US Foods Holding Corp. (USFD) Earnings Call Transcript & Summary

All right. Good morning, everybody. I'm Kelly Bania, food retail and distribution analyst here at BMO. Really excited to have US Foods, the second-largest food service distributor in the U.S., join us. With us, we have Dirk Locascio, CFO of US Foods. Thank you so much for joining us from Chicago, Dirk.

Good morning. Glad to be here.

I, obviously, again, have -- just want to remind everybody, I have lots of questions for this fireside chat, but you are also welcome to submit questions to me through the app. I'm monitoring that here. But time seems to fly by, so we'll just dive in and start with some Q&A.

So I guess, Dirk, the big question post recent earnings was some of the reinvestment of the cost savings, so $50 million being reinvested. It sounds like talent, sales force maybe, some mention of digital. So just wondering if you could help us understand this in a deeper way. It sounds like maybe some of these are a little bit more volume-related. And I guess if you can loop in, is there a potential that the other $130 million does get reinvested over time or is that [Audio Gap]

On both local and national. And on the national side, part of it is with the strong success we've had over the past year and have this year, it's really to support that incremental $1 billion of new business as well, so all really growth-related. And just -- I commented on this during our earnings call, but we really do see more opportunity for market share gains now than we did pre-COVID and especially in specific markets, and we want to take advantage of that. And just as we did pre-COVID, in those markets that we see that continued growth opportunity, we're going to continue to add talent and add sellers to enable that growth. But I wouldn't think of that as part of the $130 million. That's more what I would think of as ordinary course over time. And to the last point around talent. So talent is really the [Audio Gap] To a lesser extent, but it is an opportunity for us to upgrade talent in some markets there. But we're excited. We think it really kind of helped us to continue to grow our focus pre-COVID and been to grow 2x the market, especially in independents. And that really is unchanged coming out the other side given our differentiated platform.

Right. So something we used to talk about a while ago or long ago was just kind of the -- how to think about the sales force, the amount of accounts per sales rep. I haven't talked about that in a long time. Obviously, a lot of the volatility. So just wondering if you could update me on how that looks today and what you expect maybe over the next couple of years and loop in again how that is changing with digital ordering.

Sure. Sure. Good question. So our sales force continues to be more productive and able to manage larger books of business than it was even a couple of years ago. We really continue to seek feedback from our sellers on how to improve tools and process and how to help them be more effective. Even -- so after the reinvestment, our sales force will be a little lower than 2019 but really that -- these incremental sellers plus the additional sort of efficiency tools, again, allowing them to be more productive, again, is what adds up to, we think, kind of ability to really continue to grow for a long time to come. And as you pointed out, so digital -- the combination of digital ordering, so customers do more of their own ordering, and that's really making that as easy as we can, and we continue to invest in our digital platform to make that easier for customers to manage ongoing. So I think even as probably you and I as consumers, where we used to want to talk to someone or a customer service agent or person, now we'd rather do a lot of it where I can see it on my screen and confirm the size and know the order and quantity, et cetera, that I'm going to get. So those are things that all do make it easier for the customer and allow our sellers to be more effective. And also a number of our internal tools. So CookBook is one we've talked a lot about that are really continued enablers of that -- of making it easier for them to operate. I think that our restaurants have continued, small and large, to adopt digital technology more and more. And you saw whether -- especially on the ordering side, meaningful acceleration across many restaurant types during COVID, and I think that we got people to be -- even some of those that maybe wouldn't have tried in the past to be more willing to try. And our tools continue to, we think, give us an advantage and really especially over our smaller competitors and help those restaurateurs and other customers be able to be more effective in this kind of new world going forward. And I guess, finally, the thing is just really the technology, we think, will continue to help customers be able to have an easier job of ordering and interacting with us and our sellers then be able to continue to grow.

So that's very helpful. Let us go back to the market share gains comment. And it sounds like more -- or maybe more bullish now versus pre-COVID. Is the largest factor driving that service levels? Or if there's anything else, what would that be? And how are your service levels today?

So service levels are definitely a component of it. And I think the other thing, though, is technology. You have more people that have been willing to try and/or use more extensively than they did before. And I think that's where our differentiation shows up versus competitors, especially again versus some of the mid- or small-sized competitors there. I think the service levels, the -- one of the advantages we have is with our size and scale because we have vendor supply issues in many places that are impacting the broader industry. And so as you may remember, Pietro commented on our earnings call that we're carrying roughly 25% more inventory on hand and on order. And that is to really be able to minimize the service-level challenges for our customers. So service levels for us and for the whole industry are below where they were before. But from all the indications we get from our field organization as such is we believe we're at or better than really anybody else out there. And I think that as this continues, that really becomes more of a challenge, especially for the mid- and smaller-sized distributors from both the working capital piece as well as, again, with size and scale, we're working actively with our vendors to try to position us at the front of the line for the supply they do have, and we're seeing that pay off. I mean we know sort of anecdotally through a number of our local markets, just different mid and smaller size that are really struggling even more so with vendor supply challenges. So we think that's a definite advantage.

