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

Good morning, and thank you for joining us. My name is Jeff Bernstein, and I'm the restaurant and foodservice distribution analyst at Barclays. Happy December. I want to welcome all on the webcast to day 1 of Barclays Seventh Annual Eat, Sleep, Play Conference. With this year focused on the Eat. We're excited to have 13 restaurant and food service distribution companies attending our conference over the next 2 days. For the second straight year, unfortunately, the event is virtual, but fingers crossed, in person again in 2022. And while this year is focused on the Eat, we look forward to returning to a full Eat, Sleep, Play in 2022. In fact, we announced this week the hiring of a new gaming, lodging and leisure analyst Brandt Montour, who spent the past 14 years at JPMorgan. We're looking forward to having him join us and expanding our coverage back into the full gaming, lodging and leisure world. With that out of the way, I'd love to introduce our first presenting company, U.S. Foods. With us this morning from Rosemont, Illinois, we have Pietro Satriano, Chairman and CEO; Dirk Locascio, CFO; and Melissa Napier, SVP, Investor Relations and Treasury. By way of background, for those not familiar, U.S. Foods, a leader in U.S. food service distribution, supplying 300,000 restaurants and foodservice operators from 70 broadline locations and 80 cash & carry stores. And there are 3 large publicly traded U.S. foodservice distributors and then thousands of small to midsize, which leads to a tremendous market share opportunity for someone like US Foods.

So with that said, thank you, Pietro, Dirk and Melissa for joining us this morning. I will kick it off with some bigger picture industry questions. and then dive into some more specifics on US Foods. But first, I thought I'd start with just a bigger picture market share question. I think investors look at the foodservice distribution segment as kind of a potential roll-up story accentuated through COVID with the big 3 still having modest share. So I'm just wondering where do you expect your share to trend over the next 5, 10 years? And maybe specific to acquisitions, what are you looking for and what are maybe some of the inhibitors?

Sure. Thanks for the question. Good morning, everyone, and thanks for joining. In terms of market share, our Great Food. Made Easy. strategy, which I think folks are familiar with, which are around our product innovation, our technology leadership, and our expert resources has driven market share gains over the last number of years with our target customers. Apologies for the planes here in Rosemont. We've grown historically at 2x the marketplace when it comes to independent restaurants, one of our target customers and healthcare and hospitality, where we are over-indexed for market share, we continue to make gains as indicated by the $1 billion in new business that we've brought on board since COVID began across healthcare, hospitality and national chains. And by the way, that is a segment that attractiveness has continued to improve over the last few years and has become -- we've gone from being opportunistic to think about that as a segment where we can really make some nice gains, which we've proven over the last 1.5 years. And those gains come from a combination of existing customers and share of wallet as a result of our differentiation and as well from new customers. In terms of your specific part of the question, Jeff, in terms of acquisition, as you know, we've made 2 significant acquisitions over the last 3 years. One was SGA Food Group in the Pacific Northwest, and that really provided a much better footprint than we had. We went from, I think, 1 distribution center to 9 distribution centers in that part of the country, which has allowed us to better serve customers, especially multi-geography customers and grow in an attractive part of the country. And then secondly, as you talked about in your intro, the 80 Cash & Carry stores, which are branded CHEF'STORE. They -- that's a segment of the industry or channel, I should say, that is faster growing, that is more profitable than the delivery side we've traditionally been in. And that, that channel also presents opportunities to grow market share from customers, independent customers that we haven't historically had as good luck reaching, and that business is performing well as indicated by same-store sales and EBITDA by 2019.

That's great. I appreciate the background. And in terms of the customer opportunity, I think most people think of growth in terms of adding new accounts or M&A, like you mentioned. We often think that the greater opportunity is growing share with existing where you already have a strong relationship. So I'm just wondering what's your current -- how do you think about your current penetration, whether it's with chains or independents, and potentially the opportunity to grow that mix again with your foot already in the door?

