Blackstone Inc (BX) 2004 Q3 法說會逐字稿

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

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

And 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 begin.

Thank you, Darcy.

And good morning, and welcome to the Performance Food Group conference call to review the Company's announcement earlier today of financial results for the third quarter of 2004.

I'm joined this morning by Bob Sledd, our Chairman and CEO, and this call is primarily intended to review financial results for the third quarter.

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

I'll briefly address our highlights for the quarter, and then Bob will provide more insight to the quarter and discuss certain expectations for the balance of '04.

Before we start, let me say that certain of the statements we will make 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, remarks may include certain non-GAAP financial measures as defined by Regulation G. The presentation of the most directly comparable GAAP financial measures and a reconciliation of the non-GAAP measure to the comparable GAAP measure will be available on our website, also.

In looking at financial highlights, net sales for the quarter registered a strong 1.5 billion.

This represents an increase of 11.5 percent from the year ago period.

All of our sales growth was generated through internal growth.

Each of our business segments contributed to improvements in net sales and a complete segment breakdown is included in our press release.

On a consolidated basis, inflation amounted to approximately 4 percent for the quarter.

Our gross profit increased 7.4 percent from the year ago quarter, while gross profit margins decreased 56 basis points to 14.95 percent from 15.51 percent last year.

The decline was driven primarily by our inability to leverage our cost infrastructure in our Fresh-cut segment as we transition our customer and product mix to a more stable base of business.

Gross profit margins were also impacted by a shift in product mix toward more center of the plate products in our Broadline segment, and by the impact of inflation in our Customized segment which operates primarily on a fixed fee per case basis.

Operating expenses for the quarter were 197.6 million, or 12.77 percent of sales, which represents an increase of 12 basis points versus the prior year.

The increased operating expense ratio is due primarily to incremental costs associated with the recent hurricanes and severe weather activity, as well as higher fuel costs in all of our business segments.

Broadline operating expenses were also impacted by incremental start up costs associated with new multiunit business that we began rolling out in the third quarter.

We were able offset many of these increases with improved operating efficiencies.

Operating profit for the quarter was 33.7 million, and our operating profit margin was 2.18 percent, reflecting a decrease of 69 basis points versus the prior year quarter.

Interest expense and the loss on sale of accounts receivable increased slightly to 5.3 million for the quarter versus 5.2 million in the prior year quarter.

The increase was due to an increase in our average borrowing rate, offset by reduced borrowing levels during the third quarter compared to the prior year quarter.

Other income increased $43,000 to $255,000 for the quarter, compared to the same period in 2003.

Our effective income tax rate was 38.1 percent , and we expect our tax rate to remain at approximately that level for the balance of 2004.

Net earnings for the quarter were 17.8 million or 37 cents per diluted share, compared to 21.6 million or 44 cents per diluted share in the year ago quarter.

At the end of the quarter our balance sheet remained strong.

Our debt to cap ratio was 25 percent, which is down from 26 percent at the end of June and 31 percent at year end.

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

Additionally, after the end of the quarter, we completed the redemption of our convertible notes in mid-October.

Days sales outstanding in receivables were 23 days compared to 22 days in the prior quarter.

Inventory turns amounted to 17 times, compared to 18 times in the previous quarter due primarily to increased inventory levels associated with the roll-out of new business in our Broadline segment.

Accounts payable float was 125 percent compared to 133 percent for the prior quarter.

Depreciation amounted to 12.7 million, and amortization amounted to 2.0 million for the quarter.

Capital expenditures were 15.7 million versus 16.4 million in the year earlier period.

Free cash flow was positive for the quarter and amounted to 17.2 million.

Based on the year-to-date activity and anticipated results for the full year, we expect the following for the full year 2004 -- Depreciation to be approximately 50 to 52 million; amortization to be approximately 8 to 9 million; and capital expenditures to be in the 100 -- 90 to 100 million -- $100 billion range.

CapEx is trending lower than previous guidance due primarily to our own internal discipline, as well as construction delays for Customized facilities in both Indiana and California.

We would expect internal sales growth in the high to single -- high-single to low double-digits for the balance of the year.

With that, I will now turn the call over to Bob Sledd, our Chairman and Chief Executive Officer.

Good morning.

Thanks for joining us.

I'll briefly add to the comments John made regarding our third quarter results, and discuss the operational highlights in each of our business segments for the quarter.

We were very pleased with our quarterly sales performance in light of recent hurricane related challenges in the market, especially.

We are staying focused on driving improvements in each of our 3 business segments, and we are making good progress.

We are attracting new business in Broadline distribution, and we're working aggressively to optimize the production and logistics infrastructure in our Fresh-cut business to capitalize on growth opportunities in that segment.

We are confident in our ability to execute on our strategies to improve the long-term earnings performance of our Company.

