Sysco Corporation (SYY) Earnings Call Transcript & Summary

Good morning, everyone. Thank you for joining us. My name is Chris Mandeville. I'm Jefferies' staples and retail distribution analyst. It's a pleasure to have with us this morning the folks of Sysco, led by CEO and President, Kevin Hourican; the EVP and CFO, Joel Grade; accompanied by Neil Russell; as well as Rachel Lee from corporate affairs and investor relations team. Thank you, folks, for joining us this morning. Really appreciate the time and helping us better to understand how things are going thus far or more recently as well as how we're looking on a longer-term basis.

Kevin, I suppose, I was hoping maybe we could just start off right from the onset here discussing some of the most recent of trends, if you will, if there's a way whereby you might be able to update us on that front. We know that you guys attended a conference or competitor conference several weeks back, looked as though sales volume or case volumes were somewhere down along the lines of maybe 40%. But what's transpired over the most recent of weeks? And if there's an ability to maybe break out some color around independent versus chain, I think that would be particularly helpful.

Yes, sure, Chris. Thanks for the confidence. And we'll get started with that. It's an important topic, obviously, the business recovery and how are things going. We're really pleased with the progress of the recovery. I think our best way of describing it is we continue to see sequential week-over-week improvement and that, that sequential improvement is actually accelerating. And it's pretty straightforward as states within the United States begin to ease restrictions, people are able to go out to restaurants, and the volume is picking up nicely. And you can see in our data, the states that began easing restrictions earlier than others, our business is recovering quite quickly. Just a reminder to everybody, we have a pretty large European business in Europe. The continent was quicker to lock down, it has been much slower to open up. So the U.S. recovery is ahead of the European recovery. Canada is kind of running in line with United States. Latin America has been slightly behind Canada, and the United States been ahead of Europe. So the good news is the following, even in Europe, all of the countries within which we operate, we'll be open for business by the first week of July. France began reopening last week with patio dining. I think everybody knows that eating out on a patio in France is a part of the culture there. So it's a big part of restaurant dining, and they were really shut down during the coronavirus pandemic at its peak. There was no restaurants open for business in France. So France is now up and running in their Phase 1 of the recovery. The U.K. has been slow to recover. It will be opened by the first week of July. So that was good. And within our U.S. business to be slightly repetitive. Southern half of the United States, very strong recovery. The large population corridor of the northeast, so New York, Austin, Washington, D.C., Philadelphia, Chicago, L.A., these cities were slower to reopen than some of the other major metros. And they too now, however, are in their reopening phases, and we're beginning to see acceleration in business results. So the trough was about minus 60, as you all know, back in March. We're not going to quote our June month-to-date steps since our June year -- our year-end ends at the end of June, and we'll talk a lot more about that on August 11, our next investor call. But we're pleased with the recovery. It's a week-on-week sequential improvement that recovery curve is actually accelerating, and it's ahead of schedule versus where we had forecasted. So we had done labor planning, inventory planning, expense out to a more conservative recovery, and we're pleased that the recovery is happening faster than that. I'll pass it back to you, Chris.

Yes. Well that's great, really much -- very much happy to hear about the accelerated rate of recovery as well as for that matter, do appreciate the regional color as well. Maybe if we could hone in a little bit on just simply the customer mix domestically a little bit. I think it's important for investors to understand, especially given some of the color that came out yesterday from a competitor that you have a different customer mix. So is there a way whereby you can give us some sense of what the restaurant community is doing relative to maybe some of your noncommercial accounts?