Yes. We agree that the opportunity on growing share with existing customers is just as good, if not better. The economics are better. As you know, the truck is stopping at the back door of the restaurant. And so that incremental case is very accretive. I'll answer the question in 2 ways, Jeff. When it comes to large multi-geography customers like health care, like hospital like chains, we typically have virtually all the business. That is the nature of that business. It's typically contract. Typically, it's lower margin, but in return for lower margin, you have commitments to give a distributor all the business, except perhaps for some specialty items. And so that one is where historically, what we've done is just focused on bringing on the right business at the right margin. When it comes to -- and that extends a little bit to -- The Street, but not nearly as much. When it comes to independent restaurants on the street, as we call it, share of wallet is typically around 1/3. Now that is an average. It ranges from a little bit less than that to more than that. And that's where we're very focused on growing market share of wallet, whether it's through our fresh offering, whether it's through showcasing our innovation that I talked about earlier. What we find is -- I was talking to one of our presidents recently, I tried to talk to different presidents who run the field organization every week. And one of them was saying, we've got this large multiunit customer and they've got Scoop on their menu. And they're not going to leave us, I don't want to say never not wood, but they're just -- we are so embedded into their menu that would be very painful for them to leave us. And so our differentiation really helps drive share of wallet. Obviously, assuming we do the fundamentals well in terms of service and product assortment, which we're very focused on.

But the likelihood of moving that 1/3 to 40% or 50%? Is there a reason why that's just not achievable, maybe the customer doesn't want to focus too much on one distributor?

There are some -- that's a good question. The -- so there's different customer types, and we've categorized different customers into different types. There are some who use multiple distributors, and there's a couple of reasons. Sometimes they're looking for, they believe that specialty -- local specialty distributors in meat or produce have a bit of a reputational halo. Those ones, we think we can, for sure, penetrate greater as we strengthen our offering on the COP side and on the produce side. And then there's others who do it more because they're price-sensitive. Those customers were very careful in terms of -- and selective in terms of which ones we bring on. But that's where the cash and carry channel really, really works because the economics of that channel because it doesn't have delivery offer a proposition that is very attractive to the customer and very accretive to us, which is one of the reasons why we're excited about the expansion of that channel.

Right. And obviously, we've gone 9 minutes without talking about COVID. It seems like a ...

I think that's positive.

It seems like COVID has had an accelerating effect on maybe structural changes that were already going on in the industry for the past few years. I'm just wondering if you could talk about maybe what you think has been the most transformative change during the crisis, maybe both positive and negative that COVID has brought on that maybe that you're thrilled to have enhanced or the other part has created a challenge that you weren't used to?

Sure. And then you're asking, Jeff, about the industry. We, as a company, a bit of both, just to...

Bit of both would be great.

Okay. Good. So let me start with the industry. I think the first point I'll make is, I think everyone has been probably a little bit surprised at how resilient the industry has been. I remember during an interview on CNBC last April, where I talked about this industry will come back, and there was a lot of feedback that perhaps my hopes were misplaced at the time. And the industry truly has proven that it's incredibly resilient. Consumers have this desire and need, you could argue to eat out and now increasingly take out. So one of the transformative changes has been the importance of takeout curbside pickup or delivery has grown significantly and dramatically. And I think that's a change that's going to stay, and that will help the industry gain share from the grocery channel. So that's a positive one. I think another one, too, that probably didn't anticipate as everyone was concerned about the health of some restaurants, especially what typically called some of the mom-and-pop operators. For sure, some of them have gone by the wayside, but what's taken their place is stronger operators, multiunit operators in a city that have 2 or 3, they've now gone to 4, 5, taking advantage of more attractive lease conditions. And so I think the industry itself is not only recovered, but probably stronger than it was, which is not what many folks anticipated. So that's on the industry side. And as I said, the technology has become increasingly important. In terms of us as a company, we've made a few changes to our operating model as a result of some of the learnings from the early days of COVID. One, as we've talked about, we have to move very quickly in terms of putting safety protocols in place and other things in place like our Ghost Kitchen playbook and our re-opening playbook. And we learned how to be a more nimble and agile company as a result of that, we've put in place these excellence teams, which have responsibility for end-to-end process across the country. We funded that by reducing the number of regions. And so as a result, we believe we have a better model now, which allows us to roll out best practices much more quickly than before. I know I gave an example on an earnings call some time ago about how it would have taken us 2 months to roll out a new best practice with respect to the warehouse, and we did it in 2 weeks at the time. So one is the operating model. The other is to take advantage of the technology, whether it's internally and being more aligned as a company or externally with customers. These restaurant operations consultants who are so, so helpful to our customers in the early days of COVID with the re-opening playbook how to apply for PPP, that's a real expertise, and you can't necessarily replicate that in every one of our 70 markets. And so using technology to make those experts available to our best customers across the country has been another win from COVID. And I guess the third thing I would say is we talk a lot about our differentiation as a company, and that was emphasized during COVID but process excellence, when you run a multi-geography operation like ours, semi distribution centers, as you said, a fleet of 7,000 or 8,000 trucks. What COVID has really continue to call upon is the importance of the process excellence, and we continue to be very focused on process excellence, which drives reliability for customers and efficiency for our warehouse and delivery operation.

