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

Hi, everyone. Thank you for being here. I'm Brian Harbour, cover restaurants and food distributors, at Morgan Stanley. Real quickly for important disclosures, please see morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. And now we're going to talk US Foods. Dave Flitman, CEO; Dirk Locascio, CFO. Thank you guys for being here. Much appreciate it.

Thank you, Brian.

Maybe just let's begin real quick. Last week, so you said you were no longer going to pursue a transaction with PFGC. Maybe make some comments just on the drivers behind that. You did reaffirm, of course, all short-term, long-term guidance, but how does this affect any aspect of your strategy or your market approach going forward?

Well, first of all, it doesn't affect it in any way. And this was a distinct and separate piece of work. We wanted to take a look at it to see if there was industrial logic there, and if it made sense in any way. And there was really 3 key components to why we wanted to take a look and it had to do with potential synergies. Obviously, regulatory was a consideration. And importantly, from the beginning, this had to make sense for our shareholders. And what you saw last week was the culmination of that. What I will tell you is we had a point of view going into those discussions around synergies, and that was affirmed through the process. But at the end of the day, we decided it wasn't the right thing for our shareholders. So we, in fact, never did make an offer. But back to our business, the core strategy is intact exactly as it was. Importantly, you saw us announce just a new tuck-in acquisition on our earnings call. We haven't deviated from the core strategy, continue to grow the top line, take share in independent, health care and hospitality, which we've done for a long time and leverage that to double-digit bottom line growth and industry-leading earnings per share growth and that will continue.

Makes sense. Do you think the bigger M&A opportunities are more limited at this point in this industry?

I don't know that's true. I mean, obviously, the details matter around that. But importantly, what you see in the big 3 is about just a shade more than 1/3 of the market. So it remains a very highly fragmented industry. And importantly, for our strategy, it's always been about tuck-in M&A. We've done 5 of those in the last 2.5 years. There's a whole bunch of those that we'll continue to take a look at. And importantly, for us, it's about finding the right opportunity, a well-run company. Importantly, independent mix is important for us. But it also helps us scale in markets that we already have a position in. And as you look at those 5 acquisitions that we've done, that was the answer for all of them. It helped us take miles out of our distribution network and/or added an increment of capacity to help us in those local markets. And there's a lot of opportunities there ahead.

Okay. Got it. Maybe let's shift to demand top line drivers. I guess just a bigger picture question. Obviously, you serve a very broad swath of the U.S. food service market. So how are you feeling about -- then there's certainly mixed signals here, but how are you thinking about demand right now? How are you feeling about demand as sort of going into next year at this point?

Well, I think importantly, for a while, all of us have seen foot traffic challenged more than 2 years in this industry. And importantly, we've continued to execute our strategy and deliver our outcomes. I'm hopeful for next year, foot traffic will see a rebound. I think at the heart of it is consumer confidence, which has been challenged really since COVID. I think we'll need to see interest rates come down as a boost to that. I'm hopeful what may happen here as the month progresses. But importantly for us, we talked about it on our call, September was the strongest month of the third quarter for us, and we saw that continue into October. Overlay the government shutdown. We talked about choppiness. For us, importantly, we've got about 8% of our revenue is directly linked to government business, whether it's through the military or other government institutions. So that was the root of the choppiness. But importantly, since the shutdown is over, we've seen that growth recover to levels where we exited the third quarter. So we're actually quite encouraged that the government shutdown didn't have any long-term lasting effects once it was over, we're seeing the rebound.

Good. Okay. Yes. I mean data would also suggest that independents are doing better than chains. Also, I mean, we know very clearly that full service tends to be doing better than quick service on average. I mean do you have any views on why that is or what's driven that?

Well, I think it's a trend that's continued for a long time. I don't think it's new that independents have been taking share a decade or longer. I personally believe that's going to continue. I just think the independents lend themselves more to what diners are looking for, which is more an overall experience in dining. It ebbs and flows, and it's not that there aren't some chains that are strong and are going to do well. But I just think the game will continue to be won by independents, which is why we've got such an intense focus on it.

Yes. I mean, certainly, value prop, I think, has been a question for restaurants, too. I mean do you think independents have done a better job protecting their value prop in some way?

I think they have, and it is about that experience. And I think what independents have is a very loyal local customer base, where they've got relationships. They tend to live close by and I think that's at the heart of why the independents hold up very well, particularly in tougher economic times.

Yes. Are you also seeing your -- some of your full service customers doing a little bit better currently?

We are. I mean, we've got a big focus on casual dining, full-service casual dining, bar and grill is big for us. Those have been hallmarks of our focus with independents for a long time. And on a relative basis, they're holding up well.