We have significant opportunities in all areas of our business.

Going through each division starting with our Broadline distribution business, Broadline distribution generated strong sales growth of 13 percent for the quarter over the prior year period to 797 million.

Internal real sales growth for the quarter was a strong 9 percent adjusting for 4 percent inflation.

As a result of our focus on count penetration with independent restaurants, our higher margin street sales grew 13 percent to date, compared to last year.

Operating margins in the quarter declined by 16 basis points versus the same period last year, as a result of costs associated with recent hurricanes in the southeast, the impact of inflation, and the costs associated with new business roll-outs in the multiunit segment.

Operating profit in the segment increased in the quarter, and we expect operating margins to increase in the fourth quarter.

Our previously disclosed new business roll-outs in Broadline are continuing to progress on schedule.

We were pleased with the ongoing improvements we've been making this year in our Quality Foods operation.

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

We are also pleased with the 13 percent growth of our higher margin Street business during the year.

While we have been opportunistic recently with the addition of previously announced new business in the multiunit segment, we will continue our focus strategy on growing our Street sales as a percentage of total sales in Broadline.

Most have been successful and continue to increase our product mix in the center of the plate items, which we believe positions us favorably with our customers.

Products in the meat category have been impacted by inflation this year, and are usually sold on a cost per pound basis rather than a percentage markup.

Although the higher case price during inflationary periods can result in a lower sales margin, our strength in this category is an important part of our strategy to grow our higher margin Street sales.

In Broadline distribution, we continue to maintain our focus on improving customer satisfaction by achieving high levels of operational excellence.

We are working aggressively to continue our implementation of best practices throughout our operating companies to improve our order fill accuracy and on time delivery to customers.

PFG -- our customized distribution achieved a 13 percent increase in quarter sales to $510 million.

The increase was the result of growth with existing customers.

Quarterly real sales growth was 6 percent adjusted for approximately 7 percent inflation.

Operating margins for the quarter declined 10 basis points.

This decline was primarily the impact of inflation.

Customized operations -- excuse me, operating profits did improve in the quarter and we expect that trend to continue to improve in the fourth quarter.

We are pleased with the progress Customized distribution has made in growing with customers during the third quarter.

We continue our focus on efficiency improvements and the addition of new capacity in the Customized segment.

Our new distribution facility in Indiana is scheduled to be completed during the first quarter of 2005.

We are also planning construction of replacement facilities at our California and Carolina operations, as well as additions to our Texas and Florida distribution centers.

These other expansions are planned for completion in the latter half of 2005, and will give us the capacity we need to handle new business during 2006.

Fresh-cut sales grew 4 percent during the quarter to $244 million.

Inflation for the quarter was nominal.

Operating profit margin was 5.5 percent .

Operating margins declined 219 basis points.

Fresh-cut results have been impacted as previously disclosed, by the effect of the hurricanes in the Florida market, the slow category growth of retail packaged salads, and the continued impact of the transition in our customer mix as we refocus our production and logistics infrastructure toward more stable, high volume retail and foodservice business.

We continue to work aggressively in optimizing our processing facilities.

Our Fresh-cut fruit initiative continues to be a work in progress, as we focus on improvements in sourcing and production efficiencies.

In the retail markets, our Fresh Express brands continues its leadership position in the packaged salad category, and our sales continue to grow well ahead of category growth.

As we mentioned in October, retail category growth remains below historical levels, most recently at a growth rate of 3 to 4 percent over the same period last year.

We are continuing our efforts to develop new sales opportunities with high volume retail and foodservice customers in the premium salad and Fresh-cut fruit categories.

We believe that our proven ability to help our customers drive category growth, our innovation of new products, and our state-of-the-art production methods will continue to reinforce our leadership position in the Fresh-cut segment.

We are experiencing some weather related crop challenges in the fourth quarter.

However our contracting program has successfully helped us maintain our supply.

Our bigger challenge the last couple of weeks, has been yields and resulting production efficiency.

To recap, Company-wide, sales growth was solid in the quarter, and we continue our aggressive focus on driving operational improvements to enhance both short-term and long-term earnings growth.

We do anticipate solid operating earnings growth in the fourth quarter and in 2005.

With that, we are ready to take questions.

(OPERATOR INSTRUCTIONS) John Heinbockel, Goldman Sachs.

This is Simeon Gutman for John.

Can you guys discuss the hurricane impact in greater detail?

How the 4 to 5 cents is divided among your divisions, with respect to top line and EBIT margin?

And I know you've built some lingering impact into the fourth quarter here.

Has there been any improvement to date?

Yeah, Simeon.

The split in the 4 to 5 cents is roughly, half distribution and half Fresh-cut, as far as the total impact.

You have not quantified total sales.

I mean you get some pretty good public data points.

