Blackstone Inc (BX) 2005 Q1 法說會逐字稿

Good morning, ladies and gentlemen.

And welcome to the Performance Food Group first quarter 2005 earnings conference call.

A brief question-and-answer session will follow the formal presentation. [OPERATOR INSTRUCTIONS] 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.

Welcome to our conference call and Webcast to review the Company's announcement earlier today of its financial results for the first quarter ending April 2, 2005.

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

And this call is primarily intended to review financial results for the first quarter of 2005.

Our first quarter earnings 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 operating highlights for the quarter.

And then Bob will provide for insight into the quarter and current expectations for the balance of 2005.

Before we start, let me remind you that certain of the statements we'll 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 our SEC filings.

In addition, these remarks may include certain non-GAAP financial measures as defined by SEC Regulation G. The presentation of the most directly comparable GAAP financial measures and a reconciliation of the non-GAAP measures to the comparable GAAP measures will also be available on our Website.

Turning to our financial highlights, net sales and continuation operations for the quarter registered a strong 1.4 billion, this represents a 16% increase from the year ago period.

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

Each of our business segments contributed to improvements in sales, and a complete segment break down is included in our earnings release.

On a consolidated basis, inflation amounted to approximately 3% for the quarter.

Gross profit from continuing operations increased 13.8% from the year-ago quarter while gross profit margins decreased 26 basis points to 12.65% from 12.91% last year.

The decline was driven in part by the increase in our mix of multi-unit business and an increase in our product mix toward more center of the plate products in our broadline segment.

Operating expenses in continuing operations for the quarter were 170.5 million or 11.98% of sales, which represents a decline of 46 basis points versus the prior year.

The decline in the operating expense ratio in the quarter is due primarily to the increased mix of multi-unit business, which as you know has a lower gross profit but lower expense ratio than our street business.

And also through improved operating efficiencies in our broadline segment.

Customized operating expenses were also favorably impacted by the lacking of higher labor costs associated with the labor dispute in the prior year.

Higher fuel and insurance costs in each of our segments partially offset some of these improvements in our operating expense ratio.

Operating profit from continuing operations in the quarter was 9.4 million, and our operating profit margin was 0.66%, representing an increase of 19 basis points versus the prior year quarter.

The increase in operating profit margin in the quarter is due to the decline in operating expense ratio as I previously discussed.

Interest expense and the loss on sale of accounts receivable decreased 2.0 million for the quarter versus 2.5 million in the prior year quarter, primarily as the result of our redemption of our convertible notes in the fourth quarter that were replaced with lower interest debt.

The increase was partially offset by higher interest rates versus the prior year period.

Other income was 164,000 in the quarter, compared to 200,000 in the same period of 2004.

And our effective income tax rate was approximately 38.5% for continuing operations for the quarter.

We would expect our tax rate to be approximately 38.5% for the balance of the year for our core distribution business.

Net earnings from continuing operations in the quarter were 4.7 million or $0.10 per share diluted, compared to 2.2 million or $0.05 per share diluted in the year-ago quarter.

Net earnings from continuing - - or discontinued operations were 9 million, who are $0.19 per share diluted, compared to 5.3 million or $0.11 per share diluted in the prior-year period.

As a result of our agreement with Chiquita brands to sell our fresh cut business and in accordance with generally accepted accounting principles, depreciation and amortization were discontinued in that fresh cut segment as of February 23, 2005.

This resulted in a reduction of pre-tax expense of approximately 3.7 million or $0.05 per share.

At the end of the quarter, our balance sheet remained strong, our debt-to-capital ratio was 23%, which was down from 24%, the fourth quarter.

This excludes 130 million in interest - - interest in accounts receivable sold under our receivables purchase facility.

Looking at working capital, days sales outstanding and receivables were 23 days compared to 22 days in the prior year quarter - - or prior quarter.

Inventory turns amounted to 18 times which improved from 17 times as of the fourth quarter.

Accounts payable float was 130% compared to 126% at year-end.

For continuing operations, depreciation amounted to 5.5 million, and amortization to about 900,000 for the quarter.

Capital expenditures were about 18.5 million in the quarter, versus 5.4 million in the prior year period.

Free cash flow from continuing operations for the quarter was a negative 7.4 million, due primarily to our emphasis on adding distribution capacity, as we'v previously talked about.

Looking ahead, we continue to expect internal sales growth for our distribution businesses to be in the high single to low double digits.

We're experiencing higher trends in insurance costs, particularly increasing healthcare costs in each of our business segments.

Also, as a result of incremental costs associated with the completion of our recently disclosed audit committee investigation, our corporate costs have increased during the first quarter.

Given these factors, we expect our operating profit from continuing operations to be toward the lower end of our previously disclosed range of 73 to 78 million.

