Q2 2019 Earnings Call
At this time I would like to welcome everyone to U.S. Foods second quarter performance your view.
All lines have been placed on mute to prevent any background noise.
There will be a question and answer session.
If you would like to ask a question. During this time simply press Star then the number one on your desk phone keypad. If you would like to withdraw your question grossed up balance sheet. Thank you.
Now I would like to turn over the call to be somebody suddenly ma'am the floor is yours.
Thank you very much Carol good morning, everyone welcome to our second quarter fiscal 2019 conference call.
During today's call Patrick Vettriano, our CEO and Dirk Locascio, our CFO will provide an update on our second quarter and first half of fiscal year 2019 result.
Well take your questions. After our prepared remarks concluded. Please provide your name your firm and limit yourself to one question.
During today's call and unless otherwise stated we're comparing our second quarter results to the same period in fiscal year 2018.
Our earnings release issued earlier this morning, and today's presentation slides can be accessed on the Investor Relations page of our website.
In addition to historical information certain statements made during today's call are considered forward looking statements.
Please review the risk factors in our latest Form 10-K filed with the FCC for these potential factors, which could cause our actual results could differ materially from those expressed or implied in those statements.
Lastly, I'd like to point out that 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.
And I now turn the call over to Pietro.
Good morning, everyone and thank you for joining us for our second quarter earnings call.
The positive momentum we saw in our first quarter results continued into the second quarter and we remain on track to achieve our 2019 full year guidance that we discussed earlier this year.
So let's begin on slide two with an overview of this quarter's results.
First from a volume perspective total organic case growth for the quarter was a solid 1.7%.
The result of strong independent case growth of 4.8%.
As well as improvements in the health care hospitality and the all other customer types.
Second we expanded our operating leverage for the 14th quarter in a row.
Gross profit out the operating expense by eight cents per case and that expansion and operating leverage as well as in line with the gains that we have achieved for the last three years.
Expansion in gross profit per case was driven by strong freight performance as well as the continued improvement in customer mix and private brands.
With respect to operating expenses, our continued focus on improving productivity.
Help maintain our operating leverage gains despite the continued tough operating environment.
Third we grew adjusted EBITDA by a healthy 6.7%.
And increased our adjusted diluted EPS by 12.3%.
As we look towards the second half of the year, we expect adjusted EBITDA growth to be similar to our second quarter results.
And we remain confident in achieving our full year guidance of at least 5%.
Finally, I would like to provide a brief update.
On the Sta Food group acquisition.
While the regulatory process has taken more time than we did originally anticipated we do expect this transaction to close in September .
As a result, we are launching financing for the deal later today.
And we will announce the leadership team for the show to be formed northwest region in the coming days.
Operating results for last year continued to be strong, which is a real testament to the commitment to customers. The rest your associates continue to demonstrate.
I also know from my own but that's the best year Associates are excited to join this truth and combine the strengths of our two companies.
Until we receive final approval from the FCC, you're not in a position to comment on it on any other aspects of this transaction.
Let's now take a closer look at our volume growth for the quarter beginning on slide three.
As I said total organic case real for us, 1.7% for the quarter accelerated sequentially for the sixth quarter in a row.
Starting with independent restaurants organic case growth of 4.8% was towards the top end of our outlook for the year.
Fill rates and on time delivery to our customers continue to trend above prior year.
And our own outlook for the industry as well is that some of the latest industry data remains positive.
We continue to feel good about delivering independent case growth at the high end of our 4% to 5% range for the year.
Healthcare and hospitality growth improved over prior year and came in at 1.6%.
Also in line with our outlook for the year.
We expect better performance with both new and existing customers during the quarter and we remain confident we will achieve our 1% to 2% case growth outlook for the full year.
Last in our discussion of volume for the second quarter. The all other customer type came in essentially flat at negative 10 basis points. We continue to trend in a positive direction with this group of customers and we expect to achieve our outlook of roughly flat case growth for the year.
Which does imply an acceleration during the second half.
Some concepts are performing better than others, which is consistent with publicly available data from black box and that truck, which continued to show negative restaurant traffic for chain operators.
Overall, the competitive environment remained stable and we are well positioned to achieve our case growth for the year.