We don't like to talk about sales with specific customers, but I know some of our customers have had public remarks, so I would probably defer to those comments.

As far as the impact going into the fourth quarter, we think most of the impact will be really on our Broadline segment.

Some of the small mom and pop restaurants that we think may or may not reopen, have a little bit longer term impact, whereas most of the big, stronger multiunit accounts have rebounded fairly quickly.

So more of the risk is in the Broadline segment as we look into the fourth quarter.

And that risk is not just sales, but also the receivables that are outstanding from those customers, if they don't reopen.

If they don't reopen, right.

Second in Broadline, I guess your top line is defying gravity a little bit here in light of restaurant slow down, and in the face of what Sysco said yesterday, I think you guys have a slight acceleration sequentially in the top line.

What particularly is driving that right now?

You know, that's a really good question.

We are growing both with Street and with chain business, so obviously the pick ups of some major chains has had some impact on that in the third quarter, and actually, that will probably accelerate in the fourth quarter, as we have those new customers on for a whole quarter.

As it relates to Street sales, we just continue to work diligently to penetrate our customers, add sales reps, we've been doing a great job of training those sales reps.

So, our goal is not just to grow with the market.

But obviously we don't have a huge percentage in any one market, so we also have the opportunity to take business away from other competitors.

So we are focused on both those areas.

So that's really, I think, what's driving that growth, and we are working hard to make sure that continues.

Any kind of early update here on Compass?

I know you are probably break even in terms of profitability by year end, but any early progress there?

Yeah.

We are actually happy with the roll-out.

We think it's going well.

The roll-out is completed at this point in time, and now the goal really is just, we've added -- well there's 2 things.

You mentioned, Simeon, our goal is to be at break even by the end of the year and I think we will accomplish that for -- so that the impact in the fourth quarter should be negligible.

And the issues that we face -- the challenges any time you face rolling out that type of business, is one that costs associated with hiring and training and getting people as productive as they need to be.

And then secondly, we rolled that out pretty rapidly, and so we've got a significant amount of temporary equipment and temporary drivers in place.

And as we replace those, that equipment and temporary people with regular people and our normal equipment that has been our regular leases, that should improve profitability as well.

So that should all be done by the fourth quarter, and we expect it to be nicely profitable in 2005, starting in the first quarter.

Bill Chappell, Suntrust Robinson Humphrey.

A couple of things on the Fresh-cut business.

I guess first, did you have any lingering problems from last quarter as you were rationalizing the customer base, did that carry over or was this all really hurricane and category volumes?

No, it was -- well, the only lingering problem is just we did have one other major customer in foodservice that left.

We had already anticipated that.

We knew it was happening, so we had built that into our forecast.

So nothing that, we did not make the Street aware of.

But we did have one customer who left, not because of rationalizing, but because of their competition with PFG.

They decided they didn't want to buy from a competitor.

So those -- that significant customer left.

But other than that, it was basically category growth and the hurricane.

And I guess the other thing, the carry over piece of that, Bill, is the fact that we are still having trouble leveraging our infrastructure.

So that essentially, is a carryover from that rationalization.

Right.

When we say trouble, I mean, it just takes time.

Sure.

Second, I mean, it's now been about a month and a half since you announced -- officially announced strategic alternatives for that business, and it sounds like you've spent a lot of time out in California just evaluating it.

Can you give us an update on what you are seeing, or what would make you want to keep the business long-term, or not want to keep the business long-term, and what needs to happen?

Well, we are not really going to talk about the process, but just in terms of the business itself, I mean it's a good business.

I think as we've mentioned before, we think it has a bright future.

And the question is, is it better off that bright future with another, either another company, as a stand alone business, and that's the big question.

And so our board will be looking at that over the next few months, and we will reach a conclusion on that.

But I think the biggest things are just our ability to manage the bumps in the road that comes with a company that has raw product and a combination of number one, raw product, and the requirements of a raw product that has an extremely short shelf life.

Those are a couple of things -- a couple of the driving factors that have gotten us to where we are today, and something that the board will be looking closely at as we move forward, and kind of how that all ties in with our ability to have consistent, stable earnings growth.

So we are continuing to work on those items within the Fresh-cut division.

But we will be working with the board as we go forward, and talking about how this all shakes out in the next few months.

Final question, just on Quality Food service, you mentioned briefly in the press release that it is still trailing a little bit.

Are you still seeing improvement in that business, or have we plateaued, or when do you expect the margins to get closer to Company overall margins?

We are continuing to make improvement there.

Our new management really has been in place now about year, is really -- their initial focus has been in getting the house in order, getting focused on the basics.

Now our focus is on driving operational excellence, continuing to drive account penetration, making sure our Street sales are profitable and driving that even further, and just implementing our core strategies.

So we are making good progress there, but for us to get it close to our overall Company averages, that's going to take some time.

