Blackstone Inc (BX) 2004 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Performance Food Group second quarter earnings conference call.

At this time, all participants are in a listen-only mode.

A brief question and answer session will follow the formal presentation, if anyone should require operator assistance during the conference, please press star, zero on your telephone keypad.

As a reminder, this conference is being recorded it is now my pleasure to introduce your host, Mr. John Austin, Senior Vice President and Chief Financial Officer of Performance Food Group.

Thank you, Mr. Austin you may now begin.

Thank you and good morning and welcome to the Performance Food Group conference call and webcast to review the company's announcement earlier today of its financial results for the second quarter ended July 3, 2004.

I'm joined this morning by Bob Sledd, our Chairman and CEO.

This call is primarily to intended to review financial result for the second quarter 2004.

Our second quarter earnings release was issued this morning and a copy of the information is available on our website at www.pfgc.com.

I'll briefly address our operating highlights for the quarter, and Bob will provide more insight into the quarter and discuss certain expectations for the balance of 2004.

Before we start, let me say that certain of the statement made in this call may be forward-looking statements under the Private Securities Litigation Reform Act of 1995.

These statements involve risks and are based upon current expectations.

Actual results may differ materially.

These risks are more fully described in our press release and SEC filings.

In addition, these remarks may include certain non-GAAP financial measures as defined by regulation S G of the SEC.

A presentation of the most directly comparable GAAP financial measures and a reconclilation of the non-GAAP measures to the comparable GAAP measures is available on our website.

In looking at our financial highlights, net sales for the quarter registered very strong 1.6 billion, this represents an increase of 14% from the year ago period.

All of the our sales growth for the quarter was general through internal growth.

Each of our business segments contributed to improvement in net sales, and a complete segment breakdown is included in the news release.

On a consolidated basis, inflation amounted to approximately 6% for the quarter.

Our gross profit increased 9.5% from the year ago quarter while gross profit margins decreased 60 basis points to 5.13%, from 5.73% last year.

The decline was primarily driven by our inability to leverage our cost infrastructure in the Fresh Cut segment, due to the loss of contribution margin from certain of the divisions food service customers that exited during the quarter and slowing of category growth of retail.

Gross margins were also negatively impacted by the Fresh Cut divisions fruit initiative.

Gross profit margins were also impacted by inflation in our broadline and customized business segments.

Operating expenses for the quarter were $200.1 or 12.86% of sales, which represents an increase of 33 basis points versus the prior year.

The increased operating expense ratio is due primarily to increased warehouse and delivery expense, in our Fresh Cut division, related primarily to in inefficiencies in our production networks and related cross stock.

In addition, selling expenses increased in your Fresh Cut division due to higher promotional spending.

Operating expenses were also negatively impacted by incremental costs associate with the temporary labor issue in our customized distribution division in Maryland.

Operating profit for the quarter was 35.3 million, and our operating profit margin was 2.27%, reflecting a decrease of 93 basis points versus the prior year.

Interest expense in the loss on sale of accounts receivable decreased slightly to 5.29 million, for the quarter versus 5.33 million in the prior year quarter.

The decrease was primarily due to lower debt levels outstanding in the quarter compared to the prior year.

Other income increased 167,000 to 374,000 for the quarter compared to the same prior period in 2003.

Our effective tax rate is at 38.1%, and we do expect that tax rate to remain consistent for the balance of 2004.

Net earnings for the quarter were 18.8 million, or 39 cents per share, diluted compared to 23.9 million or 49 cents per share diluted in the year ago quarter.

At the end of the quarter, our balance sheet remained strong, our debts to capital ratio was 26%.

This excludes 110 million of interest in accounts receivable sold under our accounts receivable purchase facility.

Day sales outstanding in receivables were 22 days, which is an improvement of one day compared to the prior quarter.

Inventory turns amounted to 18 times which is flat against the prior quarter, and accounts payable float was 133% of inventory, compared to 137% for the prior quarter.

Appreciation amounted to 12.2 million, and amortization amounted to 2 million for the quarter.

Our capital expenditures were 22 million in the quarter versus 33 million in the year earlier period.

Free cash flow was positive for the quarter and amounted to 11.2 million and again that's based on net income plus depreciation and amortization minus CapEx.

As we told you in February, we expect a following for 2004, depreciation to be 50-55 million, amortization to be approximately 10 million, and CapEx to be 120 to 140 million.

However we do expect to be toward the lower end of that capital expenditure range for the full year 2004.

We also continue to expect internal sales growth, in the high single to low double digits.

With that, I'll turn the call over to Bob Sledd and to give you more insight into the quarter.

Welcome and thanks for joining us.

I'll add to John's comment regarding our second quarter results and discuss the operational highlights [INAUDIBLE] business areas of the quarter.

Since reassuming the role of CEO in March, I've been working with staff closely to assess our progress in each of our growing business areas.

Our ability to consistently drive sales growth in each of our business divisions is a validation of our sound business strategies in driving value and service excellence to our customers.

We continue to make quarter over quarter progress, and by the end of the year, we expect to show significant improvement over the prior year's quarterly earnings.

As an organization, we're aggressively focussed on achieving our short term objectives while effectively planning to capitalize on our growth opportunities in the future.

We are working diligently to add new capacity and drive operational improvements in each of our divisions.

Our earnings per share of 39 cents for the quarter met our current expectations and we are confident we have plenty of opportunities to improve our longterm earnings performance.

Going through each division starting with Broadline Distribution.

The Broadline division produced strong sales growth for the quarter of 13% over the prior year period to $775 million.

Internal real sales growth recorded were s 6%, adjusted for 7% inflation.

At a result of our focus on account penetration to independent restaurants, our higher margin street sales were 15% year to date compared to last year.

Operating margins in the quarter declined by 39 basis points versus the same period last year.

That was impacted by both the low improving margins in Quality Foods operation as well as the impact of inflation, cost associated with transitioning into new replacement business, in the multi- unit segments.

There's also an increase in our expenses as we worked in our Broadline infrastructure to help us better implement our strategies.

And there was some shifting [INAUDIBLE] to lower margin, higher [IINAUDIBLE] products.

