Performance Food Group Co (PFGC) 2017 Q1 法說會逐字稿

Good afternoon, and welcome to the Performance Food Group first-quarter FY17 earnings conference call. Today's call is scheduled to last about one hour, including remarks by PFG's Management, and the question-and-answer session. I would now like to turn the call over to Michael Neese, Vice President Investor Relations for PFG. Please go ahead, sir.

Thank you, Stephanie. Good evening, and thank you for joining us. We are here this evening with George Holm, Performance Food Group's CEO, and Tom Ondrof, PFG's Chief Financial Officer.

During our call this evening, unless otherwise stated, we are comparing first-quarter FY17 results versus the same period in FY16. We issued a press release regarding the results after the close of the market today. You can find our earnings release on the Investor Relations section on our website at pfgc.com.

Our remarks in the earnings release contain forward-looking and cautionary statements, and projections of future results. Please review the forward-looking statement section in today's earnings release and in our SEC filings for various factors that could cause actual results to differ materially from forward-looking projections.

On today's call, we may reference certain non-GAAP financial measures. Descriptions of these non-GAAP financial measures, and reconciliations to the most closely comparable financial measures calculated in accordance with GAAP, are included in today's earnings release and in our presentation slides.

Now, let's turn the call over to George.

Thanks, Michael. Good evening, everyone, and thank you for joining us today. I am pleased to announce PFG's results for the first quarter of FY17. Our underlying business performed well in the quarter; however, we experienced many challenges during the first quarter.

We grew our total sales cases by 6.5% with incremental market share gain; this is at the high end of our 4% to 7% guidance. The 6.5% total case growth is one of our best growth quarters since FY15, despite our national account business softening during the quarter.

Our Performance Foodservice segment reported strong independent case growth of 8% and double-digit independent Performance Brands case growth, all of which were organic. We made planned strategic growth investments in PFG Customized and Vistar in the first quarter, and these investments will continue through our fiscal second quarter, as we enhance our diverse business model to further provide us significant growth opportunities in FY17 and over the next several years.

We experienced higher-than-expected new business transition costs and corporate expenses during the quarter, leading to adjusted EBITDA coming in below last year and below our expectations. Tom will discuss this in greater detail in his remarks.

We remain focused on improving sales, productivity, and increasing gross profits. We continue to expect to grow our overall cases in the 4% to 7% range in FY17, and grow our independent cases in the 6% to 10% range. We are focused on managing our corporate expenses, but at the same time, we will continue to add talented sales associates as we enhance and strengthen our foundation for growth. In addition, our pipeline for future M&A continues to be attractive.

Before we get into the financial details, I would like to continue our practice of highlighting one of our associates, this time for her service to our country. As our nation observes Veterans' Day this Friday, I would like to recognize Andrea Baldino, a military veteran and Field Accounting Manager with our Vistar division. Andrea served in the US Army for nearly 2.5 years, primarily as a diesel mechanic at Fort Hood. After finishing her bachelor's degree from the University of Cincinnati, Andrea joined our Vistar location in Arlington, Texas, nearly two years ago. We are proud to have Andrea on our team, and want to thank her and all our veterans for their military service.

Tom will go into the detail of our financial results, but I would like to discuss a couple key highlights for the quarter and provide updates on Customized's and Vistar's strategic growth investments we outlined for you last quarter. Our case growth of 6.5% in the first quarter continued to far exceed forecasted real industry case growth. Case volume growth reflected new and expanded business with independent customers in the Performance Foodservice segment and broad-based growth in Vistar's sales channels. Net sales for the FY16 first quarter increased 3%; net sales were driven by case growth in Performance Foodservice, particularly in the independent channel and sales growth in Vistar.

Overall food cost deflation was approximately [1.5%] in the FY17 first quarter. We continued to experience deflation in meat and eggs, and to a lesser degree, in dairy.

Gross profit increased 6.3% compared to the prior year, and was driven by the growth in cases sold. Gross margin as a percentage of net sales was up 40 basis points in the quarter.

Now, let us turn to the performance in our three segments. Performance Foodservice net sales for the first quarter increased 2.9%. Case growth was fueled by securing new independent customers and further penetrating existent independent customers. Independent sales as a percentage of total segment sales were up approximately 130 basis points to 45.2%.