Okay. The targets that you laid out last year, so 2% to 4% case growth over time, 3% to 5% in health care and hospitality, 5% to 8% with independents. What are sort of the puts and takes of getting to those in the coming year, which of those pieces would you say you have the most confidence in.

Well, I think when we laid out those targets at Investor Day, the independent targets was predicated on a normalized 2% foot traffic growth year-over-year, which we haven't seen since we laid those targets out. But importantly, we've got 18 consecutive quarters of taking market share. And when that foot traffic comes back and rebounds and it will, we're going to be very well positioned there. Health care is a little more agnostic to the economy and the ebbs and flows of that. You've seen us take share for 20 consecutive quarters there. I think that will continue. Hospitality, that consumer linkage, it feels a bit more like restaurants, in terms of how that ebbs and flows. But importantly, we continue to grow that faster than the market, and we've made some shifts in our targeting and hospitality. Historically, we've been over-indexed a bit to lodging. We've gone more down to entertainment and those sort of venues, and I think that will play out well for us in time.

Yes. And I mean those are the 2 segments where you probably have some pipeline visibility, too, because it tends to be kind of contracting business. Is that still robust as you sort of...

Very strong in both health care and hospitality.

Yes. Okay. Got it. Maybe explain the rationale just for moving to the fully variable sales force compensation structure and how you're kind of managing that changeover?

Yes. I can talk a long time about this. We've gotten a few questions about it, as you can imagine, since we announced it. So first of all, that was something I was contemplating since I joined US Foods 3 years ago in fact, and for me, it was about having the company in the right position, ramping up the execution as we had. And importantly, we felt like this was the right time to lean into that change. But there's a few important pieces that I think might have been missed when we first communicated it. First of all, we've been working on it all year. It wasn't a new thought. We've been thoughtful about what that needs to look like and the shape of the comp plan. And secondly and probably most importantly, and I think what's underappreciated we're moving from a 50-50 fixed and variable to 100% variable. No one enters our company today at a 50-50 mix. Everyone starts at 100% base, and then there's a click down process that eases those individuals into that commission plan. And it's a very individualized conversation and ramp based on whether they have industry experience or not, whether they've sold before or not, importantly, whether we see them with new business or not. So it really is a tailored approach. So you think about this move then, it's going to be very similar. So there's not going to be a date certain where we're going to say now here this and everyone is on 100% commission. There'll be a similar click down process. And importantly, in the meantime, we talked about this a bit on our call, we've got 4 pilots going on around the country. And those pilots are nothing more than running the new comp and the old comp to give visibility to the sellers around what that will look like if they don't change their behavior, we haven't changed anyone's pay. We're having those individual conversations. We may or may not learn some things that might tailor our approach to when we take it company-wide next year. But importantly, when we do take it company-wide, it will be a similar process to the pilots. We'll give them some lengthy visibility to what their comp might look like in the new plan before we make any changes, and then we'll ease people into that click-down process. So the reality is it may take us a couple of years to get the majority of our sellers on to a 100% commission. And for me, that's okay because it's more important that we start moving that direction than it is that we get there by a date certain. If that makes sense.

That does. Yes. I mean presumably, things will unlock sales. But I mean, is there any other behavioral change that this causes or will cause in your view?

Well, I think the way we've tailored it, we've simplified the commission plan. It's largely going to be based on gross profit per drop as it has been historically for commissions, but there's some kickers in there around independent case growth importantly, our exclusive brands and also Pronto acceleration. So it lines up perfectly with our strategy, right? Our sales force will be selling in the way that is consistent with what -- how we want to drive growth. And importantly, it will be simple and they'll all understand it.

Okay. And so it seems like some of the other initiatives like Pronto or driving private label. So do you think this will be an accelerant to those sales drivers that you laid out in 2024 as being key to your plan?

Right. I'm confident we'll look back on this in a few years and view it as kind of the final unlock to accelerating our growth.

Yes. Okay. Used to hire different people at all? Does it change how you hire people?

It may attract a different type of seller through the course of time. But importantly, we've got a home for all of our sellers that are with us today. Let me give you 1 example. I've used this, and it's helped resonate. Even as we move to 100% commission, we may have some sellers that have a very large territory and a ton of customer relationships, but they don't grow. And that's why these individual conversations are so important. That person, very important to the company may not fit in a 100% commission plan. We may move them more to a base plus of variable pay component versus 100% commission. So that's why we've got to be thoughtful about having these conversations and making these changes.

Yes. Okay. Makes sense. What -- I mean food inflation has come back in a few different pockets. Has there been any change in customer buying behavior due to that? I mean, are you -- is that potentially an accelerant for private label as we work through that.