Yes. It's a good question. [indiscernible] first. But it allows me to give a little more color into the by sector and by segment now. I'll kind of do it from hardest hit to highest or best performing. The hospitality sector is the hardest-hit sector. I think that's pretty obvious as to the why. Hotel occupancy is well below historic rates due to the lack of business travel and obviously, the residential travel. So hospitality, very hard hit. Foodservice management would be our second hardest-hit sector, which is sporting venues that aren't currently live, schools that have been shut down early, although we anticipate schools reopening here in the month of August. And then when you sector from that into the restaurant segment, yes, independent customers, that local independent-operated restaurant has been harder hit as well as fine dining, fine dining in major metropolitan markets like Manhattan, very hard hit. And when you get into the casual dining and quick-serve restaurants, you're beginning to see recovery. So I'll talk about our business trends. Our SYGMA business, which serves fast food chain, as you know, we actually had an increase last week in SYGMA. So it shows the strength of those restaurant operators that have drive-through windows, pizza, in particular, has been performing very, very well. But we do over-index in the independent restaurant sector versus others. That's a good thing for our business for the long term. It's the most profitable segment of the business. Pre-COVID was a growing segment of the business and one where we have tremendous market share still to be gained and to be had. And we're transforming our company actually to be even more effective in how we serve that sector, which I can talk about in a little bit. The good news is all of those businesses are recovering, but they're each at a different place. I think what's been written about most recently is elevated bankruptcies within that independent space. I'll just address that if it's okay. Now I know it's a question on every investor's mind. Yes, we are seeing an increased level of bad debt. Joel can talk about that a little bit. We talked about that on our Q3 call. We'll talk about it again at the end of Q4. It, too, bad debt is performing slightly better than what we had modeled, but it's elevated versus historical levels. There will be an increased level of churn in the independent space. As you know, every year, there's churn in that independent restaurant sector. There are quite a few people that leave. There are just as many that get back in. Over the long term, we anticipate that independent restaurant door count and overall volume will return to pre-COVID levels, but it will take time. It will take more time than other sectors that we are in. There will be an elevated level of bankruptcies. So we see the strong getting stronger within even the independent space that customers are still going to want to go out to eat, they're going to want to go to independent-type restaurants and select restaurants will see more share of business than they had pre-COVID. And again, I'll toss it back to you.

And actually, if I could just add one thing to that, Chris, is one other bit of color to Kevin's point about people going back to restaurants. One of the things we are seeing in some of the markets, particularly in the southern markets that have actually reopened. There's probably, again, I'll call it, approximately 10% of our operating companies that are actually experiencing year-over-year growth. And so there's actually, again, what you can see in some of those markets that have reopened, that actually, again, people are going out and there's been a good amount of restaurant traffic, et cetera, et cetera, in some of those places that have reopened. So just one little bit of color to add to what Kevin said there.

No, I really appreciate that nugget there, Joel. Maybe to follow up on that, actually, either one of you can certainly address this. But as you have seen the states reopen and dining rooms become more available, albeit at a limited capacity. Have you seen the pivot during COVID where restaurants have turned some more off-premise stick to some extent? I mean is there some incrementality that we can talk to?

Yes, I'll take that one, and Joel can add any color at the end. So I would say, emphatically, yes, the restaurants that have performed the best during this crisis are those that quickly pivoted to takeout and delivery. If they didn't have it beforehand, they were able to add it. One of the things we're most proud of as a company actually during this crisis was our ability to help our customers do that. We provided them tools to set up websites that they didn't have their website of their own, provided them with connections to delivery services, provided them all the takeout containers and cleaning supplies and the like. Those that chose to do that, that leaned in, if you will, are performing much better than those that did not. Those that converted to a mini marketplace, which we helped them with. We have over 16,000 restaurants that we converted to many kind of grocery stores within the restaurant. This is an important stat we've not quoted publicly are running a 20% better performance the prior year than those that did not. So the point is it matters, Chris. Those that have made that effort to sell pantry goods, produce, protein and the like, it's helping them make payroll. It's helping keep them afloat. It's helping them get through this crisis. And then what we are seeing, Chris, is what you just said, is that their patio has reopened, their dining rooms are still with limited capacity, so they need to continue to takeout and delivery. And they've learned how to do it more effectively, more profitably from a staffing perspective and from a business perspective. So I believe that there will be a continuation of that business model. But Neil uses this expression. People have food-at-home fatigue. There's an experience associated with going out to eat, birthdays, celebrations, holidays, business meals, better food than you can prepare at home. We really believe people do want to go out to eat. You can see in our offices in Texas and people are actively back out. In many states across the country that are in the earlier phases, they're being quite liberal with allowing restaurants to expand their patios even out into streets as long as they have safety codes and the like, and it's working. Cities across the United States that have chosen to allow their restaurants to do that. As long as their tables are 6 feet apart, they can have as many tables as they want in that outdoor segment. So it's all helping, and we're seeing -- that's why we're seeing the acceleration in the weekly trends.