Understood. There seems to be a new variant over the past several days. We're moving along the Greek alphabet quickly here. Just how does your system prepare for this maybe versus the last? Is there learnings that lead to a change in the approach? Or like do you have a big pow wow on Monday morning to say, we need to revert back to this behavior? Or at this point, is your system running? So that new variant, old variant, we are always going to be using these type of precautionary measures, presumably.

Yes. So I think, unfortunately, as a result of the various waves associated with the various letters of Greek Alphabet, as you said, right, Alpha, Delta, now Omicron. We're pretty well prepared in terms of come what may. There's a lot to be learned about this particular variant. But in terms of our plays, our safety protocols, how we continue to serve customers, those playbooks, they're pretty well honed at this time. And then the other thing I would say from an industry perspective, I think the other piece of good news for investors is, as I was saying at the outset, the consumer in the industry are really resilient. I mean if you look back at how different geographies have recovered as quickly as they have when different variants have hit, that shows that the end-user demand really sees through these different ways pretty quickly.

Yes. Good to hear. And in terms of maybe future profitability, we've seen over the past 18-plus months, yourselves and others talk about doing more with less, like you said, with efficiencies and with technology. And now it seems like maybe we're getting sales back to full strength. Just wondering how you think about the margin or your prior margin potentially upside to that margin, maybe the magnitude of that? And maybe what would be the drivers of that? If you got -- if you sustain the sales back to full strength or, obviously, if you were to accelerate those sales above pre-COVID levels, kind of what's the biggest opportunity from a margin standpoint?

Sure. And good morning, Jeff, thanks for having us. I'll take that one. So as you point out, so our expectation is that we will return to pre-COVID margins from an EBITDA perspective and then continue to increase further from there. Just if we look back in the 4 years leading up to COVID, we expanded our EBITDA margins about 90 basis points, which is about 25%. And we'll continue to focus on that further expansion. Ultimately, we're focused on maximizing EBITDA dollar growth and our EPS growth which we expect to come from the market share gains that Pietro already talked about as well as expansion through a combination of gross profit growth as well as OpEx efficiency. A few examples of that customer mix, so as we continue to grow with more attractive, more profitable customers, that is accretive. Private label, we had very good success leading up to COVID and have begun to see some good improvement in that again and are focused on that because that's a great win-win for us and for the customers. Also around logistics continuing to expand our logistics network, deploying some additional routing opportunities within supply chain, which is, again, from a customer perspective, its service and its efficiency and effectiveness for us. and then really the assortment improvements that Pietro talked about on our last earnings call, which is around taking a number of products that are still moving out of our warehouses, which again helps the customer. Also so you see we're focusing on things that really are a balance of helping the customers and help our margins. So that volume and margin expansion are really both key enablers, we think, as we look ahead and look forward to first returning and then surpassing where we were from an EBITDA margin in 2019.