As we have previously discussed, this excludes stock option expense but includes corporate overhead costs.

This reflects a mid double-digit increase in operating profit compared to the prior year period.

Also in conjunction with the delay in the implementation of FAS123 for expensing stock options, we would now expect to begin the adoption of that new standard at the beginning of 2006.

We've been focusing our efforts on continuing to develop efficient and cost-effective equity compensation programs, particularly with an emphasis on the issuance of a greater mix of restricted stock.

So, in spite of the delay of FAS123R, we do expect to incur pre-tax stock option expense - - or stock compensation expense of approximately $1 million to $1.5 million for the full-year 2005.

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

Thanks, John.

Welcome and thanks for joining us.

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

We're pleased with our solid gains in internal sales growth and operating profit performance in the first quarter.

Our focus on being a valued partner to the customer by delivering service excellence is contributing to our growth with new and existing customers.

Our ongoing efforts to improve the accuracy and efforts - - efficiency of our operations combined with the changes in our customer mix are beginning to show a favorable impact on our operating expense ratio, particularly in the broadline segment.

We will now review the results of each of our segments beginning with our broadline distribution business.

The broadline segment achieved a strong 19% increase in sales to $860 million.

Internal real sales growth was a solid 16%, adjusted for 3% inflation.

Our strategy of account penetration with independent restaurant customers helped drive gains with 6% growth in our street sales in the quarter.

Our new business rollouts in the second half of 2004 have contributed to a faster rate of growth in multi-unit business, versus street business in the quarter.

However, the recent growth in multi-unit business has not changed our continuing focus on the growth of street sales as a percentage of our total sales.

Also, we believe that the growth of our product mix in the center of the plate categories is favorably positioning us with our customers who are relying on our expertise more in this critical area of their menu.

Since the relative margin in this category is lower, due to the fact that these products are sold on a cost per pound basis rather than a percentage markup, the growth of this category has had an impact on our margins.

We are maintaining our focus on the continued refinement and development of our proprietary brands, which help differentiate our Company in the market and add value to our customers.

Our strategy to enhance our customer experience by improving the accuracy and efficiency of our operations is not only supporting our ability to grow with customers but we are now beginning to achieve steady improvement in our operating expenses, particularly in our broadline segment.

The addition of previously disclosed new multi-unit business combined with the operational discipline achieved through the additional regional finance and operations management staff over the past year has helped us achieve a 79 basis-point reduction in broadline operating expenses during the first quarter.

Even with the changes in our customer mix, and increases in our healthcare costs, our operating margins increased 4 basis points during the quarter versus the prior year.

We're pleased with the continuing operational improvements of broadline and will remain focused on incremental improvements in this area.

We expect continue to expect strong top line growth as a result of the additional multi-unit business in the latter half of '04, as well as our continuing effort in growing broadline street sales.

We continue to expect sales growth to be in the low double digits for the year.

As we discussed in March, we expect broadline operating margins to improve modestly for most of the year and progress at higher levels at year-end as we lap the new multi-unit business.

Our customized segment generated solid sales increase of 12% to 563 million in the quarter.

Internal real sales growth was 9%, adjusted for inflation of approximately 3%.

The increase was a result of continued growth with existing customers.

Operating margins increased 33 basis points for the quarter.

A significant part of this margin improvement was the result of the resolution of a labor dispute that was resolved in the third quarter of '04.

In customized, we're maintaining our focus on achieving efficiency, improvements while expanding our warehouse capacity throughout the country.

Our new Indiana facility began serving customers in April.

Our capacity initiatives are continuing with the construction of replacement facilities in California and South Carolina and the expansion of our Texas and Florida distribution centers.

These expansions are planned for completion by the end of 2005 and should provide us the capacity we need to take on new customers during 2006.

As we discussed with you in March, beginning in the second quarter, customized operating margins are expected to be negatively impacted as we begin to incur the costs associated with the opening of the new distribution facilities.

As a result of the continued expansion of capacity throughout the year, We do not expect customized operating margins to increase in 2005 compared to the previous year.

As a result of our agreement in February to sell the fresh cut segment of our business, our Company met the criteria required to account for fresh cut as a discontinued ope\ration.

Sales in the fresh cut segment increased lightly in the first quarter.

Retail sales increased well ahead of category growth during the quarter.

Foodservice sales decreased compared to the same period last year, due to the lapping of reduced foodservice sales resulting from customer rationalization in the prior year.

To recap, Company-wide, our sales and earnings performance was a strong start to the new year.

We will maintain our focus on service excellence, and operational improvement to achieve a solid operating earnings performance for the year.

We'll also remain attentive to the long-term development of our Company to ensure the continued growth of our sales and earnings performance in the future.