EBITDA for Performance Foodservice was $73.8 million, up 4.7%. The EBITDA increase was led by strong case growth and a 6.6% increase in gross profit. This growth was against a strong EBITDA growth of 27% in the first quarter of FY16.

PFG Customized net sales for the quarter decreased 6.5% to $867.3 million. The decrease was driven by the planned exits of certain customers to free up capacity for the addition of new business with Red Lobster, as well as lower case sales to some customers in the casual dining segment.

EBITDA for PFG Customized decreased 46.6% to $3.9 million. This was a decrease in excess of what we expected, as two of our chains that we were exiting left early. We kept the warehouse and delivery employees associated with that business until the onboarding of Red Lobster.

We experienced a decrease of 7% in gross profit and an increase in operating expenses. Increases in personnel expenses, costs associated with upgrading a portion of the segment's fleet, and increases in insurance expense impacted Customized EBITDA.

As we previously mentioned, PFG Customized had planned exits of certain customers to free up capacity for the addition of new business with Red Lobster, to which we began making shipments in some geographies back in August. The planned exit of customers affected Customized first-quarter financial results, but we expect to benefit from this transition in the back half of FY17.

In the first quarter of FY17, we began providing distribution solutions to a portion of Red Lobster's restaurants. As of this week, we are now delivering to all 678 domestic restaurants. This week, we began delivering the last group of Red Lobsters, which was 118 restaurants from our Texas distribution center. The rollouts have gone well, and we want to thank the dedicated associates from Red Lobster and PFG Customized.

With the planned customer exits, we expect Red Lobster will generate new revenues of approximately $500 million. We expect to no longer have approximately $100 million in sales annually based on previously communicated customer closures. So, on a net basis, including the addition of Red Lobster and customer closures, we expect to generate approximately $400 million in incremental annualized net sales this fiscal year, which is in line with what we communicated last quarter.

Turning to Vistar, net sales increased 17.3%, driven by strong broad-based case growth across Vistar's channels and by recent acquisitions. EBITDA for Vistar increased 0.9%; although gross profit dollars growth was 14.4% for the first quarter, operating expense dollar growth increased 19.5%. The operating expense increase was driven by investments associated with expansion of geographies served in the dollar store channel and the opening of new facilities.

As we have mentioned previously, Vistar's results will reflect some investment for future growth. First, in the latter part of FY16 fourth quarter, Vistar began service into new geographies in the dollar store channel, which required additional expense with another distribution center to service the customers in metro New York. Productivity improved as we progressed throughout the quarter, and has continued to improve in the month of October. The additional expense will be with Vistar for the next several quarters until the volume can be efficiently integrated into a new distribution center, which will combine two centers to one.

The second investment for Vistar is the new prototype distribution center in the metro Memphis area for handling our pick-and-pack volume more efficiently. Although we have not integrated the entire automated process, the new distribution center is now shipping product, and productivity is progressing each month. We will continue with two Memphis pick-and-pack distribution centers until we have fully integrated the facilities. Once the project is fully operational, it will drive future productivity and profitability, as we consolidate the two distribution centers to one.

PFS and Vistar's growth plans are in place to deliver growth for several years. Customized is now growing their sales, as they have on-boarded all of the Red Lobsters. We have a strong pipeline of potential acquisition candidates, and we will remain disciplined in our approach to acquiring companies. We are committed to growing value for our shareholders over the long term.

I would like to introduce PFG's new CFO, Tom Ondrof. Tom joins PFG following a 24-year career with Compass Group North America. During his tenure at Compass, he held several leadership roles in financial planning as Controller, CFO, and Chief Strategy Officer. We are very excited to have Tom join our PFG family, and I would like to turn the call over to Tom.

Thank you, George. It is great to be a part of the PFG team, and I look forward to contributing to the continued growth and success of the Company. I will briefly go through our detailed first-quarter financial results, discuss our cash flow and balance sheet, and wrap up with our FY17 outlook.

As George mentioned, case volume growth was very strong at 6.5%, while net sales for the quarter increased 3% over prior year to $4 billion. The difference between the sales and case growth rate was primarily a result of ongoing deflation. It was also impacted by case pack size changes from some of our suppliers.

