoint. Obviously, most of the conversation is around drivers when we’re talking about pinch points and labor. And we’ve done a lot of things to make sure that we’re competitive that we’re making their job easier. And I think that will help us a lot this year.

[Operator:]

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

[Andrew Wolf:]

Tom, when we look at the EBITDA margin as a proxy for earnings power, painting 14 at about 1.2% so this year is down around 30-35 basis points. Could you guys give us a postmortem on how you split that up between say operational issues that the company sensibly is within your control and maybe issues in the industry, particularly the cigarette volumes which you can't control so we can get a sense of how we can at least model out what the potential peak earnings power return is for the company?

[TomPerkins:]

I think, Andrew, it’s interesting when you compare like 2014 to today. One is -- and between 2014 -- well actually ’16, we added Murphy which is a large cigarette and tobacco account, which automatically will write down the percentage, the EBITDA percentage of sales. And so mix plays a huge part it now. And which is really reassuring is our results in the fourth quarter was getting our non-cigarette sales up to 31%. And so as we drive that, we will see -- that will automatically drive into a higher EBITDA as a percentage of sales. So that's one thing. If I look at 2017, I think a couple things. The biggest area was under our control and that was operating expenses, particularly in those two divisions we’ve talked about. And so that’s under our control and I believe very strongly as Scott reiterated that those divisions are on a good track to get back to where they should be. And that's really driving the cost out of their systems, because we had a lot of incremental cost last year that was not productive. Second thing it is concerning a little bit about -- when you have hardened declines, it impacts -- definitely impacts sales, it impacts profits. But it's hard to leverage, because again if cartons are down three cartons per customer, let's say and you got 10 customers on a truck route well that 30 cartons but that's little over Cuba product. So you can't reduce the truck-off the road because of carton decline. And the same thing in the warehouse, cigarettes are very productive. So we have to be really smarter. We have to be more aggressive on coming up with solutions to lower the cost of delivery as well as increasing our throughput in the warehouses. So that’s' going to drive a lot of the performance, higher performance in 2018. And at the end of the day, I think it’s growing the non-cigarette commodities, it's growing the same-store sales in our independent accounts, as well as really being market share in that all-important independent account base that will really we make more money and it drives a higher return and higher margins. And so that's really how we get back to where we were, don't know if we’ll get back 1.2 just because of the cigarette mix but it's all going to be depended on what the our mix is from a sales perspective.

[Andrew Wolf:]

Getting into '18 then, I guess I'll switch to Scott and I see you talked about some of those areas you talked about delivery efficiency, route drop sizes and a throughput, and I guess getting better retention. And here you just -- could you give us a sense of where you’re at with that and how you feel about those and which order them so we can get a sense as we look at the year unfold what you're expecting and how you're doing?

[Scott McPherson:]

I’d start off with transportation that probably was our single largest opportunity last year. And the real opportunity for us in leveraging transportation is when we come into the summer season come March, April, we start to reroute our fleet for the summer season. And that's a real opportunity to capitalize on cubes per load and reduce the number of routes on the road. And so we worked really for the last 90 days preparing for that. But right now, we are continuing to see -- we saw through the fourth quarter and into we’re only really closing out February but into the first couple of months, we've continued to see leverage on our fleet. But the big bang will come when we see the summer season. The throughput piece, fourth quarter wasn't quite as strong as I would have like to see. We've seen good results year-over-year in the first couple months from a throughput standpoint. So really I'd say you we’ve had, since I started ICR it's been a short window, but I would say that we've made good progress since then in both of those initiatives.

[Andrew Wolf:]

Just on the housekeeping side. California companies in the fourth quarter often get lacked with accruals and auctorial changes, particularly for workers compensation. And I know that in some legislation it's a little less onerous. But is there anything like that that impacted you, the company's fourth quarter results?

[TomPerkins:]

We did see higher workers’ comp expenses in the fourth quarter than we expected and definitely over last year. And also health and welfare where our claims were a little bit higher, about $3 million or so between the two. We don’t expect the health and welfare to be, I mean we’ll have to see but it just seem like it was a little bit of a blip. But yes, there were some higher costs in Q4.

[Operator:]

Our next question comes from Kelly Bania from BMO Capital Market. Please go ahead.

