Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Milton Gray Draper - Director, IR

Mike Walsh - President and CEO

Stacy Loretz-Congdon - SVP and CFO

Analysts

Jonathan Lichter - Sidoti & Company

James Ray - Hawkshaw Capital

Garrett Stevens - Giovine Capital

Ian Wallace - Third Point

John Colive - Oppenheimer & Company

John Hardy - Principal Global

Andrew Volt - BB&T Capital Markets

Peter Black - Wynnefield Capital

Brian Duran - MFC Global

Core-Mark Holding Company, Inc. (CORE) Q4 2008 Earnings Call March 16, 2009 12:00 PM ET

Operator

Good morning everyone and thank you for joining us today. We would like to welcome you to Core-Mark Holding Company's Fourth Quarter Earnings Conference Call. You are all in a listen-only mode until we open up the call for as many questions as time permits. This call is scheduled to last 60 minutes. We ask that you limit yourself to one question and one follow-up question so that others can get an opportunity to have their questions addressed. (Operator Instructions)

At this time, I would like to turn the call over to Ms. Milton Gray Draper, Director of Investor Relations; please go ahead.

Milton Gray Draper

Thank you operator and welcome everyone I would now like to read a statement about the use of forward-looking statements and non-GAAP financial measures during this call.

Statements made in the course of this call that state the company's or management's hopes, beliefs, expectations or predictions 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-K, 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, Michael Walsh; and the Chief Financial Officer, Stacy Loretz-Congdon. Also in the room is Chris Miller, our Chief Accounting Officer, and Greg Antholzner, our Vice President of Finance and Treasurer.

Our lineup for the call today is as follows. Michael Walsh will discuss the state of our business and our strategy going forward, followed by Stacy Loretz-Congdon, who will review the financial results for the fourth quarter. We will then open up the call for your questions.

Now, I would like to turn the call over to our CEO, Mike Walsh.

Mike Walsh

Good morning and early happy Saint Patrick's Day to all. Our fourth quarter results, I believe, are reflective of one of the strengths of Core-Mark, and that is we should be viewed as somewhat of a safe haven during times of economic turbulence.

Our sales increased 8.7%, our EBIT increased 32%, later Stacy will cast a more refined perspective. As a reminder, my comments are always on FIFO basis. But those are the numbers that represent the headline.

While the economic downturn began in the fourth quarter of 2007, for the year, our sales increased again 8.7% and our EBIT was down 19.1%, not due to weakening performance of this year but primarily due to the one-time tax gain of $13.3 million last year. Adjusting for these tax refunds holding gains and LIFO expense our EBIT was up 20.8% for the year.

These results were achieved despite the fact that the industry continues to experience cigarette carton decline. For the year our same-store carton sales for the US and Canada combined dropped approximately 3.4% while we understand the industry dropped about 4% in the US.

In the fourth quarter, our total company same-store sales cartons declined nine-tenth of 1%. You may recall we regained some of the loss Imperial Tobacco volume in 2008 which allowed Canada to show an actual increase in same-store carton volume.

Now contrast this to the drop in carton volume to the improvements in our profits, effectively we absorbed the loss in cigarette profit dollars and generated improvement in our EBIT. We achieved this result through a focused plan successfully implemented in 2008 which enabled us to shift the loss carton profitability to primarily the non-cigarette category.

And as I have stated over the past two to three years the entire industry must and will affect this shift. The good news is that according to our long range forecast models this shift can occur in an orderly fashion without resulting in the convenience channel becoming price disadvantage for the non-cigarette products sold in comparison to other channels.

On the topic of cigarettes, we are certainly mindful of the SCHIP that is State Children's Health Insurance Program that was recently passed by congress. This law will add about $6.17 of federal excise tax to every carton of cigarette sold in the US.

Almost all of the cigarette manufacturers have already announced an increase in their pricing that is going into effect prior April 1st. It is our hope that these price increases or other possible measures that could be taken will be sufficient to cover the entire tax obligation. We think that outcome is highly likely, but we can’t be absolutely sure at this point.

Based on announcements made today, it appears that we will retain the traditional cash discount allowance on the incremental tax. At the least this helps the distributor in covering the annual cost of inflation and inventory carrying cost. As far as what happens post the tax increase, we expect that our any profit per carton should be positively impacted primarily due to the cash discount. Of course, this legislation will accelerate the industries carton decline; which ironically will negatively impact the revenues; the states count on to balance their budgets, including MSA payments.

As I stated above, we expect to recover the bulk of the loss profits due to carton decline, if any associated with SCHIP to the same steps we took in 2008 to absorb normal, historical carton declines. Based on 2008 carton volumes, SCHIP good result in an overall gross increase in our sales of somewhere between 400 million and 450 million in 2009. This increase, we estimate will be largely offset, by the expected drop in carton consumption. The SCHIP effect was not included in our recent revenue guidance for 2009 and we will continue to monitor its impact on our forecast.

Unfortunately SCHIP will result in an increase to the industry’s working capital demand while it may affect our borrowings to a degree and may also cause some distributors to revaluate their future and result in some acquisition opportunities for us. As we are all painfully aware, the recession of 2008 seems to be picking up steam as we move through 2009.

Well, I am not a macroeconomist for sure, we hear unemployment is predicted by the White House to reach 9% this year which appears to be a safe bet given the fact that the February rate was over 8%. Some economists have forecasted the rate to reach as high as 11% in 2010. Who knows when or if the stimulus package will take effect but assuming this macrounemployment numbers are directionally correct what effect does this have on our customers? Normally unemployment is say 5% so one could reasonably anticipate that a same-store traffic decline could diminish our revenues somewhere between 0% and 5% although I admit this is not a very scientific calculation. This drop is material but not catastrophic. I would expect that we would flex our variable operating cost plus increased market share to offset the consumption decline impact on our bottom-line. I know it sounds easy when you say it fast but that’s what we expect.