That's great to hear. I was going to pivot to some recent legislation that's come about, but maybe I'll circle back to that, be it that you just brought -- the grocery opportunity, Kevin. I guess maybe I'm still trying to understand the longevity of this opportunity and the willingness of the restaurant tours to really stick to it. And maybe, Joel, you can kind of chime in as well into terms of how we should think about this influencing Sysco's margin profile on a go-forward basis?

Yes, and I think the first part of your question on the grocery is the partnerships that we did with actual grocery stores. That's a little bit different than the restaurants becoming a marketplace. The restaurant becoming a marketplace is an existing customer of ours, who we're selling food to at a very similar margin profile to what we sold them that food to previously. And then they're just instead of selling it as finished product, they're selling it as raw produce and proteins and the like. And whether or not that continues or not will be determined by customer interest, customer demand. What our customers have told us is their consumers like it for the convenience. If they're already coming to the restaurant to pick up their prepared food to be able to buy some groceries, to be able to buy some pantry goods is a convenient place during COVID and perceived it to be a safer place because there are fewer people in the building. I think the first part of your question was tied to the partnerships we did with retail grocery stores and whether or not it has longevity or not. Our honest answer to that is it will be determined over time. We're not 100% sure. What we can color the lines in pretty clearly on, though, we're not going to attempt to be a supplier for huge, large national global companies. Think someone like Walmart. Walmart has purchasing scale. They have world-class logistics. What's our right to play with them? Smaller than others. But think about our regional grocery store where we at Sysco purchase substantially more food than they do, i.e., we have better COGS and where we have a robust supply chain that can deliver to their stores 7 days a week. For them to be able to carve out certain products or certain items to us where we can buy it better than they can or deliver it more fresh than they can, that is staying power. And the margins in that business are healthy. You shouldn't think of them as problematic because it's incremental business. We're not treating -- we're not going to do independent restaurants or service that. It would be incremental. And it's actually a flywheel on our COGS because the more volume we can be purchasing from our key suppliers tied to any form of business with which we do, it lowers our overall inbound COGS across the board. So as that volume grows, it benefits all of our sectors of business. Joel, anything to add to that?

No, I think you covered it. Thank you.

Okay. Perfect. And then just as I referenced some recent legislation that is that we've been proposed thus far, but I'm intrigued to get your thoughts around the potential for its passage and what that might mean for Sysco's business as well as the industry at large. So the RESTAURANTS Act of 2020, potentially $120 billion being provided in the path of grants, not necessarily a loan for largely independent restaurant; tours. So maybe you could discuss that a little bit and what you think about it.

Chris, it's Neil. I'll jump in on this one, if I could. So yes, as you described, the bipartisan bill being proposed here, there's both a house version and a senate version. And the house version, it allows restaurants that are not part of a larger chain to be eligible for direct grants. In the senate version, it would include restaurants that are part of a chain to be eligible for grants. What's important, and as part of this proposed legislation is that the funds could be used to cover things like rent, payroll, utilities, but also supplies. So important for foodservice distributors as part of this legislation. I think it's worth noting, it's early in the process. The bills are being negotiated and worked on. So it's going to take some time to work through this. We're likely looking at July before kind of a meaningful progress update on this. But we're hopeful that this can continue to move through. And in fact, Sysco's government relations team is actively supporting this. So we're helping to push this through, and we are actively lobbying on behalf of our customers to see if we can get this $120 billion in aid to our customers.

Great. Yes. So clearly, very early, but nonetheless, great to hear that there's a dialogue being had right now and very much speaks to some of the concerns that investors have surrounding obviously independent closures. So maybe, Kevin, we could shift over to some of the key initiatives that you guys have on your plate right now, starting off with the Shop platform and what you're seeing thus far with regards to activity and in terms of wallet share for those accounts that were actually utilizing it right now? And any new elements of the model or platform itself that have recently been introduced?

