Core-Mark Holding (CORE) Q4 2019 Earnings Call Transcript

Core-Mark Holding (CORE)
Q4 2019 Earnings Call
Mar 02, 2020, 9:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Welcome to the Core-Mark fourth-quarter 2019 investor call. My name is Hilda, and I will be your operator for today. [Operator instructions] I will now turn the call over to Mr. David Lawrence.

Mr. Lawrence, you may begin.

David Lawrence -- Vice President of Treasury and Investor Relations

Thank you. Today's call will be led by Scott McPherson, our president and chief executive officer, and Chris Miller, our chief financial officer. Before turning the call over to Scott, I will point out that Core-Mark intends to take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act as noted in the earnings release we filed this morning. Please remember that our comments today may include forward-looking statements which are subject to risks and uncertainties, and actual results may differ materially from those indicated or implied by such statements.

Some of these risks are described in detail in the company's SEC filings including our annual report on Form 10-K. The company does not undertake any duty to update such forward-looking statements. Additionally, we will refer to certain non-GAAP financial measures during this call. You can find a reconciliation of these non-GAAP financial measures to the most directly comparable GAAP measure and other related information including a discussion of why we consider these measures useful to investors, in our earnings release and our annual report on Form 10-K.

I'll now turn the call over to Scott.

Scott McPherson -- President and Chief Executive Officer

Thanks, everyone, for joining us today on our fourth-quarter call. 2019 was certainly a dynamic year for our industry, and I'm proud of what Core-Mark accomplished. In a year of accelerated cigarette carton declines and unprecedented regulatory disruption, we executed on our strategic priorities, leading the company to records in revenues and profits, headlined by 29% growth in pre-tax profits and 16% growth in EBITDA. Strong non-cigarette sales growth, margin expansion and cost leverage were the catalysts that allowed us to deliver a solid year.

This morning, I will start out by providing comments on our fourth-quarter and full-year results and finish with details around our 2020 strategic priorities and guidance. Our results for the fourth quarter were in line with our expectations, showing continued growth in sales, accompanied by margin expansion that helped drive strong growth in EBITDA. Sales growth of 1.6% was driven by a 5.4% growth in non-cigarettes. Our same-store sales growth is down from our year-to-date average of 6% due to flat year-over-year alternative nicotine sales for the quarter caused by the regulatory disruption, a third-quarter retail load and manufacturer flavor eliminations experienced during the quarter.

Despite the headwinds, we still delivered quality revenue growth. We delivered another quarter of margin expansion through continued improvement in our sales mix and gains from strategic pricing initiatives that drove a 24-basis-point improvement in non-cigarette remaining gross profit margin. Operating expenses were impacted by higher employee bonus and stock comp, given stronger performance for the year compared with 2018. Adjusted for the difference in these accruals and excluding the benefit of inventory holding gains, we delivered EBITDA growth of 12%.

In summary, we are pleased with our results for the quarter which demonstrate our ability to drive meaningful earnings growth in the face of elevated industry carton declines and flat year-over-year growth in the vapor category caused by the aforementioned regulatory and manufacturer disruptions present during the quarter. From a full-year perspective, we delivered $190.7 million in EBITDA, a 16% growth over 2018. Excluding the benefit of the unplanned candy gains and cigarette inventory holding gains greater than guidance, our 2019 EBITDA would have been approximately $180 million, putting us at the upper end of our original guidance. Overall, it was a strong performance by the company, and we are proud to have delivered on our profit commitments to our shareholders.

Our results for 2019 reflect successful execution on our strategic initiatives focused on: growth in sales of higher-margin food; fresh and alternative nicotine categories; the rollout of our strategic pricing initiatives; and cost leverage. We delivered sales growth of 1.7% for the year despite the downward pressure of carton declines. In a year of modest top-line growth, we've proven we have the ability to continue to elevate profits and leverage costs in a meaningful way. In noncigarettes, we delivered 6% same-store sales growth above the industry average of closer to 4% on the strength of the food, fresh and alternative nicotine categories.