Right. And like you said, over 4 years, pre-COVID expanding by 90 basis points. If there was no COVID, I would assume your goal would be to expand by 10, 20, 30 basis points a year, whatever an internal target might be. But is there like a step function change because of COVID that all of a sudden you implemented these totally different initiatives that would lead to a potential jump up and creating a new floor that you then build off of? Or do you think it's back to kind of consistent small basis points every year kind of slow and steady improvement?

We do think there's some opportunities from some of the things Pietro talked about, some of the fixed costs we've talked about that we took out that are opportunities that we increased from. And so without focusing on a specific number today, we think that, first, again, just like you talked about earlier, just getting -- past COVID getting sales back, getting margins back. We don't see a reason, we don't get back to that and then continue to expand from there. And -- our focus, like I said, ultimately, is optimizing for EBITDA dollars in EPS, and we expect that balance to come from both top line growth and margin expansion as it did in recent years, which really gives the healthiest way to grow.

Yes. Right. Obviously, Margins are a popular topic for everyone. It brings me to kind of commodity and labor inflation. Just wondering kind of from a high-level perspective, whether you -- what you view as transitory versus permanent? Like, how do you assess when you're thinking about the impact inflation having on your business? Presumably, you'd be looking to pass on costs that you believe are permanent, maybe a little bit more debate on what's transitory, but at this point in this cycle and the fact that it's been with us for so long, like how do you think about commodity and labor in terms of transitory versus permanent?

Sure. Transitory, very popular word. I didn't think in the same year we'd be talking about necessarily both of them, but nonetheless. So if I start with labor on that one, so our expectation is that future years labor inflation will revert to more normal or historical levels of cost increases. So we think that a higher level this year through the temporary pieces with retention and signing bonuses, through some higher wage increases because of labor demand to be transitory in that sense, and we don't expect it to be the new norm every year going forward. So if I take that then and I take that to sort of margins, ultimately, we have -- as I talked about on the last call, we've had very good success early on and continue to focus on it with larger and smaller customers of engaging in some good discussions about improving margins. And so ultimately, our expectation is that even with the current year's higher level of cost inflation, TBD and how much of that remains permanent, but we would expect most, if not all of that, getting mitigated through margin improvement. So we don't think that the higher level of labor inflation in the current year has any meaningful negative impact on the ultimate profitability of the business. And in fact, it does provide a good opportunity to really engage in those discussions with customers. And as I've talked about before, some of those come in the form of margin increases, come up -- some of it come from just simplification in product offerings, fewer delivery days, et cetera, which help us service as well. If I move then to food cost inflation. As we've seen this year, commodity items, especially have been more volatile and especially in center of the plates and we would expect that to probably continue for at least the near term. Do expect inflation to remain at an elevated level, at least through this year and likely into 2022. And TBD, I think the crystal balls out there, unclear on what happens over time. I think with the product shortages, that's a little different dynamic than you have in a -- I'll call it a more traditional or normal inflationary cycle. So our focus really is on managing our way through it. And as I talked about in Q2 and then in Q3, I'm very pleased with the way we've been able to manage through it with gross profit per case in Q3, the highest level we've seen in a number of years. So strong performance there and working with our -- across our organization. Ultimately, a benefit that we do have is roughly 70% of our customers are on a contract. So unlike a lot of industries for food costs, specifically, that does pass through pretty automatically when those contracts reset, which are pretty short order from a few weeks to some month or so. And I think the -- so in each case, it's a bit of a watch and see, but we don't expect ultimate negative impacts in the industry as we look ahead of our business.

Yes, I think that's what's amazing and maybe not fully appreciated by investors is people question how it's possible if you'd be able to pass along all the inflation you're seeing. So it sounds like the 70% that are contract, that's just in the contract, they're not -- I mean obviously, they don't like it, but they're just dealing with it. The other 30%, is there pushback or is there risk to losing business? Or how do you think about it? Can we pass all this through? Or do we have to absorb some of this, again, transitory, structural kind of how you think about the remaining 30% perhaps?