I think, Dirk, you can chime in here. But I think we have seen our private label accelerate really since COVID when you think about all the costs. And these are great products. And importantly, they're cheaper for our customers and save them money, and it helps them in many ways. And so yes, I think that's part of why we've seen the acceleration in the past couple of years. We're really excited about our private label penetration and where it can go.

Yes. Let me shift to the cost side a little bit. Even in this year has been -- I think it's fair to call it still a variable sales environment, but you've actually probably over delivered on the cost side and certainly on bottom line. What's made the most difference in that? And I guess, what's kind of high on your list for 2026 when you think about the cost side?

Really, it's -- any year, we have things that we're working on across supply chain productivity, admin productivity and then the indirect spend. So it's the non-people, noncost of goods spend reduction. And it's all going toward our goal of 3% to 5% productivity per year. And so I'll just use a few examples this year. So one of them that we've talked a lot about is our Descartes routing system. So that will be fully deployed here by the end of the year. We've driven last quarter, a little over 2% improvement in cases per mile, and that is one where we think there's more opportunity still in the next few years. When you put it in as a new system, you only want to turn the dial so much to start with. So you don't change the customer experience all that much. So in that case, it's been a productivity improvement, but also the actual on-time performance the customer has improved as well. So that's been a driver. UMAs, which is our standardization of our supply chain operating system continues to deploy to more markets. That's been a positive for us. Our indirect spend that I mentioned is on track to deliver $50 million. We continue to in sort of the admin or back office selling type of things. Those that make most sense to be for full accountability. We're moving those into the field. Those that have scale across the network, considering to scale those, leverage technology. So there's not 1 thing. But really, whether it's that, whether it's gross profit or other things that drive market share. Each of them have a portfolio of activities that we're working and think of it as different stages of the maturity cycle.

Yes. I mean, do you think you've delivered on sort of just vendor management, some -- is there more of that comes next year as well?

Yes, there is. So there will be some that comes to the next 2 years, across all 3 years of the plan. As we said earlier this year, we see line of sight to exceed our $270 million target that we outlined. This is one where the team has done an excellent job. They've overdelivered on the initiative -- the vendors they worked with to date. And this is one where for vendors, it really is a win-win that we see between us and them with our gaining share and helps vendors drive there and grow their volume. We're looking for things that we can do to simplify the way we interact with them. And so vendors there as a result, are willing to compensate us more for that. So we think there'll be more there also. This is one where we've done this multiple times since I've been here so there's always further opportunity. You continue to get smarter on how you can improve the process over time.

Remind us where we are in Descartes rollout.

It will be fully deployed here by the end of the year across all of the markets.

And was your comment that even once it's fully deployed, there's sort of ongoing optimism -- presumably like the software kind of gets smarter as it learns your routing...

It does have some AI capabilities in it. And I think importantly, there's the opportunity to have more dynamic routing than we've ever had. And it was more event-driven where we had to drive it episodically throughout a quarter or throughout the year. And importantly, this helps us drive continuous optimization. So I think we will, now that we've got it fully deployed, continue to yield benefits.

Okay. You mentioned kind of the 3% to 5% annual productivity savings, anything else within that bucket that drives that? Or do we basically talk about the main things, but anything else that...

Those are some of the biggest. I mean, there's a variety of things, places where we put technology in that streamlines sort of what people have to do that allows us to operate those processes more efficiently. So there's not -- and most of these, a lot of times, we'll get asked, what are the 2 or 3 big levers. And distribution is typically not 2 or 3 big levers. There's a number of different activities. But the thing that we don't do after productivity is say, Dirk, I just need you to work harder versus how do we work smarter through either technology, process improvements or better insights.

I mean this year, you're slated to over deliver on bottom line versus your plan, what could cause that to continue as we go into next year? I guess, that's maybe the overarching question.

Well, it's really -- the thing that you're seeing us do again this year for really kind of the third straight year is execute our self-help story. I mean this is -- there's not a lot new. Like I said, some of the initiatives change that continue to mature through the process. But it's that balance of gaining share, especially with independent health care and hospitality, drive gross profit expansion faster than OpEx. And so that's what will continue to drive the next 2 years, and we're highly confident that we can deliver against this long-range plan and for a number of years to come.

I do really think, Brian, people under appreciate the amount of self-help and the line of sight that we have to that over the long term. And through the course of this year, we've talked about new initiatives that have come on. And as we go into '26 and '27, you'll hear more new things through the course of time as it just speaks to the length of that runway that we've got.

Okay. Do you still see good, I guess, not just on the sales side, but good labor availability, hiring has sort of been status quo, no real issues on that side.