And I would be a little reluctant to give you any specific timetable on that.

We have said that we think that's a company that has the potential to have 4 percent operating margins 5 years down the road, and we still think that that's a possibility.

Obviously, that's the goal that we are working towards.

Bill Leach, Neuberger Berman.

Bob, you said earlier you expected solid progress in the fourth quarter, and solid progress next year.

Could you quantify that?

Are you reconfirming your previous guidance?

What does that say about your outlook for next year?

Okay.

For the fourth quarter, yes.

I mean, we are not looking to change our guidance at this point in time in the marketplace.

For next year, we are in the middle of our budgeting process and we are confident that we will have a good increase in earnings next year.

We will not complete that process for several more weeks.

We expected to have it completed before year end.

However, we do not expect to give Street guidance this year, until we really get this Fresh-cut situation finalized.

And as we said, we have kind of a 6 month time frame from the time we started the process to the end.

So maybe, it will be somewhere within that 6 month time frame.

So around the end of the calendar year?

(multiple speakers) -- specific guidance for next year, even though we could give it, again it would be so subject to change, relative to what happens with Fresh, we thought the guidance would be pretty worthless.

So, at this point in time, our feeling is that we will not give specific guidance until we rectify that outcome.

Okay.

One other question I had.

Your corporate expense is almost double what it was a year ago.

Is there anything unusual in there that might decline next year?

I don't think so, Bill.

I think you're right in that it's up significantly from the prior year quarter.

However, it's been trending down if you look at the sequential quarters in the current year.

So I think the main drivers of that increase, one, are our Sarbanes-Oxley initiatives.

Obviously there's a tremendous amount of cost that we've been incurring this year as we are preparing for our 404 certification.

There will be some recurring costs related to our 404 initiatives, just the cost of complying with that.

Again, we don't have any '05 guidance as it relates to that.

In addition to the Sarbanes-Oxley costs, there is a little bit of insurance and IT related initiatives that are in the numbers this year versus the prior year numbers.

And as for next year, again, we are still going through the budgeting process.

But our expectations would be for very modest increase in those costs because we are not going to have -- we still have some related Sarbanes-Oxley costs going forward because obviously, once it's in place, you have to continue to manage it.

But most of those costs have been incurred this year.

We are getting our arms around some of these other areas, so we would expect our corporate costs next year to moderate significantly, and be -- we would look for modest increase in corporate costs next year.

John, what's the guidance for interest expense, now with the convert called?

Our convertible, if you remember, had a coupon of a 5.5 percent , when you included the amortization of deferred issue cost, it was averaging I think an effective rate of 5.75, roughly.

It was about $12 million in pretax interest per year.

That was paid off with our revolver, and as you probably have seen in our historic Qs, our revolver is a LIBOR based rate.

There is a pricing grid, depending on some of our leverage ratios, over and above that.

That's all public data out there.

That's, depending on your assumptions for where LIBOR goes, right now it's running kind in the high 1 percent range, and there's a spread over top of that.

So -- .

So that is a long winded of saying there's not much change?

It's actually a long winded way of saying it will be slightly more favorable.

Slightly more favorable, okay.

And also, you've got to model, obviously, the change in the shares and the like as well.

Okay.

Well, good luck with the fourth quarter.

Edouard Aubin, Deutsche Bank.

Bob, just to follow up on what you said regarding sales, if you could comment on current trading when it comes to Fresh Express and foodservice.

And basically my question is, excluding inflation, do you expect growth rates in the fourth quarter to be above or below the third quarter?

Okay.

You're talking about in the Fresh-cut side of the business then?

Actually both.

Okay.

The growth rate is -- as far as category growth in our Fresh-cut business, we are not forecasting an increase in the current category growth.

We are not saying it's not going to increase.

We are just saying we thought it was prudent not to forecast an increase.

We are continuing to forecast in the 3 to 4 percent range in category growth at retail.

That being said, we are growing significantly higher than that, in the high single-digits kind of, to low double-digits range at retail.

So we are rapidly outgrowing the category growth.

And we've modeled that same kind of a range in the fourth quarter, kind of a high single-digits (indiscernible) in the fourth quarter at retail.

Foodservice and Fresh-cut, as we've said, we have -- we expected to lose kind of on a rate of about $70 million of volume in the year.

That last piece went away in September, as we mentioned earlier.

And so we expect foodservice to be down some.

And so, if you take that all in effect, we would estimate that the fourth quarter growth in Fresh-cut will probably be somewhere in the same range as the third quarter growth.

Taking those, both those areas and combining them.

As it relates to the foodservice side of the business, we expect growth in Customized to be similar to what it was in the third quarter.

And in the fourth -- excuse me, in the fourth quarter in Customized.