Turning to slide four I'd like to give a quick update on two of the three elements of our differentiated platform.
Namely innovative products and technology.
First let's talk about our summer schools are three times your platform by which we launch innovative products that are new to the industry and exclusive to U.S. foods.
The theme of this summer school is anytime anywhere dining.
Hey, that's helping restauranteurs take advantage of the explosive growth and take up which has grown by over 300% since 2014.
The latest screw features a variety of sustainable packaging and to go food offerings.
Lastly, I'll skip our most recent analytics confirmed that customers, who purchase scoop products continue to have high retention rates and larger basket sizes.
Moving to the right our E Commerce platform continues to evolve and we now have over 60% of independent restaurant sales coming through E Commerce.
Your to your most recent analysis confirms that customers, who purchase three commerce continue to have high retention rates and larger basket sizes, we believe our leading technology. It gives us a competitive advantage, especially over the smaller players oversee our many in our industry.
And last we continue to expand our suite of value added services or what we call check business tools, We recently announced a new exclusive partnership with coast to coast as a cloud based point of sale solution that is one of the fastest growing in the U.S. integrate seamlessly with a myriad of restaurant management solutions, including some tools in our own portfolio.
We believe toast will further strengthen our offering a value add services, giving our salesforce and additional point of difference.
In summary, we can continue to improve both our product and technology offerings for customers and it is it is this differentiated platform that continues to support our profitable growth, especially with independent restaurants.
Before I turn the call over to Dirk I would like to close by thanking associates at U.S. foods for their commitment to helping keep our promise to our customers and helping them make it.
I'd also like to thank associates at last year food for their dedication and their hard work.
We are really excited to welcome Dan to U.S. foods.
I will now turn it over to our CFO Dirk Locascio for a walk down of our financial results.
Thank you Patrick and good morning.
Our business performance in the second quarter continued the positive momentum we experienced in the first quarter and we are reiterating our guidance for the full year as Pietro noted.
We're very pleased with our strong independent restaurant case growth.
And improvement in our operating leverage despite the higher cost environment, we continue to operate in.
Adjusted EBITDA for the quarter increased 6.7% and adjusted diluted EPS of 64 cents increased over 12% from the second quarter of 2018.
Starting on slide five.
Second quarter net sales were $6.4 billion, an increase of 4.6% from the prior year.
We experienced 290 basis points of year over year inflation and product mix.
And 170 basis points of case growth.
Inflation was across multiple commodity and grocery product categories.
And increases in commodities remained very manageable.
On slide six we delivered strong gross profit gains again for the quarter.
Gross profit was $1.1 billion.
2.5% increase over the prior year period on a GAAP basis, and 4.8% increase on an adjusted basis.
As a percent of sales gross profit was 17.7% on a GAAP basis and 17.9% on an adjusted basis.
This is 40 basis points lower than the prior year on a GAAP basis due to an unfavorable year over year change in the LIFO reserve and its flat to prior year on an adjusted basis.
Adjusted gross profit as a percent of sales was flat as a result of higher year over year product inflation as I noted in various commodity care categories as well as in grocery and would have increased almost 30 basis points, if inflation had been flat.
Our adjusted gross profit rate per case expansion was strong again this quarter up 18 cents per case, an acceleration from the first quarter.
The expansion as Pietro noted it was driven by a continuation of initiatives Weve discussed such as private brand penetration and freight optimization combined with customer mix.
Moving to operating expenses on slide nine Opex increased 4.4% from the prior year quarter to $948 million, driven primarily by higher wages acquisition related costs and depreciation expense.
Adjusted operating expenses increased $32 million or 4% over the prior year quarter.
And as a percent of sales was 13% a decrease of 10 basis points.
Adjusted operating expense as a percent of sales would have increased approximately 25 basis points without the impact of inflation on net sales.
We continue to manage through the supply chain wage pressures impacting us and others in the industry.
Our focus on reducing turnover and improving productivity is delivering benefits.
However, as we previously discussed these benefits do not fully mitigate the higher cost we are seeing.
Overtime, we expect that we can mitigate more of the higher wage costs as we execute against the initiatives on our supply chain roadmap, which includes our focus on continuous improvement.
