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

Okay. Thank you for being here, everyone. My name is Brian Mullan. I'm the restaurant and food distribution analyst here at Piper Sandler. Very happy to have the CFO from US Foods, Dirk Locascio. Dirk, thank you for being here.

Thanks for having us, Brian.

Okay. So I just wanted to start off with the underlying industry backdrop. In the second quarter, I think you shared total foot traffic at restaurants was down about 3%, and yet US Foods was able to report organic independent case growth 3.2%, total case growth, 5.7%. It's impressive. Dirk, have you ever seen US Foods operating this well before or at such a spread to the industry? And then related to that, just zooming out a bit, is there something in this current operating environment that is especially conducive to large players accelerating the share gains versus everyone else?

I'd tell you, we're pleased with our performance and ability to continue to gain share in independents for 13 consecutive quarters. I think the ability to outgain really is the combination of our overall technology platform, the products, our team-based selling, so you put that all together. But yet we know we have opportunity to continue to accelerate that performance over time. The foot traffic with the 3% that was leveraging some black box data, independents, we're seeing are holding up better than that. But overall, still not immune, so encouraging. Our team has been very focused on continuing to identify opportunities within existing customers, but in an environment like this has also significantly increased the onboarding of net new customers. And so you put those things together, and again, we think it sets us up for continued share gains for a long time to come as we look ahead. As far as the environment, I don't think there's anything in this environment that makes it more conducive for larger operators as opposed to when I think of US Food specific. Back to the points when we talk about the technology, the service model, the products. It's all about the customer at the center and how do we help the customer and more focused on helping the customer be successful. Those are things that help us continue to grow and continue to grow faster than the market.

Okay. And then I wanted to touch on some of the top line initiatives that you laid out at the recent Investor Day. Start with Pronto. You're starting to expand this to your existing customer base. I think you've launched 2 new pilots now with existing customers more to come later this year. Can you talk about the pilots? And how is it different when you go into a market with Pronto and target new customers versus existing customers? And what are you looking for to see in the pilots before you might look to do more with the existing?

Sure. Pronto is something that I and we are pretty excited about. So it's something that's in -- or to your point, targeting new customers, it's in 40 markets. It's on track to do about $700 million of business this year. It really allows us to serve more dense neighborhoods, customers that may need more frequent stops, more frequent deliveries. And this has really opened another avenue of sales for us for customers. And so they get the service of, say, a specialty provider, but yet to get the advantages of our larger SKU assortment, our broader technology, our innovative products, all those things that we can bring. And that's been just a success. And we think even there, we've had markets that have been live on the original Pronto for 5 or 6 years, and we continue to grow and continue to add trucks. So we're definitely not done there. But opening up to existing customers is an exciting next step for us. As you pointed out, we started with 2 store pilot. We've expanded to 4 additional -- sorry, 2 locations to 4 more distribution centers now. And really on this, the thing that we're studying more closely when their existing customers is just looking to make sure that we're not cannibalizing our base so that you're really getting the incremental cases and sales that we think. And any time you have a program, it's a new word like this, there's always going to be some things you learn from it. So we're making sure that we're looking closely to learn. And the early results from those first couple of locations have been quite encouraging. So we'll be thoughtful and go slow to go fast in order to expand. But I think this is a way to really provide a better service experience to our customers, increase our share of wallet and be another thoughtful accelerator of growth in our broader offering to customers.

At the Investor Day, you also talked about an AI-enabled digital pricing tool. I think there's a pilot going on in some of your markets. Can you just elaborate on what this is? Give any extra color or context on the genesis of this tool and what you've learned thus far and would be looking same question, like what would you be looking to see before you deployed it more broadly?

Well, I was -- I'll start with the latter part is. So we were very happy with the pilots we did. So we are in network deployment right now, and this will be deployed by early next year. And this is replacing an internal developed system for pricing with an industry-leading solution. It has some AI embedded in it. It allows us more flexibility, more granularity and ability to really balance that volume and margin equation to help us grow, but of course, make sure we're priced right with our customers. So it's just -- it's another capability that we have. And I think when you think of even how we're using and leveraging AI across our business, this is just one example of we're leveraging it in some of the new technologies that we're buying and deploying. And at the same time, we're developing internal tools such as enhancements to where's my truck, which uses some advanced analytics and machine learning to be able to provide better understanding of customers and predictions of the customer when their trucks are going to be there, and there's plenty more that we have on the horizon.

Okay. And I wanted to ask about specialty. At the Investor Day, you talked about the progress you've made over the last few years, specifically on produce. And I think you said now the team has an opportunity to focus more on proteins and grow that part of the business. Can you just elaborate on that opportunity a little bit? Where are you with your specialty protein offerings? And what are some of the things you are working on now on the protein side of specialty?