As a reference point our non-cigarette same-store sales in 2008 was actually up approximately 2.6% for the year and a 4.1% for the quarter versus 2007 absent the impact of foreign exchange.

Our reading of some recent [next] forecast for 2009 supports our belief that the industry’s non-cigarette sales will not be down. We cannot guarantee this but that’s what the data suggests. We certainly have an aggressive agenda for VCI and Fresh in 2009 which we believe will be an effective counter measure to the soft economy for the benefit of our retail customers and for Core-Mark in 2009.

The 2009 economy poses another issue for us, credit availability for our customers, lending for non AVLs is generally not available as we all know.

The few of our midsized chain customers could be at risk in a weakening economy. It is reasonable to conclude our bad debt losses could surpass normal expected levels, but I do not anticipate that this will be a material reason for us to miss our 2009 business plan targets.

We are closely monitoring our AR exposure. In terms of day sales outstanding, we lowered our AR exposure by 7% in 2008 as measured by daily averages. I believe our retailers have enjoyed an infusion of profitability in the fourth quarter as gas prices plummeted for now they seem to be relatively stable.

If we are headed for a deeper recession I would not expect the sharp increase in gas prices which would otherwise of course represent a double whammy for the convenient retailers who sells gasoline in 2009.

I begin my statement by highlighting our top line and EBIT performance. And while Stacy will go into more details and explain the effects of one time items normalizing for new divisions like. I do want to touch on a couple of financial metrics for the fourth quarter and the year.

First, I was pleased with the continued progress we have made on non-cigarette gross profits. The 11% fourth quarter growth in non-cigarette revenues was accompanied by 17.8% increase in our margins if we ignore state OTP tax refund.

Two causes for the increase VCI and Fresh initiatives and transitioning the declining carton volume profits to non-cigarettes.

For the year, the 13% growth in non-cigarette revenues was accompanied by a 16% increase in our margins, again, if we ignored the state OTP tax refunds in both years. Likewise, VCI and Fresh and transitioning cigarette profits helped us achieve this performance for the year.

Secondly, let me comment on our operating expenses. I was pleased that our warehouse and delivery expense as a percent of sales for the fourth quarter trended down by 20 basis points.

However, our G&A expenses were markedly higher due to the following three items.

First, we suffered an approximately $5 million swing in workers comp benefits, due largely to a one-time gain last year associated with the Fleming legacy workers comp.

Secondly, we incurred a swing of over $3 million in bonuses. And you may recall that last year, corporate folks were not paid a bonus by virtue of the fact that we took responsibility for the two bad debt hits, but did not take credit for the Washington OTP tax gain. This year we made a bonus. Plus, more divisions qualified for bonuses this year than last.

And thirdly, the balance of the increase in G&A versus the fourth quarter of last year is attributable to higher cost of health care, which exceed our growth in headcount. This is an issue which has attracted focus and action plans which we have, in part, implemented for 2009.

Setting the effect of these three items aside for the quarter, our total operating expenses as a percent of sale, actually went down slightly, even adjusting for the bad debt of last year. For the year, those same three items explained more than 100% of the 14 basis point increase in our total operating expenses as a percent of sales, unadjusted for the 2008 bad debt.

The rapid rise and the increase of our health care cost represents a new challenge for us.

All companies seem to be struggling with this phenomenon. We have changed our benefit package for 2009, we continue to educate our employees and we have implemented additional initiatives to tackle this cost growth.

Workers comp is another area where costs are troublesome. We have changed our outside administrator and we are attempting to bring more aggressive management to the more severe cases.

We have focused our safety programs and have changed the incentive programs for each of the division in an attempt to educate everyone on the importance of an accident free work environment.

Now let me change gears for just a minute. I want to call your attention to the rebranding of Core-Mark that we recently announced. You may have seen our recent press release and I do encourage you to check out our new website presentation.

The point of this new look is not simply to update our colors; it represents a declaration to the convenience retail industry in that. After three years of building the capability to handle Fresh, we believe we can now claim the lead position.

The convenience retailer can rely on us to comprehensively meet their fresh needs. It is a symbol of our deep commitment to Fresh which we see as the emerging trend in convenience retailing for years to come.

We have tied rebranding with a strategic and focused initiative for 2009. And without giving too much away to the competition, let me just say we will be expanding our fresh offering to increase both the scope and scale of our Fresh program.

Our new look has without doubt galvanized our entire organization. Over the past few years I have been asked a question by many of you, like if fresh is such a good idea, why is not the competition pursuing it.

Recently we have seen the competition coming out with ads their fresh capabilities. I think this is a good development, since the fresh movement needs many key members of the channel supporting the movement. We could not do it by ourselves. I will say that there remains a real intangible difference between heavy or cold supply chain, which we all have years to service traditional frozen and chilled items versus having a fresh supply chain.

Fresh requires developing the organizational confidence, modifying and upgrading our facilities and fleets, sourcing new vendors and products and offering retail marketing programs suited for the new highly perishable consumer goods demanded by leading retailers.

But we also fully understand the difference from simply having the capability as opposed to leveraging the capability. Our new initiative represents another level of penetration that will further differentiate Core-Mark in the marketplace.

My time is running short, so I will end my comments with a couple of brief observations. The continued volatility of the stock market and its impact on the investment community, the freezing of credit markets and the weakening of the economy have not been helpful to any company's stock price today, including ours.

But let me summarize our position. Our balance sheet is strong, our credit line is solid, we have ample borrowing capacity, we are growing, we generate cash and we excel in an industry that is one of the least affected by the recession. A lot of companies today can't make that statement.