As we announced in May, we face an approximately $50 million of [INAUDIBLE] annual multi-unit business that will begin rolling out in the third quarter.

This roll-out combined with our first [INAUDIBLE] of $80 million in the multi-business will effectively replace the $130 million in multi-end business that we exited in the first quarter.

In July, we announced an additional $200 million annualized business that will begin initial roll- outs in August with the balance of locations to be added during the fall of this year.

We're also pleased at the continuing improvement for making this year in our Quality Foods operation.

Overall sales for the second quarter exceeded sales in the same period last year and we continue to drive improvements in is sales per delivery.

Quality Foods has significant longterm potential and although it continues to impact our margins in Broadline, we are encouraged that the improvements are about where we expected.

In the Broadline division our ability to effective gain business with customers is a direct result of our efforts to achieve high levels of customer satisfaction.

An important aspect of this effort is our ongoing initiative surrounding operational excellence.

We're in the process of initiating several programs to enhance our daily execution of order accuracy and on time delivery to the customer.

Our current initiative includes a new activity based compensation for drivers and warehouse workers, testing of new on board fleet management systems, and implementation of enhanced warehouse management system.

Our Customized division achieved very strong 17% growth in the second quarter.

These are result of growing with existing customers and effective account penetration.

Quarterly real sales growth was 9% adjusted for approximately 8% percent inflation.

Operating margins for the quarter decline 17 basis points.

This decline was the result of the $1.1 million in cost associated with the Maryland labor dispute that began in late 2003 and [INAUDIBLE] our margins.

After the close of the quarter, the company received a petition from our drivers in Maryland stating that they no longer wish to be represented by the union.

Quarterly, the company was legally obligated to withdraw recognition from the union.

We're pleased with strong progress our Customized division has made in the second quarter.

Our objective moving forward continues to be a focus on efficiency and to add new warehouse capacity to handle future growth opportunities.

Our new distribution facility in Indiana is on schedule for completion in the fourth quarter of 2004.

We're also planning construction for new facilities at our California and Carolina operations.

Facility additions are also planned for Texas and Florida distribution centers.

These other expansions are expected to be completed in the latter half of 2005 and should give us the capacity to handle a new major customer by 2006.

Prescott sales grew approximately 11% during the quarter to $266.5 million.

Inflation for the quarter was less than 1% resulting in solid real sales growth.

Group representative fairly significant part of our Fresh Cut growth in the second quarter contributing approximately 4% of Fresh Cut sales in the quarter.

Operating profit margin was 6%, operating margin declined 292 basis points.

As we indicated in June, margins were being impacted as we exit out of certain less stable customer relationships and transition our customer product mix towards more of a longterm value added partnerships that we've been most successful with in both retail and food service.

Although the transition in business moved faster than we originally anticipated, it remains an important partner of our strategy to reduce volatility, resulting impact from longterm earnings in the Fresh Cut business.

We're now working diligently to leverage our infrastructure as we lose the associated contribution margin while absorbing the costs of refocusing certain processing facilities.

Also as we discussed in June, we initiated a roll-out of Fresh Cut fruit on an earlier schedule than originally planned to meet the needs of several major customers in retail and food service.

Early roll-outs were costly and had an impact on the second quarter.

Fruit continues to be a work in progress, and we're evaluating our next steps.

In the retail market, our Fresh Express line continues to be be market leader in the package salad category, and our sales continue to grow well ahead of the category [INAUDIBLE].

As we mentioned in June, we've been seeing a decline in the rate of growth in the category of retail.

Most recent data indicates continued slowing of the category growth while the category has occasionally experienced periods of slower growth.

Second quarter slow down was significant.

We're monitoring category growth trends in the segment and will continue to assess any ongoing impact on our business.

In our Fresh Cut division, we continue to explore new sales opportunities with retail and food service customers, in the premium salad and value added produce categories.

We believe that our innovation in new products and production methods and our ability to drive market share will reinforce our position as the innovative leader in the category.

To recap, company wide, sales were solid in the quarter, and we're aggressively focused on driving operational improvements to get back on a strong earnings road track as quickly as possible.

We are now ready to take questions.

Thank you.

Ladies and gentlemen, we will now be conducting a question and answer session.

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Once again, that is star, one to register your questions at this time.

Our first question is comming from A.J.

Jones of UBS.

Please proceed with your question.

Hi guys, thank you.

I guess apart from the Fresh Cut issues, I know you highlighted the fact that Quality Foods for example still seems to be under performing in Broadline.

Since there didn't seem to be any real operating, you know, year-over-year improvement in operating profit for Broadline, to what extent are you still dealing with some issues that surfaces late last year ?

Across you know, Broadline and Customized, like for example replacement cost of the drivers that you talked about in Maryland and higher self insurance costs, etc.?

That's a pretty broad question.

We'll tackle that one.

The higher insurance costs, let me take that one first, you know, we're working diligently and it's in our claims area, we've gotten a new actuary to look at our costs and what has, you know, what's been in this self insurance program.

What we've got accrued to it, and we've got a very high comfort level that, you know, we're accruing accurately in that and have ample money accrued to meet our needs, so we do not expect any surprises in insurance.

So with that being said, people across the country, with worker comp costs and liability costs continue to escalate and so we're putting a tremendous amount of some emphasis in that area as well as just training in safety and so forth, which we do for two reasons.

One is because it's important to us that our people work in a safe environment, but secondarily, it also helps us do a better job with keeping those costs under control.

So we do think we've got that under control, although, you know, it has impacted us this year, and increasing insurance costs continue to impact us.

But we do everything we can to get that under control.

Do you expect replacement costs for the drivers in Maryland?

The drivers in Maryland, we expect that to continue to reduce over the course of the year.

There will be a significantly less impact in the third quarter, and by early in the fourth quarter, we expect that cost to be gone.

We expect all the temporary drivers to have been replaced.

I think A.J., we experienced about $1.1 million impact in the quarter related to those temporary drivers.

Adjusting for that, Customized did show a nice improvement in operating margins, so I think that, that was part of your question is why didn't we see any operating margin improvement?

