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

Thank you, everyone, for joining us a little bit late in the afternoon here. It's John Ivankoe with JPMorgan. We're very happy to have the US Foods team with us today. Pietro Satriano is the company's Chief Executive Officer; Dirk Locascio is the company's Chief Financial Officer; and Melissa Napier runs IR. JPMorgan is restricted on this name from a research perspective. So I'm going to deviate a little bit from my typical discussion style and ask a series of questions, which you do not infer any research bias whatsoever in the questions that I will ask. So don't be surprised as I just simply read through a list of questions and let the management ask -- answer them without any further color for me. So thank you, everyone, for joining us, and I look forward to hearing your thoughts.

So the first question, discuss what differentiates US Foods to other distributors? What factors create a selling proposition that will allow for a growth rate of 1.5x the market per share in the lucrative and competitive independent restaurant segment?

Great. Hello, John, and good afternoon, everyone. I'm going to take that question in 2 parts: first, what distinguishes us; and then secondly, I think your question about what drives our confidence in the 1.5x the market. So there's really 2 things that differentiate us versus most, if not all, competitors. The first is our footprint, our scale, which gives us competitive cost of goods from a procurement perspective and a footprint that allows us to attract some customers in different parts of the country that may not be as available to other competitors -- regional competitors. And then secondly, the second thing that differentiates us is our differentiated solutions. We've talked a lot about these in the past. Our technology, our innovative products, our team-based selling or team of experts, and they have really driven the kind of market share gains over the years leading into COVID that we anticipate will continue as we get out of COVID. So specifically with respect to the 1.5x the restaurants, John, if you look at our track record, with independent restaurants, we grew 4% in the 4 years leading to COVID very consistently. And that was about 2x the market. And what drove that was a reliable service platform, very competitive with other distributors and then the differentiators I just talked about in terms of technology, products and team-based selling. And every month, I spent time with new sellers coming in. We've been ramping up the number of sellers who've come into the company, as we've talked about. And many of them, not all, but many of them come from competitors, and they continue to talk about the advantages we have in terms of resources they have access to and our technology. On the national chain side of things, which is the other side of the 1.5x market share that we -- 1.5x the market that we call for, we've had good growth over the years, especially since the pandemic. A lot of our new gains of $1 billion in net sales have come from chain restaurants. And the thing that's very appealing about this segment today compared to perhaps a few years ago is the margin profile. The margin profile is much better than it was, much closer to health care and hospitality, the middle of that range that we've talked about over the years. And so that has increasingly become a good customer type for us to target, which is why we combined the 2 -- 1.5x independents and change. And then what makes us different is our operating model in terms of one point of contact, same level of interaction and service regardless of which division or operating company you're dealing with. I was touching base recently with a customer that joined us during pandemic, and they were comparing us quite favorably to their experience before. So that's a function of not just of our scale, but how we leverage our scale in a consistent service model.

Thank you. You presented a first look at your long-range plan through 2024 on your last conference call. What gives you confidence in your ability to execute this plan?

Sure. Maybe I'll start and then turn it over to Dirk. The first is the long-range plan that we presented, I'd say 3 things. It's very balanced around volume and EBITDA margin expansion, all of which lead to $1.7 billion EBITDA by the third year -- in the third year of the plan. So it's a balanced plan. Secondly, it really does build on some of the track record we do have in terms of market share gains that I just referred to and EBITDA margin expansion. We grew EBITDA margins 88 basis points in 4 years leading to COVID. And a lot of that success came from some of the initiatives or levers on the gross profit side of things. The third thing I would say is some of the changes we've made, where we haven't perhaps had as much success leading into COVID was on the operational efficiency side, and that's why we've made a number of changes to ensure that we have the same success there as we've had on the market share and gross profit side of things. And those 3 changes are I'll keep it short and let you ask more questions, John, if you'd like. The first is around the talent changes we've made and on the supply chain team, both in terms of the leadership team and at the different distribution centers. The second is the operating model and the changes we've made by going from 6 to 4 regions and creating these excellence teams that are really focused on driving standardization and driving support for improving underperforming markets. And the third is somewhat evolved approach, I would call it, to customer prioritization. Over the years, I think one of the things we did well was prioritize across different customer types, independent restaurants at the top, K-12 at the bottom as an example. But one of the things we've been working on over the course of the last year that started with some sprints that we did in the summer of 2020 is really prioritizing within those customer types at the customer level to ensure that we provide a differentiated experience for those customers who value it the most, while at the same time, removing some of the waste that is incurred by perhaps over -- by having more of a peanut butter approach. So I think those 3 things, talent, operating model and customer prioritization are 3 things that I think will serve us well from an operational efficiency perspective.