And in Broadline we expect chain sales because of the roll-out of the new customers, Compass in particular, for the chain growth to accelerate pretty rapidly.

And then in the, as it relates to the Street, we certainly are working towards having the same kind of increase in the fourth as we had in the third.

Obviously, there's no guarantees there.

But that's something we are obviously working hard on.

Right.

Great.

And just maybe finally, I don't know if you can share with us some of your supply chain metrics for foodservice, how they have evolved in '04 or in the third quarter, when you look at drop size or the number of line items per customers, for example.

The drop size has increased.

Because of the hurricane in the third quarter, the increase was -- we had some companies that actually declined, particularly the companies in Florida.

So that skewed our results for the year.

But we were having high single-digit increases in same store -- we don't call it same store, we call it account penetration, excluding those particular companies.

So we expect that to continue in the fourth quarter and hopefully go back up again, once these hurricanes are behind us.

Steve Chick, JP Morgan.

A couple questions.

Bob, if you could just clarify, again, what you are saying about the timing of the review process for Fresh-cut.

I thought you said something about 6 months.

Is that from the September 16th date?

That's, Stephen , when we announced our process, our evaluation process, we said it could take up to 6 months.

We also said we are not going to update the market as we go through that process.

Obviously we will, we are working diligently on that process, but real don't have any updates for that.

But we did say when we announced, that we thought it could take up to 6 months, correct.

Okay.

And John, related to that, is it safe to assume that the tax basis for the Fresh-cut piece is similar to the GAAP asset base that you guys report in your financials for that segment?

We have not publicly disclosed that.

I think you could probably look at -- I think it's probably directionally in the right neighborhood.

I think what you'd want to look back at, is our business combination footnotes.

The things that could affect that are whether it's a purchase of stock versus a purchase of assets.

To the extent that we did not get a step up in basis in the assets, for instance, if we purchase a stock, we don't get a step up in basis in the actual assets.

So as you are looking at modeling and all the tax implications of all of that, whether -- it's a hard question to answer and a very detailed question that I think you are going to have to probably look at the business combination footnotes, and try to get some assessment there.

Yes, I know it's technical.

I was just wondering if maybe within reason, if the GAAP basis was close.

But it sounds like it might be, without getting too technical, directionally close of what it might be.

Is that -- ?

There's an awful lot of moving parts in that analysis, so it's a very hard question to answer.

Okay.

That's fair.

One other thing related to the segment, is there a reason to think that the corporate overhead cost that your company incurs would be any more or less, I guess on a proportion basis, more related to that segment or less, or if we try to analyze and apply it on a percentage of EBIT basis, so to speak, is that a safe assumption to use?

I think you ought to be very careful about trying to allocate -- we push costs that are directly attributable to the divisions, and they are incurred at the divisional level.

That's how we're organized and managed.

A lot of the costs that we have in our corporate segment are related to costs of being a public company.

We do bear all the Sarbanes-Oxley costs here, internal audit, our consolidated treasury process, public reporting costs.

We do have some IT costs related to maintaining corporate-wide infrastructure, wide area networks, those kind of things.

But all the specific IT costs related to divisions are actually out at the divisions.

So I would be careful in probably not attributing too much of our corporate costs to specific divisions.

I will tell you the process that we will go through.

If, and I hate to maybe even say this, we expect if we did not have Fresh as part of our Company, that we would do an analysis on -- or we would be in the process of analysis on what costs would go away.

We've kind of done a preliminary on that obviously, and we think it would be pretty modest reduction in corporate costs.

But we would do a more thorough analysis if that did occur.

That's very helpful.

One other thing if I could.

Have you guys said, I mean, what do you speculate the reason might be within the Fresh-cut segment at retail and the deceleration of the growth rate that you've seen there for the category?

What do you expect the reason might be for that?

I mean new product introductions, there's different correlations, we've been asking ourselves that same question.

The fact that there hasn't been any significant new product introductions is one of them.

Another area may be that the price of raw product, there is some correlation between the cost of raw product, head lettuce and the category growth.

We think that's had some influence this year.

Because raw product costs have been down some.

So we will see if that affects it as raw product costs are kind of going back up.

So we will see what happens with that.

Then the third thing is there's more, as we mentioned earlier, there's more premium salads and salads being sold at quick service than there were before.

And that may have some impact as well.

So, we'll see.

We do think at some point in time, the category will pick back up and we will be introducing new additional products to help drive that category growth.

We're just not sure exactly when that's going to happen.

I mean, we are looking for additional product introductions next year.

So between now and then, we are not really sure if or how much the category growth would grow between now and then.

Okay.

And the last thing, you mentioned separately that you were seeing some construction delays, I think in some of the Customized facilities that you are building in Indiana and California.

Can you speak to that a little bit?

It sounds like a resolve that you are just pushing off to Q1 '05, but what exactly, is there any more color you could provide on that?