We strongly believe that our current stock price is well for lack of a better term, irrational. We continue to evaluate all of the options including share buyback programs, dividends and business growth opportunities, which we are fortunate to have.

For now, we have chosen to keep our powder dry. At some point, the strength of our performance measured by our earnings, our stability and our potential has to resonate with investors, which should lead to a substantially different and higher valuation of the company. I trust this will be the case. And as you know, I purchased 10,000 shares myself in November.

In closing, while my crystal ball isn't perfect, if best, I have a positive view about our prospects for 2009. We have a great opportunity to grow market share to continue to leverage our operating expenses and our Fresh capability while offering a clear path for retailers to reduce their supply chain costs.

I believe our non-cigarette margins will continue to increase and we do not plan to be boarded by SCHIP or other causes of the inevitable decline in cigarettes. Our business is strong and we intend to keep it that way.

While we maintain a positive outlook, we are keeping a healthy wariness about what lies ahead. We are working on ways to eliminate discretionary costs. We just want to be prepared for all contingencies. But frankly, I still see 2009 as a good year for us.

As always, thanks for your interest in Core-Mark, and I am now going to turn it over Stacy our CFO to discuss in greater detail the financial results. Stacy?

Stacy Loretz-Congdon

Thanks, Mike and good morning to everyone. I would first like to echo Mike's sentiments that we feel we had a good year and made substantial progress point of view of hurdles including fuel costs, carton declines and economic crisis that is terminating our daily life.

As a company, we have traditionally viewed ourselves as a recession-resistant, partly due to the consumable nature of the convenience product resale. In light of this instability in the financial market, however, I suspect that many of you are concerned about what that means to us.

Specifically, the questions we are getting seem to pivot around the same theme. Creditworthiness of our AR portfolio, our capital allocations philosophy and under funded status of our frozen pension plan.

In addition, we expect you are wondering what the recently past SCHIP will due to our working capital needs, so I will address this towards the end of my comments.

First as Mike mentioned, we continue to carefully monitor our accounts receivable portfolio and we have stepped our communication internally with all of our credit professionals in the field.

I want to remind all of you that our cash cycle is short, just over 9 days on average. We have a low tolerance for payment delays and have increased our response to slow payers through alternate credit terms, which include COD or no shift status.

Our total past due status over 30 days was 2.6% at the end of 2008 compared to 3% at the end of 2007. This excludes the AR balances related to the two customers we posted significant results during 2007 and we are still pursuing aggressively. We are doing every reasonable thing we know to protect ourselves and minimize our credit exposure.

Second, we continue to maintain our conservative capital allocations philosophy. Consistent with that view, we did not purchase any Core-Mark shares during the fourth quarter. And as Mike indicated, we are keeping our power dry.

Our share repurchase program is still in place and we continue to review our options and have ongoing internal discussions about the best use of our capital. With the current market instability, we have taken up purposely conservative approach due in part to these market conditions and also in an attempt to preserve capital for longer-term business opportunities.

And finally, if you have had to chance take glance at our pension footnote, you will see that our pension plan is now 63% funded compared to 89% at the end of 2007. This decrease was directly impacted by the market and lower rates of return on our planned assets than originally anticipated.

Note that this valuation expense is a direct charge to our other comprehensive loss in the equity section, it did not impact EPS for 2008. What this means to our future cash flows assuming no market recovery or change in rates is that the true-up of our funding contribution for 2009 will be paid in 2010. Early estimates indicate this true-up to our normal contributions will be in the neighborhood of approximately $1 million. Stay tuned on this one.

Moving onto our financials for the quarter. Mike already mentioned most of the highlights so I will try to dig a bit deeper into some of the numbers and briefly touch on areas that he has already covered. Sales were $1.49 billion for the quarter an increase of 8.7% compared to prior year’s fourth quarter of $1.37 billion.

Our cigarette sales dollars grew by 7.5% with cartons increasing 6.4%. Excluding our Toronto and New England divisions, cigarette sales dollars were essentially flat while cartons were up 1%. You maybe scratching your head about this but it is the weakening of the Canadian dollars in the fourth quarter that is driving the flat dollar growth. I will cover foreign exchange in a minute.

As Mike mentioned Canadian carton sales were strong due in part to the re-entry of the Imperial product last spring inflective zones that we delivered to.

Non-cigarette sales for the fourth quarter increased from $417 million last year to $464 million this year or 11.3%. The three fastest growing categories were food, candy and other tobacco products in that order. Candy has experienced price increases over the past few years so some of this inflation, however, our VCI and Fresh initiatives are clearly resonating with the industry as noted by the growth trends for the food category for the year as well as for the quarter. Within this category our dairy, bread and fast food showed the most growth during Q4 '08 as compared to fourth quarter in 2007.

Excise taxes which are embedded in our revenues increased by approximately $29 million in pace with our overall sales growth are 8.6%. The two new divisions operate in taxing jurisdiction that have heavier excise tax burden then most of our other divisions and may contributed nearly all of those increase.

Foreign exchange significantly impacted the fourth quarter, compressing sales by $48 million compared to that total year-to-date foreign exchange impact amounting to only $5 million net increase. This means our Q4 sales growth would have been 12% compared to the 8.7% realized this quarter, purely due to the weakened Canadian dollar compared to Q4 '07. All of our line items on our income statements were similarly impacted by the devaluation of the Canadian dollar on a quarter-over-quarter basis.

Gross profit for the fourth quarter increased 23% before adjusting for LIFO expense, cigarette holding gains and OTP tax refund, our remaining gross profit increased 14.8% after excluding these items. Cigarettes on a cents per carton basis were stable with and without holding gains in LIFO effects. Remaining gross profit for non-cigarette categories increased 17.8% or 12.6% if you exclude the two new divisions. As a percent of sales our remaining gross profit increased 91 basis points, largely due to the timing of the 2008 Candy increases which required us to trade load in Q3 and give up some normal purchasing income during the fourth quarter.