And prior to the pandemic, you mentioned 88 basis points, I have 90 in my notes. You did achieve 90 basis points of EBITDA margin expansion from fiscal '15 to fiscal '19. Could you talk about what did constitute the majority of improvement in margins over that period of time? And a number of things that we did talk about were things such as SKU rationalization, route management, backfill opportunities and sales force efficiency. Talk about what may potentially be in the future of a runway of what you've achieved in the past?

John, I'll take that. Thanks for having us today. As you noted, we did expand the nearly 90 basis points over that period. And we think the new plan for the next 3 years that we laid out, will meaningfully build upon that further. Our plan builds upon the success of the prior volume growth. GP expansion was a meaningful contributor to the margin growth over that time frame as well as very strong admin cost management. We are refocusing attention on supply chain efficiency where progress has been slower than we hoped. And we expect meaningfully stronger results in the coming plan. So to your point on what drove some of the successes. So some of the key value drivers really have been the market share growth, pieces that Pietro talked about, especially that's roughly 2x the market in independents, given the higher level of profitability that those customers come with. The gross profit margin expansion, we saw a significant amount of improvement over the 4 years. And it's a number of the things that we've talked about from private label penetration, their e-commerce penetration, our strategic vendor management, which is focused on improving cost of goods, the customer mix that we talked about as well as pricing and customer improvements over that period of time. So really, a number of the contributors and since you'll hear a lot of the consistency between that and the plan we're talking about now is really -- it gives you good examples of how we've taken the things that have worked, adapted them and really look to build upon them going forward. I think then when we think of the areas that I talked about refocusing attention and more on continuous improvement and process improvement, namely in supply chain, that's an area. So things like your increased backhaul, which also are a form of cost of goods reduction, further route optimization to reduce miles, those are things that we have done some of but have a meaningfully further opportunity to do there. SKU assortment or rationalization there. We had some successes prior to the pandemic, but I would say not near like we have had over the last year or so with the revised operating model and we would expect to have going forward. It's actually one of the good successes during this period of the operating model. And it's been the result of benefits the customer and the company. So really looking ahead, a lot of a number of the things are the plays we know how to run, and that's what gives us the confidence and ability to deliver the plan. And through the things that Pietro talked about, we think we've adapted and put change in place in order to continue to drive significant amount of sustainable value going forward.

And beyond just the efficiency side, or I guess related to that, just a different take on it, the lines per stop are a good proxy for the ability to gain share of wallet and driving wallet share per customer, which is key for increasing gross profit dollars per case or gross profit dollars per customer or per stop. Could you discuss your current strategy to ensure that wallet share is effectively captured relative to peers and the thought process and strategy behind acquiring new customers as well as adding stops to existing?

Yes. So we've seen progress, John, in terms of both lines per stop, but also cases per line. Both contribute to increased share of wallet. And in terms of the strategy that has been driving that is, as I talked about, being very strategic and surgical about the types of customers that we go after, customers who value what we bring and our value proposition, ensuring we have the right level of service for those particular customers and additional emphasis on the fresh categories, center of the plate and produce, which really drive a halo effect and drive increased share of wallet in other categories. Secondly, in addition to that kind of foundational service and fresh, the 3 things I talked about in terms of differentiation continue to be important: the product, the technology and the experts. And then the third, where we've made some progress over the last few years is our omnichannel offering. That's a combination of US Foods Direct, which has seen tremendous growth. That's our online marketplace, where customers who are ordering on our e-commerce platform can seamlessly order direct ship for items that might not be stocked in the warehouse, which, by the way, also has an operational benefit. And then as we've talked about, our CHEF'STOREs, which allow for customers to either fill in on occasions that may not meet minimum orders or attract a set of customers who have a preference for shopping that channel. And as you know, that channel because of its capital-light model is very accretive from a margin perspective. So all of those contribute to the increased share of wallet.