Yes. No issues finding labor. We're back to pre-COVID levels of turnover with drivers right on top of it in selectors. So labor availability has not been a problem for the last year or so for us.

Okay. Got it. Maybe just on the tech side. What -- I probably have to ask this is 2025, but what are sort of the best uses of AI in your business today? Where are you seeing real benefit from that?

Well, I think the last comment that you made, those last couple of words are important. That's the way we approach it. What are the real benefit things that we can deliver in the business and it's really to aid growth and to help drive productivity, all while aiding and improving the customer experience. So I'll give you a few examples. On the growth side, in our last earnings call, we talked about did we put a new AI-powered search engine in place for MOXe, which is our digital platform. It's getting customers, better search results, which is converting into more sales from those items that they've searched in the past. It also frees up time for sellers so the sellers aren't answering those questions. The other piece that we're doing in that case is continuing to power our product recommendations, availability, inventory ordering, all with AI-powered engines, some of them from things we buy, some of them our internal team develops. And then productivity is using it against labor planning against our order guide that we talk about, which is our proposal process for local sellers and taking something that used to take local sellers roughly 3 hours to do that now takes them about 20 minutes. And so we let the machine do where it can help, but the seller still has the final steps in ownership of that process. So we're really looking for those things that can deliver against true benefit in the near term as opposed to what can be the great idea in 5 to 7 years. One of the things -- the internal development team as part of my group, we worked together with our digital team, but we -- a key part of success for us has been getting the AI development team very close with the business teams and the AI team some of your job is to help the business team with things that they didn't even know they needed and was it capable. And that really has been a big unlock over the last year to 1.5 years for us.

Yes. And so it sounds like those are things you've seen today, right? You're seeing actual time freed up for some of these people you're seeing better search recommendations.

We are. And I think just like we all know and see as much of sort of the latest generation is about 1 year, 1.5 years old. So I'm sure the things that are coming to life over the next 1 to 1.5 years will be more meaningfully advanced from there and already just even what our teams can do as far as stitching together different models that allow you to be more accurate, provide more effective outcomes is light years ahead of where it was not very long ago.

Yes. Are there also things sort of on the corporate side that like from your seat, does it sort of speed up processes and does it reduce the extent to which you have to hire people.

There are. There's some pieces there. I'd say we're earlier in the stage there. There are some pieces within, again, some of the software tools we have that have some AI capabilities embedded. And that's one where similar, I would expect that it will have a meaningful benefit as we go forward over the next couple of years.

Okay. How has warehouse automation gone...

I mean we're excited about it, just started up in July in Aurora. We've got about 50% of our volume in the Chicago market going through that facility, we'll continue to ramp it up. Obviously, with any new technology, there's a learning curve. But we're excited about what that means for the company for 2 reasons going forward. First of all, there's obvious productivity and efficiency gains that we'll get from implying -- using that technology. But secondly is the customer experience. So you think about the selection process now, people in the night warehouse, making product selections, palletizing product, putting it on trucks fraught with errors, right? Human intervention. This takes a lot of that away. You think about a product that doesn't get selected properly or put on the wrong pallet delivered to the wrong customer. Those sort of errors go away with automation. So not only will we see a productivity benefit, I think our customers are going to see a better quality and service experience as well.

Yes. So you've seen essentially lower error rates?

Exactly.

So far. Yes. Is the reliability good is what you'd expect? Okay. Maybe just a few kind of capital allocation questions so I mean leverage has come down, you're sort of within range. I mean, should we expect buybacks or kind of the main swing factor next year, more or less?

Sure. Well, we're quite pleased with where leverage is, I expect it to likely drift a little bit lower but more through earnings growth versus debt paydown because as you pointed out, our capital structure is strong and -- so really, we're investing in the business at record levels. So we're definitely not starving the business there at all. And so then you write it. And that's one of the things we like about the combination of the tuck-in M&A and the share repurchases is with the tuck-in M&A. You never know when that phone call is going to -- on the other end, result in, yes, we're willing to have a discussion, we're ready to sell or not. And if not, we'll continue to buy back our shares. And we still believe compared to where our stock should be and will be in the next few years that it's a good use of cash. And also within really a couple of years, almost 3 years into our capital return policy that another year of that will be a good use of our cash.

And how would you characterize the M&A environment right now aside from big M&A, which we know like for smaller things.

No, I think it's robust. And I think importantly, it is in our sweet spot, which is those tuck-ins hence the Shetakis announcement we made on our earnings call, the one in Las Vegas. That's our fifth in the last 2.5 years. Importantly, given the fragmented nature of the industry, we're kind of fishing where the fish are. And I think importantly, that local market density that I spoke about earlier is really the targeted play that we have with the tuck-ins. So I think we've got a long runway of doing those and the right deals that make sense for us.