Chris, thank you for the question on Shop. And there just for 20 seconds, I'm going to elevate up just to our key initiatives. I promise I'll do it very fast and then I'll double-click in to Shop. For those that are kind of hearing some of this for the first time. What I would want all investors to know about Sysco is that we're not just managing through a crisis to make it through to the other side. We're actually using this crisis to accelerate the pace of change at our company to transform our company to be a better, stronger, leaner, more agile, more capable firm, and we're doing that literally, as we speak. So we're running the play of executing the crisis management and accelerating 4 transformation initiatives. There are sales force compensation, that's point one. Point two is our go-to-market selling strategy and approach. Point three is a pricing project. And then four is Shop. And I did it in reverse order, so I could answer the Shop question last. We actually start with Shop. And the why we start with Shop is because it's customer-facing. The goal of the Shop tool is to be very, very easy to do business with and to create really sticky relationships with our customers, and we have proven data point number one. For those customers that utilize Shop, our retention is higher, our penetration is higher and the loyalty, a.k.a. NPS, is higher. So we're easier to do business with. We provide suggestions to the restaurant, things to order, think about a world-class website. Other customers like you have also ordered or a suggested order. In our business, a decent amount of the work we do with them is on a replenishment, right? They use similar foods in preparation of menu items, and we could then provide them with a suggested order. Just click one button and it's on your next truck versus having to remember to go to your laptop, open it up and key enter the orders. That's a proxy to other industries, in health care companies like McKesson and Cardinal Health do that quite well and we're doing all those same things within the foodservice space. To directly answer your question on what's new, we are actually in the full agile development methodology now within Shop. So we're deploying new code every 2 weeks, which is pretty cool for our sales associates and for our customers. And then monthly, we bundle kind of the new enhancements to educate both our sales force and our customers about what new. So what's new for this summer is a customer onboarding. So new customers can now be onboarded through Shop in less than 48 hours, and it used to take a pretty substantial amount of time to get people through corporate approval of credit checks and all of those types of things. Because of this technology, we can accelerate all of those things, et cetera, and so onboarding new customers substantially faster than before. But why that matters and why that's important for the summer as we've tasked our sales consultants to do more new customer prospecting this summer than we've ever done in the history of the company before because we're in a mode where we believe there's tremendous market share to be captured during a period of substantial disruption. We'd like to say we don't wish ill upon anyone in this space during a time of tumult, but the reality is there are those that are going to struggle, and we believe that we have an opportunity to go in new business as others' fill rate struggle. And we believe that's where the friction will be visible to the customer for other people in our space aren't able to actually get the inventory into their distribution centers in a timely manner. And as this recovery is meaningfully accelerating, they're going to struggle with on-time and in-full shipments. We're prepared to be able to be on time and in full. And the fact that Shop can onboard customers more quickly is important. A second enhancement, and then I'll stop and toss it back to you is curation and cultivation of lists. So our sales consultants and our marketing associates can build menu designs and actually send it to a customer in an e-mail to say, here are some suggestions for new items for your menu. And if you're interested, all the ingredients are clearly laid out. And again, all I have to do is click one button. It populates as in an order, and it shows up on the next truck. It's just removing friction, making it easier to do business with. That's a practice we've had in place for years where our sales consultants would provide suggestions on menus and then, therefore, build an order. But when you make it easy, when you remove the barriers, customers' willingness to say, yes, goes way up. So higher retention, higher penetration and higher NPS is what we're seeing with our Shop platform.

Perfect. Perfect. And Kevin, maybe if I could actually circle back to one of your comments earlier about how you're seeing an acceleration in the rate of sequential improvement? Is that very much a reflection of what you're doing with Shop as well as your alterations to your go-to-market strategy? And is there a way of breaking down attribution between greater penetration relative to new market share gains?