Sure. Yes, Jeff. So you're exactly right on the 70%, it passes through. But on the other 30%, we have had very good success on that as well. And part of that is making sure we're providing our sellers with the right information so they understand why these costs are going up and then they can actually articulate and work with customers. One thing in restaurants, as you see increases, you see restaurants be -- Pietro talked about very resilient through COVID. But even outside of that, with inflation and such restaurants are quite resilient in portion size changes, menu changes, et cetera, to manage their way through it. So we are having a successful -- we do watch closely volume and margin. So if you go too hard one way or the other, we don't think it's a healthy way to grow and/or you can risk losing sales. So we manage them in order to ultimately optimize the dollars that we're generating.

And my next question is a differentiator for US Foods, the Cash & Carry business, which is a major asset that you guys operate at scale and your largest competitors don't. So a couple of questions on that front. Maybe if you could provide an update on the performance of the Cash & Carry channel, seemingly all now branded as CHEF'STORES. Maybe how are the customers interacting with the overlap between Cash & Carry and Broadline. Just trying to get a feel for, again, this point of differentiation that you guys have relative to the competitive set.

Sure. And just by way of a reminder, Jeff, the strategic rationale for the acquisition was in large part, accessing new independent restaurant customers that perhaps we weren't accessing before, perhaps more price sensitive, where I said the economics are very favorable from this channel perspective or different ethnic groups or fill-in occasions. And so we are now accessing that part of the business, which is in a more meaningful fashion and a part of the business that is growing well and profitable. But the other part that we found, this is what I call the 1+1=3 is our existing customers. What we found when we were doing this experiment in the south of the country with a handful of stores, which was then the impetus for making this acquisition, was we found that our share of wallet with existing customers was growing not only as a result of the fill-in occasions from them going to the store, which you would have predicted, but them growing share of wallet also through our delivered business. They were buying more from us on our truck than they were before. Once the Cash & Carry option became available. And I think that's just a share of mind and what you often hear from retailers in terms of the omnichannel strategy. So that one is really kind of an important benefit of this channel that was proven in the original experiment of 5 or 6 stores and that's proven itself as well in the Northwest where we made the acquisition of Smart Foodservice, once we converted the brand to CHEF'STORE and once we put the customer and seller incentives that help make our salesforce channel agnostic and help create awareness and trial on the part of our customers. So we're pleased -- so things have worked out as we would have anticipated. And then with COVID, this channel has proven to be an even more resilient channel because of the -- they don't have the requirements on small order size. So as you think of customers kind of edging back into normal business. This channel has done well. There's been a little bit of additional retail business, again, which for us is -- it's the existing business model, so we don't have to change anything about tapping into that. And as a result of all that, same-store sales, as we've said, have trended above 2019 and EBITDA is trending above 2019. So we're very pleased with the performance so far. And what we're focused now is the expansion of this channel to parts of the country we're not present, and the real estate team is very busy securing real estate for that.

I was going to say, geographically, when I think about your foodservice business and on your Cash & Carry business, from a foodservice perspective, are you now well equipped to be covering the nation? Or is there still geographies on the foodservice side that you could be doing some infilling on? And then the same question for Cash & Carry, although I get the feeling that based on looking for real estate and only 80 sites that there is a tremendous opportunity for lots of expansion. So maybe compare and contrast the geographic opportunity from foodservice and Cash & Carry.