That was actually encouraging if you consider inflation.

Inflation has had a most significant impact in both Customized and Broadline, so that's another item.

If you look at, the item we talk about last year which was Quality Foods, we, you know, we took a company that was focussed on sales and worked diligently to get them focused on profitability, and it's been a painful transition as we've already talked to everybody about, but we are making good progress there.

We expect them to be profitable by the end of the year, and contribute nicely to earnings next year.

So they're on track where we thought they would be.

It has been a painful transition, but there's a good team of folks there.

They are committed to excellence and committed to moving that company forward, so we are optimistic we 're going to continue to keep that company on track and move that company forward.

Okay and just as a follow up, if I could, you talked about the category decline at the retail level for bagged salad.

Just wondering what you really would attribute that to because we're kind of in a peak salad season right now.

Is it a function of the category decline being based object actual volume demand trends or you've mentioned [INAUDIBLE] competition with the food service related portion of your Fresh Cut business.

Is that also an issue that's contributing to the dollar sales decline?

With retail [INAUDIBLE], are you talking are you talking about the package salad resale?

It's interesting, because that, we looked at store trends at the retail category growth, and that does happen occasionally, and we don't know exactly why it's happened historically, bur our best guesstimate at this point in time is we believe it has to do with a few factors.

And I'm not sure in what order of importance we think these are having an impact, but the cost of head lettuce is dramatically less this year than it was last year, so we think that may have an impact on packaged salads.

Secondly, just, there's no, there's been no major product introductions this year.

Where last year, last couple of years, we've had significant product introductions so we think that's another reason it's down.

And lastly, and we are really not sure how much impact this has, but just the growth of salads in QSR, there is a possibility that because people are eating more salads out, maybe they're not eating quite as many at home.

So those three factors we think are the contributing factors, as we introduce new products, we think that will help the category of head lettuce, you know, creeps back up or whatever, that will probably help the category some, so I think we're just kind of at a point where, you know, we are having some softness, and we don't really know when that's going to pick back up.

But we're working diligently and targeting promotions, and working with customers to do the things we can, as well as develop new products to pump the category up over time.

Okay.

And I had one last question if I could.

Just in terms of general management oversight and governance issues do you think you've taken all the appropriate measures as far as management oversight are concerned or do you think there are there other remedial measures you might need to implement?

Are you talking about every area of our business?

I guess, you've had some changes at the corporate level, at the CEO level, and also in your Fresh Express business, as it pertains to that and other management changes at Quality Foods, for example.

Do you think you've kind of cycled through all the changes you need to make?

One thing I mentioned is in Broadline, we're beefing up our infrastructure and to help us better, you know, have better controls as well as better drive our strategies forward.

At Broadline, we've done quite a bit of beefing up.

We've added regional CFO's, this doesn't have anything to do with controls, but regional trainers, but we've also added regional kind of Presidents to work more closely with each of these companies.

We think the combination of that, we think we've done a better job of putting in controls.

404, is a pain in the butt, obviously forces disciplines that you got to have, and there are are a lot of things throughout the company that we are really working very diligently on to make sure we have controls in place so we don't have any surprises.

And we're confident that we're getting there very rapidly, and at this point in time, we have no reason to believe we're going to have any surprises.

In the Fresh Cut division, we have a good management team there.

You know, this latest move was really to enable me to have a closer relationship with Mark Drever who is really calling the shots in that division and have a better understanding of where we can take the business and talk to him more on a daily basis.

So I think he is a talented guy, he has a lot of very talented people on his staff, and, you know, we have a lot of confidence that that team is going to do as good as any team in the country in terms of moving that Fresh Cut division forward and getting it where it needs to go, or where it needs to be.

And we're going to supply them any help that we can supply to help them achieve that.

Okay, thank you.

Thank you.

And I didn't mention Customized because they continue to do a great job day in and day out.

So we never had any issues there.

Thanks, A.J.

Thank you.

Your next question is coming from Jeff Omohundro of Wachovia.

Please proceed with your question.

Thanks.

A couple of Fresh Cut questions.

First I guess given the slow down in retail Fresh Cut, I think you mentioned in your prepared remarks the pick up in promotional activity.

I wonder if you could just touch on that, what you are seeing in the pricing environment, how your competitors have responded.

Also are there any categories with Fresh Cut that might be holding up a little bit better or is it across the board?

And then finally, on Fresh Cut, given these events, and also given the capital spending in that division, I'm just curious about your current thinking on the return outlook strategically in Fresh Cut.

Okay.

The first question is on promotional activity, and kinds of what's going on with that.

We haven't really picked up promotional activity in Fresh Cut.

We are doing a more targeted promotional activity in Fresh Cut.

We do not see the need to do any additional promotional activity.

You know, we really don't think it's in the interest of the customers at retail to do a huge amount of promotional activity because it actually reduces their profitability.

And our experience, historically is that you may have a short term pump up, but longer term, the category does not benefit from that because then the consumer gets used to buying everything on promotion, so then he doesn't buy so much when it's not on promotion.

So our goal is not to increase promotional activity but rather to have more targeted promotional activity.

The second part was any category slowing down more than others and you know, not really.

I think from a market share perspective Jeff we've still seen gains in marketshare in some of the blended categories.

Where our marketshare pick up really is on the blended category which is better for the retailer and for us.

Anyway, let's see, the last part of your question was kind of what is the return outlook.

Jeff, I guess are you asking what our view is long term for Fresh Cut and thinking about where returns should be in margins structure?

Yeah and also as you've categorized your deployment of capital.

You know, we believe that historically, it was in the 8% or better range.

We think over the next couple of years, we can get it back up to that range within the next two or three years.

That's our goal.

We're working diligently with the folks at Fresh Cut to make that happen.

You know, return on capital is a pretty capital intensive business, so for us to increase our returns we've got to improve the operating margins there so again, that's our goal.

Great.

Thanks a lot.

Thank you.

Our next question is coming from the Bill Leach of Neuberger Berman Please proceed with your question.

Good morning.

Good morning.

Bob, is there any undate in your earnings guidance for the third or fourth quarters?