Donna, we're now ready to take questions.

[OPERATOR INSTRUCTIONS] Our first question today is coming from John Heinbockel of Goldman Sachs.

Please proceed with your question.

This is Simeon for John.

Hey, Bob, you guys indicated you now expect EBIT to come in at the lower end of your guidance rage, 73 to 78.

But relative to what we were expecting, first quarter sales in EBIT were a bit better than expected and things seem to be picking up a bit.

Can you kind of talk about the reasons why - - I know you mentioned corporate costs are higher but that seems temporary and then I know you mentioned healthcare but are you guys building in a little cushion to that number?

Not really.

Healthcare costs really are kind of driving force behind that.

We did incur as you know, which costs associated in the first quarter particularly with the investigation.

But and that puts back a little bit for the year.

But the main driver of that really is healthcare costs, which we had projected about a 10% increase this year, and over the course of the first quarter, they've ramped up pretty significantly.

And right now we're projecting about a 20% increase in healthcare costs, which would increase what we had originally forecast by about $4 million in the year.

So that was - - that's a pretty big number.

Okay.

And then my follow-up is relating to broadline.

I know you reported total sales up 19%, 3% inflation.

Can you deconstruct that a bit more?

Can you kind of tell us how much Compass was, or acquired businesses?

And we're just trying to get at a normalized organic number for the quarter for broadline.

If you take out Compass, the growth was roughly about 10% or so.

Without compass.

But Simeon, I kind of glossed over your other point.

Trends are positive.

We're investing a lot of money making a lot of improvements throughout the Company in efficiencies.

And picking up momentum in sales and so forth.

So trends are good.

But that being said, I mean, there are little things like health insurance that are beyond our control and we do have to build those into our numbers.

Okay, thanks.

Thank you.

Thank you.

Our next question is coming from William Leach of Newburger Berman.

Please proceed with your question.

Good morning.

Can you update us on the timing of the expected sale of Fresh Express and can you say anything about the use of its proceeds?

The second part of question is no, we cannot comment on the use of proceeds yet.

We do expect to once we close.

Based upon the comments that Chiquita has made and the terms of the agreement we have, we would still expect to close in the second quarter.

And are still proceeding in that direction.

Okay.

So you don't feel the deal's in any jeopardy at all?

Based on their comments, we expect to close in the second quarter.

Okay.

Can you just help us out, modeling, just give us a few of the operating things like interest expense, capital spending, D&A for the full year from continuing operations?

Yes, as you know, we gave guidance for the continuing operations of CapEx to be in the 80 to 100 million.

We had about 18.5 million from continuing operations spent in the first quarter.

So we still feel pretty good with - - pretty good about that overall guidance for the year.

Depreciation was 5.5 million, and amortization roughly another 1 million, about 900,000.

So we still think we're in tracking on the previous guidance we gave you for D&A as well.

And what was that?

About 25 million.

So you're spending basically four times your D&A right now?

Yes, we're making a fairly significant investment in capacity this year, which we've talked about.

We would not expect that to be kind of an ongoing run rate but, yes, we are investing pretty significantly in CapEx.

Points will catch up with facilities particularly in the customized area of the business where we were having the, as we mentioned, two new replacement facilities, two expansions.

And then rollout - - or re-opening of Indiana, which is a whole new facility.

So should spending go down in 2006?

Yes, I would not expect to keep up the run rate that we are posting in 2005.

Right.

We haven't given guidance for '06 but yes.

And then lastly, do you have an estimator for interest expense for the year presale?

Yes, let's see.

Interest expense for the period was about 2 million.

We had both loss on sale and accounts receivable as well as interest.

I think a lot of the interest expense number, I can't give you specific guidance, because the use of proceeds issue.

Barring that, I think this current run rate is probably a fair number to use for your model.

But then obviously use of proceeds will - -

Right.

Okay, thanks very much.

Thank you, Bill.

Thank you.

Our next question is coming from Jeff Omohundro of Wachovia.

Please proceed with your question.

Yes, I'm wonder to go you could expand a little bit on some of the operating efficiency initiatives you're pursuing and what's driving the results you're putting out?

Well, there are a number of areas.

One is the area of account penetration in broadline.

As we've always said, it helps us to improve with existing customers, or sell more to existing customers.

It costs less to do than it is with other customers.

So we're continuing to focus in on that area.

Secondly, is in operations, we have these warehouse management systems that we're implementing.

We've got a number of those in place.

I think we've got about 13 updated warehouse management systems in place now.

And we expect to have all of those rolled out by the end of - - or by the middle of next year.

And about the same with a new system, ABT system, which also tracks - - does a better job of tracking statistics of operations and picking by individual, et cetera, et cetera.

