US Foods Holding Corp. (NYSE:USFD) Q2 2023 Earnings Call Transcript

US Foods Holding Corp. (NYSE:USFD) Q2 2023 Earnings Call Transcript August 10, 2023

US Foods Holding Corp. beats earnings expectations. Reported EPS is $0.79, expectations were $0.76.

Operator: Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the US Foods Second Quarter 2023 Quarterly Earnings Conference Call. [Operator Instructions] Thank you. Adam Dabrowski, Director of Investor Relations. You may begin your conference.

Adam Dabrowski : Thank you, Rob. Good morning, everyone, and welcome to US Foods second quarter fiscal 2023 earnings call. Speaking on the call today, we have Dave Flitman, Chief Executive Officer; and Dirk Locascio, Chief Financial Officer. We will take your questions after prepared remarks conclude. Please provide your name, your firm and limit yourself to one question and one follow-up. Our earnings release issued earlier this morning and today’s presentation slides can be accessed on the Investor Relations page of our website. During today’s call, and unless otherwise stated, we are comparing our second quarter results to the same period fiscal year 2022. In addition to historical information, certain statements made during today’s call are considered forward-looking statements.

Please review the risk factors in our 2022 Form 10-K for a detailed discussion of these potential factors that could cause our actual results to differ materially from those anticipated in those statements. Lastly, during today’s call, we will refer to certain non-GAAP financial measures. All reconciliations to the most comparable GAAP financial measures are included in the schedules on our earnings press release as well as in the appendices to the presentation slides posted on our website, except that we have not provided a reconciliation of forward-looking non-GAAP financial measures as indicated therein. Thank you for your interest in Food, and I’ll now turn over the call to Dave.

David Flitman : Thanks, Adam. Good morning, everyone, and thank you for joining us today. It’s hard to believe that I’ve already been at US Foods for seven months. During this time, I have continued my focused effort to get deeper into the business and interact with more of our associates, customers, suppliers and investors. I’ll start today by sharing highlights for the quarter and progress against our strategy and long-range plan before I hand it over to Dirk to review our financial results and updated fiscal 2023 guidance. We remain intensely focused on executing our long-range plan, and it showed in our strong financial results again this quarter as we delivered record adjusted EBITDA of $432 million. We achieved 17% adjusted EBITDA growth through a combination of profitable volume growth and margin expansion.

Additionally, we delivered healthy total case growth of 3%, led by 5% independent case growth, underpinned by 5.5% growth with broadline independent restaurant customers, along with 7% healthcare and hospitality growth. This is the ninth consecutive quarter our team has gained independent market share. Finally, we accelerated cash flow generation through our earnings growth and working capital improvement. Our strong cash flow year-to-date has allowed us to invest in the business for organic growth, prepay additional term loan debt and return capital to shareholders via share repurchases. As a result of our strong performance for the first half of the fiscal year and continued momentum, we are increasing our full year earnings guidance, which Dirk will share leader.

My expectation is that we will continue to execute our plan and build upon our strong momentum. Now let’s turn to Slide 4. Our strategy guides how we operate and what we focus on to win at US Foods under our four pillars of culture, service, growth and profit. Last quarter, I introduced the simplified model, which is much clearer for our associates, so we can be more action and outcome-oriented across the company. These changes are resonating with our organization and are helping us remain focused, which contributed to our strong second quarter results. The other key change I made was to our organizational structure, bringing our four region presidents on to my management team, and that change has been outstanding. Having them at the table has improved communication between our functions in the field and streamlined our decision-making regarding execution of our broader strategy.

I’m going to briefly focus on second quarter progress points against the culture and service pillars, and then Dirk will talk about the growth and profit pillars later. Turning to Slide 5. The first pillar is culture because our culture and our people fuel our strategy. Instilling a stronger safety culture has been a focus since the day I arrived at US Foods. I am pleased to say that we have made very good progress in just seven months. Our second quarter year-over-year results improved approximately 20% compared to the prior year through a combination of tone from the top and focused programs to drive results. We have good early momentum with significant opportunity remaining. On a related note, I would like to recognize the 13 US Foods drivers who were recently named to the International Foodservice Distributors Association Truck Driver Hall of Fame.

This prestigious accolade is only awarded to those who have exceptional safety records, including 25 years of service without an accident. What makes this year even more special is that Alicia Seyler, one of our drivers based in Loveland, Colorado, with 27 years of service was the first-ever female driver elected to the IFDA Hall of Fame. We are proud to have these world-class drivers dedicated to safety at US Foods as we strive to provide our associates, customers, business partners and the communities we operate in with a safe and hazard-free environment. Additionally, we recently published our 2022 Corporate Social Responsibility Report and I am proud that we have made continued improvement across our three focus areas of people, product and planet.