Gross profit dollars also showed solid improvement, increasing 6.3% in the quarter compared to prior year. The increase was the result of growth in cases, as well as selling an improved mix of products and customer channels, specifically through the independent channel.

Operating expenses increased 9.7% to just under $480 million during the first quarter versus the prior-year period. While we planned for our operating expenses to increase in the quarter due to the strategic growth investments in Vistar and Customized, significant additions in our sales force, and incremental expenses with being a public company, we were further impacted by higher-than-expected new business transition costs and corporate expenses during the period.

Let me take a moment to expand on each of those, starting with new business transition costs. The rollout of sizable new customer accounts at Customized and Vistar was in full swing during the period. In order to ensure we provided a seamless transition, with complete product availability and outstanding customer service at each location, we opted to incur higher-than-planned labor, facility, and transportation costs. Along with the start-up cost to bring our new automated retail center online, these short-term transition costs are expected to normalize in the second half of the year, and provide the platform for significant top- and bottom-line growth over the next several years.

Additionally, corporate expenses were higher than planned during the quarter compared to prior year as a result of incremental increases in employee medical claims, legal expenses and settlements, insurance expense related primarily to workers' comp, and stock-based compensation expense. Our adjusted EBITDA of $76 million was down 5.1% from prior year. Net income was flat at $12.2 million in the quarter, as operating profit, which was down $12.4 million, was offset by an $8.1 million decrease in interest expense, and a $4.3 million decrease in income taxes and other expenses.

For the quarter, the income tax rate decreased 390 basis points to 37.4%. The majority of the decrease was a result of an increase in permanent deductions related to the adoption of a new accounting standard. Diluted earnings per share decreased 14.3% in the first quarter of FY17 over the prior-year period to $0.12, and adjusted diluted EPS decreased 4.8% in the first quarter over the prior-year period to $0.20 per share.

Turning to cash flow, we absorbed $75.2 million in cash from operating activities, an increase of $49.3 million versus the prior year. If you will recall, the prior year included a $25 million break-up fee payment received related to the terminated agreement to acquire 11 US Foods facilities from Sysco and US Foods. The remaining increase in working capital was due primarily to the Company's continued sales growth, and investments related to the rollout of new business in the Customized and Vistar segments.

Turning to investing activities, the Company spent nearly $35 million in capital expenditures in the first quarter, or 0.9% of net sales, versus $17.7 million in the prior year, or 0.4% of sales. The Company also paid just under $15 million for a tuck-in acquisition in our Vistar segment. While our net debt at the end of the first quarter increased $123 million during the quarter to $1.3 billion, we remain disciplined in our uses of cash and leverage, as evidenced by our net debt to adjusted EBITDA improving by nearly 1 turn compared to the end of the quarter last year.

Based on the impact of increased new business transition costs and higher corporate expenses during the first quarter of 2017, we now expect full-year adjusted EBITDA growth to be in the 7% to 9% range on a 52-week to 52-week basis, and between 5% to 7% on a 52-week to 53-week basis, versus a comparable 53-week FY16 adjusted EBITDA of $366.6 million. The 53rd week fell in the fourth quarter of FY16.

Also, due to the first-quarter results and the remaining impact of new business transaction costs and other strategic investments in the second fiscal quarter, the Company now expects adjusted EBITDA in the first-half FY17 to be down slightly versus the prior year. The second half of FY17 adjusted EBITDA growth is expected to be in the mid- to high-teens versus the second half of FY16, which excludes the extra week.

Overall, we were pleased to deliver 6.5% case growth and 6.3% gross profit growth in the quarter. And as we clear the sizable new business transition efforts over the next few months, we remain confident in our ability to manage controllable operating expenses, and continue to drive both sales and gross profit as we progress through 2017.

With that, operator, George and I will now be happy to take questions.

(Operator Instructions)

Vincent Sinisi, Morgan Stanley.

Hello, good evening, guys. Thanks very much for taking my question.