No Bill at this time at this point we have no change to our previous earnings guide we provided a couple of weeks ago.

When you look at the third quarter specifically, do you expect your Broadline and Customized earnings to be up year to year since they were kind of flat this quarter?

Yes.

So the worst is over there?

Yes, absolutely.

And the last question I have is can you estimate how much you are going to lose in fruit this year, and take any ballpark stab as to what it might do in 2005?

You know, that's a really good question.

We, in the second quarter, you know, as we said earlier, we lost about 4 cents, you know, we do expect to continue to lose money for the balance of the year.

I don't wants to really take a ballpark stab as to what that's going to be.

We've run some numbers, but let's just say it will be at a diminishing rate.

We've made improvements in that area of our business, you know, it's a work in progress.

We've improved our apple yields, we have and are adjusting our fruit pricing to better reflect the seasonal nature of fruit with our customers.

Our productivity output continues to improve on this new equipment we've put in.

We've have plenty of room for improvement throughout this whole effort.

At this point in time, we're really evaluating our next step to maximize shareholder value as we continue this roll-out.

So really, we're going through that process of evaluating what our next steps are over the next few months.

Originally, it was budgeted to lose $10 million, wasn't it?

That's what we actually lost last year.

Bill we were actually anticipating about half of that in 2004.

So are we still at the 10 million-dollar level roughly?

Somewhere in that ballpark.

Okay.

Thanks.

Okay.

Thank you.

Thank you.

Our next question is coming from Eric Larson of Piper Jaffray.

Please proceed with your question.

Hi, everyone.

Quick question on the inflation front.

This looked like a more of a hyper inflation quarter.

Is it your meat costs and what do you expect that to do going forward?

It's meat and dairy.

Dairy expectations are that dairy is probably going to moderate some in the last half of the year.

I mean, meat, it really doesn't affect us whether meat goes up or not.

It affect our margin, but all of our meat is basically sold on a cents per pound basis, so that, whether it goes up or down, actually has little or no impact on us.

On operating profit dollar it does effect the margin percentages, and meat, we are just not really sure where that's going to go at this point in time.

And Eric, the other point I would like to make is there was a slight up take from where it was in the first quarter, you know, 100 basis points or so on a consolidated basis where it was from the first quarter, but we're still not lapped all the hyper inflation we had from the fourth quarter.

So we are not seeing a continued rapid acceleration versus where we were in the first quarter.

It's really just lapping the prior year.

In the fourth quarter, as we lapd that hyper inflation, our guess is inflation will moderate.

Okay.

If you were to look at your gross margins, your 60 basis point decline, some of that would obviously be what you just said percentage decline, versus inflation.

But you penny profit would be okay.

How much of that would be Quality Foods then that would have hurt both Quality and Fresh Express?

How would that break out in terms of your gross margin?

You are talking about our operating margin or our gross margin?

No, your gross margin.

Eric, that's a difficult question to answer, because we don't disclose gross margin or operating margin by individual subsidiary.

Obviously Quality Foods is continuing to progress and we're, you know, they are making nice progress and they are where we are expect them to be.

But I think it's a hard question to answer.

As far as breaking out individual impacts of Quality versus -

We think gross margin has been impacted by quality, by the shift mix towards center of the plate, and by this inflation.

So I think the combination of those three things is impacted the gross margin line more than anything else.

We have no significant amount of research into that, but all of our companies we look at on an individualized basis.

Other than looking at kind of pulling that together on kind of a, I guess an informal basis, we don't pull together the exact reporting yet and probably won't until we go to common codes which we'll start that process next year.

So we really manage these companies on a company by company basis.

Okay.

And just a quick clarification follow up to Bill's question on earnings guidance, should we still be using the same numbers you gave us, I think, when you talked to us on June 14 or thereabouts, mid June?

Should we still use those same numbers, $1.30, $1.40 for the year?

Yes it was late June, and we have no changes to the guidance.

Okay, alright.

Thank you.

Thank you, Eric.

Thank you.

Our next question is coming from Edouard Aubin of Deutsche Bank.

Please proceed.

Hi good morning, this is Dick sitting in for Edouard.I had a couple of questions for you.

In terms of your corporate overhead expense, I know in the first quarter, you posted about 8 million or so and some of the issues that went in there were IT related costs and some were with Sarbanes Oxley.

And the indication was that though it shouldn't be I guess held as a run rate going forward to through the rest of the year, but looking at your corporate overhead in the second quarter, it's still fairly significantly higher year-over-year from second quarter of last year.

I was wondering if you could give us an indication of what we should expect on the run rate going forward and what's built into that number?

Sure.

Absolutely.

As we talked about, and I know we talked also about the first quarter included some severance costs associated with some of the management changes we had here.

We didn't expect those obviously to continue.

We had some slight charges related to severance costs, but the biggest impact still in the second quarter of this year is a continued ram-up of Sarbanes Oxley costs.

In the quarter, there's about a million to a million two of incremental costs related to our Sarbanes Oxley initiatives.

That's continuing to accelerate versus where it was in the first quarter.

We will actually continue to incur some of those costs in the third and fourth quarter, once we kind of get through the certification process and a lot of our initial work.

I would expect Sarbanes Oxley type costs to moderate, there will still be some ongoing 404 compliance type costs but at a much lower rate than we're spending it this year.

We've already looked at next year in terms of our ongoing costs and expectations are for next year.

And although it's early to give you specific numbers, we look for the increase to be dramatically less than it has been running.

So for the remainder of this year, it looks like the run rate might be just a little bit less, but you still anticipate some of those costs to be built in there?

That's correct.

And also you had talked about last quarter about the rationalization of some of your Fresh Cut customers.

I was wondering if you could give us an update, where are you in that, are you targeting more potential customers or should we be expecting more to come?

We don't have anymore than we've already identified.

We have a significant customer that will be, we've already built into our numbers that is going away in the, at the end of this quarter, and -

That was already disclosed?

And that was already in these numbers that we based in here.

But other than that, there are no additional customers that we expect to give up.

Okay.

And just lastly, in terms of inflation, to go back to inflation, if you look at your customer base, it looks like your sales in products you are doing a pretty good job of passing through the inflation to the customer.