Gross profit dollars per case has been the highest it's been since 2016. However, deflationary environment, we're obviously in a very inflationary environment now, has the potential to impact gross profit dollars per case or at least gross profit margins per case. What changes can be implemented on either the supplier or customer side to mitigate the risk of falling GP dollars per case, especially in an environment where fuel prices may see spikes?

Sure, John. As you know, one of the benefits of our business and our industry is steady inflation over time is not a headwind because -- as it can be for others since we're able to pass this through to our customers with roughly 70% of our customers being on a contract and being basically a markup over our cost. So in a period now when our fill rates continue to climb back to 2019 levels, and we know that customers value our reliability and proper pricing, both from a contract and noncontract, is really important. Our teams have really done a good job through this in leveraging our process and analytics to have the right recommendations and pricing. And we think that, that process will affect well and allow us to manage well even in the event of some level of deflationary environment. We would expect during that any level of deflation could cause a little noise here and there, but we think we'll manage well through it. And then we do expect to continue to build upon the strong gross profit per case than we saw in 2021 as we look ahead. And then we think also in that period, our customers will continue to value the differentiation that we can offer and continue to grow those margins through some of the things that I've talked about here, whether it be strategic vendor management, private label, continued backhaul opportunities, et cetera. So that, combined with optimizing our customer mix and continuing to margin up some of the lower profitability customers all gives us the confidence in our ability to execute against this plan.

Are there comments that you would like to make about the current spike in oil prices?

What I would just comment, John, on that is as we go through that, so we typically do have a portion of our fuel that is locked in. The other portion that is at market. We have some of it that gets offset by surcharges we have in our customer contracts. So it doesn't necessarily move exactly the same, but it does mitigate some of it. And then during this period, things like our routing initiative will help mitigate some of it. Depending on how long the higher levels stay, then we consider that as part of our pricing process as we go through it. So we will manage through that as we would other levels of inflation or deflation and are watching it very closely.

You got this question on the conference call. Do you think the margin gap to Sysco can be closed?

So we're very focused on our EBITDA margins, John. We, I think, have demonstrated an ability to grow EBITDA margins over time, as I talked about at the outset, 88 basis points over the years leading through COVID. And at the time, the gap was 200 basis points. And so from where we were, we made good progress against that. And we believe that the opportunity is still there to continue to increase EBITDA margins and the initiatives that Dirk talked about, both on the gross profit side, which build on the success we've had and on the operational efficiency side, which are relying on us doing some things differently, we'll continue to grow EBITDA margins over the foreseeable future.

The rationale behind the Smart Foodservice acquisition was largely driven by the cash-and-carry market, which is growing roughly 2x your core delivery market and coming with higher margins as well. Could you discuss how US Foods, how you look to differentiate this business model with the omnichannel approach and how the operational requirements differ at the Smart Foodservice cash-and-carry business relative to the traditional business?

Yes. So we're very pleased with the progress we've made since acquiring Smart Foodservice. As you said, the rationale was around the part you mentioned, which is better margins and better growth. But as well, the revenue synergy that's associated with this channel and why it was particularly important for us. What we used to see prior to the acquisition of Smart and what we've continued to see is increases in revenue from customers, not just as a result of purchasing from that channel, but also increases in revenue from the delivered core business. So what I call the 1 plus 1 equals 3. And in terms of how to ensure that we leverage that solution, that channel, which I think we're very unique on: one, that's why last year, we rebranded Smart to CHEF'STORE to make sure that customers understand that this is the same company and as we expand to new geographic markets really makes the -- lowering the acquisition cost of existing customers or new customers new to the channel much lower for us. That's number one. Number two, ensuring that our sellers are incented to offer both the delivery channel and the cash and carry channel. So there's no channel conflict, and we've done that successfully in our legacy stores. And the third thing is providing advantages to customers in terms of pricing or billing that makes it a really seamless experience across both channels. And just having now that we have the team and the capability to expand capability and team, we feel like we're in a good position to accelerate the growth of this channel. I think as we mentioned, we've secured the real estate for new -- 4 to 6 new stores in 2022.

You went public with a strategy that was based on merchandising and technology. Could you talk about the technology piece, in particular, of how that has evolved and improved and has continued to allow a differentiated gap relative to your competition?