I wanted to just ask, regarding the investments around Customized and Vistar, it sounds like maybe a bit higher than expected, but so far things are going, at least, relatively well. Can you just give us a little more color around the different steps, and how we should think of the investment path as we go forward? I think you mentioned for at least one of the items normalize as we get into the second half. But if you could give us a little more color around the basics of the process and how you see that as we progress this year? That would be great.

Yes. I will start with Customized, George, and then I will move into the Vistar. With Customized, we thought we had things planned out fairly well as to when we would exit business and when the new business would come in, and we had a couple that changed, that did leave early, which was fine. We still decided that we are obviously not going to lay off employees for a short period of time, and then try to bring them back and risk losing them.

So we held onto all of those employees with less business than we expected, so that we could on-board the new business properly. It has gone very well; we have not had any issues. Great help from our people and from theirs, and we now have all that business in place starting this week.

So we expect to have some impact in November, obviously, not anywhere near what we had in the first quarter. And then as we go into December forward, then we will be in very good shape there with good growth.

We will have less customers, actually less concepts, less SKUs. We will have more scale per concept; obviously, higher dollars sales, higher gross profit dollars, fewer stops and bigger drops. So that situation is now behind us, and we feel very good there.

When you get to Vistar, not quite as simple. The additional distribution center that we put in New York, until we find the right facility to put the two together and it is not something we want to rush and make a mistake. We need some significant excess capacity there for some things that we have in the future.

So that is going to continue; it does get better each month. I think we will be able to give much better guidance coming up. Our productivity has gotten close to what we are in our other metro New York center, but we lose a lot in density because we are only doing one piece of business out of that distribution center.

Then if you move to -- and by the way, we also brought that into our Connecticut, our mid-Atlantic and the Carolinas division center. With a little bit of pain there, too, but that is all behind us and those centers are back to normal productivity and have the additional business.

If you move to our Retail Automation Facility, what we call Retail Central, that is in Memphis. Once again, getting better all of the time; we are adding business into there each week. We are taking it slow, and we are taking it carefully, but once again, better productivity all the time.

We are at a point now, we are more productive in that automated facility than we are in our existing pick and pack facilities, which are entirely manual. So good news there; it is just going to take us a little time to get that consolidated from two down to one.

Okay, that is very helpful, George. Thank you. And just a quick follow-up, if I may. Your two main competitors, of course, have reported this week, as well. And I think there is just a little bit of confusion on what you are seeing, either in results, and or commentaries by some of the Management in terms of the overall health of the restaurant, in particular, industry. So if you guys could just give us your take, by customer segment within that, that would be great.

Yes, this will just be, obviously, my take and what we see. We are in a little different world than them; I think they both had really good quarters. And we had better growth, but certainly not as good of quarters as they had.

If you look at our Performance Food Service business, we were -- in the month of August, we were right at 9%, the same independent growth that we had run the previous quarter. As soon as we hit the -- what do you call those? Come on, help me out here.

The convention.

Yes, we hit the political conventions, we saw a little softening. We were mid-7%s for case growth in the month of August, a little softening during the Olympics, as well. As we got into September, we perked back up again, a little under 8%, and then in the last weeks, we have been actually better again.

So whatever that means, I am not sure. I think it means that independent restaurant continues to do well, and we are doing well in that area.

And Performance Food Service, our national account business, did weaken throughout the quarter, and that has continued into October. We go to our Customized business, and we saw continued weakness in casual dining. That has continued into the month of October.

We do not expect it to continue from here, fortunately, we will still have sales growth because of our additional new business. But we think a lot of it has to do with the election; maybe this disconnect between the price of food at home and the price of food eaten out.

Our Vistar business has been extremely strong. Every channel that we are in, we are seeing sales growth, and we are actually growing that business organically better than we have grown that business, I would probably say, in its history, since at least -- since we have owned it, which was 2002. So three different worlds there, but that is what we see today.

That is incredibly helpful. Thank you, George, and Tom, best of luck and welcome aboard.

Thank you.

John Heinbockel, Guggenheim Securities.

George, I was going to ask when you look at Vistar, it looks like there was a sequential pickup right at the [back out] the extra week from the fourth quarter. Is that primarily organic? And what channels, I know it is broad-based, but what channels would drive the bulk of that? Is there one or two that stand out?