Excluding an estimate of this impact we still see substantial improvement in gross profit as a percent of sales north of 20 basis points. As Mike mentioned this increase was driven by our VCI and Fresh initiative as well as our focus on recapturing loss cigarette profits due to decline in carton.

You may have noticed in the product line table on page 36 of the 10-K that we broke out LIFO expense between the cigarette and non-cigarette categories. Bear in mind that LIFO is essentially a evaluation process and used for tax strategy purposes. We continue to operate and manage our business on the FIFO basis.

Moving to operating expenses. Mike already covered the fourth quarter in a fair amount of detail so a big picture. These expenses increased 34 basis points as a percent of sales compared to fourth quarter of last year. If you ignore the three cause of factors he mentioned and add back the additional bad debt reserves we expensed during the fourth quarter related to our two customers, we would have shown a 19 basis point improvement in our total operating expenses as a percent of sales, inclusive of the two new divisions.

We are pleased to see a 20 basis points improvement specifically in the warehouse and delivery line. We made meaningful progress in our underperforming divisions compared to the third quarter of this year. Year-over-year, our warehouse costs were stable and delivery costs were leveraged. In addition, if fuel prices avoid the kind of volatility that we saw during the first seven months of 2008, we should continue to see favorable comps until this trend lapse itself.

I won't repeat the reasons for increases in SG&A expenses. However, I do want you to know that we are focused on our contingency cost control plans in the event we incur future losses that exceed our expectation. We have a well thought out business plan, that focuses on continued leveraging of our cost structure and we stand ready and are nimble and flexible to the changing dynamics that maybe presented in today's economic environment.

Foreign currency losses continued to dilute EPS with a $3.7 million charge recorded in Q4 '08, unlike the slight gain we enjoyed last year. Most of you understand that this largely represents the revaluation of our investment in Canada and the expense of the non-cash items. This January we started to see a slight recovery of the Canadian dollar, which if the trend continues may allow us to focus like gain in the quarter.

Our effective tax rate for the quarter was 6.3% compared to 13.6% for the same quarter last year before adjusting for interest and other items. Our tax-rate this quarter benefited from the expiration of statutory limitations on uncertain tax positions, which we had reserved for totaling $1.4 million net of interest expense.

In addition we also benefited from a recovery of foreign tax credits totaling $1.6 million. Without these benefits our effective tax rate would have been approximately 39.5%. Diluted EPS was $0.70 per share for the fourth quarter this year, versus $0.46 per share for the fourth quarter last year, a $0.24 increase.

Asset holding gains, OTP Refunds, LIFO, foreign exchange and tax benefits, the adjusted EPS for the quarter was $0.64 per diluted share compared to $0.60 per share, Q4 '07, a 6.7% increase.

For the year, the adjustment EPS grew 17.1%. We hope you saw the non-GAAP reconciliation table included in our press release to help you bridge the numbers.

We call out significant non-cash items in the table on Page 25 of the 10-K for those wanting to do a quick EBITDA calculation.

Overall cash flow generated from operations was about $56 million for 2008 compared to $67 million last year.

During 2007, we benefited from the restoration of tobacco tax credit in the State of California. Our investment in Toronto working capital is also reflected here along with the establishment of New England's AP balances subsequent to their purchase. As in these three items the remaining operating cash flow increased about 10%.

We spent approximately $20 million for fixed assets during 2008 $26 million net of cash acquired for the purchase of our New England divisions' assets and $11 million for our share repurchase program.

We have in our 2009 planned guidance to spend no more than $27 million in capital. You should note that this is not a guarantee of spending. Our divisions must request funding and prove an appropriate return on investments before we commit.

In addition we have some flexibility in our planned expenditures should we decide for the more conservative investments schedule as warranted.

Moving to our balance sheet, our key statistics measured on a daily basis at the operating level remain steady.

DSOs are running 9.5 days down from 10.2 days last year. Inventory on hand is running 15 days versus 14.8 days last year, with the slight increase due to investments in our cigarette inventories in anticipation of price increases.

Our average AP days including taxes payable decrease slightly to 9.8 days compared to 9.9 days last year.

As Mike mentioned, we expect our working capital needs to increase as a result of the new SCHIP legislation, we are estimating thus to be in the $30 million to $40 million range consisting of increased investment in our accounts receivable, inventory and vendor prepayment.

While some say carton consumption will be impacted it is too early to tell by how much. Although manufactures and their analysts have all have their own opinions on this.

What I do expect, is there will be a settling period, volume trends will likely be distorted for several weeks based on the trade loading that may or may not have occurred at the wholesale as well as the retail level.

But as we move into the summer months we should have a better view of the consumption trends and what that might do to our mid year forecast.

Also as Mike mentioned, this working capital investment will be borne by all wholesalers and retailers in our industry. We are queued up to address the credit risk and our radars up for any opportunities that might exist for those wholesalers who may not have the capital structure to support this shift in our industry. I will say that this is the type of development in our industry that makes conservative approach to capital prudent.

Our borrowings under our credit facility at the end of the year were $30 million compared to $29.7 million at the end of last year.

In addition, we had another $186 million available to us under our credit facility at the end of the year which should be more than sufficient to absorb any increase in our working capital requirements resulting from the SCHIP legislation.

And with that, I would like to thank our employees, our vendors, our customers and you our shareholders for your continued support.

And operator, you can now open the lines for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Jonathan Lichter from Sidoti. Please go ahead.

Jonathan Lichter - Sidoti & Company

Hi, good morning.

Mike Walsh

Good morning.