The outperformance we delivered this year is directly attributable to our commitment to providing industry-leading category management solutions to our customers. As Chris will discuss in a bit more detail, our free cash flow for the year came in lower than our guidance, strictly as a result of the timing of year-end cigarette buys in anticipation of a price increase in early 2020. However, we ended the year with financial leverage of approximately two times, leaving significant availability under our ABL facility. Our liquidity and capital structure are well positioned as we evaluate our capital allocation priorities for 2020 and beyond.

Before I turn to our 2020 guidance and strategic focus, I want to share a few additional thoughts on the vapor category as a follow-up to my comments on our last call. The decision by the FDA to ban vapor flavors other than tobacco and menthol and increase the minimum legal age to 21 were consistent with our expectations. The upcoming FDA premarket approval deadline will likely result in a meaningful contraction in the open tank vapor market which relies heavily on flavors. We believe, in the long run, consumers will continue to shift to closed systems like JUUL, Vuse and NJOY, where sales are led by the C-store channel.

Further, the CDC recently stepped back from their broad-based recommendations against vaping which should help to moderate the health safety overhang for the category. While we expect there may continue to be some near-term choppiness in the vapor category as users adapt to the market changes, we believe this category will continue to grow over the longer-term, and C-stores are well positioned to be the dominant sales channel. Changing gears, I want to provide the highlights of our 2020 guidance and then share some insights into our strategic focus. Our guidance this year reflects sales growth ranging from approximately 1.4% to 2.6%, predicated on continued elevated cigarette carton declines, no major customer wins or acquisitions and modest growth in e-cigarettes.

Our EBITDA growth ranges from approximately 5% to 11% after adjusting for the 2019 candy price increase income of $7 million which is not expected to reoccur, and the cigarette holding gains forecasted at $20 million versus $23 million earned in 2019. We continue to refine our strategic priorities around growing faster and more profitably than the industry, serving as the industry leader in category management solutions and driving cost leverage throughout the organization. From a growth perspective, we are actively working on a number of new potential customers, along with opportunities to expand relationships with existing customers. We continue to focus on accelerating the pace of market share gains with specific focus in 2020 around churn reduction, sales force structure and incentive alignment, while leveraging the meaningful investments we have made in our category management capabilities.

I am pleased to report that we opened the Center of Excellence or in short, the COE, in January and have already had several customers come through the facility and provide very positive feedback. The COE provides an immersive and collaborative experience that enables our customers to explore the latest in C-store innovation and lead with actionable strategies and data analytics to drive growth in same-store sales and margins. The COE is designed to evolve along with the industry, and I am excited about the incredible opportunities to grow sales and earnings for our customers and for Core-Mark. We also recently launched a platform to provide our customers with access to real-time data analytics through online and mobile platforms.

This rollout takes our focused marketing initiative to the next level as we are able to provide our customers and our sales organization real-time access to actionable intelligence to help drive profitable sales. In addition to growing profitably through improved sales mix and growth, our strategic pricing framework will continue to play a role in enhancing our margin profile. I'm pleased with our progress in 2019 and see significant opportunities ahead. Driving operating expense leverage, both in SG&A and in warehouse and distribution, remains a top focus.

We continue to make smart investments in technology to improve efficiency and drive our efforts to consolidate the transactional activities in our business. This includes investments we have made in robotic process automation to drive efficiency in our accounting and finance functions as well as voice-pick and driver-handheld capabilities to improve our warehouse and distribution efficiency. We are confident in our ability to continue to drive cost leverage throughout the organization. I want to wrap up my prepared remarks with a few comments on our capital allocation priorities.