And so those type of systems just help us with our errors within the facilities.

Know where the product is, tell us what our inventory turns, particularly on product that is aged inventory.

Make the picking more efficient, improving productivity and things of that nature.

We're also in the process now - - we have a road net system, which is a - - helps us route our trucks efficiently.

We're also span expanding that in broadline, going to a more sophisticated system that helps us track our trucks, measure fuel efficiency on the trucks, and a number of other variables that measure - - that we can help us better control that.

And know where our trucks are at all times, things of that nature.

And have you seen any benefits from that yet, especially given the high gasoline prices?

In terms of total miles or - -

We just have actually been testing that, and we're just in the process of starting to roll that out as we speak.

So we only have a couple facilities.

Yes, we have seen the benefit of that.

Or we wouldn't be rolling it out.

As relates to fuel, with our customers we have - - I know what question you asked, but we do have contracts with our customers which enables to us pass the fuel costs onto our chains, and with our - - with other parts of our business?

We do have some fuel locked up at established prices for most of the balance of the year.

So, you know, those are just some of the initiatives.

But those are things that are driving efficiencies in the operation, helping improve operating margins, or expense costs and operating margins.

We think those will continue to be leveraged.

And we've got several other initiatives underway, too, which are kind of in the early stages.

We talked about kind of the ability to purchase better, we're continuing to - - we've got all of our products cross-referenced now.

We alluded to that last year.

And we're going to be going to standard product codes over the next year.

So we have accomplished the cross-referencing, that's 100% complete.

Using that in our purchasing area but we're going to be taking that to the next level over the next year.

So a lot of issues underway, it's an exciting time in the Company.

As we've said before, we finally have had the time to really focus in internally and really start to get some exciting initiatives moving.

Thank you.

You bet, Jeff.

Thank you.

Thank you.

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

Please proceed with your question.

Hi everyone.

First question is just talking about the revenue growth in the quarter, I guess I was a little confused.

When did you complete Compass?

When was the acquisition date of that?

And how much again did that contribute in the quarter to revenues for broadline?

We brought Compass on late third quarter, early fourth quarter last year.

And it contributed - - we already had some Compass business but we added another 200 or so million, a little over 200 million.

Okay.

So then what was your internal growth rate in the quarter, if you strip out the new incremental sales of Compass?

Well, what we're saying is in broadline we grew around 10%, excluding Compass.

It's about half and half, Eric.

We grew in broadline about 19%, that's about half and half between Compass and other internal growth.

And then customized would be all internal, or just - - with expanded business with the existing customers?

Exactly.

Okay, got you.

Then the fine question, I know we're only suppose today ask one.

Can you give us an update on Quality Foods?

I noticed that in broadline in the quarter, you did see a little bit of margin improvement, now, you should be able to get I would think against some better comparisons as you go forward?

And then within that, you didn't talk anything about your private-label sales.

Could you give us an update on that?

That's two more questions.

But I only said it in one comment.

Okay.

Quality Foods is actually progressing very nicely.

We're - - I mean, just - - we don't give specifics on the companies but they're operating margins are improving, their sales are growing nicely, their street sales are growing nicely.

One of the issues we talked about before was their sales per delivery.

They're increasing that significantly.

Showing extremely nice increases in sales per delivery.

So they are -- they're really on the right track.

And we're feeling very good about our Quality Foods operations.

As it relates to brands.

Still got a long way to go with Quality.

A long way to go where we want to be but they're making good progress.

Let's see, as it relates to brands, our brands sales are pretty flat to last year.

And the reason for that is we're really just analyzing our brands, looking - - we are very focused on them.

But really exploring every category, looking at it, analyzing the profitability of it, analyzing how it differentiates us with the customer and what value it is to the customer.

And so we've taken a step back on our brands just to make sure that we are getting the benefits internally as well as providing the benefits to the customer.

And we're just kind of in that process now.

I would say over the course of this year, I do not expect brand sales to increase significantly.

I would say this is kind of a year of evaluation and regrouping and then continuing to move forward.

Not that there's anything wrong with the brands.

They're progressing nicely.

But again, I think it's every once in awhile, a good idea rather than just charging forward, to take some time to evaluate where we are.

But I'm pleased with the brands overall and I think we've got some really strong brands out there.

And we'll continue to move forward.

And our overall focus more than just brands is just the whole area of kind of category management.

So - -

Thank you.

Thank you, Eric.

Thank you.

Our next question is coming from Ann Gurkin of Davenport.

Please proceed with your question.

Good morning.

Good morning, Ann.

I was wondering if you can comment on - - or review your long-term outlook for the customer's division in terms of sales and operating profits - - operating margins, sorry.

And then secondly, are you close to announcing any new customers?