And like that -- using that as an example. I mean you're already in that market, right? So is this sort of adding customer exposure, you are running out of space with your existing facility?

It wasn't a facility play. This was a market play. So you think about what we do in Vegas, it's equally split between independents and we have a relatively high share in the casino business in that market. And that's where Shetakis has played. So it was the right overlay for us in that market, made total sense. Now others that we've done have been more capacity play. We're always thinking about whether we expand or put steel in the ground versus an acquisition target. So it could be either. It just happened to be this was more of a market play for us in Vegas.

Okay. Got it. And other sort of like CapEx buckets so is there any sort of step changes you see, whether it's tech, new capacity fleet over the next couple of years, anything you'd call out.

No. I would say -- so fleet stays pretty steady. We target an age plus growth of the fleet. So we spend on that. Same with a lot of the aspects of maintenance, whether it be buildings and/or technology. Buildings in tech can ebb and flow a little depending on where different projects are throughout their life cycle within that particular year. But overall, I think we'll stay at a similar to where we have been as far as the split how we spend it. In most years, it tends to be pretty distributed of roughly 1/3, 1/3, 1/3 of fleet billings and technology.

Okay. Got it. I have a couple of sort of like bigger picture things. I mean, if I think like over the next 5 years, is there anything you see as more of a structural change in your industry or any like bigger trends that you're watching specifically.

On the technology?

Not just tech, sort of if I think about food distribution, where your customers are going, anything you think will be a bigger structural change?

Nothing that I would call out, Brian.

Do any of your customers ask about sort of adapting to GLP-1s? Or like how can you help, hey, we want like Max protein on our menu. Anything -- has that occurred at all?

We have those conversations with customers. I think importantly for us, the high-quality fresh product is 1/3 of everything that we sell today. So we're well positioned for any shifts in culinary desires driven by GLP-1. We really haven't seen a negative volume impact. I think all the data says people still go out to eat, they may take some of that home with them, but they're still going out for that meal and that dining experience with friends or family that will continue.

And that's 1 of the places our chefs and our menu design team will work with customers regularly on helping them, whether it's profitize on a menu, whether it's how to add new dishes or if you have certain proteins that are inflationary and other deflationary, how you do menu swap-outs and this is just another flavor of how they would do that.

Have you had to help customers adapt to tariffs on certain products? Or is that something you've had your salespeople worked on?

Well, I think importantly for us, tariffs is a relatively minor impact. We import mid-single-digit kind of volume. But importantly, it lends itself to things like our private label, right? To the extent there are -- we think of tariffs as just another inflationary impact on our customers, which really plays into our business model and what we do to help our customers every day, get more efficient, save time in their kitchens, take these great quality products in there and save them money.

Yes. Okay. Is there any changes in sort of the competitive environment that you've noted lately or think will happen in the near term.

Haven't really seen anything. We get asked that question a lot. I think at the heart of it is it's such a fragmented industry, Brian, that it's very competitive all the time. And things may ebb and flow in a certain market from time to time. But you step back big picture, I don't see the competitive dynamic shifting.

Yes, right? It's more market by market. Okay. I was going to finish with my lightning round questions. I think we've sort of covered these, but just to have it officially in the right so demand outlook relative to recent trends, how do you expect consumer demands over the next 12 months, accelerate, stable, decelerate?

I think stable to accelerate. And I think, as I said earlier, consumer confidence, interest rates key unlock to that, I think, going forward, and we'll see what happens, but I'm bullish.

Okay. Cool. And on the margin side, over the next 12 months, would you expect margins to face more tailwinds, more headwinds, balance of the 2.

So for us, it will be more tailwinds, but really driven by our self-help, more of the same of what you've seen in the last few years. Again, as Dave mentioned earlier, we think the competitive environment stays pretty neutral. So that probably is really all our own self-help continuing to come to fruition.

Okay. And on capital allocation, you kind of covered your priorities, but any of those buckets moving up or down in importance as you go into the next year?

No, all are important. We're going to continue to invest across all 3. And as I mentioned earlier, we're investing in record levels of CapEx for maintenance and growth of the business, and we think it's a very good use of our cash.

Okay. And 2 subquestions. CapEx for technology, increase, stable, decrease.

Stable to increase.

Okay. And lastly, focus on portfolio optimization, acquisitions or footprint rationalization increase, stable decrease?

Stable.

Okay. I think that does it then. We'll leave it there. Thank you, guys.

Thanks, Brian.

Thank you, Brian.