And you mentioned in the recent quarter needing to hire about 1,000 drivers and warehouse pickers. So just a big topic across the space. So wondering a couple of things. One, what percent of an increase is that? How substantial is that? And what can you do to insulate your business from this? It seems like a recurring pressure every couple of years.

So I'll start with your first question just on the percentage. So that 1,000 represents less than 10% of our supply chain headcount. So it's -- it sounds like a bigger number but it's really still not a huge percentage. And I think when we compare that to our peers and others in the industry, we believe we're as well, if not better, positioned than most people in the industry. But that doesn't mean that we haven't doubled down efforts in recent months because it is -- I think what we would have thought today -- a couple of years ago, especially on drivers about a tighter labor market, I think the difference is now is you have so many companies hiring as we're coming out of this. So you sort of have this surge in demand that likely becomes more temporary over the course of this year as people ramp up. But the few things that we think we can continue to work on around creating an environment that our associates want to work in and continuing to make environments better for them through, whether it's a driver, through the way we're loading the back of the truck to make their job a little bit easier, in a warehouse by -- whether it's a process or technology improvements, to make that a little bit easier. These are hard jobs, and we have a lot of -- I have a lot of appreciation for the individuals that do that and appreciate the individuals, especially in our company, that do this. It's really -- from a wage perspective, these are well-paying jobs. And so we continue to watch the markets. But to date, just with the challenges, we've really focused more on using sign-on, retention bonuses as opposed to working to structurally change the impact over time because we think, again, with the level of compensation they're at, we think it's the right level. And it's really -- the other things we've been doing are around really increasing the awareness of the roles out there using different recruiting tools and tactics that we have in the past in order to raise that visibility out there. So we're, I'll call it, fighting the fight like many others. And we think with our tools and the attractiveness of our business that we will continue to make progress.

I guess the big topic that we should touch on is just inflation, inflation everywhere. So we touched on wages. I want to touch on freight. And just help us understand how you would frame what's happening in the freight market today. And what's a [Audio Gap]

When you had that tightness in capacity, you saw rates compress. And ultimately, though, when -- as I mentioned before, when we've looked at some of the third-party data that's out there on multiple economic cycles is, over time, when you see that compression, you do see carriers adding capacity. So that is one we'll continue to watch out there. I think there definitely are some things we learned from the last time around just the way that we have been able to work more effectively internally as an organization around just awareness within our organization and then to our customers that these freight changes are not us as opposed to the markets and then more actively engaging in dialogue with our vendors. And that really continues along with finding ways to continue to optimize our own network. I think the -- it's an environment where, for us and others, although -- so we feel good about improvements we've made. It remains a challenging time when you have the capacity through there and really is one where we are relentlessly working with vendors, both on service levels and also then on kind of freight rates and sort of the combination of those 2 there. But at this point, don't feel like there's a permanent change as we come out the other side of this as opposed to transitory.

Okay. And just to step back, you guys often talk about your new operating model. Maybe just remind us what are the biggest components of how you've changed with your operating model. And how do you think -- how do you feel like it's being executed in what is -- seems like a challenging environment to execute?

Sure. I think probably the best way to think about it is it's evolution, not revolution. So some of the changes perhaps that one of our peers talked about that are much bigger are things that we went through 4 or 5 years ago in the way we went to our team-based model and selling model and multiple distribution centers under one leadership team. What we're doing now that we began to put in place months ago are really around taking some of our -- some more of our expert resources, which are primarily coming from the field, and putting them into these centers of excellence to be able to help us to be more effective in the way we operate and deploy these best practices to really do a better job of -- in any organization, there's always, I'll call it, 5 or 10 that are struggling in a particular area. And it's really always working to consistently improve on those. We think with this model that we will be able to do that more effectively. In fact, even though it's pretty young, we're seeing some good early wins in a few markets already. And again, this is not a bunch of external folks that we've hired. It's really taking some of our best really and applying them -- kind of pulling them out of regions and putting them into these individual centers of excellence. So look forward to being able to talk more about this as it continues to live on further, but I think it will really help us from an effectiveness perspective.