Sure. I think both produce and protein, important categories, but just demonstration of why we felt we didn't need to buy versus we had the good platform, and it was really about some enhancements to build in order to develop those produce, as you pointed out, has been one of our fastest-growing categories. We are underpenetrated. We're seeing strong continued growth there. And that has to do with investing in capabilities over the last few years. So we're not letting them off the hook there of continuing to grow at an accelerated pace. Proteins, we have a good base. I'd say that the 2 areas that we really are focusing on there is, one, just another step of further integration with our broad line. So we own both the businesses, so making sure we're connecting and focusing on sharing our sellers, our customers know the offerings we have. Making it easier for broad line customers to buy some of those stockyards or internal COP proteins. And then the second piece is just capabilities. So we have a good base but there are some places in the country where we have the ability to sort of build out some additional processing capability and again, have more offerings to the customer, both from a meat -- from a seafood perspective. So this will happen over the next few years. These are 2 important categories. And when you own those categories, you tend to have an overall larger share of the basket. So we're being thoughtful in the way we're doing it, and we think really that this path will set us up for even more success.

And when you say improve the processing capabilities, a silly question, is this in some of the cases just building new facilities, CapEx, new ground up? Or is it hiring people to be able to do --

Just mostly true building capital. I mean it's not a large number. Again, it's because you can really leverage unlike the broad line distribution, you don't need many of these facilities based on the footprint they can serve. So it's a little bit of incremental capital, and we think we'll be in good shape combined with the closer integration that we've already started with the broad line.

I want to ask on the health care part of the business. I think senior living is an area that's growing just given an aging population. You've -- you've talked about some of the changes to the VITALS program. And I think you maybe have grown the development team internally, too. So maybe could you just comment on all that and talk about your optimism around growing cases in this part of the business, health care. And then I know senior living is one part of it, but just it's a little open-ended there. But on your health care assets and how the business is doing in the growth?

Sure. Well, health care and hospitality are both key parts of our business. They're important in areas to grow. Within health care, as you've seen, we've been growing at a very healthy rate. It was almost 6% in the second quarter. And we are the industry leader in health care. We have a differentiated offering, both from the expertise and the service model we have with customers. So we have specialists, nutritionalists, the way we interact with customers, it's easier to do business with us, fewer touch points than, say, some competitors. We also have brought VITALS. We have a part of our technology platform that is focused just on health care, and it goes beyond just the interaction with us and the customer. It actually helps them manage patient feeding costs and helps them manage labor costs, understand retail performance. And so it's helping them manage their overall business. And then from an economics, we also have a decade-long partnership with a large group purchasing organization. That really allows for very good economics for the customers and yet it makes them still profitable cases for us as a business. And again, that relationship has been there for decades. It's in place contractually for a number of more years. And so we think it's an area because of our differentiation and ability to help customers in it. Health care operators, it's a tough environment to operate in. And the more we can help them be successful helps both of us continue to grow. So a long runway of growth there.

Then on the hospitality piece of the business, you've talked about growing the emphasis on the nonlodging part of the business. Recreation and entertainment, just speak a little bit, elaborate what type of customer is that? And have you been growing the business development team on the hospitality side as well like you did on the health care?

So hospitality, our focus to date has been more on full service lodging. And we have a good presence there. It's not going to be less of a focus. It's increasing the focus through some additional resources, as you pointed out in -- so recreation net and entertainment will be, whether it's sports venues, large theme parks, things like that to continue to grow again more in that broader base there. We have the ability to differentiate and drive the same service things that I talked about, largely apply in hospitality, our MOXe platform and our digital platform in order for those operators to be able to understand the analytics for their business, ease of interacting with us still applies there and similar relationship with another large group or organization that allows for attractive economics for both parties. So health care and hospitality are together a meaningful part of our business. We expect to continue to gain share and outgrow the market in each of those. Our focus for growth, as you well know, is around independent hospitality, and we'll be opportunistic with other customer types. And so we still have a relatively low share there and have a lot of opportunity for growth.

That's great. And then I'm going to ask on private label. At the Investor Day, I think you said and maybe even on the following call, but no ceiling in the near term that you can see in terms of the penetration that's exciting to hear. Using data to help stock more effectively expanding the assortment, maybe even relaunching certain categories in the field, these are the things you've been talking about. Could you just unpack that a little bit? Elaborate more on what the organization is doing and where it is in that process because you already have a successful business, but you're going to make it better on private label?