We continue to actively pursue opportunities to acquire traditional C-store wholesale distributors that enhance our scale and capabilities, provide a pathway to profitable growth and meet our return requirements. Additionally, given the hyperchanging consumer preferences and expectations in the industry and the importance of innovation in our food and fresh programs, we are also actively exploring potential partnerships, exclusivity arrangements and acquisitions that will enhance our offering and capabilities. And finally, given our current leverage, free cash flow generation and stock price, we are also committed to share repurchases. We completed $22 million in share repurchases in 2019 and reduced our outstanding shares by almost 600,000.

We recently announced that our board approved a new $60 million share repurchase program. We will strategically execute share repurchases in accordance with the board-approved plan and our return objectives. In closing, I want to thank the 8,500 Core-Mark employees whose commitment made 2019 a success. I will now hand the call over to Chris to provide more details on our financial results.

Chris Miller -- Chief Financial Officer

Thank you Scott. And good morning everyone. I'll start off by providing some full-year highlights, then provide commentary on the quarter and close with additional insights on our 2020 guidance. For the full year, net income increased 26.8% to $57.7 million.

Diluted earnings per share increased 26.3% to $1.25, and EBITDA increased 15.8% to $190.7 million. The strength of our full-year results reflect overall sales growth of 1.7%, led by a non-cig sales growth of 6.6%, non-cig remaining gross profit margin expansion of 36 basis points and the benefit of operating expense leverage. In short, we are proud of the results for the year. We delivered double-digit earnings growth through successful execution on our key strategic initiatives, improved sales mix, margin expansion and operating expense leverage.

We also benefited from approximately $10 million of nonrecurring inventory floor stock gains earned during the year. For the fourth-quarter results, net income increased 33.9% to $16.2 million. Diluted EPS increased 34.6% to $0.35, and EBITDA increased 23.8% to $48.3 million. Our strong results for the quarter primarily reflect the benefit of strong non-cigarette sales growth, remaining gross profit margin expansion in non-cigarettes and higher inventory holding gains.

Total sales increased 1.6% over Q4 2018 to $4.15 billion. Non-cigarette sales increased 5.4% for the quarter driven primarily by an increase in same-store sales of approximately 4% and net market share gains. Total cigarette sales declined 0.3% in the fourth quarter compared with Q4 2018 driven primarily by a decline in same-store carton sales of approximately 4%, offset by price inflation and market share gains. Remaining gross profit which excludes significant inventory holding gains and LIFO expense, increased 2.8% to $225.2 million for the fourth quarter.

Remaining gross profit margin increased 6 basis points to 5.42% driven by strong non-cigarette remaining gross profit margin expansion of 24 basis points. However, our cigarette remaining gross profit margin declined by about 22 basis points. Cigarette margins in Q4 were impacted by the timing and amount of vendor incentives and higher inflation versus prior-year quarter. For the full year, our cigarette remaining gross profit margins were down by only 5 basis points which was due primarily to the higher level of inflation in 2019 compared with 2018.

We believe this is more reflective of cigarette margins going forward. Our cigarette inventory holding gains for the quarter of $10.1 million came in higher than expected resulting from price increases for certain brands that exceeded the historical average price increase and resulted in our total cigarette holding gains exceeding our guidance of $19 million for the year. We also had $1.1 million in candy gains in the quarter that were deferred from the Q3 manufacturing price increase to align with the sell-through of the corresponding inventory. Our operating expenses as a percentage of remaining gross profit in the quarter were flat year over year.

As Scott mentioned, SG&A expense included $3 million of incremental employee incentives compared with Q4 2018. The large spread is due to a combination of stronger performance in Q4 2019, compared with a somewhat weaker performance in Q4 2018 which resulted in us having to lower accruals for incentives. Turning next to cash flow. We delivered approximately $61 million in free cash flow for the year, below our expectation of $100 million, due to the timing of year-end cigarette prepayments.

Given our anticipation of a cigarette price increase early in the first quarter, we chose to begin building inventory in late December resulting in higher cigarette inventories than expected. This also contributed to a higher loan balance at the end of the year. Our total capital expenditures for the year came in at $29 million, approximating our guidance of $30 million. We also paid approximately $21 million in dividends in 2019.