I guess this most important thing, top line, you had some very positive things to say, I guess, that was last week. Independents, I think, turned positive in April. Chains were positive for the past couple of months. I guess the area that's still lagging is hospitality. And so I guess, one, I think that was down 40% maybe in Q1. So hard to nail down a time line, I guess. But the question is, as you do a deep dive into who those hospitality customers are, can you help us understand leisure versus business? Or just anything to kind of help think about a reasonable time frame for an expectation of recovery there?

Sure. So you're exactly right that hospitality is the slowest to recover. But as you probably remember, as we went through the first quarter, as we showed, we saw continued improvements. And I would expect that to continue as much of hospitality has just begun to reopen and, in many cases, have pretty limited capacity. And so all indications, whether it's quantitative or just qualitative, indicate there's very strong demand there. It's really just about getting the capacity at the level because you have more and more people getting comfortable and really having that pent-up demand from not being able to travel last year as we have cases of COVID going down, vaccinations increasing, et cetera. And so when we look across our hospitality, leisure is the bigger piece versus business. And so that's the piece that we would expect to rebound much quicker as we have capacity lifted because of that demand. Business is a smaller piece, and that's the one that's a little harder to tell. But again, if you kind of break it down to that smaller -- it's a much smaller impact. But we're very encouraged over the last few months by the continued uptick that we're seeing across the hospitality.

And so if the restaurant side of the business continues to ramp over the summer and hospitality come back, can you keep up with this, I guess, is the question over the summer as you need to hire? Is there any concern about being able to fulfill this demand?

Well, I think that -- so we expect to be able to serve our customers. Part of -- you may remember all the way back to our fourth quarter earnings call when I talked about beginning to focus at that point already on hiring and looking ahead. So that's what we've done, and we continue. So when Pietro talks about the 1,000 people, that's really looking all the way ahead through the summer, into the fall and with some demand increases that we expect. So it's not necessarily where we are today as opposed to where we expect to be. So on a -- the way our process works internally is on a distribution center by distribution center, we're focused on what the needs are in the hiring and we have the resources focused on that. So we do expect, I think, because the tighter markets, it's not -- like I said, for us, in the industry, it's not as easy as it was, but we're doing -- pulling out all the stops and really are focusing on ensuring that we can serve our customers as best we can and continue to grow.

Perfect. I have a question from the app here. This client is looking for just your thought on ghost kitchens and the possibility of more pickup as opposed to dining in, more takeout, I guess. And are any of these factors changing your approach to how you work with your customers?

It's a good question. So ghost kitchens continue to increase as far as popularity, meaningfulness of size. And you have, as you probably have seen, more sort of even established concepts that are exploring versions of ghost kitchens there. So we've continued to see the increase in there, and we were one of the first to really put out the playbook on that for customers. And so what it -- what I will tell you is we're not changing our sort of go-to-market approach, et cetera. However, what we are doing, though, is we're continuing to work with customers because what you find is you find a lot of these are where someone may have an established restaurant and then they're adding a ghost kitchen on top of it. So this is where we think and are seeing our team-based selling and our expertise team of the restaurant operations consultants, et cetera, be able to provide more value and helping customers really get these established than our peers can offer. So do think that, based on some of the projections of -- I forget the number, but some big numbers of size that are expected over time, that we think we can continue to be a leader as we have early on.

Are there any different needs of a ghost kitchen customer? Or anything in particular, any service that you could provide them?

Not a whole lot. I think the main service is really around helping them with our learnings that we see across different customers as far as the pitfalls, the steps to take, et cetera, through there. I think the differences would really be more around because a lot of times they will tend to be in -- using, I mean, its existing facilities with something else during an off-hour or a true remote kitchen. And so it's -- the op risk could be a little bit different not meaningful enough that I would really call anything out specifically.

So this may be a hard one to answer, but just to see it around in the neighborhoods. When you look at the amount of capacity that restaurants have added with outdoor space and taking over parking lots and expanding, do you think some of that will be permanent? Do you have a sense of what that could do for your customer base in terms of expanding their own capacity?

So it's, to your point, it's hard to know what level it permanently adds. But we do expect it to probably add some capacity because I think that it's restaurants. In many cases, we use your outdoor dining that they may not have added before. And whether they can continue to use parking lots they converted or at least have some level of seating ongoing, I think that if it brings more diners to the concepts, to towns, et cetera, I would think that, that continues over time and it adds probably some incremental capacity. I think all the survey data you see is really around people who want to go out to eat, they like to go out to eat, and I wouldn't expect that to necessarily change, especially with pent-up demand we have over this past year.

Absolutely. And I would think that, that's a positive for drop size.