In the Broadline division, if you look at your multi-unit customers and your pure street customers, are there any segments that are more or less willing to take the price increases?

You might have territory contract on some of your multi-units that limit the ability to sway pricing on that end, but are you seeing most of the increases being taken by street customers or are some of them balking and walking away?

I'm trying to get a feel for trends there.

I think it's pretty evenly divided.

We're passing the price increases on to all of our customers.

As they know we don't work on very large margins so we have to pass those increases along, they understand that.

So we are able to pass those on.

There is some lag time as we indicated because of, you know, we may have a weekly or monthly price contract with some street customers that doesn't allow us to, you know, to raise prices immediately, but we do raise prices within specifically no more than 30 days

Okay.

And it's been fairly even across your [INAUDIBLE].

Uh-huh.

Thank you.

Our next question is coming from Bob Cummings of Shields and Company.

Please proceed with your question.

I have two questions if you I don't mind.

First, I'd like to get a little more insight into the shift that's going on in your multi-unit customer base in Broadline where you've loss some business, but you seem to be picking up substantially more.

As I figure, at least $200 million net increase in your sales, which is pretty significant relative to the size of that division, and I'm just wondering, obviously, margins will be lower, but it seems to me that this just sheer added volume could contribute nicely to the profitability of some of your local companies.

Are there any instances like that?

We think that's certainly the case.

I mean, our focus is on getting some customers with larger drops sizes with, you know, good margins that can contribute as well as any customer we've had historically, and we've been successful at that in the customers we've added recently.

So we think they will be, you know, nicely accretive to earnings as we get them implemented.

Obviously whenever you take on a significant piece of business, it takes several weeks if not months to get, you know, as you hire new drivers and new people in your warehouse to get them up to speed so that they are as productive at their counterparts.

But once that occurs, we expect all of the these changes to be nicely accretive, and at the same time, we're working diligently to continue to grow the street sales which we've had great success with.

So I mean we've got a lot of very positive things going on in our Broadline division.

Great.

With respect to the added multi-unit business, would you think we would see the few net benefits to earnings by next year, by 2005?

By the end of this year, first of next year, yes.

Okay.

Great.

My other question had to do with the roll-out of your fresh fruit business, can you give us an update on where you stand in going into Wal-Mart and Cotsco on the retail side, and also rolling out throughout the McDonalds system with the apple slices?

We, with the Wal-Mart and Costco, you know, and then [INAUDIBLE] market, we did have that roll-out, you know, as we've indicated.

It was, you know, it went fine.

It's just getting our people gearing up and being more productive with the equipment that we had.

We took good care of the customers, but we didn't necessarily do it on a profitable basis, and we're still not quite there yet.

I would say that our folks feel like we're, you know, we've had, made significant strides in productivity, but you know, we've still got plenty of room for improvement.

And with the apple dippers with McDonald's, we've also completed that roll-out, we did that a few months ago, and again, getting the equipment to run more quickly, you know.

This is just such a whole new category to us.

We feel bad that you know, our people and us were more optimistic than I guess we should have been that this was going to be a fairly easy thing to get into.

But as we've learned, in this painful experience is that, getting into this whole new category and dealing with competition and this whole new category and educating customers and educating ourselves, and sourcing of products, this is just a bigger, since this is a whole new category, just a bigger challenge than our folks anticipated.

So we are, you know, we are going through a pretty major learning curve here, and we're really kind of each couple of months sitting down and saying okay.

Where are we?

And what are our next steps?

Because we understand that at some point in time, we've got to maximize shareholder value, so how do we do that?

Quite frankly, at the moment, we are really over the next few months are in the process of going through that exercise again, looking at where we are, looking at what our next steps are and how do we grow this business without, you know, without hurting shareholder value and at the same time, improving shareholder value long term.

It's a real challenge.

But I think our folks are up to it.

Great.

With regard to the Wal-Mart and Costco business, are those chains already selling your fresh fruit products in other regions where you have them available in and is it their intention to go national when they have the opportunity would you say?

We're kind of doing it region by region.

We are right now, we're selling them in Atlanta region, we did some tests with Costco on the west coast.

We are not selling in Costco on the west coast now, but we may expands with some of these other customers as we go forward but we'll see.

It's too early to tell.

Okay.

Great.

Well, thank you very much.

Okay.

Thank you, Bob.

Thank you.

Our next question is coming from Preston Wilkinson of BB & T Capital Markets.

Please proceed with your question.

Good morning.

Sitting here listening to all my questions getting asked.

And I have to think of some new ones.

On the Fresh Cut fruit, you know, two things.

With the operating loss staying roughly where it has been, two questions come to mind.

One is you know, is the additional loss just related basically to you know, getting product out fast in new plants as you sort of have, to new customers or is there something intrinsically kind of just not working in the core product.

And stated another way, I guess more positively is do have some evidence, with some of the more mature products with higher profitability that are higher sell through products that, you know, that at least some of these products at some points, you know, can be profitable for you in the retail?

Well, we think they can be profitable for us and the retailer.

The question is, you know, really how quickly can we make that happen?

And so we honestly just don't have the answer to that yet.

We are adjusting our pricing and we've got retailers that are working with us as well as food service customers that are working with us.

Adjusting our prices to better reflect the seasonal nature of fruit, and that's starting to help us and that will help us going forward.

We are working on ways to improve our yields getting a better understanding of the seasonal nature of yields and different product categories, and where we need to source product.

We're looking at going to different parts of the world to source product to make sure we have a better product, and get a lower cost product, so again, we've, I mean this is kind of a painful process for us.

And unfortunately, our shareholders are sharing that pain but we're going through a learning curve now, and you know, we're improving productivity, we're getting better in all areas, but you know, as of the ends gain, we just don't have the answers to that yet, and you know, our commitment, however, is not to do something crazy that's going to hurt shareholder value, and so as I said before, we're really closely assessing that and assessing our next step.

Just don't have the answers for you right now.

Can you just more generally, I guess, just speak to demand of at retail?

As you are hearing from the people you are selling to?