As we outlined in our earnings release this morning, our 2020 top-line expectation is $16.9 billion to $17.1 billion. This guidance does not incorporate any large customer wins or business acquisitions. Our EBITDA guidance is $190 million to $200 million which represents growth of 5% to 11% over 2019 excluding the benefit of a nonrecurring candy and excess cigarette inventory holding gains. Diluted EPS is expected to be between $1.15 and $1.30 per share, and diluted EPS excluding LIFO expense, is expected to be between $1.66 and $1.81.

Free cash flow for 2020 is expected to be between $80 million and $100 million. Our guidance assumes $20 million of cigarette inventory holding gains and no other significant holding gains. It's worth mentioning, in 2019, we saw three cigarette price increases totaling $2.60 per carton which was a substantial increase over the $1.90 per carton in 2018. We believe the higher price inflation in 2019 was driven by certain market factors and do not expect to see the same elevated level of cigarette inflation in 2020.

Other key assumptions in our guidance include LIFO expense of $32 million, a 26% tax rate and 46 million fully diluted shares outstanding. Our capital expenditure guidance for 2020 is $45 million and includes the budget for the relocation of a distribution facility and funds for certain other upgrades, in addition to our normal maintenance capex. In summary, we are excited about the significant opportunities this year to drive growth in revenues and earnings on multiple fronts. We are committed to delivering quality revenue growth and believe that we have the right initiatives and resources in place to gain market share and reduce customer churn.

And as Scott discussed, we are actively exploring traditional M&A as well as opportunities in adjacent industries to help accelerate our growth. Operator, you may now open the line for questions.

Questions & Answers:

Operator

[Operator instructions] We have a question from Ben Bienvenu from Stephens.

Ben Bienvenu -- Stephens Inc. -- Analyst

Hey, thanks. Good morning everybody. I wanted to ask, starting out on the cigarette outlook, just kind of generally how you guys think cartons fare in 2020 relative to 2019. And then on the pricing increases, I believe we've gotten a price increase in the first quarter.

Is there a part you aren't guiding for a similar magnitude of pricing increases in 2019? Is it possible that we get the same level of pricing increases in 2020 and that could prove to be incremental to your guidance? And just generally, how you think about cigarette consumption as we move.

Scott McPherson -- President and Chief Executive Officer

Sure Ben. From a carton decline standpoint, I think about it consistently with the guidance we've seen from Altria and Reynolds and others, in the 4% to 6% range, and that's consistent with our guidance range as well. From a price increase standpoint, last year, we had $2.60 a carton of price inflation. That's coming off of two or three years more in the $1.70 to $2 range.

I think a lot of that was driven by the dynamics that took place with Altria making a significant investment in three different companies that kind of drove what I'd call kind of an exceptional inflation rate. I think about it more in the $2 range to low-$2 range for this year. So I don't think it's likely we'll see one quite as high as we saw last year, and that's why we moved the price increase guidance down from $23 million to 23 -- or to $20 million.

Ben Bienvenu -- Stephens Inc. -- Analyst

OK. Fair enough. On your free cash flow outlook, you've got a little bit higher capex in 2020. How should we be thinking about capex past 2020? You're relocating a facility.

That's a onetime cost. What is kind of a normal level of capex for you guys? And then similarly, on the balance sheet, you did delever sequentially from 3Q to 4Q as you would expect the seasonal working capital, but you do still have some elevated working capital in the fourth quarter ahead of the pricing increase. How should we be thinking of leverage in 2020, let's just say, absent an M&A deal? Even though I know you guys would like to consummate a deal.

Scott McPherson -- President and Chief Executive Officer

OK. Well, let's start with the normal capex. I think a normal run rate for us is in the $30 million range. That includes maintenance capital and some moderate growth capital.