[Kelly Bania:]

Just want to go back to the method on the two divisions that are having the challenges. I thought you said in your prepared remarks that they were below expectations but then it sounds like it’s in line, maybe I'm just not understanding the timing was that fourth quarter and into the first quarter there on track. What is the message there and is there any difference in timing that you’re expecting then to get back on track during 2018?

[TomPerkins:]

I think we probably confused you, but definitely they were below our expectations in the fourth quarter. But currently based on -- and again, there from what our expectations are for the 2018, they’re on track in 2018. So to achieve what we expect them to you achieve from a financial performance perspective.

[Kelly Bania:]

And in terms of housekeeping lot of adjustments this quarter. If you were to take out LIFO, the pension settlement and the tax benefit. Are you looking at adjusted EPS of $0.26, is that the right way to think about it?

[Chris Miller:]

So it’s $0.33 adjusting for the LIFO, so its $0.23 adding $0.10 back for LIFO is $0.33. And then there is $0.25 for the pension and $0.32 for the tax. That’s $0.26, so you're right.

[Kelly Bania:]

And then in terms of Farner-Bocken, what is the run rate of sales that we should be assuming for that now. I think I am not sure when exactly they come and go business filters out or what the trends are there but just as we think about the first half, any comments there.

[TomPerkins:]

We really -- in Iowa division, we don't really share particular information with it. But our guidance assumes, one it assumes the come and go business out effective I think the end of March. And definitely we’ll have about a six-month lapping their activity versus 2017. So that’s been included in our sales guidance number.

[Operator:]

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

[BenBrownlow:]

Following up on an earlier question around the root efficiencies and then cost per delivery and retention. I think last year first half of ’17, you had a notable overrun in cost. And I think specifically in the second quarter, you commented around $8 million to $9 million of cost overrun. Can you just, taking all of these initiatives and the expense reduction and all the moving parts and just sum up how are you trending at this point, how much have you right sized the cost structure relative to where you were first half of ’17?

[TomPerkins:]

I think, I would say that we definitely are seeing an improvement versus first half of 2017. And only -- again a lot of that coming from those divisions that were in trouble. We spend a lot of money in the first half and getting those two divisions stabilize. So we definitely are seeing an improvement from that perspective. Like Scott said, I think it's important as we get into our summer routing and that’s where we are going to see a bigger improvement in our route efficiencies. And our throughput continues to improve and so that in and itself is showing improvement in our cost structure.

[BenBrownlow:]

And when you say improvement, you mean less than -- less cost overruns than what you had in prior year?

[TomPerkins:]

Correct, yes, lower cost.

[BenBrownlow:]

And just following up on the last question with the come and go. How should we think about that as you prepare for the loss of that contract, short-term deleveraging. What are you doing differently maybe from what you learned with loss in Circle K. And just remind us again what the revenue threshold is reporting large chain wins and losses and the number of renewals from 2018?

[Chris Miller:]

So just maybe touch on the Farner-Bocken piece and come and go. So we obviously had a lot learnings last year from customer inflow and outflow and as recent as yesterday, I had a call with that group and we feel really good about how they are going to leverage warehouse and transportation. The one somewhat unique thing about come and go is there were a number of areas that they were servicing out of the Iowa division that were dedicated to come and go. So eliminating the fixed and variable costs in those situations is much easier than when it’s integrated throughout all your routes and what not. So we definitely I think feel good about how we’re going to leverage warehouse and trends, still working on some of the other fixed cost infrastructure. But yes, I think we definitely learned a lot last year and we’re applying that to that division. And we contemplated in our plan that it’s going to take them 60 days to get back to an efficiency level once that volume goes away. So we’ve worked that into our plan and our guidance.

[TomPerkins:]

I think in our threshold we look at for large chains either wins or losses of $450 million, right now. And the bigger we get materiality threshold changes.

[BenBrownlow:]

And there are no rollovers that we’re aware of outside of come and go in 2018?

[TomPerkins:]

No, there is. The only one -- so Kroger we stopped shipping to Kroger in the middle of April of 2017. So definitely we’re lapping for those 4.5 months versus ’16 and then also -- but we’re also picking up about five months of incremental Walmart business, because we started Walmart in I think the middle of May. So you can almost look at those being an offset to a certain extent.

[BenBrownlow:]

And if I can just squeeze in one more on the G&A for the second half of '17 when you back out the pension charges and integration expenses, it was up around 9% or so year-over-year for that second half, driven by Farner-Bocken, obviously. But is that how should we should think about that the G&A growth in the first half of this year?