Sure. You're right. The Great Food. Made Easy. strategy that predates actually going public, but we talked a lot about being public was around product, technology and the team of experts, and the team of experts is important because it helps the customers take advantage of the products and the technology we have. I think over time, our technology offering has evolved. In the early days, it was primarily around order entry and e-commerce and a better user experience. Over time, that's evolved into offering recommendations to customers that -- for items that we believe they're buying from the competition and they could be buying from us or items that they may have purchased from us in the past and either did not purchase recently, what we call, Did You Forget. So that offering has continued to evolve, and we are actually piloting a new generation of that in market now. Secondly, it's the value-added services that -- some of which hang off that technology, so menu planning, inventory management, labor staffing. Some of those are tied to third parties. Some of those are owned, but they help create a management system for our customers to help them run their business. And then the third aspect of that technology that I talked about earlier, US Foods Direct, our online marketplace, which has, I believe, somewhere between 80,000 to 100,000 additional SKUs that are not stocked in our warehouse that really dramatically expand the offering for our customers.

And perhaps tied in that, could you talk about how the product part of product, tech and team of experts has evolved and allowed you to maintain a competitive gap?

Specific with respect to products, John, to make sure I understand the question?

Specifically related to products -- it's -- for example, the merchandising and marketing part of the value-added products that perhaps are unique to US Foods and the customers providing them solutions.

Right. So one of the things we did early on, as you know, is we streamlined the number of exclusive brands and created these brands. It's really stood for unique offering that was relevant to customers, that was on trend or help them save labor, brands like CHEF'STORE and old brands that have been renewed and refreshed like Rykoff Sexton. And we -- and those come to life in our 3 times a year Scoop program, which continues to do well in terms of trial rate, in terms of impact on basket, in terms of impact on profitability of the customers who participate in Scoop, continues to do better than the rest of our customers, which is why we continue to drive adoption of Scoop. The emphasis has shifted a little bit over time, as you mentioned. More emphasis these days on labor-saving products that is such a pain point for customers and more emphasis on plan forward, more sustainable offering, which has also become an area of increasing interest and appetite for operators. And I think the ultimate statistic of the success of that program, which continues to hold today is that almost 80% of the products that we've launched over the last 10 years that set this innovation offering under Scoop are still available somewhere in the country today.

Could you discuss capital allocation priorities in the buckets of spend in fiscal '22? How will returning capital to shareholders be prioritized over the long term while ensuring leverage goals are achieved?

Sure, John. So capital allocation, the priorities for us right now really are, first of all, to invest in the business and reduce leverage. So investing in the business. We talked about the level of capital spend being similar to what we've had in prior years. From an acquisition perspective, the 2 primary acquisitions that we were focusing on from a strategic perspective are the two that we did. And our focus right now is on successfully finishing the integration on those two since they're pretty far along. We will opportunistically look at tuck-in M&A over time, but our focus is on delevering and investing in the business there. As you pointed out, so we've talked about a target -- a leverage target of about 2.5x to 3x and that we expect to reach that in 2023. As we reach that target, we would expect to look at and potentially pursue other forms of return of capital such as share repurchases. And as I said, remain opportunistic on M&A. And really, it's their -- it's about the right acquisitions that are attractive at the right times, nothing imminent. But at that point, it really is a balance of these, and we expect to have leverage remain at that lower level within that target range for '23 and '24.

And that as we finish up, and I'm going to leave this completely open to you, are there any final thoughts that you would like to leave us with?

So thanks, John. I think maybe more of a recap of some of the questions you asked. And this first point, first takeaway, which we didn't talk a lot about is, this industry has really good tailwinds. It recovered remarkably from COVID. The -- this channel continues to gain share from the grocery channels from a tailwind perspective. And as Dirk mentioned, the ability to pass on inflation, this is a good category or industry for investors to participate in. And then secondly, in terms of some of the things, our plan, our plan is a very well-balanced plan that builds on some of the success and track record of the years leading to COVID in terms of profitable market share gains, increase in gross profit and the opportunity we recognize from an operational effectiveness and efficiency perspective. And with real change that we've brought to place over the last 18 months to ensure that from an operational efficiency perspective, we will deliver changes such as the talent changes I've talked about, the operating model and the approach to customer prioritization. So I think overall, very good story from an industry perspective and equally good story from a US Foods perspective.

Thank you very much. Thank you for your time.

Thanks, John.

Thank you, John.

Thanks, John.