Jonathan Lichter - Sidoti & Company

So your estimate for working capital for SCHIP is $30 million to $40 million additional?

Stacy Loretz-Congdon

Yes.

Jonathan Lichter - Sidoti & Company

Okay. Why were the non-cigarette margins this high, is it all related to Fresh initiative?

Mike Walsh

No, not all. I would say we had some higher than normal price increases on non-cigarette items that also helped us for the increased margins. So I wouldn't say these kind of pressures are 100% responsible for it.

Jonathan Lichter - Sidoti & Company

And those should be sustainable, I imagine then?

Mike Walsh

Well, Jonathan it hits us. Those things happen pretty regularly, you just can't tell when or how much. But in the 20 years I have been here, they have been pretty consistently.

Jonathan Lichter - Sidoti & Company

Okay. And then just lastly Canadian sales then were down entirely because of the currency, is that correct?

Stacy Loretz-Congdon

There was a significant impact of the result of the currency. For the fourth quarter it was $48 million.

Jonathan Lichter - Sidoti & Company

Okay, thank you.

Operator

Our next question comes from James Ray from Hawkshaw Capital. Please go ahead.

James Ray - Hawkshaw Capital

Yes. I was just wondering if you could provide an update on the VCI revenues similar to what you have provided last quarter.

Mike Walsh

This rough of the year, we are, I would say, about $80 million for the year of 2008, which was under what we had hope to achieve largely because of our milk contract to sell-through. We are planning to do a 100, again this year.

James Ray - Hawkshaw Capital

Okay. And for Fresh total?

Mike Walsh

Yeah. I am talking about VCI and Fresh as one category.

James Ray - Hawkshaw Capital

Okay. That's all. Thank you.

Mike Walsh

Welcome.

Operator

Our next question comes from Garrett Stevens from Giovine Capital. Please go ahead.

Garrett Stevens - Giovine Capital

Yeah. Hi, thanks for taking question.

Mike Walsh

Sure.

Garrett Stevens - Giovine Capital

Expand a bit on your thoughts around your capital plan, Mike? I think we can understand kind of shielding buyback to some degree though, I think it's really nice to see enough activity there to offset any potential option dilution, but why can't we move forward a bit more forcefully with the dividend at this point?

It seems like that only consumed about $4 million of the capital for the [22%] dividend and that seems relatively modest in light of the cash that you got to be drawing off this year.

Mike Walsh

Okay, got it. Garrett I think the thought here is that given the volatility of the markets, we want to keep our powder dry. If you just look at what we forecast and we can see, things look pretty solid, but we don't know what we don't know. And not many companies are jumping out there and adding dividends today, a lot of companies are rolling back their share buyback programs that have had them.

And I think it's really due to just trying to take a conservative posture in a time where the markets are very volatile and sort of unpredictable. I think the company will address this again when all of us see a little more stability return back to the markets. And I think most companies are taking that position.

Garrett Stevens - Giovine Capital

Absolutely, it just seems like $4 million isn't that much relative to the cash flow that you should you know hopefully see this year. So I think in light of your comments is it safe to assume that we shouldn't expect the dividend to put in place in the near future?

Stacy Loretz-Congdon

Yeah, we are having a hard time hearing you, can you speak up?

Mike Walsh

You tailed off a little bit, Garrett.

Garrett Stevens - Giovine Capital

Yeah, sure. Just kind of based on your comments then is it safe to assume that you won't be putting a dividend in the very near future?

Mike Walsh

We do not have plans to put in the dividend right now, so I would say in the very near future, that's right we don't have plans. I think it's fair to say that we are monitoring the market and the stability of credit and everything else that's going on out there.

And I think when we get comforted that there is some stability that we can rely on. I think that we manage and then the board we will then again begin to address these kinds of options.

Garrett Stevens - Giovine Capital

What sort of stability would you want to see?

Mike Walsh

Well, actually it's hard to measure. I think you will know it when you see it. But to define exactly what it is, I don't think we have sat down and constructed a formula. But I think when you see some liquidity returning to the financial markets, when bank start to loan again, when our customers get small businesses, get access to capital, I think all of these indicators, I think we will all kind of know it when we see it.

Garrett Stevens - Giovine Capital

Okay. Thank you very much.

Mike Walsh

You are welcome.

Operator

Our next question comes from Ian Wallace from Third Point. Please go ahead.

Ian Wallace - Third Point

Hi, guys.

Mike Walsh

Hi, Ian.

Ian Wallace - Third Point

Hey, how are you?

Mike Walsh

Good, sir.

Ian Wallace - Third Point

With respect to the working capital increase due to SCHIP, is $30 million to $40 million that's net increase or is?

Stacy Loretz-Congdon

That's a net increase, because remember this is an excise tax embedded in the product value from the manufactures, and the majority of our manufacturers are COD or prepay. And I think, our guesstimate is somewhere in the neighborhood of 18 days working capital days.

Ian Wallace - Third Point

Okay. And we will see that for $30 million to $40 million hit in the second quarter?

Stacy Loretz-Congdon

Well, as we mentioned, the manufacturers have already announced increases and those are being ruled out primarily before April 1, so we definitely will see the impact, probably going, you may see it in the first quarter numbers actually. And good chunk of it anyway.

Ian Wallace - Third Point

And then, with respect to using capital, when you look at, you probably do not have the answer, anyway, but when you look at the acquisitions the company has made over the last couple of years, and you look at EBITDA contribution from those, how does the multiple on those compared to the company's aggregate valuation?

Mike Walsh

I would say very favorably, both of those acquisitions have exceeded our pro forma projections. And we are very happy with the performance of those, and I think they did very well with the overall company. I will say, I think, the team here did an excellent job in doing their homework and in negotiating those deals. And that gives me confidence that we are not bad at this. And we are acquisitive and we are looking for opportunities that will result in the same outcomes the two that we had in the last couple of years.