The bulk of it is organic; our acquisition was not real big. As far as the channels that are driving it, one is not necessarily a channel, but we call it Good To Go, and it is like protein bars and energy bars and energy drinks and things like that, where we have put a great focus on. That would be the fastest growing part of our business, even though it goes across several different channels.

Our business and hospitality has grown well as more people put pantries into their mid-scale hotels, is where that has been good. Theater business has been okay.

Our retail business, in spite of retail being soft, but our retail, what we call our big box business has been very strong. And then vending has been an industry that has slid for a long time, and for the first time, we are seeing -- we have grown each year, but it has just been through adding share and it has been fairly small growth.

We are seeing good growth there today, and we think it has a lot to do with micro markets. A lot to do with free vend, which is something that started on the West Coast, and is really spreading. So that has been good for us, but really, it is just across every business that they are in, we are seeing good growth and double digit in some of the channels.

Okay. And then, secondly, when I look at the Performance Food Service segment, and I know that you are up against a big gain one year ago. Mid-single-digit, probably one of your slower rates of growth in the past couple of years. Was there any investment in that business?

We invested -- (multiple speakers). Yes, we invested fairly heavily in sales people. We have three large additions that we are doing to facilities, but that would not have impacted us to any real degree. What it was, really, is we have been building that business, we have been building people and we have been adding a lot of drivers, we have been adding salespeople. We, actually, are at the highest level of increase from a percentage standpoint in salespeople that we have been in many years.

What really impacted us there the are the most, I would say, as far as not leveraging as well as we would like to have been, would just be the softness that we experienced in national accounts. If you think about our Performance Food Service business, and you compare that to our competitors, we do so little in healthcare and contract feeding and lodging and the restaurant industry, especially the chain world, was lower, at least that is what we read everywhere. And that is what our business is when you get outside of our independent restaurant business, so I think that probably had something to do with it.

We are very confident moving forward in our Performance Food Service business that we will do a much better job of leveraging the growth that we have the rest of the year. And we will be up against slightly softer comps.

Okay, thank you.

Kelly Bania, BMO Capital.

Hello, good evening. Thanks for taking my questions. I was just curious, what was the dollar amount of incremental transition costs that you experienced in Q1 above your expectation, and how should we think about that in Q2? And I guess on top of that, is that something that you expect to cycle and not incur next year when we get to Q1 and Q2?

Kelly, it is Tom. Just to answer the second question first. Yes, unless there are additional investment opportunities that we come across later in the year, but none of those are right in front of us at the moment.

I think the best way to look at the transition cost is the operating expenses are up about 970 basis points. About 250 of those are what we would say, would be -- were higher than expected, 250 basis points in two buckets. The corporate costs I talked about, medical, workers comp, were about 60% of that, and the other 40% were the transition costs. So of the 250 basis points, 60% of it was corporate costs higher-than-expected, and 40% transition costs higher-than-expected.

Yes, this is George. I think I will add a couple of comments to that. We operate with quite low expense ratios, and we are used to leveraging growth when we have growth, but these were somewhat unusual circumstances. We will get our arms around each one of these, and I think, put it to you this way, what I tell our people today is let us not let this quarter bother us very much. We have a lot of great things going on, but do not be patting yourself on the back when we get to this time next year, either, because we will have some easy comparisons.

We do not see anything here in the near future that would be any big investment. We have plenty to get on track right now, and we have some good built-in growth, so that is our biggest emphasis right now is to get back to leveraging this growth that we have.

Okay, that is very helpful. Your guidance for the second half is now for -- I think you said mid- to high-teens EBITDA growth, and I think it was mid- to single-digit to low double-digit prior. I guess just the delta there, are you expecting these investments to drive some incremental EBITDA in the second half, or what is the difference in the guidance there in the second half?

Yes, obviously, number one is we leverage this growth that we have. That is the number one as far as importance going. We have some additional business that is coming in just after the first of the year, which will also help us. And I think another thing to remember, some of this investment started in May of last year; it was very heavy in June. So we are going to have some fairly easy comparisons as we get toward the end of the fiscal year, so that is part of it, as well.

Okay, thank you.

Edward Kelly, Credit Suisse.