Obviously, this year, we have a building relocation. We do have another building relocation likely in the next couple of years. So you're likely to see a range in that $45 million again in next year or the year after. From a balance sheet standpoint, I think we look to see our leverage next year in the one and a half to two times range.

And clearly, we made a strategic decision at the end of the year. We could have very easily hit the $100 million of free cash flow at a point in time at year-end. But we made the decision to start buying inventory in the last two weeks of the year which obviously paid off because we had a cigarette price increase in February. And so we needed the time to be able to build that inventory up.

So did I touch all of your questions there?

Ben Bienvenu -- Stephens Inc. -- Analyst

That's perfect. Thanks and best of luck with 2020.

Scott McPherson -- President and Chief Executive Officer

Thanks Ben.

Operator

Thank you. We have a question from Christopher Mandeville from Jefferies.

Unknown speaker

Hey good morning. This is Blake on for Chris. I just wanted to make sure I had one comment right. On the alternative nicotine, you -- I believe you said that was -- those sales were flat for the year.

What did you say they were for the fourth quarter?

Scott McPherson -- President and Chief Executive Officer

They were not flat for the year, they were flat for the fourth quarter. We're definitely up for the year.

Unknown speaker

OK. Got it. On the 2020 EBITDA guide, is there any way you can kind of break out the impacts there? Those are a little higher than we expected. Could you talk about -- any way you could size up the headwind from alternative nicotine? Any kind of growth rate you can give us there? And then maybe any benefits you could size from operating expense leverage?

Scott McPherson -- President and Chief Executive Officer

So from an alternative nicotine standpoint, we planned that up slightly. So we'll just see in the low single digits. We think there's going to -- definitely be some choppiness, really, probably over the next three months, but we also think that there's going to be, over the course of the year, a continued consolidation toward the C-store channel. As you see, the regulation I think will have a big impact on open-tank sellers, who are continuing to sell flavors until the deadline of May.

So that definitely continues to play alternative nicotine. And then we see continued growth in other alternative nicotine items which is like on and ZYN which is a substitute for things like Copenhagen and other items like that. So we definitely see a contribution from alternative nicotine. We definitely have a continued component of cost leverage in there, and then the rest of that is built off of our growth for the year.

Those are really the three drivers of our EBITDA gain for the year.

Unknown speaker

Got it. That's very helpful. Can you give us an update -- I know last quarter, you talked about reorganizing your sales force, focusing more obviously on midsized chains. You said you haven't included any in guidance yet.

Any early insights in the conversations you can provide us? Any traction on that front? And talk about your pipeline maybe for the next six months or so.

Scott McPherson -- President and Chief Executive Officer

Sure. So we definitely have completed the kind of build-out of a -- it's not a large team. It's a small team that's going to be focused on that midsized -- small- to midsized-chain grouping. So they are actively now pursuing conversations and leads and having discussions with that group across the country.

We have a handful -- or I'd say, a couple, two or three larger chain bids, opportunities that would impact the back half of this year, and those are current dialogues right now. But obviously, nothing in guidance. And then just as far as the sales organization as a whole, as I mentioned in my comments, we are definitely looking at our structure and compensation and how we are positioned to continue to grow share. And so we'll definitely be making some changes from that perspective as the year progresses.

Unknown speaker

Got it. And last one for me. Just wondering -- could you walk us through how you're thinking about the pending flavor and menthol ban HR2339? Any way -- what are the odds you think it gets passed by both the Senate and then also the president? And any way you could size up menthol and flavors for us as a percentage of your sales?

Scott McPherson -- President and Chief Executive Officer

Well, menthol in cigarettes is about 35% of total consumption. Flavors, now in vapor, a very small part of our sales. But there's been a lot of choppiness over the last five months in flavors. So it's kind of hard to sum up the vape piece.

I do not think it's likely at all at this point, with the current president, that we will see that bill passed. I think that bill was far overreaching. The original intent of that bill was focused on minors and moving to age 21. But I think they -- I think it was a bill that outreached what the real intent was and I think that will be recognized as you see a Senate vote.