Primarily building permits.

There's been some, I hate to say red tape, but a challenge in getting a couple of building permits that we needed to finalize the project.

So we are, we think we will have that done and we do believe that the Indiana facility will be done in, during the first quarter still.

We are making every effort to make that happen.

That's really the main project that's been slowed down.

I think the other ones are still on track.

Obviously, weather always has an impact, things of that nature.

We work hard to control the things we can control, and sometimes you run into things, either governmental or weather, that are sometimes beyond your control, and unfortunately that's one of the issues we've run into in Indiana.

So w e are confident we'll be opened -- I say confident, we expect to be open at this point in time, sometime during the first quarter.

Eric Larson, Piper Jaffray.

A quick question on Customized, just so I make sure I understand this.

You quoted that there was some growth margin deterioration in the quarter due to the inflation.

I'm assuming that you're able to pass your costs off.

You have a fixed, a built in fixed dollar profit, so that when you pass that on, your percentage profit declines, is that correct?

That's correct.

As you know, a lot of chain business both in Broadline and Customized, but all of our Customized business essentially is on a fee per case basis, so it's a fixed fee per case.

So as the raw product, or the cost of the product increases, yes, that does get passed through.

But our fixed fee does not change.

Gotcha.

And then on certain product categories, for example, beef, whether it's chain or Street, it's typically kind of a cents per pound basis.

So again, you've got a situation where we are making the same gross profit dollars, but a lower percentage.

Okay.

That makes sense.

Then if you take the combination of adverse mix, with more center of plate sales, and then your Customized percent of gross margin decline, if you those 2 factors, what was that as a part of the gross profit margin basis point decline in the quarter?

We haven't quantified the specific amounts there.

But for instance, if you look at Customized, they had roughly a 10 basis point decline there in operating margins.

And a good portion of that, or a substantial portion of that, is inflation related.

And Broadline we had a change in mix shift -- actually we think it's a positive change in mix shift toward center of the plate, not an adverse change.

That went from 34 percent of our Broadline sales, up to 37 percent.

Those products are typically at a lower margin, and as Bob had mentioned, a fixed fee or fixed price per pound.

So that did negatively influence gross margins and ultimately operating profit margins.

Okay.

Actually, I'm not sure John had seen the analysis, but we actually, the Customized division actually did do an analysis.

If you take inflation into account, it was -- their margins would have been flat to maybe up slightly, except for the impact of inflation.

Okay.

Good.

Then the final question is, can you give us just a little bit more flavor on fourth quarter?

I know what your guidance is.

Fourth quarter last year obviously had a lot of noise in it, you had an extra week, you had obviously the issues with Quality foods, you had the Fresh-cut issue.

But when you look at your guidance, you are only getting to about half the distance to the goal line from what you earned in the fourth quarter in calendar '02, 2 years ago.

Can you just give us a little, maybe some qualitative guidance as to how we should be thinking about fourth quarter, relative to each of the last 2 years?

Well, you know, if you look at the fourth quarter last year, there were a number of issues that cropped up.

And this year we are still having some of the hang over from some of those issues.

In Fresh-cut we continue to have, we continue to have -- continuing to have weather events in the fourth quarter.

Although we are doing a much better job of dealing with them.

In fact, to this point we have not had to go out and contract product because of our new policy of contracting product.

But we still have the issue of, you know, yield and productivity efficiency issues.

So we are doing a better job this year than last year.

But still, we will have some impact.

This whole -- and last year, category growth in Fresh-cut was growing very nicely.

This year it's substantially lower.

The other issue in Fresh-cut is that last year we had the foodservice business.

This year as we mentioned earlier in the year, we are dealing with this whole giving up of this partly rationalizing and partly as a result of competing with PFG, this foodservice business.

And so we are having to rebalance our network.

So all of those things in Fresh-cut are having substantial impacts on us this year.

If you look at the Broadline, we do expect a nice improvement in operating margins in the fourth quarter.

Still being affected somewhat by inflation in the year, in terms of -- and the impact of operating margins on inflation.

But we are making good progress there.

But we had the hurricanes, and we still are having as we said before, some impact to us on the hurricane in the fourth quarter this year.

And there's still some impact as relates to lower margins with the addition of Quality Foods as a part of PFG.

Although we are glad they are here, they continue to have impact on our operating margins, and will for, even into next year.

And so as relates to operating margins, we are not where we were historically, but we are still dealing with some of these issues.

We are working through them.

We do expect a nice earnings improvement in the fourth quarter.

And we expect to continue to make good, steady progress from there.

Okay.

Thanks.

The final question, corporate overhead.

Maybe you already said this, you talked about the sequential decline, gradual sequential declines in the second and third quarters this year from first quarter.

Is that sequential decline something we can look forward in upcoming quarters?