Yes. So as we've talked about before, our focus on growth is really the balance of increasing share of wallet to solve the drop size. And that's really another reason why our value-added model of helping customers because people will often ask us would you charge for these things and a lot of it is not. But the better that customer does, the more that they're selling it and the more that they're buying from us, which just naturally improves the economics for kind of all parties involved.

And I guess -- so there's a number that's, I guess, floating out there on closures now, somewhere around 10%, do you agree with that? There was so much concern about that earlier, assuming we're worse the past -- past the worst here. But do you agree with that 10% figure? Is there a difference between chains and independents? And is that almost, I guess, maybe a positive in that if demand is still there, the drop size for the other 90% of customers could be even stronger, which would be, I guess, more efficient for a distributor?

So the 10% is consistent with some of the industry data we've seen and the group has kind of inferred it. Hard to get an exact number out there, but that is in line with the industry data we've seen. The point is chains that have tended to -- it seems like fared a little bit better as far as closures largely probably due to their access to capital than independents throughout this. But ultimately, you're right. It does help drop sizes and volume in the near term. I think the thing that we will continue and we also continue to watch, though, is over sort of in the past even, there are a number of restaurants that open and close every single year. So many of these storefronts that have closed may not mean they're permanently closed as opposed to you have new operators that come in. And you may remember, Pietro talked about -- I think it was on our Q4 call, where we have some of our stronger operators that you're seeing that have empty storefronts that they're looking at to be able to open new concepts as you look ahead. So I would expect it's an area -- it's a hard business but it's an area that seems to drive a lot of interest from people with new door openings, and I would expect that to continue.

Question, I saw an interesting post from US Foods about QR codes. And I thought maybe you might want to talk about that and how you're helping customers with QR codes.

Sure. I think that QR codes have really increased in their prominence, as we kind have all seen over this past year or so. And the crisis definitely or pandemic definitely helps with the adoption on that front and making it so easy to use our smartphones for that. And menus are a perfect place where they've shown up in more and more restaurants, and it makes it very easy to allow customers to use the menus and order from their mobile phones. And our sales team, this is just another area where they can add value and help customers, where customers don't need to know at all, share the experiences and the expertise we have and that we see across on educating customers on QR codes and also assist these customers in setting up their contactless menus. And when they do that, it also helps restaurants be more nimble with their menus. And so it's just an area that I would expect to be here to stay and continue to see that increased use just because of the ease of use and access.

That makes sense. So I wanted to talk about the CHEF'STOREs. You recently rebranded the Smart Food (sic) [ Smart Foodservice ] stores to the U.S. Food CHEF'STOREs. Just a question on the economics. Those are higher margin. Curious if you think the pandemic has created more of a white space opportunity for those, how those are continuing to perform as things start to normalize. Just a broad update maybe on the CHEF'STOREs.

Sure. So we've been very pleased with how well that business performed. And I will tell you that this last year has done nothing but increase our confidence in the growth ability of that business over time. So what we've talked about to date is we have about 80 stores and ability to [ duck Trinity ] as we look across the country there. And again, the doubling is our initial focus there. And as you said, it's a meaningfully higher EBITDA margin. And then as we talked about with our much smaller sample of our legacy US Foods CHEF'STOREs is, as we expand this, there's no reason for us to believe we wouldn't see that same benefit when we have a CHEF'STORE market that we don't expect cannibalization instead that we get more share of wallet with customers. So that very optimistic and the continued growth that the leadership team there has driven is, we think, is here for a long time to come.

And I think I saw online maybe the CHEF'STOREs partnering with Instacart even. So I was curious how that's working, what you've learned from that partnership.

Sure. So it's earlier on. And again, it's about finding ways that let customers shop their way. And so that is a way that, should customers choose, they can do that. It's a little different in the sense that our -- versus our delivered pricing, which is guided, for example, a customer has a contract where Instacart doesn't really reflect that. Our focus in the CHEF'STOREs continues to be if customers are big enough, we'd rather them be a delivered customer and then do fill-ins at the CHEF'STOREs. But at the same time, you have others that are smaller and/or may run -- operate food trucks, et cetera, it's a perfect opportunity for them. And then sort of the Instacart is just another way, whether it's for those individuals and/or if someone shopping for school or certain other events like that, that they just need it time to time. And then we have that added benefits of some of the consumer benefit -- the consumer traffic that we continue to grow there. So continuing to look for innovative ways to make it easier for customers to shop and focus more with US Foods.

That makes sense. I wanted to touch on just some financial stuff. But I also wanted to ask about -- just before we get back to that, just inflation, I think I skipped over that earlier. So just curious, always a lot of questions from investors on are foodservice distributors and US Foods inflation beneficiaries. Can you remind us just how this passes through your system? And if inflation ends up being a little higher than historical, is that okay? Is that going to be a margin pressure near term, if you look at this as transitory or just what you're seeing on food cost inflation, specifically?