As you pointed out, we have a good platform. It's really increasing the focus and much of that has to do with the fact that supply availability has returned over this past 6 to 9 months. When we're coming out of COVID, many of the manufacturers struggle for the entire industry, it wasn't just our company to provide the inventory. And so therefore, sellers didn't have the confidence to go out and sell that private label. So there wasn't as much focus. Well, that's returned in the last couple of quarters, you've really seen that show up in our private label growth with our independent penetration increasing about 100 basis points year-over-year in the second quarter to 52%. Our overall business is penetration of around 34%, 35%, and that was up about 70 basis points year-over-year. So we are seeing that come to fruition. And it really is a focus. Sellers are incentivized as part of their program to grow private labels. It's a value for customers. It's more profitable for us. And we -- when we talk about category relaunches and some of those, again, it's all part of that focus. And with the availability and making sure we have the right focus, sellers understand, customers understand what our portfolio is. We are -- our category team is always looking and then there are products that get added here and there if we think there's enough of a sales opportunity through there. It's all part of our product development, a small team that we have there. But private label to your point, we don't see us ceiling anytime in the near term. And especially in this environment with when you think what operators have gone through and the challenges they faced. It's a good time for them and again, for our sellers to work through where those conversion opportunities are given the economic benefit and the cheaper price point it is for customers for equivalent or better products. And in many cases, the products that we're selling at a private label have some form of labor savings. So it can be partially prepared, so it takes some form of labor out as well for them.

Okay. And to shift over, talk about some of the COGS initiatives. At the Investor Day, you talked about an additional $260 million of COGS savings over the next 3 years. When talking about this, I remember Dave Poe talked about an evolution from strategic vendor management to strategic category management. Can you just elaborate a little bit in terms of what that means and what it means inside US Foods? And then how does that -- that evolution manifest itself in the business results and achieving the COGS?

So the cost of goods work and strategic vendor management and category work has been an important part of our initiatives set for a number of years and will be through this next long-range plan, as you pointed out. And so the category management focus is really focusing on more in-depth analytics and getting into certain categories where you have the way our pricing work is a buildup of all the inputs into there. Just being more strategic, more thoughtful in working with vendors on what those are, making sure that we're balancing more again that volume and margin with vendors and how do we grow those categories. If we're underpenetrated, more thoughtful on strategies to actually drive increases in penetration within certain categories. So I'd say it's not a revolution versus an evolution of just how that team works. And the way that shows up is just making sure typically, it's a form of improved service level. So working closely with our replenishment team. It's part of the assortment work that we do, making sure we're sorted properly for the types of customers we serve. And that we have -- if we have voids that we're filling those in with additional categories. And if we have products that aren't selling as well, that we're managing those as well, but typically, those are again around the tails and looking at it in that way. The other piece is, as you pointed out, the vendor management work around our actual cost of goods. And team has done an excellent job, well on track to deliver the $220 million in this long-range plan through 2024. And we've committed to $260 million in the '25 to '27 period. And that really is a combination of partnering with our vendors through improving our cost of goods, but also the win-win of growing as we're growing faster than the market and gaining share in our independent health care and hospitality, where you have more of an opportunity to influence the cases with customers there. It's helping these vendors in many cases, haven't been growing volume to be able to grow. So that's where we're in it together is working with those vendors for that combined growth. So good work behind us and plenty of good work still to come.

Okay. And then I move on the routing software. I hope I pronounced it right, but they're currently live in 8 markets going to 18 by the end of the year. You'll have 50% of your routed miles will be on the software. What's the biggest thing you were managing for when you're deploying this software? And I'm asking because you're phasing it in, it's just turning all in. And then is the intention to get to the rest of the markets by next year?

So I'll start with the end, yes, the intention is to be done with the rest of the markets next year and team is in full deployment mode for that now. But as you pointed out, being very thoughtful in the way it's been deployed, go slow to go fast at the beginning is what the team did. This is really taking our decades old legacy system and replacing it with a best-in-class system, which allows us to be much more nimble, more effective in how we route to customers. The way this shows up, it shows up in benefits from a reduced number of miles. So that helps from a productivity. But also when you have fewer miles, it improves typically safety results, so less chances of traffic and accidents and also typically results in a better on-time experience for the customer. Because again, really, the things that we're doing, many of them are all focused on sort of the customer at the center as we think about this. The -- with the Descartes deployment, one of the things that I am most excited about for this work is the fact that over the last 2 years plus, we've done what we refer to as market lead routing which had nothing to do with new technology. It was all around kind of increasing the collaboration between sales and supply chain and getting them working more actively than we have in the past. And because of that good work and sort of the record levels of cases per mile that we've seen in the last few quarters, I think that really has been a good foundation to set us up for the success as Descartes rolls out. And just because Descartes in, we're not done. We want to make sure that the customer experience is good or better early on, and we'll continue to work on optimizing it over time once it gets in.