I think we are pretty close to where we are stabilizing at this point, Eric.

We had some incremental costs related to some severance in the first quarter, as well as higher insurances in the first and second quarter.

So I think some of those we have lacked.

But our Sarbanes-Oxley initiatives and IT related expenditures, I think will continue.

So I would not look necessarily for a significant decline in the fourth quarter.

There may be some slight decline, but not a significant decline.

Okay.

Thanks you, guys.

That being said, we do expect our initial roll up of our budget reflects just a very modest increase in corporate cost next year.

Because, again, we've already taken the brunt of these increased 404 costs in '04.

Jeff Omohundro, Wachovia Securities.

I wonder if you would give us a little bit of color on the state of labor and turnover.

And also where you see any union contracts might be coming up say over the next 12 months?

As relation to union contracts, we've talked about it.

There's no really major union contracts that are on the horizon.

Turnover.

I mean, we are working diligently to improve turnover.

Have communications programs in place and so forth.

Our turnover is about where it has been historically.

Company by company, maybe slightly better.

We do track that on a monthly and quarterly basis, company by company, and as historic, some companies are better and some companies are trending about the same as historic.

So -- .

So nothing unusual in the Fresh-cut division.

Nothing unusual, right.

Ann Gurkin, Davenport.

Wondering if you could talk about your outlook for meat costs next year?

And are you making any changes in those contracts to try to capture better margins?

I'm not sure we have a very good crystal ball on projecting or anticipating what meat may do next year, Ann.

Obviously, we've -- we expect to be lacking a lot of the significant ramp up we had in the fourth quarter late last year.

As far as changing the pricing dynamics, Bob may have some additional thoughts, but I think changing the pricing dynamics of meat, I'm not sure I hold out a lot of hope for that.

It's historically been priced on a cents per pounds, or tight mark up.

So I don't -- shifting that to a percentage mark up, I don't think is very likely.

Bob may have some --.

No.

We don't expect that.

In terms of contract, that's kind of rolling the dice at this point in time.

We hear that there's some chance that beef prices may moderate.

So right now probably wouldn't be the point in time we would want to be contracting prices.

So I wish we had a better answer for you, but we are kind of playing it by ear right now.

Okay.

And then, Bob, I'm just curious, you've been back in the CEO role for 8 months or so now.

Are you happy back in that roll, or do you have any plans to bring in some help, or can you just update us there?

We are having fun.

I mean I think we've got a good team here.

I don't see the need to bring in anybody else from the outside.

I think we just keep working on implementing our strategies and stay focused, and I think we will be fine.

John Emerick, Bricoleur Capital.

I am new to the story.

I just have a couple of higher level questions about the business.

Revenue ig going to be up something like 38 percent over 2002, and earnings are a little lower.

Can you talk to kind of the businesses you are getting into, and are they lower return on capital businesses that used been in before.

Or have we paid more, and maybe too much for acquisitions that we've done since then?

What are the things that have caused that, or is it very temporary?

And we think that those historical margins are readily achievable again, despite whatever businesses we've gotten into?

John, we would be glad to spend sometime with to you follow up on this, but let me try to cover some of the higher points that you were alluding to.

One of the significant drivers in the change in profitability has been related to Fresh-cut, our Fresh-cut business.

As you know, we are in 3 different business segments.

Fresh-cut margins back in 2002 were about 8.3 percent.

As Bob mentioned this quarter, they are roughly in the 5.5 percent range, as we've been working through some restructuring in that business.

So that's going to be a big part of your driver in operating margins.

There have been a couple of other things that we've continued to work on in changing mix of the business.

For instance, Customized has historically grown at a faster rate than our Broadline business.

That is chain business.

Chain business typically has a much thinner operating margin than a lot of your street business.

So some of those mix shifts will ultimately end up driving changes in operating margin profile.

So we'd be glad to walk you through a lot of that in more detail and bring you up to speed.

I suggest you can either contact myself, or Kevin Collier our Director of IR and they will walk you through that.

Just one other point to that.

We did make one acquisition -- one major acquisition of a company that we knew going in was a low margin company, which is Quality Foods.

And we've had some operational challenges with that, which we've worked through, which is why we mentioned that earlier.

I will follow up off-line.

It's a good idea.

But just to reiterate, we did make a acquisition into a lower margin business that in the best of times, and it seems to be having some problems.

And the move into the increasing presence of Customized which is a lower margin business than our other businesses, and then the problems at Fresh-cut which we think we are going to fix.

Right.

And the attractiveness of the Customized business is even though it has low margins, it still has a good return on capital.

As good as the other businesses?

Actually, it's our best return on capital business.

Yes.

But the other businesses, I mean, obviously they all have lots of room for improvement in return on capital.

Ajay Jain, UBS.