We are not close to announcing any new customers.

Let's see, as it relates to long-term goals, I think we've - - we're comfortable reiterating our goals of growing in the five basis point and hopefully a little bit more but hopefully in the five basis point range a year and then going forward.

This year, we said they would be flat because we are opening so many new facilities in the second half of the year.

Operating margin will probably actually be down slightly, which will bring them down to around flat to the year.

But longer term, we expect the operating margins to improve slightly as we go forward and are able to leverage our internal growth.

Get more benefit from that.

Continue to implement - - use systems.

And then we do expect to grow in the mid teens with the addition of one good new customer a year and our existing customers.

And we are blessed to have some very good existing customers that are growing nicely.

And then lastly, that growth, that mid teen growth is not going to be consistent.

There's going to be some years where we might add one or two good customers, and other year where we may just integrate those customers, so it's not going to be an exact straight line.

Thank you very much.

Thank you, Ann.

Thank you.

Our next question is coming from Andrew Wolf of BB&T Capital Market.

Please proceed with your question.

Good morning.

Yesterday Cisco said that the weather in the Northeast and Midwest kind of impacted sales a little negatively.

Southeast was good.

Did you see that kind of regional situation as well?

You know, it's really hard to say.

I mean, there might have been a slight increase.

We were - - we picked up a lot of Compass business in the Northeast, and as a result of that, we're pretty focused on the Compass business.

So we personally did not suffer.

But - - and so it would be hard for us to really gauge that impact to us as a Company.

But obviously the weather - - there were some weather challenges up there this year.

On the street sales, they picked up a little bit this quarter.

Last quarter you said there was a little focus issue.

So do you think this was more internal or do you think the industry environment with independents might be getting a little better?

We think they might be better.

Certain categories, particularly such as family dining, and casual dining are, we think, doing well from our research.

And so we think that's better.

It's really kind of a company-by-company focus.

And some of our companies are doing an extremely good job of growing street and others because of the rollout of some chain business, kind of got a little distracted.

And so we have to get those particular companies back on track.

And - - or I should say they have to get themselves back on track, which I'm sure they will.

So we've got some companies doing a great job growing it, others just need to get back focused on it.

So but overall, we're happy with the progress and we expect to continue to grow street sales and make it major emphasis.

Thank you.

Thank you.

Our next question is coming from Steve Chick of J.P. Morgan.

Please proceed with your question.

Hi, thanks.

I guess first off, John, you guys plan to release any more information on the discontinued operations like any other allocations such as interest expense and D&A?

No, but I can comment on that as far as the allocation of interest.

We allocated interest based upon the net assets employed in each of those businesses.

So the discontinued operations did absorb some of the interest costs during the period.

To give you kind of a comparable number, it was about 1.9 million that was allocated to fresh in the current period, versus about a 2.4 million, 2.5 million in the prior-year period.

A lot of that also is driven, you know, last period, as I commented in my general remarks, the interest costs of the convert was a good bit higher.

So obviously retiring that with our lower-cost debt was part of that driver.

Right, okay.

And actually, do you have the same figures for the D&A allocation?

I mean, there's really no allocation.

Each of the segments absorbs its own depreciation and amortization.

So there's not an allocation process.

If you look at discontinued operations, we did incur depreciation costs of about 5 million and amortization costs of about 600,000 in the first quarter within that segment.

So --

Okay.

And second question, in the unlikely event, I guess, that something I guess should happen to the Chiquita bid, can you just speak broadly - - and I understand the sensitivities, but can you speak broadly about what the demand and the interest level was with the Fresh Cut asset when it was out for bid?

We obviously conducted a very robust process based upon Chiquita's comments and the agreement that we have with them, we would still expect to close in the second quarter.

So that's our primary focus.

Okay.

That's fair.

But I mean I guess there were - - when the process was underway, you had various levels of interest anyways, that's fair to say?

There was a significant amount of interest, there's no question about that.

Yes, beyond that, we're not going to comment.

Yes, that's fair.

And last thing if I could, just with your operating earnings guidance, you know, for the core businesses, 73 to 78 million, you did 9.4 million, it looks like for this quarter.

And I understand that with seasonality this may be a low-point quarter, but it looks like you need a nice ramp as the year goes on to hit that target.

Is there one thing we should be thinking about that's going to help that?

No, if you look at - - I mean if you look at our store numbers, Steve, and you go back and look quarter-by-quarter at our continuing ops, you know, you'll - - the first quarter historically is significantly lower than the other three-quarters.

That's correct.

So I don't think - - we're not going to have to have a significant ramp-up to achieve that number.

Okay.

Yes, I've done the path, I thought even with that in mind, it looks like you needed a bit of a ramp.