[TomPerkins:]

Well, yes, because you will have the Farner-Bocken cost in there. I think that we would probably have a lower growth if you back out Farner-Bocken in that. But that's probably should be pretty close right. Because yes, I’ve listened to Chris's script and we do have all those normalization things that are certainly driving you nut sometimes.

[Operator:]

The next question comes from the line of Ryan Domyancic from William Blair. Please go ahead.

[Ryan Domyancic:]

So in the prepared remarks, you talked about some OTP products helping offset some of the gross profit decline we saw with the slower cigarette sales. Can you take some time to provide a bit more detail about what the gross profit dollar difference is between delivering carton or cigarettes versus heat not burn product?

[TomPerkins:]

Here is the way I look at it is cigarette margins is about 3%. Our margin on OTP is probably about 6% and then on the e-cigs, it's probably double digits. And so definitely as we’re seeing this and it's -- the cigarette companies call it multi-users or poly users. Basically they say okay you got a big cigarette consumption decline in combustible cigarettes, but then you got increase in OTP, and e-cigs and vapors. So people are going back and forth. So it's almost like looking at you got to look at the mix teen category in total, which includes the cigarettes, the moist, the e-cigs vapors and then the cigars. And so the intent hopefully is the margins we grow on those other categories besides combustible helps offset the cigarette decline. We haven't seen that yet but maybe when iQOS heat not burn product comes out from all three if that gets approved and out there hopefully that will help offset some of the combustible cigarettes. But it is -- definitely it's going to help our margins and it will help to offset some of that profit loss from the carton decline.

[Ryan Domyancic:]

And then we think about your customers. Do your customers have a full offering of these heat not burn products for these alternative base products out there or your customers still have work to do in terms of getting those on the shelf, which internal help you drive more demand once they build with that selection…

[TomPerkins:]

I would say that they probably do but they don't have -- it's not everything that they should be caring.

[Chris Miller:]

Ryan, we have a big sales meeting starting next week and actually that is a significant component of the education even for our own sales organization, because that whole -- I mean we've been selling e-cigs for a long time but that whole arena is very dynamic and changing every day. So I think there's certainly a significant opportunity and we've seen products like JUUL and other things just go crazy as we’ve gotten those into the market. So I definitely think there's an opportunity for us to help educate customers.

[Ryan Domyancic:]

And then shifting gears for last quick question. The guidance assumes cost improvement throughout the year. Are there any that we need to be cognizant of in terms of how that profitability will scale throughout the year or what that cadence looks like?

[TomPerkins:]

It’s our normal seasonality, our first quarter is our smallest contributor to our overall profit guidance. It starts to grow in the second quarter and in the third quarter is usually provide the greatest contribution and then it flips back down to a certain degree in the fourth quarter. So that’s normally how that -- historical trends of how our profit comes in.

[Operator:]

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

[John Lawrence:]

Can we start off with a competitive landscape a little bit. I mean it looks like few days ago McLean is talking about $200 million decline in earnings since ’15. Can you talk about intense competition? We know they’ve made some acquisitions. Tom can you talk about the industry, is there anything thing there? And certainly when you look at your profile for the fresh categories and some of those higher margin, just compare and contrast of what you see from those guys compared to your situation?

[TomPerkins:]

It’s competitive -- I would say the bid the RPs are out there, it’s the volume is very small, if any. So definitely saying will it be more competitive or not, it’s difficult to say because we really haven't been into one of that that RFP process in a few months. But what we do know and is that as our retail customers or the convenience store industry shows stagnant sales or shows slower growth, it becomes a more competitive industry across the board for not only large distributors but also local distributors, because if you're a local distributor and you are the old style distributor focused on candy and tobacco and snacks and cigarettes, and you got a big decline in cigarettes, your profits are going to be really punished. And so there is competitive competition from there. But the other thing and the latter part of your comment is that’s where our opportunity lies, because what we're hearing is that customers they see that, they see that the cigarette profit decline. And they need to make that up. And normally what happened is their distributor doesn't provide the products they need to increase their profitability and their store count, and our store traffic. And so that's where we have a definitive competitive advantage against both large and smaller wholesale distributors. And so that's as Scott said it’s really focused on those strategies on increasing the same-store sales and increasing market share within the independents, because we have -- I believe our strategies can help them offset and grow their profits in and through by increasing store traffic having the right products.