I encourage you to go to our website to read about our progress from our sustainable products, the US Foods scholar program to our compressed natural gas trucks and Scope 1 and 2 emissions reduction. Moving to service on Slide 6. As a reminder, our research tells us that the most important services to our customers are on time, correct orders and high-quality fresh products. Our product service levels to our customers are back in line with pre-COVID levels. Vendor service levels to US Foods have also steadily improved. However, they remain slightly below pre-COVID levels. This progress is yielding positive results from a service level perspective and is also helping us reduce our working capital. Our routing initiative continues to make progress.

And in the second quarter, we delivered the best cases per mile metric in the last three years. We are also preparing for a pilot of our new routing software later this year, which will significantly increase our capabilities. I look forward to our learnings and the progress we will continue to make. Finally, MOXē, our digital customer platform has now been fully rolled out among our local customers and feedback continues to be very positive as are our Net Promoter Score results. Turning to Slide 7. I’ll walk through our second quarter highlights in a bit more detail. We grew adjusted EBITDA by 17% despite essentially no sequential inflation and, in fact, modest year-over-year product cost deflation, driven by center-of-the-plate categories.

Our adjusted EBITDA margins also increased 60 basis points from the prior year as our initiatives continue to ramp up, and we gained operating leverage this quarter. Year-over-year, total case volume growth was healthy at 3%. Case growth was led by 5% growth in independent restaurants and 7% growth in both healthcare and hospitality while chain cases were down 4%. Our independent case growth was negatively impacted about 70 basis points from slower growth in our CHEF’STOREs as we work through a systems conversion which is largely behind us now. This means our broadline independent customer case growth was 5.5% for the quarter. The software chain results this quarter are primarily due to no longer lapping Omicron, the softer macro and the impact on same-store sales across most of our chain customers.

Healthcare and hospitality continues to demonstrate strong growth, driven in large part by helping net new business. We are pleased with how our target customer types continue to outperform the industry, resulting in share gains. With that said, we still have opportunity to improve performance as we focus on more consistent execution. We have good momentum and expected to further accelerate. Moving to our customer experience. We, again, gained year-over-year market share in our target customer types as we remain focused on executing our differentiated strategy. For independence, this is the ninth consecutive quarter of share gains, which demonstrates the progress we continue to make. I am happy to report that MOXē is fully rolled out to our local customers, reactions continue to be very positive, and we are releasing regular updates based on customer and seller feedback to improve this industry-leading platform.

We are now beginning to roll out MOXē to our national customers. This platform, combined with our other leading digital tools and service model will enable us to continue to service our national customers well and build it and convert a strong new business pipeline, especially in our target customer types. We also actively expanded customer usage of VITALS, our technology suite for healthcare customers to leverage added capabilities and help our customers more effectively manage their overall costs. Very importantly, we continue to make progress on our supply chain excellence journey during the second quarter. In addition to our improved momentum in safety, our productivity performance also improved year-over-year and sequentially for both delivery and warehouse, which is very encouraging.

I am pleased with the progress we are making and expect us to further accelerate that progress in the back half of this year and into 2024. Our flexible scheduling and seven-day delivery pilots are progressing well, demonstrating results in line with our expectations, including a double-digit percent reduction in turnover in each of our pilot markets. As I called out last quarter, our near-term focus will be to expand flexible scheduling broadly. We only roll out seven-day delivery opportunistically where capacity is constrained. Our team is actively working to expand the flex scheduling approach and we expect to have more than half of our locations live on flex scheduling by year-end, which we believe will further improve associate satisfaction and retention.

Finally, we continue to strengthen our capital structure and prudently allocate capital to fuel long-term growth. Through earnings growth and additional debt reduction, we lowered our net leverage to 3x, which is the first time we’ve been in our target range since it was established. Our debt ratings were upgraded by both rating agencies, demonstrating our strong progress and underlying business momentum. In parallel to the continued leverage reduction, we spent $166 million on share repurchases. Shortly after the end of the quarter, we closed on our first tuck-in acquisition in six years, Renzi Foodservice. As part of our continued investment in Renzi, we are slated to break ground on the expansion of our Renzi distribution center this month, which includes approximately 10,000 square feet of construction, providing additional loading dock space for 8 new refrigerated loading base to support our growing customer base in the area.

We are excited to welcome the Renzi associates, and I look forward to working closely with this high-quality team to drive future growth. Each of the actions we’ve taken on deploying capital in a balanced manner reinforces our commitment to being responsible stewards of capital to drive long-term shareholder value creation. With that, I’ll hand it over to Dirk to go over our financial performance and guidance in further detail.