Hello, good afternoon, guys. Welcome, Tom, by the way. Could I just start with a follow-up on the transition cost.

George, it sounds to me like taking a step back and listening to you guys, that the issue on this side is more timing oriented than I guess execution oriented, and I just wanted your thoughts as to -- around whether that is fair or not. Why is it harder to forecast some of this stuff? And as it relates to all of this, is there anything going on here that would impact the customer, and what the customer sees from you?

No, I think that is part of what caused some additional expense is wanted to make sure that the customer did not. I would have to tell you that our initial performance in the Dollar segment in metro New York was not something we are proud of, but we got that handled fairly quickly. Other than that, and I would have to say other than that, I do not think our customers have seen any difference in us.

All right, and also, just a follow-up on the guidance. I was going to ask the question in very straightforward way, and the question really is, is it conservative enough?

The reason that I ask that is because obviously, you were just asked about the back half, and the guidance is now higher than what it was before. But could you just give us a little bit more color to give some comfort on what has changed today versus the end of last year that gives you more confidence in the back half of the year?

Well, like I said, we have some additional business coming on. We typically, through the year, we build payroll and we do not see that really happening; we have already made those investments early in the year.

The only thing, I would say, where it could be -- where we may be conservative or not conservative, I guess I should put it, is that we really do not expect to see the national account business as -- I guess I would use the term weak as it has been in the last couple months. We are through the political stage here, we also are through the Olympics and some of the things that you seem to put some slowness into that business, and we just do not believe that people's eating habits changed that quickly.

The other thing that was impactful was that people did not promote; some of these larger chains did not promote that much through that period of time. TV advertising was very expensive to get because of the political season. Radio time was very expensive to get. So there was not the advertising to support heavy promotional activity. It is just a combination of many things, and we just feel we are not going to experience that degree of softness.

Okay, and last question for you is related to M&A. George, you mentioned an attractive pipeline. Can you just remind us of the types of opportunities that you are looking for? Does the current -- the challenges of the business currently, in the first half of this year, impact, in any way, the way you would think about timing of all of this, given that you have a lot going on as it stands?

No, not at all. We do not really announce acquisitions that are not material, but we have done two in the last couple of weeks. They are both center of the plate companies, which is something we want to build on; very important. Obviously, Broadline Food Service Distributors, which we have a pipeline there.

And then Vistar, we are always looking at the right opportunities and we have confidence that we will have more of those. From an operating standpoint right now, the issues that we are dealing with are so isolated, particularly with Customized back on track, we have no desire to make any acquisitions in that business. I think that it really will not have any impact at all.

Okay. Thanks, guys.

Karen Short, Barclays.

Hello, thanks for taking my question. Just a couple of follow-ups, in general. First, starting with Vistar, I am wondering why there was a disconnect on gross profit dollar growth versus sales growth, given that there was about a 300 basis point spread on that? So that is my first question, and then I had a couple of others.

Okay, on the difference between sales growth and gross profit dollar growth, we had a fairly good increase in sales in that dollar channel, and a big customer involved with that has increased their SKU base. In other words, they are offering a wider variety of product. They do not operate with storage; this stuff is delivered and goes to the shelf.

So they are using smaller pack sizes, and so it almost makes it appear like it is kind of deflation, if that is how you are looking at it, and that is not the case. It is just that our average case price in our Vistar channel was affected by that.

Okay, that makes sense. Just to understand OpEx increase, and I feel like you have been asked this, but I guess I still am not clear on the answer. But I feel like in 4Q, you indicated that you felt that you had kind of resolved or smoothed out the OpEx lumpiness post-fourth quarter for the new business. I guess I am wondering what kind of caught you by surprise?

Well, the things that caught us by surprise were it took us longer to get the automated to compact the facility up and going. We had problems at one of the stations; it took us a while to resolve that. We found that we did not have the capacity in New York, and did not realize that it would take us -- it probably was going to take us a while to find a distribution center there.

Like I said, these things are improving month-to-month, so we are still dealing with that. And then we had Customized planned out pretty well, and then we had business that left earlier than expected. So it left us with more employees, and a reduced amount of gross profit dollars during that period of time, which had a pretty significant impact on OpEx.