Ian Wallace - Third Point

Okay. Can you kind of give a sense of what the total capital committed on those was and what the EBITDA contribution?

Mike Walsh

No, I will, pardon me.

Stacy Loretz-Congdon

We don’t break out each division contribution to the EBITDA. I would say that, the asset investment we have disclosed in our financial statements, so you can definitely look at that. But I will reiterate that we do not break out the individual division EBITDA contribution.

Ian Wallace - Third Point

Okay, thank you.

Operator

And our next question comes from [John Colive] from Oppenheimer & Co. Please go ahead.

John Colive - Oppenheimer & Company

Good morning.

Mike Walsh

Good morning.

Stacy Loretz-Congdon

Good morning.

John Colive - Oppenheimer & Company

I had two questions, coming directly from the K. The first and you surely touched on this earlier was the bad debt expense, and that you are watching credit carefully. I noticed that additions were $1.6 million but the write-off was $2.1 million. I was just wondering if perhaps you can help me understand why the addition to the allowance was so low given the write-off.

Stacy Loretz-Congdon

I am trying to put in context of what you are looking at, so $1.6 million was primarily for accounts that we had reserved for in prior year. And we took those into; you are probably looking at the valuation table I am thinking.

John Colive - Oppenheimer & Company

Right.

Stacy Loretz-Congdon

The bad debt expense actually went to the P&L and then two would be just a normal recurring provision that we satisfied. Our provision is based on a specific identification and now it's a certain large accounts that go over terms and as I mentioned we have experienced a slight decline in our over term statistics. So, it seems somewhat replacement to me more of a turn in the portfolio.

John Colive - Oppenheimer & Company

Yes, I was just wondering if you are using a specific case basis, I guess that would explain the difference.

Stacy Loretz-Congdon

Yes, it’s based on specific identification that we have a small general reserve for accounts under a $1000.

John Colive - Oppenheimer & Company

Okay. And then I guess, you mentioned earlier in comments about the Candy Q3 purchase over Q4 that it was accelerated I think, if I heard that correct?

Stacy Loretz-Congdon

Well, I think I have mentioned in other calls that it's really difficult to breakout Candy increases from our normal recurring merchandise income that we earned because we trade load when there is an opportunity which foregoes the regular merchandise income that we would earn on the normal recurring purchases.

John Colive - Oppenheimer & Company

Okay. Then, my next question was why was drop in vendor incentives receivable. And I guess that would explain it then.

Stacy Loretz-Congdon

Yes, just timing of the purchasing.

John Colive - Oppenheimer & Company

Great, thanks very much.

Mike Walsh

Thank you.

Operator

Our next question comes from John Hardy from Principal Global. Please go ahead.

John Hardy - Principal Global

Yes, good morning, I had a question on your Canadian operations and looking at the segment results, you went from a loss of $1 million to $5.6 million this year. I am assuming biggest chunk of that was the foreign currency hit but its still looks like you probably would have had a little bit larger loss. I wonder if you could discuss what's going on there and how you are fairing and attempting to gain new customers and increase throughput through your facilities up there.

Mike Walsh

Right, okay. One of the issues is, Toronto we open a new division, in Toronto January 21, of last year. That was an investment we made in the Ontario marketplace because that’s where most of the people in Canada are located, we have been in Western Canada for a number of year's. We entered into a contract with a key customer, up there that sort of gave us a critical mass to consider putting an operation up there. And because of that we incurred some losses but our hope is that with our presence there we can, and will penetrate the market and our guys are doing that, I mean, never as fast as you want but we have had some gains that give me hope and some excitement that we are going to be fine in Toronto. But if you compare one year to the other it did add to the losses.

The other area that I talk about was Calgary. Calgary struggled again in 2008 for the most part. But two favorable things are going on Calgary.

First of all, their results are getting better, but primarily due to one, the employment situation in Alberta is easing somewhat. There was a very severe labor shortage that's been going on for a year and half to two years. Big oil shale is up there and it was sucking up all of the available labor.

That is easing somewhat with the price of oil nationally dropping. I think it's now below the economic value by which they can process the sands. And that's having an effect on our turnover which is having a positive effect on our operating costs. The other thing also I believe having an effect is we have a brand new management team up there that we put into place.

End of last year we, last year we had a lot of corporate support in there to analyze and evaluate what we needed to do and we put in place a what we believe is an excellent management team and they are already showing improvements to that operations.

It's large marketplace. Our revenues are very robust up there. It's just a matter of getting our operating costs to process those sales efficiently. I do believe that we are, we had a few months down where, if shown that are on the right track there. So I believe that Canada will show a nice turn around in 2009 for those reasons.

John Hardy - Principal Global

You will be picking up additional volumes in the Ontario market and cost coming under better control in Calgary?

Mike Walsh

That it’s to summarize that's exactly right.

John Hardy - Principal Global

In terms of the Ontario operation, mean when you first went in did you think it was going to be like maybe a three to four year time frame before you had sufficient volumes to, break into the back or earn an acceptable return on investment. And has that changed at all, whatever the time frame was?

Mike Walsh

I would say yes to the first question when you open up a distribution center its all you are going to take it two or three years to really to get all the volume that you need. But having said that I would say that the revenues were certainly softer than we anticipated in 2008 and I would like to get into, to why that is but the revenues were certainly softer. But towards the end of the, we were really just focused on setting up an operation that we could deliver the product in a reliable way. We did not even start pursuing additional revenues until mid summer I would say and that had some positive results and as we thought there would be. So little weaker start than I had anticipated, but signs that long-term, we are in the right position.

John Hardy - Principal Global

Are there opportunities in the acquisition area to accelerate throughput through that Ontario facility?