I guess what you're saying, if the business kind of runs as you see it, the guidance is achievable as your thought process that fair?

As we said, we are comfortable with the mid teens growth, we're up 64% in the first quarter, so the rest of the year - - so, yes.

It's mid teens growth over the previous year on continuing ops.

Yes.

Thanks, guys.

Thank you, Steve.

Thank you.

You are next question is coming from Bob Cummins of Shields & Company.

Please proceed with your question.

Thank you.

Good morning everybody.

Good morning, Bob.

I was just - - I may have missed it, but have you put out restated earnings per share from continuing operations for the remaining three quarters of 2004?

We have not put anything out but I can comment on that, Bob.

Okay.

If you look at 2004, the second quarter would be $0.39, third quarter $0.37, and then the fourth quarter $0.18.

However, that includes the costs of redemption of convertible notes which we had in the fourth quarter.

Right.

If you adjust that - - I'm sorry, that was the total, I'm sorry.

Picking up - - continuing operations was $0.22, $0.23, and $0.09 in the fourth quarter, however, if you normalize that one-time charge, it would be $0.22.

Okay.

Say that again, now?

You reported number would have been $.09 but adjusted it would be $0.22 in the fourth quarter?

Right, in the fourth quarter.

Okay.

Okay.

Related to that, I noticed that the earnings from discontinued operations are up quite substantially in this first quarter.

And of course recognizing that that business hopefully is about to be sold, still can you give us a little insight into what drove that substantial increase in earnings from the produce business?

There are two things, Bob that I think you really need to make sure you take into account.

One is that once the decision was made to discontinue those operations, we, in accordance with GAAP, you stop directing and amortizing your fixed assets.

And that was about a $3.7 million impact in the quarter or $.05 a share.

So to compare apples and apples, you'd really be looking at more, you know, $0.14 for this year versus $0.11 last year.

The other impact, as you know, if you look back to the first quarter of last year, we had about a $2.4 million unusual lettuce costs in the prior year.

We feel comfortable that they're making good progress.

The business is continuing to perform well in things like that.

But I think you need to make sure you take into account those particular - -

But they are on track, and they're doing a nice job of overcoming, you know, the lost foodservice business rebalancing their network.

They are making good progress.

So, we think they're very much headed in the right direction.

We do expect them to have a good year.

Great, great.

That's very helpful, thank you.

Thank you.

Thank you.

Our next question is coming from Ajay Jain of UBS.

Please proceed with your question.

Yes, good morning, I just had a question on the healthcare cost guidelines you provided earlier.

I'm definitely not an expert in this area, based on guidelines or surveys that I've seen, it seems like annual healthcare premiums for most companies are kind of growing in the 10% to 12% range.

I'm just wondering why it's ramped up, in your case, from 10% to 20%?

Ajay, there's a couple of components to that.

As you know, we are self-insured up to a certain amount in our healthcare programs.

And then beyond that, obviously, we pay a premium based upon any insured exposure there.

And so I think you're right.

I mean, we are seeing about that amount in our premium increases.

However, what we've really seen, especially in the first quarter, we had a significant ramp-up in both the number of claims and then the number of large claims, cancer cases, and things like that.

That have been continuing to increase, but we really saw that start to ramp up in the first quarter.

So based on our current projections, the self-insured portion of that, the healthcare program, is driving a lot of that cost increase.

And as Bob said, we're forecasting right now about a 20% increase year-over-year.

That may change, but that's the current trend.

That's correct.

Okay, thank you.

That was very helpful.

I I just had one quick follow-up question.

Can you also comment on the loss on the sale of receivables?

That seemed to be a fairly significant swing versus last year.

I know that's probably related to your off balance - -

That's correct.

- - facility, but is there any specific color you can provide on the receivable trends?

Yes.

It's really not driven that increase - - or change in that cost is not driven at all by receivable trends.

The average balance outstanding for the period increased about 20 million.

In the prior year, we had about 110 million of exposure under that facility, and for the current year about 130 million.

So just our borrowing, if you will, or exposure under the facility has increased.

Plus, the rate that we pay on that facility is a commercial paper-based rate.

Which while it doesn't directly correspond to LIBOR, the rate has increased significantly as well.

So both of those drivers are why you're seeing that increase loss on sale of receivable.

Okay.

But on the margin, would you say it was driven more by the higher rate or the increased borrowing?

You can do your volume cost - - or volume analysis there, but it's probably rate-driven more than anything else, and again again that's a commercial paper based rate.

So it fluctuates monthly based on standard commercial paper rates.

Okay, great.

Thank you very much.

You bet.

Thank you.

Our next question is coming from Forrest Tempel of FlyLine Partners.

Good morning, guys.

Good morning.

I have a question for you and it kind of goes back to the last conference call - - earnings call that you all had.