Yes, the Customized made sense on the OpEx, I was kind of wondering on Vistar. But since you bring up Customized, just to clarify, so the top line miss, then, was entirely a function of the planned exits happening earlier than expected? Meaning Red Lobster is contributing at the run rate you expected? I know you gave us a pretty detailed -- (multiple speakers).

Yes, that is correct. But Karen, we did have a softer sales environment than we expected with our existing customer base, and we did talk about this on the last call. It had not happened yet, but we had one concept that closed 98 stores and we had another concept that closed 27 stores. So those were rather unexpected for us, as well.

Okay. Last question on deflation. When -- a retailer earlier last week mentioned that salmon, in particular, had turned inflationary, but I am wondering if you could give some color on -- given that your exposure to seafood obviously is higher now, but what your deflation or inflation outlook might be for FY17?

Yes, we have seen the deflation pretty much go away in seafood right now. The shrimp pricing has come back, and as you mentioned, with salmon, those are the two really big items.

The areas that we are still seeing fairly significant deflation are in beef and then in cheese, and of course, eggs. But that is somewhat deflation, but it is more about them being so high-priced last year.

What are your thoughts for the year for deflation?

We can only go with what the supposed experts tell us. It appears as if beef is going to stay down in price for quite a while, just because of the availability, unless something would happen in the export market. Cheese was really going down last year, so from now until the end of the calendar year last year, it softened, so we do not expect to see a big reduction in -- we do not expect to see as much deflation as we have had over the last year in cheese coming up from now until the end of the year and probably not into next fiscal year, should we see any deflation, either.

Our customer mix is -- I mean, our item mix is not the same for every company in this business, but I think ours was 1.5%, I think we had for deflation, so it is moderated for us some.

So maybe flat is possible for the year?

I do not think with beef staying deflated that it would be flat, but I perceive that it should continue to go down a little bit, and heavily impacted by cheese for us.

Okay, thanks very much.

All right.

Bryan Hunt, Wells Fargo.

Good afternoon, George, and welcome aboard, Tom.

Thank you.

Just to touch on two topics that have been touched on already. One, when you look at acquisitions, and I know you are always looking and you have done a couple, how would you describe the pipeline? Is it more robust than it was a year ago, or less? Is there a way you can give it some quantification?

We have not been as inquisitive in the last few years, but we would call it much more robust than it was then. And we feel better probably today, I would say, than we have ever felt about the possibilities that we have in the acquisition area.

It is that because just numerically the number of companies that are for sale, or is it because of the multiples are more reasonable? Are (multiple speakers).

No, I would say it is more so just people who are willing to sell today. Just a bigger pool.

And when I think about acquisitions, I think you all touched on this in the past, but where do you feel comfortable running the leverage up to on balance sheet?

Well, we are going to be opportunistic, and it just depends on the quality of what is out there. But for us to lever back up -- we have been at size 5.7 before; we certainly do not want to do that, but we could easily lever up a couple more returns if the right acquisition was available.

Great. And then my last question is when you look at all of the projects you have, and it seems like you have some duplicative facilities you are trying to exit. Automation that you are getting for that project, as well. What is your outlook for CapEx? Last time we talked, it was $140 million to $160 million. Has that changed at all in terms of tempo?

Our budget this year is for $150 million, so right in the middle of what you just described as the range. Once again there, we are going to be opportunistic with it. We have some great additions that we are doing now in our Performance Food Service, and that is certainly where we most want to spend our money.

The opportunity was great in Vistar, to do this new facility. We did a large one, we have a very robust pick and pack business. We have a B to C business, where we do fulfillment that we feel can be a big category for us, so that is why we did that.

And then we have a lot of OpEx that we can take out in Vistar, just by going to one facility in three markets where we have two. So those, obviously, will be something that we will look to do when the right facilities are available.

My last question is when you look at the customized division, and you pull out the locations that were closed, and the roll up of Red Lobster. Is there any way you can gauge what same-store case volume was in Q1, and do you feel like it has actually troughed now that you had seen October numbers?

I say this all the time, we are really careful that we do not talk about any of our customers, that is their job. But in its entirety, definitely soft at the same-store sales level.