Our volume is steadily picking up, and in fact, when our product goes in to a retailer, their volume has picked up on average.

I'm reluctant to give the specific numbers because they vary from week to week to week, but their volume of their group has in fact picked up when they put our product in.

So I don't know if it's the power of the recognition of the Fresh Express brands or the facts that it's better quality.

Hopefully it's a combination of those two, but the volume has picked up within the retailers.

And our volume continues to grow as you can see, it went through and then this included food service, of course, but went to 4% of our total sales.

It was a huge increase from the year before

Can you give us the year before numbers so we can try to back into --

Just a few hundred thousand dollars.

This was, you know, --

Thank you.

The other question was do you have some recent, you know, [INAUDIBLE] numbers on the category to update us, what you gave last time and I think you had tied that into your guidance.

I think as of our last conference call, we had [INAUDIBLE] data that went through the week of June 6th, that following four week period overall category growth was about 3.5% category growth.

And that's as of the four weeks ending July 4th or so.

The category is now substantial.

Am I thinking correctly, am I remembering that you, did you tie that no your guidance that you needed the category to stay at where it was and not deteriorate further?

We did specifically tie that category, as Bob said, we've been growing faster than the category.

We did point out obviously that category growth, we're not sure where that's going, and exactly why it's going where it, and slowing as it has.

You know, but that is a risk in our outlook as far as where the category ends up going

Do you think the 4% category and, you know, you are performing at, you can make the current guidance?

Like I said, at this point, we don't have any change to the guidance we gave you in June.

Okay.

Just wanted to ask you one last question on Broadline.

When I ask you most of the time, some of chain restaurants or most of them, did not have a particularly good second quarter versus the first.

What about the independences?

Did you notice any similar change in the order rates or some anecdotal observations with the independent restaurants?

In the latest numbers we saw, the food service is still growing at about a 4% rate which is pretty good, and a combination of integrals and chains so we think that you know, we're not seeing any real moderating in our sales growth, a significant mowed rating in our sales growth.

The chains aren't blowing the doors out, but they are all doing okay.

Some chains better than others.

Just my sense is the independents, their earnings sales generally recover a little earlier than the chains.

I would think they would be less affected by what's going on with the chains, and that's sort of what you're saying?

As I reconcile with what you're saying?

All we can say is, our internal street sales rose up 15%.

That's pretty good.

Thank you.

Thank you.

Thank you.

Our next question is coming from Forrest Temple of [INAUDIBLE] Partners.

Please proceed with your question.

I think that most of has already been asked, so maybe you can could give us a little bit more concrete and walk us through.

I guess I was taken aback and clearly street was also, hence the stock trading where it hasn't traded for a couple, three years.

What exactly can you walk us through the process or maybe the process has been put in place now so that we are not signing up accounts that are not earning our cost to capital, and what concrete plans have you put into effect, and the regional CFO's helped this to make sure we have a process to make sense going forward on the Fresh Cut side?

I think your maybe talking about two different things, because the regional CFO's are, you know, we don't have our Fresh Cut is pretty centralized control so the regional CFO's are really a broad end in the Broadline area, and we do do a model on any change that we add in the Broadline areas.

By the same token, whenever we introduce new products and we do capital spending, each of our our divisions whether it's Broadline or Fresh Cut, they have to go through a process of doing a ROC and a profitability analysis before we approve the line.

And they bring those presentations and those models to the senior management, to our senior management, including me, of course, and John Austin, and we also bring it to the boards, and so we do analyze those models, ask a lot of questions.

And you know, the only issue then becomes how well that is executed, and you know, sometimes we've done a very good job of executing new protect introductions and sometimes it's been a a challenge, so we just have to get better at these new product introductions and executions, and our people know that, and so we're working diligently on it

On the Fresh Cut side, there's nothing we can point to where you can say, we're doing to do this differently, this is going to go through a different process, we're going to analyze these things differently.

The food service volume that we gave up was a conscious decision, or we didn't voluntarily give all of it up, you know, that's really , you know.

There's two things driving the issues at Fresh Cut right now.

One is, and they are working together, and one is the fact that we gave up so much food service business and some of it left on its own fruition because we were competing with them.

Probably 2/3 of it we gave up because of volatility and the fact that those customers were not partnering with us.

And one third of it went away because we were competition and they were going to go away regardless.

Because we distribute against them in the Broadline side of this.

So we didn't have any control over that, but the part that we voluntarily gave up, [INAUDIBLE] it was given up, our category growth was running very strong, and our folks felt like the category growth stayed recently strong.

That there would be a minimal impact to earnings and that we should make a pretty good profit, in other words pretty close to our original projections and those little cushion built in there, so that was that whole thought process.

What happened was that the category growth slowed down dramatically.

It was in the mid teens, early part of the year through March, and it slowed down to 3.5%.

And so there's no way that we can control that.

I don't care how many models we've run.

There's just no way can control that category.

We have estimated that head lettuce was going to drop as low as it did or that these consumers were going to go and make these decisions.

Maybe that's something we definitely have to know in the future, and consider that as we go forward.

But those assumptions were not made this time, so I guess you could say we are going through a learning process.

Would we've still made the same decisions if we know the category growth was going to go down?

Would we have given up that food service [INAUDIBLE] or just sucked it up?

We may have decided to keep that food service business and somehow deal with the volatility, but that's, at this point in time, hindsight is 20/20.

I know.

I wants you guys to know I appreciate the critical eye that you get rid of business where you are not going to he earn your cost of capital and you walk away from business that is too competitive that doesn't make sense.

My hope is, and at least maybe I'll talk to you guys off-line just about there are pieces of business that seems to me where you look back and you say we probably shouldn't have signed this up regardless of what volume did.

We thought that they were going to partner with us and those things didn't, and how do you stop that?

Is there something that you can proactively do to stop that from happening again?

And it sounds like your management change was directly related to that.

Maybe I'm wrong.

Let me say this.

Those pieces of business have been with us for a number of years, and the nature of competition in food service has changed somewhat, quite frankly, in that we have all private competitors at food service.

At retail, we have the power of our brands, so we work closely with the retailers to grow the category and we have done a great job of that.