Sure. And so maybe I'll start with where you asked, just some reminders on how it works and such. So as you know, about 2/3 of our customers are on some form of a contract. The other roughly 1/3 are not. And so -- and inflation flows through differently on those different customer types. So most of our contracts are some form of a markup, whether it be a fixed amount per case or a percentage. So that inflation flows through automatically whenever those contract resets, which could be week by week, monthly. The noncontract, so it gets passed through, again, through our CookBook pricing system and happens over a relatively short period of time, take a little longer when you have higher levels of inflation, but again, they tend to pass through. And so our industry likes that slow and steady inflation because it tends to be since a good portion of our business is a percentage markup. So it does end up being gross -- or gross profit accretive over time. The -- a lot of the inflation that we're seeing right now, we are seeing it in some of those categories like whether it's oils and disposables and that, that are -- it's aided by a lot of the supply challenges, unfortunately, that are going on across. So it's not just sort of the underlying commodity. And then -- but a good portion of it is coming in center of the plate, so your proteins of poultry, beef, et cetera, there, which -- so in those cases, what you see is that a lot out of that category tends to be a more fixed markup. So it will be a certain dollar amount per case. So when you have this kind of inflation, if you looked at gross margin, so as a percentage of sales, it would look like gross margin is eroding even though we may be making the same or more per case. And so that's why, internally, for the COVID time, we would talk a lot more about gross profit and OpEx per case because that's really what you post to the bat and your volume is what you take to the bank. So I think the thing to remember here is if in the shorter term, we see some gross margin compression because of that inflation, that's just simply the math on sales. So whatever you see as erosion in gross profit, you're going to see as a benefit in OpEx because it's the math. And so our focus is really around continuing to profitably grow volume and then getting our gross profit per case back to then exceeding 2019. And during this time, the thing that I've talked a lot about is when we have more inflation, especially higher level or volatile, that's where it's about really trying to operate the processes tightly. We have in order to pass that through. But at the same time, we want to make sure we're pricing fairly to our customer, and this is an area where we can work with them on if you have certain areas that are -- have more inflation, are there menu changes, portion changes, et cetera, they can do to be able to offset a portion of that versus true price pass-through.

Perfect. We'll welcome any help in modeling that the next couple of quarters. Another question here from the app, just about the long-term implications from maybe more hybrid or work-from-home models. And do you think that changes the long-term potential for US Foods?

So I don't know that it changes it over the longer term. It's probably the patterns by which people eat out may be a little bit different as we think ahead. But the thing that is harder to know is this sort of ongoing appetite, pun intended, for eating out that people have and the desire that people have to eat out and then also just the busyness which people have. So it still may be where you see people going and grabbing something for a lunch, even though they may be working from home. So it's hard to know exactly. But ultimately, based on the consumer demand and the 30 years of trend that we've seen of food away from home growing, I wouldn't expect that it's going to meaningfully change that demand.

So last question to wrap it up. We have a minute here. So I'll just ask for some modeling help here. So we kind of estimate pro forma EBITDA for acquisition synergies plus, I think it's 900 net new business. So we kind of estimate EBITDA pro forma for all those factors, about $1.6 billion, which would be a 5.4% EBITDA margin. I guess any comments on that or any thoughts on bigger -- big headwinds or tailwinds to get back to that or maybe above or below that once things are fully kind of normal?

Sure. Well, I think you have the big pieces, as you pointed out. The biggest factors for recovery really are more around what the case volume trajectory by customer groups looks like. And we do expect each of them to recover. It's more about timing. And then over the shorter term, you have the impacts of freight and labor supply chain. But again, as we've said, we expect mostly transitory. I think that the only other piece I would consider on the pro forma or as you -- outlook is cost inflation. So we do have cost inflation every year just like all other businesses and distributors, too. So the combination of things we do around growth and other efficiencies are kind of used to mitigate that to an extent. But that is an area, when you're looking ahead, there is a headwind that goes against earning [Audio Gap] We do think that -- look forward to sort of continue to return and then exceed where we were in 2019 and continue growing the business as we had been in the 4 years leading up to that. I'm not going to specifically comment on the 5.4% EBITDA. But I think that, as you well know and I've talked a lot about, we're really balancing more dollars I think with any margin, which we had basically done in the 4 years leading up to COVID, so continuing to make US Foods a stronger company.

Perfect. Well, I think we're out of time, but thank you so much for joining us, Dirk.

Thank you, Kelly. Good to talk to you. Have a good day.

Bye.