[John Lawrence:]

And just a follow up not to belabor the West Coast again, but simply -- just the simplistic productivity curve that we’ve talked about. I guess last quarter and just for maybe a little simple explanation here is we talked about three phases. Number one is you had to get newer employees to be able to pick the product and there were problems there, which led to trucks not being full because of a lot of various reasons and then the timing of these deliveries would take the stops, would take 45-50 minutes instead of 20. Can you talk about those pieces granularly? And as far as where they or which pieces of those puzzles are getting better and where the problem still remain?

[Scott McPherson:]

I’d say in both divisions from a staffing standpoint, we have had -- we're very stable. Matter of fact one of the divisions just because our efficiency is improved, we were in a position to let some of the lower performers go, which at times last year we were looking warm bodies, to your earlier point. So I think from a staffing standpoint and warehouse, we’re really strong drivers we’re very stable there as well in both divisions. And we’ve seen a commensurate reduction in turnover as well. So I think from a staffing and headcount standpoint, we’re in good shape. Obviously, now we’re turning our focus to continuing the ratchet down, ratchet up our throughput and to try and improve our efficiency on the routes. We've done a lot of stuff in both those divisions around routing. And our stuff times have come down. When your quality of order at the store improves for perspective, we were over an hour of stop times at one point and now we’re getting down into the 50 minute high 40s timeframe. So we’ve made a lot of progress in stop times as well.

[Operator:]

[Operator Instructions] Our next question comes from Chris McGinnis from Sidoti and Company. Please go ahead.

[Chris McGinnis:]

I guess, just quickly maybe can you just talk about the outlook for the bid market and then also if you have any big contracts coming up for renewal this year or over the next 15 months?

[TomPerkins:]

We have one large chain the contract expires at the end of the year, so we’re in discussions. I mean our goal is to try and refine our customer without going to bid. So that's our focus right now with that customer. The other ones, pretty much our other chain customer large chain customers, we pretty much tied up for the next couple of years, so no activity there. But there are some opportunities out there but they're not massive opportunities. They’re more of a smaller regional chain or maybe 200 store chain, something like that that we’re looking at. But definitely like I tell, the folks around here is I think we have enough sales, our goal is to drive the profits of the sales we have. And so if something comes along that fits into our profitability structure is great, but definitely its driving the profits of our existing customers is critical right now.

[Operator:]

Our next question comes from Chris Mandeville from Jefferies. Please go ahead.

[Chris Mandeville:]

Tom, as you were just saying when times get tougher in the channel, it seems a little bit more tough for those subscale and sophisticated wholesalers. And you also referenced that this year you plan on taking a breather when it comes to going after major chains. I'm not surely opportunistic. So just wondering if that also applies to M&A as well?

[TomPerkins:]

Yes, I think so. I think we have couple of -- one of the projects we have this year in the fourth quarter is converting our northern New England division, Pine State onto our system. So we definitely are focused on that. And listen, I would never say never but I think again is we need to focus on the business that we have and really drive the profits of the business we have, as well as make sure the two -- and again think about it. Since the end of 2012, we bought three of the largest distributors with JP Davenport, Pine State and Farner-Bocken. And so really driving the profits and driving the learning's from all those acquisitions into the rest of the divisions. But I never say never, but definitely the focus now is really is independent store growth and same-store sales growth. And that’s I think where our bigger bang for our bucks could come from this year in 2018.

[Chris Mandeville:]

Just curious since we’ve been hearing a lot around maybe one or two wholesalers up for sales. And then my final question since we can't seem to avoid the subject really any call, freight costs. Does that have any impact to you guys in the quarter and what's if any ability to do that is there any percentage of COGS or sales which you can disclose?

[TomPerkins:]

No, there really isn't, because again -- so the majority of the product we receive from our vendors that's the cost that our manufacturer or vendors there. So they hire the trucking firm, they pay those costs and we haven't seen and raised prices to offset those costs yet. The only other area where we have is we have our consolidated warehouses where we use outside freight. And so we’re starting to see some increases there but that's really the only area that we wouldn’t impacted by those incremental freight costs. But I think it's going to be dependent on our vendors if they're going to have to raise prices to offset those cost and we’ll see if inflation comes around.

[Operator:]

I will now turn the call back to Ms. Milton Draper for closing comments.

[Milton Draper:]

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

[Operator:]

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