Bob, earlier I think there was some mention of what you expect to be some weather-related product for raw product for the fourth quarter in Fresh-Cut.

Is that correct?

Yes.

Okay,.

Now I seem to recall after all the product sourcing issues had surfaced late last year, I think it was Michael Gray at the time, who outlined a number of initiatives to try to mitigate future agricultural risks.

Can you confirm whether those measures are actually in place now, and also just clarify whether they are having the intended effect in terms of better managing the commodity risks, or do you still think you have some work to do in that area?

We always have some thing that we can do better, there's no question about that.

But what we have in place I think really is working.

I think the fact that we have increased amount of product we've contracted -- this is a transitional period of time for us, the fourth quarter.

Where we transition from Salinas, which where we are at for the majority of the year, to Southern California Furon (ph), and then on over at the end of the quarter to, to Yuma, Arizona.

And so we have different transitions, we have different weather that we are dealing with.

So you know, if you have weather issues, it kind of compounds the challenge in the fourth quarter.

So we had an unusual amount of rain, but even with that, because of our expanded contracting practice, where we now contract in the fourth quarter about over 100 percent of our product needs, anticipating that we will have some weather issues that will reduce yields, we actually have been able to meet our needs and are not having to go out in the open market and buy product.

So if we had had to go out in the open market and buy product, you know, lettuce is $20.

I mean if we had gone out there, we may have forced it up to $50 a carton.

So that has been a very successful practice for us, expanding our contracting.

So really the only issue that remains this quarter, as a result of that, is the fact that we do have lower yields.

When you have lower yields you've got just a higher cost of processing that product.

It's just more labor-intensive, and also somewhat higher costs in shipping raw product to some of the plants.

So that's the bigger challenge.

And I'm not sure what we will ever be able to do about that.

But if we can manage that within a few cents, that's a quarter, that's a very positive thing.

And so far, so good.

I think the key thing there, Ajay, is that we do think our contracting policies have really worked as intended and significantly mitigated some of that risk.

And based on the issues that you have visibility into now, you don't foresee any additional earnings risk for the fourth quarter?

Well, I mean we can't predict the weather.

As soon as we are able to do that, we will give you that assurance.

But from what our crystal ball shows today, barring any other really unusual weather, we continue to expect to be within the range.

Andrew Wolf, BB&T Capital Markets.

In Fresh-cut, can you tell us how much of that, how the fresh fruit did in sales?

You know, it was, let's see, that's a good question.

That's one question -- off the top of our heads.

Hold on Andy, John is pulling the numbers now.

We ended up doing about $9 million in sales in the quarter in fruit.

Can you just refresh us, was that about the same as last quarter?

That's up a bit from last quarter.

We are continuing to grow the business with our existing customers.

So, but we are not aggressively rolling out to new customers at this point in time.

Our real focus in that business, really is working on continuing to improve our sourcing so that we have year-round price effective, high quality product.

And also continuing to work on our productivity efficiency within the segment.

And the other question is on the hurricane impact, I think you said half was in distribution.

How would you split that half that was in distribution, between Broadline and Customized?

I would say that in, it's probably two-thirds of that, half is in Broadline and the remainder in Customized.

Thank you.

And in the fourth quarter, basically all of it will be in Broadline.

In Broadline, correct.

Steve Chick, JP Morgan.

Just, did you say how many facility -- Broadline facilities were actually impacted by the hurricane?

There were a good number of them, Steve.

We've got 2 Broadliners that are in the state of Florida.

Obviously Miami does a lot of cruise ship business, which was obviously impacted, and a facility up in -- outside of Tampa.

But we also have 2 others along the Gulf states, one outside of New Orleans and one in south central Georgia.

Then also, some of the facilities that were in the Mid Atlantic, for instance here in Richmond we have a facility that was closed for a couple of days.

They lost a couple of days shipping with the significant rains we had with Gaston.

And we had some huge floods here in downtown Richmond, which a number of customers there still have not reopened.

It was 7 or 8 facilities overall that had some impact.

Obviously the ones down in Florida were much more impacted than others.

So 7, 8 Broadline facilities, some more than others.

What about Customized facilities?

We had one facility that's in Gainesville, Florida, that was the primary one that was impacted.

Obviously there was no structural damage to any of them.

I think they -- so they were moderately impacted.

But -- .

There are no further questions at this time, gentlemen.

Do you have any closing comments?

In closing, would like to thank you for your participation today, and for your interest in our Company.

We remain focused on the aggressive execution of our strategies to drive sales growth and deliver strong earnings growth and return on invested capital for our shareholders.

We do believe that we will turn the corner in the fourth quarter, and expect solid operating earnings growth and we expect that to continue in 2005.

Thanks for joining us.

Ladies and gentlemen, this does conclude today's teleconference.

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

Thank you.