In food service, we have some competitors that are somewhat irrational at least in our mind, because they are private competitors.

And eventually it's going to catch up with them.

They are not making a good return on capital and at this point in time, they're willing to work on lower margins.

And as a result of that, even though they are not making a whole lot of money, they are still making some money.

Now, when it comes to getting new equipment and the few years down the road, they are going to pay the price for that, but right now, they are willing to do that.

So when you have irrational competitors, it does make life a little difficult and in the food service side, we have some irrational competitors that are making life a little difficult for us and that is really no way we could have for seen that.

And those decisions were made a number of years ago, the market has changed recently, so I'm not sure there was anything wrong that our people did.

I don't think recently we've made any poor decisions at all.

In fact, there's a lot of good things going on, relationships with the customers that we have in food service that appreciate what we've do for them.

They appreciate the fact we partner with them and help them introduce new products and have the safety and sanitation and all the things we put a tremendous amount of emphasize on.

We have an awful lot of customers that appreciate the fact we do that, we put more emphasize on that than anybody else in the industry.

In this environment, we think that's important, they think that's important, so there are a lot of good things going on.

But unfortunately, we are going through some short term pain to gets where we need to be longterm and we feel horrible that we're not achieving our numbers and we've disappointed our investors.

But it's growing pains and we've learning from it and we'll get better as a result of it

Based on that, would you guys ever entertain buying back stock down here does it look opportunistic to you?

We would have to look at that opportunistically.

Forrest I think you know, at this point we couldn't comment on any potential capital structure or financing decisions but, we will constantly look at what the right thing is to drive longterm shareholder value.

Well that's not mutually inclusive of acquisitions or buybacks.You guys would be willing to consider that as well?

Sure.

Great, thanks very much, guys.

Okay.

Thank you.

Thank you.

Our next question is coming from Gabe [INAUDIBLE] of North Sound Capital.

Please proceed with your question.

My question has actually been answered.

Thank you.

Thank you.

Thank you.

Our next question is coming from John Heinbockel of Goldman Sachs.

Please proceed with your question.

Thank you, Bob.

A couple of things.

Can you give us an updates on the Tender Leaf lines and where do they stand in terms of efficiency, and is that still a drag on Fresh Express profitability or not?

Yeah.

That's a good question, well, all are good questions, but yeah, that's something we probably should have updated you on is Tender Leaf lines are running very efficiently.

We're very pleased with where they are, and that's not one of the things that is holding us back.

Let me add a little color to that, John.

As Bob said, we've made nice improvements on efficiency of the line itself where we have them in.

We don't necessarily have all production in the right facilities, so that's parts of the facility infrastructure challenge we're still working on, and we're still doing more cross docking than we'd like to do, things like that, but we've made nice improvements in the productivity of specific lines.

We talked before about this whole deal of rebalancing, and as we're going out it's [INAUDIBLE] of rebalancing our lines, moving our facilities and and where we should be doing what, and out of which facilities.

And that process is still, you know can still going on.

And so we may have a move on the Tender Leaf line or add a new Tender Leaf line in a different area.

We're looking at a couple locations to decide where the next Tender Leaf line should go, and will help balance our system and make it most efficient.

When does that, will it be the fourth quarter that is no longer hurting Fresh Express profitability, or will it extend into '05?

It will be the fourth quarter.

We already have it baked into our numbers for the balance of the year and we'll continue to work on that.

John, that's right.

And secondly, the first the food service guys you lost that had so much negative profit leverage, to the degree you replaced that 70 million, does that automatically reverse that leverage or was there something unique about the business with those guys?

That made it as profitable as it was?

Or do you just have to replace it?

It's really kind of where it is and different parts of the country, and the fact it was food service and it's just going to take time as we mentioned to transition.

We're still working to grow food service business but some of those plans are being kind of shifted over more over to retail.

So it's just kind of a process we're going through to shift plans from serving certain types of categories and certain types of customers to, you know, to others.

And that's just been a slow, kind of a painful process which has been exacerbated as we mentioned by the slowdown in the retail category growth.

Is there [INAUDIBLE] the number you guys gave out in the last call for the hit you took, that was obviously a being annualized number.

How think that moderates, if it's not so easy to replace it, I think you said 8 or 9 cents for the quarter.

Does that come down gradually or can it come down more quickly than that?

I think until we would identify replacement business and depending on the magnitude, that's a hard question to answer.

I think the assumption right now is that it moderates a little more slowly.

I'm not sure I understand.

When you say moderates, what are you talking about?

If you look at that cost, you know, next quarter, is it doing to be 2 or 3 cents less, is it going to be half as much?

How quickly does that negative impact go away, now it would seem to be the single biggest drag on Fresh Express?

It's pretty [INAUDIBLE].

It also depends as we said on the [INAUDIBLE] category [INAUDIBLE] but it's just really hard to predict right now, John.

We think that's baked into our numbers.

But you know, we'll see how it goes forward.

By next year, hopefully we will have worked through a lots of that transition and we will see where we are.

One final question. [INAUDIBLE].

Our folks in the planning process right now for both next year and for longer term actually.

We're updating our strategic plans as well as our one year plans, so for me to answer kind of exactly where we go from here would be a little bit premature.

In terms of how quickly we're going to work through that.

I mean, it obviously won't be fully worked through this year, and we, you know, we really are just in the process of working through exactly when it will be totally worked through.

Okay and then finally, you are fairly comfortable with the economics of [INAUDIBLE] foods deal will be good, meaning, and I know that you probably have a negotiated profit margin, it will be at least as good as your traditional Customized business, no worse than that.

Is that fair?

Absolutely.

We have, yeah, yes.

Okay.

Thanks.

Thank you.

Our next question is coming from David [INAUDIBLE] of [INAUDIBLE] Partners.

Please proceed with your question.

Good morning, just two questions.

As a relation to free cash flow, you guys have generated some positive free cash flow through, you know, six months of this year, but it appears like you're going to have to accelerate your CapEx spending to hit your 120 to 140 target.

Can you update us or give us a sense of what you, where you think cash flow will come out for the full year?