Okay. Something that came up with the Investor Day, I'd like to explore more with you is the idea of a warehouse that is more automated or semi-automated. I think you've got a facility like this coming on next year, maybe one or 2 more over the long-range plan. You -- I think you've made some hires in the area. Can you just give us some more here? I understand it's really -- I don't want to get ahead of myself, but it sounds like it could be exciting and really impact the margin structure. So where are you with that? And help me understand what you're doing.

Yes. We are excited. We are in the midst of building our first partially automated facility outside of Chicago and it will be live to your point, the middle of 2025. And it really is our first foray into larger scale automation. So there'll still be plenty of associates in the warehouse. What it does though is it will work on making their jobs easier. So much of the product instead of associates are driving around on pallet jacks, the product will come to them. It will do much of the stacking of the pallets and then a lot of the loading will happen still by the individuals and certain items will still be picked. The other benefit of having this that we expect is a better quality built pallet, which impacts the driver. So the driver will spend less time in the back of the truck, moving things around, et cetera. So we think it will improve the driver experience and the customer experience as we go through here. I think the technology that we are using is not new, it's been around for decades. It's widely used in retail. The thing is, and because the last mile is so important in food service distribution compared to say retail, we don't run near as large of distribution centers as retail. So therefore, it's been more cost prohibitive historically, when we've looked at it what now costs have come more in line. So we're excited to bring it live and it's really less about does the technology work. It's more of, okay, what are the things we're going to learn is how it applies to our business and then how we apply it going forward. But we do expect this becomes sort of the first of what will be a number of uses of automation going forward.

If this works well and works how you hope, and I know we're going years down the line, would this be something where you would think any new build facility would have it most likely? And then -- but -- and then is there -- would there be any opportunity to go into an existing facility and deploy this? Or is that too difficult?

So assuming it works out, I would expect that, yes, this will likely be the norm going forward. And so this particular technology, the way you could retrofit it is if you had a facility that you were going to expand and so potentially the expanded area could have the automation in there because there are typically different ceiling heights, et cetera. But then there are other smaller forms that our supply chain team continues to explore using autonomous vehicles and other things to make an existing warehouses, the job easier for our existing associates. So I think we'll learn a lot over the next 1.5 years or so, and it's pretty exciting.

Okay. On the most recent earnings call, you announced additional cost actions. I think it was $80 million of savings for the year, $120 million on a run rate basis. Just where did those savings come from? And for clarification, is that separate from the indirect spending opportunity that you've been highlighting? Or is this a part of that?

Sure. I'll start with this does not include the indirect spend. So the indirect spend is ramping up. We're making good progress, and we'll give an update going forward on that. That is as you probably remember, that's a more than $1 billion spend bucket that we're expecting to ramp up to more than $60 million of savings by 2027. So the specific areas of cost that we have focused on so far this year that we've talked about is largely around people costs and then some areas of nonpeople costs, but in the areas of people, it really has continued a lot of what you've heard Dave talk about of. We have gotten a lot of functions that we had centralized but where the core execution was still in the field. So we had created a lot of spans and layers in between and I'll compare. So for example, some of the sales functions where they reported into centralized teams, but yet the execution is at the local level. So putting that reporting relationship and those resources back into the field, and when you do that, you don't need some of the intermediary types of oversight and such. And we still have some small teams of excellence that are driving process improvement, but it's really around narrowing the focus, simplifying some of those things. and putting back into the field locations in some of those areas where the local leadership team is closest to the execution. So it's not frontline sellers, and we're always keeping the lens of not harming the business when we do these things.

Okay. I wanted to ask about the balance sheet. You actually lowered your targeted leverage range to 2 to 3 turns at the Investor Day. I think you said you expect to be at the lower end by 2027. That caught my eye. Would that put you at investment grade? And do you think that this has been fully appreciated by investors just if you were able to get down to 2 turns because to me, I think it would be it's impressive to be able to do that while you're investing.

Well, when I look back over time, I'm thrilled for us to be at this kind of well within our new range of the 2x to 3x and I think it really shows just the strength of our overall capital structure, our balance sheet. And over time, I commented that we do expect to drift lower on leverage more through earnings growth, not through debt paydown, just because of the strength that we're starting from in that case. And what this allows us to do, whether it's investment grade or not, I think what it will show is you show that very healthy leverage range, a well-laddered capital structure and then the strong cash flow of the business, just how well positioned we are. And the thing that we're using that flow is to continue to set the business up for investing for organic growth, opportunistic tuck-in M&A and more investment in share repurchases. So capital structure, excited about the future and deploying the cash flow to all those areas.

All right. Well, thank you, Dirk. We'll leave it there.

All right. Thank you Brian. Appreciate it. Thanks, everyone.