Absolutely. So our footprint from a distribution center delivered business, which is still the lion's share of our business. We are pleased with our footprint, the acquisition we made a Food Group a few years ago, completed that footprint. Obviously, if there's opportunistic tuck-ins that come in over time, we'll take a look at those. But we are -- there are no gaps in our network like we had 3 years ago. On the Cash & Carry side, lots of opportunity for expansion. As I said, we have a handful of stores of 6 stores and Smart Foodservice, really very smart geography footprint on their part, very concentrated in the Pacific Northwest and expanding from there. So there, as we've said, we've seen an opportunity to double the footprint. We haven't specified a number of years, again, until we start putting down these stores in an accelerated fashion. It's hard to comment on the timing of it. But from the market share and real estate analysis we've done absolutely an opportunity to expand that footprint to other parts of the country. And the nice thing about this model, the Cash & Carry model that we acquired through Smart Foodservice, it's a smaller box that we were -- originally had in our experiment and the benefit of that smaller box is it's got a lower breakeven, lower capital cost and can expand to more trade areas than the big box that we were experimenting with prior.

Understood. The fact that it's meant to be a local service provider going from 80 to 160. I would think there's opportunity to go to hundreds or -- I mean it just seems like going to 160 is like just a baby step just trying to make sure you understand how to grow it before you can accelerate it.

We'll start with that, maybe step up doubling.

Absolutely. And on the balance sheet and leverage side of things, I think, Dirk, you've talked about target leverage ratio, I believe, of 2.5 to 3 turns. Maybe just talk about where it is currently and is the reduction of the leverage ratio going to be driven more by just EBITDA growth? Or are you really primarily focused on net debt reduction. Just trying to understand the strategy around cash usage and maybe any debt covenant restrictions you may be facing that might want you to have it paid down more quickly or whatnot?

Sure. So you're exactly right, Jeff. Our target ratio range is 2.5 to 3x. We've talked a lot about. That remains unchanged, and that is our target and our goal. We've -- third quarter, we were 4.8x levered, and that's down almost 3 turns from the first of the year. And that's through a combination of actual debt pay down, so the reduction in gross debt as well as EBITDA improvement. And as we look ahead, it really is a combination of those things that we expect to continue to reduce the leverage to that 2.5 to 3x target through actual reducing debt as well as increased EBITDA and are making good progress there. Cash flow of the business is very strong through the third quarter. Our cash flow was very similar to what it was in 2018, 2019 for similar periods, which on lower EBITDA is a great signal of cash generation and the strong cash generation that we expect to only get stronger as we move ahead in this business. From a timing and sort of amount of debt reduction, our debt is generally pretty covenant light. So we don't have a lot of restrictions there. Probably the main one is around our ABL kind of revolver facility and again, pretty limited there. So their interest is like our interest and like a lot of shareholders is really just that healthy reduction over time there. But we feel very good about where we're positioned and where we expect to continue to reduce it to as we move through 2022.

Understood. Right. It looks like we've got 2 minutes remaining. Just my last question, obviously, we talk to your shareholders and potential investors all the time, I'm sure you do as well. And I'm sure you don't want to share specifics on conversations with any particular shareholders. But is there any high-level color in terms of your ongoing engagement with shareholders, whether it increases or decreases in times like this? And maybe anything you can share in terms of engagement with shareholders more broadly would be very helpful, especially in the current environment.

Yes. I think you said it, Jeff, we can't comment on specific conversations with specific shareholders. But forms like these and conversations we do have with shareholders are really helpful in terms of shareholders understanding our strategy, as we talked about in the earnings call, we've kind of shifted now from -- in the middle of pandemic to a bit of a post-pandemic mind shaft -- mind shift, the 3 things that we've talked about today generally and on that call, market share to drive -- sorry, our strategy that drives market share gains with target customers, great track record on that front. Secondly, smartly optimizing gross margins, great track on that front. This year has been a really good year. Dirk talked about that. And then third, relentless focus on operational effectiveness and efficiency where we see lots of opportunity and the changes to the operating model that we've put in place, some of the changes to the team really very confident about the changes the future track record on that front. And it really comes out to those -- balancing those 3 things.

Understood. Well, we've only got 30 seconds left. So with that, I want to thank US Foods for helping to kick off our conference over the next 2 days. Pietro, Dirk, Melissa, thank you very much. Hope you have a great day of meetings, and thanks, everyone, for joining us this morning. Have a great day.

Thanks, Jeff. Thanks, everyone.

Thank you.

Thank you.