On slide eight our operating leverage gain for the quarter was eight cents per case as a result of adjusted gross profit per case, increasing 18 cents and adjusted Opex per case, increasing 10 cents.
As Patrick mentioned, our eight cents per case of leverage expansion for the quarter is in line with the gains we produce consistently for the last three years and highlights. The continued work we're doing to meaningfully drive operating leverage expansion.
In the second half of the year expect Opex per case to be in line with our Q2 results and expect the drivers of our adjusted gross profit per case growth to be largely consistent throughout the year.
I'm now on slide nine adjusted EBITDA was $320 million in the second quarter up 6.7% over the prior year period.
As a percent of sales adjusted EBITDA was 5%.
An increase of 10 basis points over the prior year.
And the first time, we've reached a 5% adjusted EBITDA margin.
Adjusted diluted EPS increased seven cents or 12.3% to 64 cents per share for the quarter.
Adjusted diluted EPS again grew faster than adjusted EBITDA as we continue to leverage the strong free cash flow of the business to reduce debt and the associated interest expense.
Finally on the far right Q2, net income decreased 8%, while adjusted net income increased 13%.
The decline in GAAP net income was primarily due to a $25 million or higher LIFO charge that I discussed earlier.
Turning now to cash flow and net debt on slide 10.
Operating cash flow for the first six months of 2019 was $394 million compared to $311 million in the prior year.
The increase is primarily related to a prior year pension contribution of $70 million that did not recur. This year combined with increased operating results.
If you recall in Q2 2018, we accelerated our plan 2019 pension contribution amount in order to capture a tax benefit.
Our business again produced strong operating cash flow and we've continued to decrease our debt levels and improve our leverage ratio.
Net debt at the end of the quarter was $3.1 billion a decrease of approximately 244 million from prior from year end 2018.
And our net debt to adjusted EBITDA leverage ratio decreased to 2.7 times.
Moving to slide 11 for fiscal 2019, we are reiterating the guidance ranges that we provided in February .
But do you expect to be towards the high end of the adjusted diluted EPS range and at the low end of the interest expense range.
I'll now turn it over to Pietro for a few comments before we go to QNX.
So in summary, we had a good quarter with sustained positive momentum.
Adjusted EBITDA grew.
Sequentially volume growth was strong and expanding operating leverage.
So, let's now turn it over to questions.
At this time I would like to remind everyone in order to ask a question breast Star then the number one on your telephone keypad again, if you would like to ask a question breast Star then the number one on your telephone keypad.
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Your first question is from the line of John .
Heinbockel Your line is open.
But is that more lines per account.
As opposed to volume per comparable line number one and then secondly, whats happening to drop size.
I assume it's growing but.
What sort of magnitude.
So Jonathan unless I am I apologize the first part of your question cut out we don't we didn't hear it.
Yes. So the question was when you think about independent growth and you look at lines per lines per account right and cases per line. Im. Just curious is is most of that growth coming from new lines new items per account.
As opposed to.
Cases per per item.
Good morning, John This is Darren so we are seeing.
Coming from from both we're seeing an increase with.
Growth comes from our new customers as well as increases in our lines for drops our focus as we've talked about before is around balancing that growth from new and then things to improve on our same store penetration with existing customers.
Okay, and then maybe.
As a follow up the.
Curious on the step up in depreciation.
What is that tied to decide that is not that sort of a little bit of a change in trend and is that a one off or that's something tied to capital projects that will continue this year and into next.
Sure. So it's really two things it's a split of some of the more recent adds about a little shorter lived items and then there was about half of that increase that related to some acceleration of depreciation that wouldn't repeat in the future.
So think of it as some part of the increase of the increase ongoing and part of a non.
Okay. Thank you.
Your next question is from the line of Dan Fromer from Credit Suisse.
Hi, Thanks for taking my questions and congrats on the quarter.
Maybe first is there any way you could comment on kind of cadence of independent or total case growth during the quarter. Obviously, one of your big competitors kind of sighting.
Some issues on the independent K side and wondering if you maybe saw any benefit from their struggles there.
So thats good morning due to.
In terms of the cadence fairly consistent throughout the quarter.
When we look at where.
Internal.
Benchmarks, whether it's some of those that John just referred to whether we look at the growth across different geographies.