Photo by Anna Pelzer on Unsplash

Dirk Locascio : Thanks, Dave, and good morning, everyone. Let’s turn to Slide 9. We are very pleased with what we accomplished in the second quarter and the strong momentum we continue to have at US Foods. Adjusted EBITDA grew $64 million or 17% from the prior year to $432 million, which was a record quarter for US Foods. In addition to strong EBITDA dollars, we expanded our adjusted EBITDA margin 60 basis points from the prior year as our gross profit grew significantly more than OpEx. Finally, adjusted diluted EPS grew 18%, which is also a record. Within our results, net sales were $9 billion in the second quarter, an increase of 2.1% over the prior year. Total case volume increased 2.7%, partially offset by year-over-year food cost deflation and product mix impact of 0.6%.

As Dave mentioned, case growth was healthy overall and especially in our target customer types. Case growth slowed from the first quarter, largely as expected, since we no longer had a year-over-year benefit from Omicron lapping in the second quarter. We faced a headwind to case growth in the second quarter, primarily from a system conversion at CHEF’STORE. However, we have largely worked through it at this point and are seeing sales improve. We are pleased with the 5.5% broadline independent case growth. We did see modest year-over-year product cost deflation, and it was driven by center of the plate as groceries still showed year-over-year inflation in the quarter. Essentially, we had no sequential inflation and still are not seeing deflation in grocery categories, which is encouraging.

Since grocery categories are predominantly a percent markup and more impacted by deflation compared to center-of-the-plate categories, which are largely fixed markups and not as impacted by deflation. We continued our strong gross profit performance this quarter as our adjusted gross profit dollars increased 9% from the prior year. Most of the strength is due to the excellent progress we have made over the past year on our long-range plan initiatives across cost of goods, logistics management and pricing. Our initiatives have been critical in mitigating the increased operating cost we and the broader industry have faced. OpEx was above the prior year for the second quarter, albeit significantly less than the increases we saw in the past two years.

The second quarter year-over-year increase in OpEx per case was largely driven by increased seller compensation and higher incentive compensation costs as distribution cost per case was better than the prior year. We continued our progress against both the growth and profit pillars, and I’ll spend a few minutes on each of these. We are focused on profitable growth and share gains in our target customer types, by leveraging our differentiated service model, digital capabilities and unique products. We are on track to exceed our 1.5x goal for restaurant volume growth for the full year led by strong independent case growth. In the second quarter, we drove year-over-year share gains in each of our target customer types and continue to develop a strong healthcare and hospitality new business pipeline.

As Dave mentioned, this was our ninth quarter in a row of independent share gains. As we grow faster with our target customer types, it helps our customer mix and drives profitability. Next to profit on Slide 11. In addition to profitable growth, we continue to make progress on our initiatives to increase EBITDA margins. Our team effectively managed a relatively volatile quarter for commodity categories as we leverage our processes and maintain our strong gross profit per case. At the same time, we further progress on initiatives such as cost of goods or COGS improvement by working jointly with additional vendors. We remain on track to address a total of 60% of COGS by the end of fiscal 2023. We continue to advance our efforts to drive operational efficiencies as productivity improved year-over-year and sequentially for both delivering warehouse.

Our flex schedule and pilots are progressing well and demonstrating good results. This powerful initiative has a twofold impact. It gives associates more scheduled flexibility and provides US Foods with better associate engagement and retention. Ultimately, this adds up to a win for our customers through stronger service. Finally, we are progressing with our indirect procurement work and have identified a number of opportunities, which we are pursuing and will ramp up further value creation in 2024. I’m now going to pivot from earnings to cash flow. Turning to Slide 12. We continue to increase our strong cash flow and expect to build upon this as we grow earnings. Our strong cash flow allows us to continue reinvesting for growth and to further strengthen our capital structure.

We have and will continue to prudently allocate capital against our core priorities to invest in the business, reduce leverage return capital to shareholders and pursue accretive tuck-in M&A to strategically expand our distribution network. Year-to-date, we have invested approximately $200 million of cash CapEx and fleet leases, including projects to expand fleet, improved analytic insights and improved technology and supply chain and sales to enable further organic growth. I’ll talk further in a moment on reducing leverage. In parallel with the debt reduction, we repurchased $166 million of shares in the second quarter, $150 million of which came from the KKR stock sale. Following this repurchase, we have $286 million remaining on our $500 million share repurchase program.

In early July, we completed the acquisition of Renzi Foodservice, and are excited to welcome the Renzi team to the US Foods family. This is our first tuck-in acquisition since 2017, and we are thrilled about the quality of this business and associates. Moving to Slide 13. We meaningfully reduced our net leverage compared to year-end 2022 through a combination of net debt reduction and earnings growth. You can also see on the slide the significant progress over the past 12 months. Our net leverage ratio was 3x at the end of the second quarter, which is the top end of our target leverage range. We continue to prioritize debt paydown and prepaid an additional $60 million of term loan in the second quarter, bringing us to $125 million of prepayment year-to-date.