Mike Walsh

Yes.

John Hardy - Principal Global

Alright thank you.

Mike Walsh

You're welcome.

Operator

Our next question comes from [Andrew Volt] from BB&T Capital Markets. Please go ahead.

Andrew Volt - BB&T Capital Markets

Thank you. Mike, earlier in your prepared remarks I think you talked about consolidation possibilities and I think you said they might be accelerating their more apparent. Was that due were you saying that was more due to SCHIP and sort of financial side, I mean for you guys it’s a big number and I imagine for a smaller wholesaler especially in a shrinking credit environment or is it more the economy and can SCHIP affect on demand. So more on the balance sheet side or more the income statement cash flow side, it might be?

Mike Walsh

I think it’s the balance sheet. I think as well as both. It’s SCHIP is going to put more pressure on people, looking for financing and as we all know that's problematic these days.

So that's a reason that we think that there might be an acceleration of the opportunities to acquire people and certainly and I think probably even more important that SCHIP as the price goes up the demand we think is going to go down. Now I do not think that most of the distributors that are out there have a strategy have a plan or can effect one that will counter the inevitable decline in carton consumption that is a very, very powerful long-term phenomenon that's going to drive more people to say what is our future and what is our exit strategy. I do think it will accelerate our acquisition opportunities out there and we do plan to be there and do that intelligently when it happens.

Andrew Volt - BB&T Capital Markets

And in terms of Core-Mark, you mentioned that everybody has to sort of pass through pricing of some sort in non-cigarettes down the supply chain on to the store to the customer.

Mike Walsh

Right.

Andrew Volt - BB&T Capital Markets

So, that sounds like an industry phenomenon. I guess you are saying that Core-Mark has obviously with Fresh and VCI and other things. Is it more of that, more of a merchandizing thing that Core-Mark would have, or is it more a scale thing that you might share with someone like [McClain] or is it some combination of that?

Mike Walsh

Well, let me break it into two parts. We have consciously said, we have to make up for the declining carton consumption affect on our profits by shifting prices to non-cigarettes, and not VCI and Fresh.

We are saying that that has to stand by itself. And I guess with my comments, I was saying that we had a very focused effort throughout the company to do just that in 2008, and we were very successful in doing it.

So I am seeing SCHIP and the continued decline of carton consumption, and I am knocking on wood that so far I believe that we have sort of the focus and methods and the approach to get that extra money, or not extra money, to replace that money in non-cigarette pricing.

But the second thing that you raised that we don't try to confuse with the first one, and that's VCI and Fresh. VCI and Fresh is our mechanism to differentiate ourselves in the marketplace and to grow our profits. The former is to keep our profits, hold, the latter is to grow our profits, and we are trying not to mix one with the other.

And I believe, that both have been very effective. We are growing our non-cigarette margins by about 20 basis points, and we have been doing that for the last couple of years. And you got to cleanup the noises in there. But, largely, it is because we are getting better margins on this Fresh stuff and that's helping to add this 20 basis points, and I see that continuing.

And we are holding our profits on cigarettes. I think we are going to be holding that, because as long as the manufacturers can. I appreciate what Philip Morris and others have done in the way they have handled this price increase. It has enabled us and other distributors, to be candid, to kind of weather this initial tax hits we are going to have to our inventory.

But overall, the way the manufacturers have done that, it should not be harmful to us. It will, of course, result in declining carton consumption. But, I think, we have really two excellent strategies in place to counter that. I am not so sure. In fact, I would be fairly sure that many of our competitors do not have that strategy. Maybe, a couple of the bigger ones would. I would say most of them do not. And I think that's going to lead to some acquisition opportunities for us.

Andrew Volt - BB&T Capital Markets

Thank you. I appreciate that.

Mike Walsh

Welcome.

Operator

Our next question comes from Peter Black from Wynnefield Capital. Please go ahead.

Peter Black - Wynnefield Capital

Hi, Michael, Stacy and Milton, how are you doing?

Mike Walsh

Peter, well how are you?

Stacy Loretz-Congdon

Great, thank you.

Peter Black - Wynnefield Capital

Good, thanks. Yeah, almost all my questions were answered. Just one follow-up on SCHIP legislation, do you have any fear that consumers are going into stores and continue to buy cigarette?

They will now have less money left over to shop the other parts of the stores and actually you might eventually see a small erosion in the comp store sales of non-cigarette products too?

Mike Walsh

Yes, yeah to some extent, but let me just give you perspective. First of all gas is a very powerful attractor. And people are still, that's what my comments about the effect of the economy. I tend to look at that as what effect is that going to have on traffic, but people are going to these convenient stores in large measure, because they are getting their gas. And with gas prices being down, that's been very helpful to us on that.

But let me give you an example. Look at what's happened in Canada over the years. You are seeing this acceleration of carton prices in the US, but in Canada, the premium brands up there, retailers selling for $80 to $90 a carton.

And frankly our cigarette business up there has been okay. So I don't know that even this SCHIP is going to have draconian effects that you would expect. So I don't think it's overall. That's not something I worry a lot about. And is really up to us and the retailer to have a better offering in (Inaudible) almost down, so you can raise your hands about this economy (inaudible) home, but really this says, smart operators people that are going to offer the consumer a better value, a better higher quality product and all that, they are going to continue to get the business and the retailers I talk to they are doing good, they are fairly happy.

Peter Black - Wynnefield Capital

Okay. Great, and so your intention now is I guess to see how the quarter progresses and wait and see how the SCHIP legislation filters through and then if need be change your guidance, but right now you are sticking with the sales target you gave.