Yes. That really is the biggest reason for the acceleration is the reopening of the economy, Phase 1, Phase 2, Phase 3. It's almost a one-to-one relationship correlation between states that have gone from Phase 1 to Phase 2, and Phase 2 to Phase 3 and the health of the improvement. Joel talked about it -- we call them operating companies. Our operating companies that are in the Southern third of the United States, which opened up sooner, we've got many of them actually running increased as the prior year. Cities like Boston, which are still substantially in lockdown just beginning to do the easing of their restrictions, I would say, are a month behind places like Florida, Texas, Alabama and all along the coast. So the biggest driver of the sequential improvement is easing of restrictions. I mean I mentioned the United Kingdom literally hasn't reopened restaurants yet. That happens the week of July 4. And then when that happens, it's like an immediate jump-up for an entire country. But yes, we are seeing for those customers that have adopted Shop and acceleration of those business trends. I'll give you one additional Shop benefits. We provide our sales consultants with suggested items to be sold to customers through Shop, and we actually now can push those offers direct to the customer. In both manner, we want the consultative selling of our sales associates, and they can't get to every customer every day, every week. We want them to be able to get directly to that customer themselves. We call them priority alerts, which is essentially, hey, this is a deal of the week. This is a key item. Those priority alerts are working, and we can track the incrementality of those sales, and they're substantial, the incrementality of those sales. What I was referring to vis--vis new customer prospecting, we've changed our sales associated compensation. It's a significant event for our company because that compensation method had been in place for a long time. It was a healthy compensation system. It was commission-based. It drove behavior of going out to sell, but there were some elements of that compensation program that were at times actually in conflict with the goals of the company. And our new compensation system addresses those barriers, removes them, and we have now complete alignment between the sales consultants' goals and objectives and what we at Sysco want for our aggregate goals and objectives, which is essentially twofold: go win new customers and then go increase penetration with existing customers. So our new compensation system is a combination of base pay, plus a bonus. And then the bonus focuses them on winning new business and growing share with existing business. So that's complete alignment with our goals and objectives, and we just rolled that out within the last 2 weeks, and we're pleased with the initial reactions of our associates, as we rolled out that new model.

Chris, I think the important point on all of this is that, as Kevin said, there are some benefits we're starting to see on this. But I think the main point here is that -- and again, he's already said it, but just to reiterate it, the crisis, we've used this to accelerate things that actually would have taken a substantially longer to accelerate. And I think the idea that we have not only solved for the short term, the mid-term, but also have made investments, again, an accelerated change for the long term in this company. So to come out of this crisis as it continues to evolve, we will be very well positioned to come out of this stronger than ever with some of that work that's been done to accelerate. Again, I think that's, again, one of the really key takeaways out of this, even more so than the sort of the immediate benefit is the ability to come out of us really, really strong for the long term.

Right. Right. A little less than 2 minutes remaining here, so maybe 2 final questions on my end. In terms of capital allocation on a go-forward basis, you guys are obviously flushed with cash right now after some financing, and the balance sheet, even prior to that, was in good standing, still is to this day for that matter. But how are you thinking about that in terms of the idea of going after and acquiring assets for that matter domestically if they're available? What are you seeing out there in terms of some subscale operators who might be a bit fragile financially? And then secondarily, how you're thinking about the support of dividend followed by any other type of return to shareholders.

Sure. I know we're short on time, so I'll be brief. Our allocation priorities have not changed in terms of investing in our business, again, ultimately, long-term growing our dividend, focusing on M&A and then the balance paydown between share repurchase -- so the lights just went out for some reason. I guess we didn't pay the bill. The -- but I guess, frankly, the opportunities for M&A, Kevin talked about it. We certainly don't wish ill on competitors, but we certainly do believe there will be opportunities. From an acquisition standpoint, we still going to find ourselves in a bit of a place where I think people are having a little bit of difficulty with valuations realigning with reality. So again, while some of those things have struggled, there hasn't been as much activity for those reasons. But it has certainly continued focus on ours. And certainly, as we evolve long term, again, this -- we certainly talked about our amendment this year as a restriction on our ability to grow our dividend this year as long as our amendment exists, but our long-term goal is to continue to grow our dividend, and we're fully committed to that.

And Chris, I know I don't I want to give you too in. What I'm most excited about at Sysco is our ability to grow during and then more importantly, post crisis, and Joel said it perfectly. The transformation initiatives that we're embarking on are going to accelerate our opportunities and ability to grow. We can win more market share with existing customers. I think we've been public before for the independent restaurant customer segment. We have 30% share of wallet for those that we currently serve. We know we can increase that penetration by offering more specialty items like fresh produce and proteins and Shop as an example, we have the opportunity also to win more business in the metro market. And we can talk about that more in the future because I know we're at time. So Chris, I'll toss back to you.

Well I think we are, in fact, at our limit here. So gentlemen, I really want to appreciate you for having joined us this morning. We very much enjoyed learning a little bit more about the company as well as you go-forward strategy. Thank you.

Thank you, Chris.

Thanks, Chris.

Have a great day. Bye.