Our overall debt structure is in good shape if we don’t have any maturities until 2025. That said, we’re looking ahead to the 2025 maturity and expect to proactively address that in the next quarter or two. Actions this quarter resulted in credit upgrades from both rating agencies. We remain focused on creating value for shareholders and allocating our capital prudently across the four parts of our capital allocation strategy. Now turning to guidance on Slide 14. As a result of our strong year-to-date results and outlook for the full year, we are raising our full year adjusted EBITDA range to $1.51 billion to $1.54 billion and our adjusted diluted EPS range of $2.55 to $2.65 per share. We remain on track to reduce leverage to below 3x by the end of the year.

We are well positioned to deliver against this guidance and expect to be at the higher end of the earnings guidance if the macro remains similar to what we’re seeing currently. With that, I’ll pass it back to Dave for his closing remarks.

David Flitman : Thanks, Dirk. I will close where I started. Seven months into my role, I couldn’t be more excited about US Foods and the opportunity ahead for our business. Slide 15 summarizes our investment thesis and why I am so bullish. US Foods is a strong company, and we continue to get stronger. We are a leader in a highly fragmented industry in a pure-play U.S.-only based distributor focused on broadline distribution. Our business is resilient across various macro backdrops and US Foods offers further stability through our laser focus on controlling the controllables and executing against our long-range plan. We are targeting independents, healthcare and hospitality for growth where we believe our differentiation adds even more value and we are seeing the results in our outsized growth and continued share gains.

This progress has been driven by the quality of our strong team, our service model and our digital capabilities, including MOXē. I believe these are all compelling reasons to invest in US Foods. We are focused on building on the company’s core strengths while finding ways to more effectively execute our strategy and accelerate our rate of improvement. I am confident this combination will lead to a very bright future for US Foods and all of our stakeholders. Finally, I would like to thank our 29,000 associates for their continued dedication and the excellent work they do each day to help our customers make it. Our associates are critical to our success which underscores why you matter is a very important one of our cultural beliefs. With that, Rob, please open up the call for questions.

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Q&A Session

Operator: [Operator Instructions] And your first question comes from the line of Mark Carden from UBS.

Mark Carden : So to start, it looks like you took meaningful market share in the independent channel, albeit with a bit of a slowdown in case growth relative to last quarter. Outside of some of the disruption with CHEF’STORE, which it sounds like you’ve largely worked your way through, what are you seeing with respect to the health of this customer overall? And any changes on how you’re thinking about the channel’s contribution to your growth in the coming periods?

David Flitman: Yes, I appreciate the question, Mark. We are seeing strong health of the operator and independents. And if you recall, I mean, we were expecting the performance that we had in the second quarter. If you recall, we had the Omicron lap go away here in the second quarter. And as we provided color last quarter, we saw some softness in the March that led into April. May and June got sequentially stronger. And while we don’t give quarterly guidance, I can tell you the start to the third quarter has been at or slightly above what we saw exiting the second quarter trajectory. So we feel very good about the health of the operator, but more importantly, our ability based on our differentiation to continue to take share in that segment of the business. And then besides that, healthcare and hospitality remained very, very strong. We’re taking share in both of them, and we have very strong pipelines across the board.

Mark Carden : That’s great. And as a follow-up, just on deflation, how much did deflation intensify as the quarter progressed? How much risk do you see it ultimately impacting your grocery category sales? And then when you think about next year and the $1.7 billion EBITDA target, is that contingent upon a return to a more normalized inflation backdrop? Or do you have enough with your initiatives to get that in a variety of scenarios?

Dirk Locascio : Mark, this is Dirk. So overall, the inflation deflation picture was pretty similar across the quarter. So you saw it changing really as you were lapping prior year. But if I think of it through the quarter, grocery overall still continued to see for the quarter a little bit of inflation. So we still haven’t seen deflation popping up there. And in the proteins, a lot of that is coming from the lapping of much more inflation a year ago. And as I said in my prepared comments, we’ll take that because those tend to be more fixed markups and our teams have very good processes to manage through it. So even in this environment of very little inflation or modest deflation, we think we’re very well positioned to manage through it. And as you’ve heard me say a number of times, as we focus on controlling the controllable, gross profit — the strong gross profit growth we driven is really predominantly been from a number of the initiatives we’ve executed.

Operator: Your next question comes from the line of Edward Kelly from Wells Fargo.

Edward Kelly : Nice quarter. I wanted to start with — I wanted to start on the cost side. You mentioned distribution cost per case better than 2019. I think we look at the progress in OpEx per case and the progress is very good. As we look out the next couple of quarters, I mean, it seems like OpEx per case maybe year-over-year is minimal growth at that seems like you might be entering a period. Can you just talk a bit more about what’s driving the cost per case on the distribution side down? Are we thinking about this rate going forward? Obviously, there’s puts and takes around wage inflation. Just any help there would be great.