Mike Walsh

Right, we said, this is what we see, that’s the best number we can see today and I have given you the gross affect that would have on our cartons, but I think that’s mostly going to be offset by the decline whatever that decline is. And we will monitor that and if we get a hand I am looking at Stacy, but if we get a handle on that I think we would adjust our guidance accordingly, right?

Stacy Loretz-Congdon

Definitely, and I think we just need to wait for the carton volume to stabilize a little probably be a little bit choppy going in.

Peter Black - Wynnefield Capital

Right, okay. Alright, thanks very much, I appreciate it.

Mike Walsh

You're welcome.

Operator

Our next question comes from [Brian Duran] from MFC Global. Please go ahead.

Brian Duran - MFC Global

Hi guys, how are you?

Mike Walsh

Fine, Brian.

Brian Duran - MFC Global

I have another working capital question, $30 million to $40 million clearly is a material amount and my math making some assumptions that should take up most of your free cash flow after CapEx next year and if you assume, you are managing to every capital decision is managed to a required return hurdle, that means that when you come up with $6 million to $8 million or down about pre-tax from a profit perspective to make up for that increase capital you use. And I guess I just wanted to be clear as most of that from what you are suggesting going to come from the pricing initiatives on the non-cigarette portion of your business. Is that the way to think about that?

Mike Walsh

Yes, I think that is the primary mechanism. However, we will still be looking at price remedies on remaining cigarettes and we will be hopefully adding to our penny profit, post the tax.

Stacy Loretz-Congdon

Yes, I would agree. I think that with the cash discount as it currently fits absent to me future developments and we do anticipate that there will be some upside on the penny profit that will help subsidize that, but to the extent we are losing gross profit dollar overall in the cigarette category. We will be looking for ways to make that up.

Brian Duran - MFC Global

Okay. Can I ask you a bit differently, so if we are going to have this discussion a year ago and have the foresight to know that we are going to have $30 million to $40 million working capital usage from this potential legislation? What are you doing differently today to get a return on that capital versus what you are doing in the plans a year ago to drives this incremental high returns from VCI Fresh, some of the cost containment initiatives etcetera. I guess the assumption is, or I have an assumption that there is something different that’s being done because of it's new $30 million to $40 million capital that you are going to have to on your business, is that fair?

Mike Walsh

I think, lets talk about the VCI and Fresh, we have been investing if you will for the two or three years. And we are getting to a point where most of that investment will be in place and will, we will establish that capability approval.

Correspondingly, we will be leveraging the return on this as we continue to grow sales of VCI and Fresh and then you would say, what's happened in between, or how are you taking the account of that. And I would say absolutely, this is the ability that we have developed has lead to market share wins that in my mind more than replaces satisfies return on capital.

Now we are starting to kick in the incremental sales of VCI in Fresh that have higher margins and that plus the additional market share wins that we are getting because we are the fresh supplier to the convenience retail industry and certainly gives us return on investment that we have plan. So and as far as what we are doing differently, we are still going to pursue the strategy of VCI and Fresh. We are still pursuing the strategy of expanding our infrastructure into the east where more stores and people are located.

So I do not think we have fundamentally changed our strategy based on this working capital increase required by SCHIP. We do plan to get the profit that is required to cover that and to get a return on that.

Brian Duran - MFC Global

Well that was my question not a fundamental change in strategy but --

Mike Walsh

Okay.

Brian Duran - MFC Global

In terms of where that incremental profit is going to come from and what you are suggesting Mike it primarily is going to come from the pricing initiatives?

Mike Walsh

Right.

Brian Duran - MFC Global

Across the board.

Mike Walsh

Right

Brian Duran - MFC Global

The last question I have was on CapEx the $27 million guidance how much of that is growth CapEx for the year that should go away by next year?

Mike Walsh

Well if I can and Stacy you can correct me if I am wrong but I tend to look at in three buckets. Our $27 million that is I would say $14 million is probably in the neighborhood, is the approximate number for maintenance replacing fork lifts and jacks and worn-out compressors and things like that. There is probably another $6 million of growth initiatives.

We have expanded some of our facilities last year at [Wax], Bayers and that sort of things and we will continue to do that. And the third component this year was the replacement of a building in Las Vegas.

Las Vegas we have a lease facility there and we incorporated in our plans at the end of last year a new division in Las Vegas because our landlord wanted to devote that property to a higher and better use. Now we are still, that was our plan. We are still looking at the situation in Las Vegas in terms of the economy and as we all know it's somewhat depressed. I think the people of Vegas would probably say it’s depressed relative to the recession.

Brian Duran - MFC Global

Right.

Mike Walsh

So, we are definitely maintaining dialogues and maintaining our options, but I am very much aware about the free cash flow formula and what the capital can do. And I am very, very sensitive about spending additional amounts, particularly during these times where the economy is not so strong.

\

I am very much aware of that. But all I can tell you is that $27 million did include a new division for Las Vegas, and we are working real hard to see what our options are that maybe an alternative to spending an extra $7 million. We are not there yet, but if we do get there I suspect, Stacy we will be changing our guidance, right?

Stacy Loretz-Congdon

Yes.

Mike Walsh

If something.

Stacy Loretz-Congdon

When we…

Mike Walsh

Something different happens there, so we are working on that.

Brian Duran - MFC Global

Okay, thanks. Well, hopefully the stock won't stay at 18 for too long. But if it does, it's a heck of buy, and heck of use of capital for you guys as well.

Mike Walsh

Thank you. And we feel exactly the same.

Brian Duran - MFC Global

Yeah, thanks.

Operator

I am showing no further question at this time.

Stacy Loretz-Congdon

All right. Thank you, operator. If anyone has any follow-up questions, don't hesitate to give me a call at 650-589-9445. Thanks for your interest in Cork-Mark.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Core-Mark Holding Company, Inc., Q4 2008 Earnings Call Transcript
This Transcript
All Transcripts