It's not guidance I can give you specifically, other than the fact we do expect to be free cash flow positive for the full year.

As you mentioned through the six months, we are about 43 million, so we are slightly behind, you know, the lower ends of that range.

We've got a couple of significant projects that are under way which I would expect that will contribute to some of those CapEx numbers.

For instance, the Indiana facility we are constructing it and Customized, I would expect those expenditures to continue to ramp up through the balance of the year, things like that.

All right, and then just as it relates to your balance sheet, picked up on the comments you made in your press release about wanting to maintain a solid balance sheet, you have these 5.5% convertible [INAUDIBLE] in October of '04.

Are there any plans to call those notes in order to reduce interest expense and potential dilution?

As you know, our current EPS does already factor those notes, adds back interest and adds shares into the shares base.

You know, at this point I think we are liking at what our options are with those notes.

At this point, we couldn't comment on what our intentions are, whether to call them or keep them in place.

We are not forced to do anything but do have some flexibility come October.

Okay.

Great, thanks.

Thank you.

Thank you.

Our next question is coming from Monica Aggarwal of Merrill Lynch.

Please proceed with your question.

Good morning it's Monica Aggarwal.

I just wants to revisit your longterm growth rates.

You had about 16 to 18% on earnings, and I think this is before you really started seeing a lot of volatility in the Fresh Cut business, and on the top line INAUDIBLE] you are being on target.

But margins contracted quite significantly [INAUDIBLE].

Where do you sort of see margins going up again?

Can you return to '02 levels and then grow from there, just given the mix and volatility of the business now?

The answer to that is yes.

In Broadline, I mean, we've at got numerous initiatives going on throughout the company.

We made a lot of acquisitions which were at that point in time.

We made those acquisitions even, you know, we had a, we had a good team of folks, but there was just a lot on their plate, and integrating those acquisitions has just been, you know, a distraction, and has kind of prevented us from implementing our game plan, our strategies as well as we would like to have.

We beefed up or internal infrastructure, our people, our IT systems, everything else, we 've got a lot of exciting things going on, in Broadline now, we've got, we've got our arms around our companies, and got they've got a lot of enthusiasm, and are moving in the right direction.

There's a lot of confidence as we progress through this year and go to next year, our operating margins will show steady improvement.

We told the market historically we'll increase that 20-30 basis points.

Next year, that maybe below that because of the amount of new chain business we've added but we still expect to have nice operating margins improvement swell as an extremely strong top line next year in Broadline.

In Customized distribution, we slowed down a little bit, we have been impacted by, you know, this union situation by the inflation this year, which has impacted our margins some, but you know, we are, and we actually filled up our facilities which we thought was a couple of years of growth.

We filled them up because of our reputation in the marketplace, and [INAUDIBLE] now we've got a couple of years where we're doing some incremental growth with existing customers adding new product lines and growing with their growth.

So we expect with those customers, you know, pretty moderate growth, or excuse me, in Customized, pretty moderate growth for the next year or so, but we're taking that time now to really focus on operational excellence on improving operating margins, by getting more efficient internally, and preparing for the next rounds of growth which we think hopefully will be adding new customers again at the end of '05 or early '06.

And then in Fresh Cut, as you know, we've just gone through some challenges there.

We've gone through, we've invested a lot of money in this fruit because we think it's a good opportunity going forward, and it's just, you know, we quite frankly haven't done as good a job as we we had hoped.

We ran into more challenges than we anticipated, and I guess any time you go into a whole new line of business, basically, you are going to have that.

But our folks are diligently working on it, and we're just kind of sucking that up.

Hopefully, we don't anticipate losing anymore money than we're going to lose this year, and we expect that we will improve as we go forward.

But again, we're in the planning process after figuring out exactly where to go and how quickly to go with our line of fruit.

As we work through these challenges, we've had with giving up the food service business, we don't really expect to have any other food service business that we're going to give up unless there's a really good reason to give it up.

Meaning that, you know, that some reason a customer doesn't meet our profit model or return on capital model.

That would be the only real reason we would voluntarily give up a customer, so as we go forward, we'll be growing with retail, we think we've gone through the worst of this at retail and food service, and so, you know, we're still having to deal with this, when you talk about volatility.

The volatility question with raw product, put a lot of tools in place for that.

We're continuing to look at dditional tools, so we're going through real challenges right now, but we are optimistic that over the next two or three years, we should be able to get our operating margins up to more historic levels.

I know that's kinds of a long answer, but that was a pretty broad question.

So we are optimistic we can get, you know, continue to grow top line sales very solidly as well as, you know, as we improve our operating margins and overall profit abilities.

Okay and then just on the capacity issues, obviously, you built new capacity in Fresh Cut, building in Customized.

What's asides from the Broadline business you are bringing in 200 million of the Compass business.

Yes.

That's a good question.

We are always looking at our facilities, analyzing our capacity facility by facility, and then making sure that we break ground on new facility you know, hopefully before we run out of capacity.

With Compass, that is going to maximize out at least a couple two or three of our facilities, but by the time you know, we lap this compass business, we believe we'll have some additions to those facilities in place, so you know, that is just an ongoing process that we do.

Our operational people go out in the field and analyze that, but that's another thing we added is for field operational people to work with our [INAUDIBLE] and then we are looking at analyzing that now.

We probably will be breaking grounds with new additions in 2006 or in 2005.

And Monica, that Compass business is spread amongst five or six individual Broadline facilities.

Thank you very much.

Thank you.

We're showing no further questions in queue at his time.

I would like to turn the floor back over to management for any additional or closing comments.

Okay.

Well, first of off, we want to thank you for joining us and your interest in our company.

We appreciate your participation and your questions.

We're focused on executing aggressively the strategy we've outlined in our business, to drive sales growth and deliver solid and reasonably consistent earnings growth and return of capital investment to shareholders.

We continue to make quarter over quarter progress, and by the end of the year, we expect to show significant earnings improvements.

Thanks for joining us, and have a great day.

Ladies and gentlemen, thank you for your participation.

This does conclude today's teleconference.

You may disconnect your lines at this time and have a wonderful day.