I sit here and look at I think the explanation last quarter was the difference in operating margins between you all and Cisco.

I look at their annual progression in operating margins.

They've moved up from kind of the high 3% margins up to 4.7, 4.9, 5,5.52 and that's looking back to '97 and getting up to 2004.

If I look at you all, our same operating income to net sales, the operating margin looks like it's been in the 1.8, 1.9, it hit 2.8, I think, in '02.

We're looking at kind of 1.8, somewhere around in the high 1's now.

I know a lot of this is size and cost of goods sold, but I haven't heard you all talk about; what it seems to me is the largest opportunity on $6 billion worth of sales to really focus only driving margin and getting into higher margin businesses.

And how we can enhance our margin or go back to where we are several years ago in terms of margin.

And I wonder if you or the Board or - - is anyone focussed on this?

And are there any specific plans that are going to drive margins and therefore, profitability in this business?

You say higher margin business, you're referring to mix of customers, is that what you're referring to?

I think there's lots of ways you guys could do that but mix of customers clearly is one.

Yes, Forrest.

We don't agree with you, as we've said, part of our strategy is improving our mix of customers with street versus chain, although we didn't do that this year because we had this opportunity.

Our operating margins, one of the things you're referring to when you give our overall operating margin, I believe, is you're including our customized business.

That's true.

If you break that out, our broadline is around 2.3%.

And one of the reasons it's gone down is because of some acquisitions we made of some low-margin business that we managed to bring down to kind of a zero operating profit.

But we're working to get that back up.

But there are a number of initiatives.

I mentioned earlier that we're working on, and better - - I shouldn't say better customers, our chain customers are good customers.

But we expect to have a 1% to 2% operating margin profit on our chain business and we expect to have something north of 3 on our broadline customers.

Which we need, because the return on capital on broadline is a more capital-intensive business than customized because you collect the money slower and you turn the inventory slower.

So all the initiatives I mentioned earlier, operationally, category management, purchasing, those are all things that just take time.

Over the course of time we've been so focused on acquisitions that we really did not have the time to work to implement some of the things that we're now in the process of doing.

That's not to say we won't continue to pursue some selective acquisitions but probably not at the pace that we had done historically.

And if you look at our margins, I mean, we've got tremendous opportunity to improve them.

So Cisco is - - does a great job and they're a good company to use as a comparison.

So obviously we do think there are a lot of opportunities.

Bob, when you look at the opportunities for customized versus your other different segments, what's the hurdle rate in terms of saying: yes we're willing to take this business even though we know it's lower margin?

What's the return on capital hurdle that you want to have on a pricing on the customer to be able to take them in the different segments?

Forrest, we don't comment on return on capital between the relative segments.

However, our customized business is our best return on capital business.

Part of that is clouded by the fact that when we acquire companies within, mostly been in the broadline segment, you've got all that goodwill that's dragging from our return on capital standpoint.

When we look at adding chain business, because there's a lot of chain business within broadline as well, it really varies based on the facility that we're putting it in, what the capacity utilization is, and what the relative trade-offs are between those and street business opportunities are.

As Bob had mentioned, this year we were fairly opportunistic and took a fair amount of multi-unit business that we rolled out in the fourth quarter.

Which didn't help our operating margins but we think it made sense based upon where that business was going in and what facilities that was going into.

Well, I would just --

But we do have hurdle rates that we do look at and that we will not bid business at less than certain hurdle rates.

I would submit to you all that the street is very focused on your operating margins and profitability.

At least we here are looking at it as one of your biggest opportunities.

As you said, you have been focused on acquisitions, have not focused on driving those margins.

And if there are those programs and incentives and you are driving for goals, any visibility you can give us as to where you think you can get those things in the next couple of years would be very helpful.

I didn't hear it on the call before this.

I didn't year it as one of your major points that you are focusing.

And I apologize, I had assumed that it wasn't being focused on.

If you all and the Board are focused on that, that would be great, and any visibility you can give us would be helpful.

Well, I think specifically this year what we've said is that operating margins in broadline we expect to be up moderately in the first part of the year until we lap this chain business.

And then towards the end of the year we expect it to accelerate probably to the low double digits.

And then in customized, we do expect it actually down because all the capacity we're adding.

But going forward longer term, our goal in broadline is to enhance our margins 20, 25 basis points a year.

And to enhance our operating margins in customized by about five basis points or better a year.

So, we have said that consistently, Forrest.

And that continues to be our goal and we are working diligently to put systems and things in place to make that happen.

So I - - anyway.

Can you break that out again one more time for me, it's five basis points on which part?

In our customized business.

And about 20, 25 basis points in our broadline business.