Unknown speaker

Got it. Thanks for all the detail.

Scott McPherson -- President and Chief Executive Officer

You bet.

Operator

Thank you. Our next question comes from Kelly Bania from BMO Capital.

Kelly Bania -- BMO Capital Markets -- Analyst

Good morning. Thanks for taking our questions. Just wanted to ask if you can help us, for modeling, just where e-cigarette dollar sales ended up for the year in 2019. And as you look at that non-cigarette gross profit margin, I may have missed it, where did that end up? And what was the e-cigarette impact on that?

Scott McPherson -- President and Chief Executive Officer

So non-cigarette gross profit margin ended up 36 basis points, was up year over year. I would break that into kind of three buckets, Kelly. You had obviously e-cigs was about a third of that. You had mix was about a third of it, and also strategic pricing initiatives that we have in place across the other categories.

When I look forward though I think we had obviously an exceptional year of e-cig growth. I've called out a number of times on non-cigarettes. We think about that from a 10 to 20-basis-point growth area. So I'd kind of think about that as I look toward next year.

We've not specifically called out our e-cigs, but it's pretty simple to look at our general merchandise. Over the last three years, that's clearly been the driver of the growth. So that gives you a pretty good insight into what the volume was for this year.

Kelly Bania -- BMO Capital Markets -- Analyst

OK. And then in terms of -- you mentioned this compensation. You're evaluating the compensation and the sales force alignment and maybe some changes. Can you just elaborate on that? And what is in your guidance with respect to that?

Scott McPherson -- President and Chief Executive Officer

I wouldn't say anything specifically in guidance. I mean obviously, what is in the guidance is continued growth in independent store count. And so we continue, as any company does, to look at the effectiveness of our compensation plans and structure so we're able to continue to drive independent store count growth.

Kelly Bania -- BMO Capital Markets -- Analyst

OK. And I guess on strategic pricing, where -- what inning do you think that's in? What are the opportunities as you move through 2020?

Scott McPherson -- President and Chief Executive Officer

Yeah. Kelly, I would say -- I'd say we're probably in inning number two or three. We cut a few of the low-hanging fruit things this year, but I think we've got a pretty good runway over the next two or three years to continue to watch that evolve and continue to pick up some margin through that initiative.

Kelly Bania -- BMO Capital Markets -- Analyst

OK. And then I'll just -- maybe one last one for me. Just in terms of M&A, seems like a little bit of change in tone, if I'm catching that correctly. So just in terms of kind of thinking a little bit outside the normal area that you are traditionally looking -- so can you just help us understand what you're talking about there?

Scott McPherson -- President and Chief Executive Officer

Sure. Yes. So first off, I would say our No. 1 priority is still acquisitions in the convenience wholesale space.

And we have a number of resources, myself included, working on those discussions and trying to drum up those opportunities for the company. Beyond that, we feel like, not just Core-Mark, but our industry needs to kind of up its game in the food and fresh arena. So we have some folks working on looking at opportunities around branding opportunities or co-branding opportunities, exclusivities, and even potential acquisitions that would help us accelerate our pace in the food and fresh game. I don't want to get too much further into it than that because we obviously have some competitors that listen in.

And so that's kind of a strategy we'd like to work on internally.

Kelly Bania -- BMO Capital Markets -- Analyst

Thank you.

Scott McPherson -- President and Chief Executive Officer

Thanks Kelly.

Operator

Thank you. [Operator instructions] We have no further questions. I will now like to turn the call over to Mr. Lawrence for final remarks.

[Operator signoff]

Duration: 34 minutes

Call participants:

David Lawrence -- Vice President of Treasury and Investor Relations

Scott McPherson -- President and Chief Executive Officer

Chris Miller -- Chief Financial Officer

Ben Bienvenu -- Stephens Inc. -- Analyst

Unknown speaker

Kelly Bania -- BMO Capital Markets -- Analyst

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