And I think they are all working hard at their business, and they are improving their business. And we will find out coming up how much of it had to do with the political season and the Olympics, and just a soft environment. And we just feel like we are going to see some sequential improvement in that business.

Very good. I appreciate your time. Thanks, George.

Ajay Jain, Pivotol Research.

Yes, hello. My question was mainly guidance related, and about your conviction about the back half of the year. I think you already got a couple of questions along those lines, so I wanted to ask you about the outlook for Q2, specifically. And I wanted to ask if you are expecting any stabilization in EBITDA trends, or are you looking for a similar decline to last quarter?

At this point, we would expect it to be better than the first quarter. We are not projecting to be ahead of the previous year for that 26-week period of time.

It is a little different quarter, too, from the standpoint that holidays affect our business a good bit. Last year, we did not have a holiday in November; this year, we will. Last year, we had two holidays, Thanksgiving and Christmas, in December.

We will have -- I mean, and this year, we will have two holidays in December, but then in January last year, we had the New Year's holiday fell in January from a fiscal standpoint. Last year, it fell in December, this year it will fall -- last year, it fell in January, and this year it will fall in December, so we are going to have an easier comparison as we get into the third quarter.

Okay, I guess the commentary on the first half of the year gives a lot of room for interpretation for Q2, so I will ask it slightly differently. Do you expect directionally EBITDA is going to be up or down in the second quarter?

Slightly down.

Okay, thank you.

Zack Fadem, Wells Fargo.

Hello, guys. Just to clarify, can you help me bridge the gap to get to your 3% top-line growth number? If organic volume was 5.3% and deflation was down 1.5%, can you help me just size the impact of the pack-size mix change? And then what was the sales impact of M&A to get to that 3%?

The M&A was very marginal; it was just one small acquisition in Vistar. I have to do the math. Do you have an idea on that, Tom?

I do not. We can follow back up with you.

Okay, that is fine. We can do this offline. And quickly to follow-up --

Primarily, yes, we will get that number to you. But in our Vistar business, we did grow our cases a good bit more than we grew our sales, so that is where it is going to be. It is not going to --

Yes, that is what I am trying to get at, is just the specific impact to bridge that gap.

Just moving on, I want to follow-up on an earlier comment. George, with respect to your overall business mix, you are under-indexed in some of the larger institutional verticals like healthcare, hospitality, et cetera. I am curious how you think about the opportunity to expand there. Is it a matter of national scale, or are there any particular hurdles that prevent you from being more involved in those channels over time?

No, we do some business in those channels where we have the kind of scale to do that and kind of product line to be in healthcare. Not having national scale, we are certainly not going to be able to do a national program with those type of channels.

But for us, we are doing a significant job growing our independent business, and we would rather focus on that today. I think we can only do so many things at one time, and that is the growth that is most important to us.

And then to properly leverage our business, we want some growth in our national account channel, and that, we were not able to get in this first quarter. We should have a little bit of it in the second quarter, and it will be better in the back half of the year. We have several things that are just better in the back half of the year.

Got it. Thanks a lot, George.

You bet.

(Operator Instructions)

We do have a follow up from Kelly Bania, BMO Capital.

Hello. Thanks for squeezing me in. I was wondering if you could talk a little bit about gross margin, and the impact, if any, that Red Lobster had on gross margin in the quarter? And how you think about gross margin for the next couple of quarters?

Yes, well, our gross margin has improved in Performance Food Service. It is fairly flat in Vistar. Our gross profits per case in Customized is slightly up; our gross profit as a percent of sales is about flat.

As far as the impact that Red Lobster would have, I think a lot of that has to do with how their mix of business settles in. As they have some very, very expensive product, and we do not have a good enough feel for that yet, as to what that will do from a margin standpoint.

We do those programs where we do in great detail what our cost is to move the case of product, and those are fee-based, not margin-based, so we really do not look at it that close. That is something that we will make sure that as we get through this quarter, and into the next call, that we will get some real color on that.

Thank you.

There are no further questions.

Thanks, everyone.

We would like to thank everyone for their participate on today's call. We look forward to presenting at the Morgan Stanley conference next week in New York City. Thank you.

Thank you. That does conclude today's conference call. You may now disconnect.