And can you tell me, Bob, are incentives in place, management-wise to get folks focused on bringing margins up?

Are people aligned with these goals?

Yes.

Absolutely.

Do you want to expand on that or - - ?

Well, we're trying to limit the number of questions, so I'm trying to answer briefly.

That's fine, I'll talk to you guys off-line.

I appreciate the time.

You bet.

But yes they are.

And we have and all of our senior management and operating Company presidents, you know, we have operating margins as one of the significant goals, along with overall operating profit growth.

The concerns if you just do it on operating profit, then the tendency is just to focus on maybe growing chain quicker than street.

So there's a number of ways that we tweak that and manage that in our bonus programs to encourage focus on operating margin improvement.

Okay, I'll follow-up with you guys off-line.

Thank you very much.

Thank you, our next question is coming from Todd Wakefield of the Boston Company.

Please proceed with your again.

Hi, I was hoping you can quantify the credit costs associated with the audit investigation?

Yes, if you look at our sequential corporate costs, as we lay out in our segment disclosures, substantially all of that increase is related to that investigation.

Okay.

So sequentially - - so I have it right 6.6 million?

Yes, we were roughly running at about a $6.5, $6.6 million rate.

So for the rest of the year, should it revert back to the Q4 rate?

We haven't given guidance, I would say it will be close to that, maybe a little bit higher than that as we kind of continue to implement some of our programs that we have in place this year.

So we had commented on the fact that we do expect corporate costs to not decrease a whole lot versus the prior period, even with the sale of Fresh.

So it will be at about where it was in the prior year from a run rate perspective.

Okay.

Thank you.

Thank you.

Our next question is coming from Dana Walker of Kalmar Investments .

Please proceed with your questions.

Thank you, good morning.

Could you comment on the operating expense progress that you talked about in Q1?

How much would you attribute to the customer mix and how much would you attribute to traction on some of these initiatives?

You know, that's a really good question, and that's a question we've tried to get to the bottom of.

And it just extremely difficult to break that out.

They kind of go land in hand.

So I wish, Dana, that I could give you a little more specific flavor on that, but it's just very difficult to separate those two.

But we do know that we are making progress.

There's no question.

When you look at some of the companies that did not pick up any new chain business that had our warehouse managers, we saw some nice improvements there.

Well, if you were to think qualitatively about magnitude and, let's just say magnitude of the progress that you would be making on operating expense as you implement some of these initiatives, when would you expect, assuming that we have the chain matter in part confusing the comparison, when would you expect to not be confused and very evident?

When we start lapping the chain business, which will be latter part of this year, late third quarter, so fourth quarter specifically.

But are there things that are truly independent of that chain lapping that are going on at the operating expense level that would be quite visible?

Yes, we're - - there's I would say a few million dollars that we've been able to identify that are results of our initiatives.

Specifically, we've actually gone in and done some analyses just to make sure the programs we're putting in place are saving us money.

So we know there's a few million dollars there.

One final thought.

Could you perhaps better edify us about the steps or the absence of further steps that you're taking on the the proprietary brands front?

Is this pause that you talked about, is that something that's an studied and conceived some while back or maybe you could share some additional thoughts there?

Well, what we've done really is to go back to the kind of the whole concept of category management and looking at the whole categories and - - anyway, the bottom line is, it was something that we probably started looking at hard about six months ago, pulling data on.

Looking at the profitability, the pricing, analyzing how we're differentiating ourselves.

So, I would say it's probably going on for about six months and we are making good progress on that area.

But as a result that have, we are kind of revamping some of our programs a little bit.

But it really falls into the whole area of category management as well.

So --

And when we slow down some of the rollout of any kind of new brands we refocus our efforts in our existing brands and making sure we're driving profitability and the differentiation we talked about.

Is this in part prompted by broadline talent that you've been bringing on board that says: hey, wait a minute, this is with a we were doing elsewhere, and this is what you're doing here and this is what I think we could be doing better if we were to reconceive?

I don't think so.

I think it's more looking at our statistics and our numbers digging into these areas and kind of finding out really the benefits of them.

So and then asking ourselves kind of how do we move forward with them.

So we're excited about the opportunity, we think there continues to be significant opportunity there.

It's just how do we best take advantage of that.

Thank you.

Thank you.

Thank you.

At this time, I would like to turn the floor back over for any additional or closing comments.

In closing, I would like to thank you for your participation and your questions today.

And for your interest in our Company.

We're pleased with our strong start to the year and we'll continue to be diligent in our efforts to provide a high level of service to our customers through operational excellence.

We remain focused on executing our core strategy to deliver strong sales and earnings growth and improvement in our operating margins and internal capital to our valued shareholders.

So we thank you and have a great day.

Ladies and gentlemen, we thank you for your participation.

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