No real significant changes.
That we've observed.
And you know the from an external benchmark data.
We look at Technomic as we've talked about in the past and.
Their latest outlook came out just a few days ago and no material change from their perspective in the mid the mid term.
And really small decline in the short term of about 30 basis points, which could easily be margin forever. So.
So put all that together, that's why we say how our outlook for the industry continues to be positive.
Okay, and I know you.
So how have things been pretty consistent since then or since the deal was announced.
Yes, so in terms of their performance as you know there's there's not a lot. We can say given the extent of supply company, but I believe I did say in my comments that they had a strong the strong quarter I think last call. We said there their performance was in line with our expectations based on.
What we saw as the pro forma when we did the deal so from a performance perspective, we feel very good and in terms of.
Whats taken so long.
It's not a process we control.
It's a very sequential or linear process.
In terms of your answer one question and you answered. The next so it's I'm not sure we have more to add.
But we do feel.
Confident about September which is why we've you know.
Made a couple of decisions in terms of launching financing today, and an out and beginning to announce the various leadership teams that will be responsible for.
Elements of the combined entity.
Great. Thank you.
Your next question is from John Ivankoe of Jpmorgan. Your line is open.
So first capex looks slightly down year on year I was hoping that you could elaborate on that maybe you are preparing for ESG and delayed some spending and as we think about.
US foods and the overall combined entity going forward, how should we be thinking about capex as a percentage of sales as you think about near and medium term projects that you plan to spend.
Sure. Good morning, John So I would think of modest decline year over year really of timing throughout the year, we don't.
We expect to have.
So meaningful change in the amount of Capex spend that we have so this is not a deliberate.
Delay or change as a result of SJ and as we've talked about before our.
Capex as a percent of sales we wouldn't expect to meaningfully change as we go forward and then we will end 2020 as part of our more complete guidance we would provide.
So capex guidance as part of that as well.
Thank you and secondly, if I may.
Theres, obviously, a lot of discussions across you mendy mediaengine entities about using their supply chain and distributors as sources of efficiency I was wondering if there is anything on the healthcare and hospitality you decide to comment on in terms of your ability to protect your profit margin per account as we as we transition going forward.
So can you can you say a bit more about your question John Im not sure.
Yes understood yes.
So certainly in restaurants, which is primarily what I cover, but I was asking on the healthcare and hospitality side, if you've had any larger customers that have come to you.
You basically seeking efficiencies for their own organization and asking you to cut the profitability that you are making on them I mean, if that's if that's clear I can restated as if not.
Thank you and your ability to protect profitability per account. Thank you.
Yes, Okay again, I think the way I would say, it's a broad question is.
Is there pressure is there is there increased pressure on margins coming from large customers.
And the answer is look large customer's always exercised their their buyer power thats why its a less attractive customer types and some of the smaller independents right. We've talked about the difference in contribution margins.
But we do not see a significant change today from where we were a year ago or two years ago.
That's helpful. Thank you.
Your next question is from the line of Edward Kelly Offloads, Michael Your line is open.
Yes, hi, guys good morning.
Nice quarter et cetera, it's good to see that things that things are back on track.
Pedro I wanted to ask you first about as Jay and I don't know to the extent you're going to be able to answer this but there's there's been a significant amount of concern amongst investors at this point about divestitures.
Do you have clarity at this point on on how things will play out here and can you speak to the market's concerned at all about that.
Look I understand the markets can still have unfortunately, I cannot speak to it and here here's here's why.
Look until we have.
Final approval from the FTC there is some uncertainty and it would be irresponsible for customers for employees and for shareholders to kind of do essentially speculate on the ultimate outcome. So that's why we've commented on and off on those things that we have complete certainty about.
And were going to stay away from commenting on things on which we don't have complete certainty.
I think I did say, though.
We've made really good progress since the last call in terms of where we are in the process, which is why were more definitive about.
When the transaction will close than we could have been three or four months ago.
Okay, and then I wanted to ask you about about guidance.
So you maintained guidance today.
Do you have sort of talked about back half EBITDA growth sort of similar to Q2.
But you have easier execution comparisons in the back half on the topline you do start to ramp I guess some of those spreads start to lap some of those ramp and expenses.
It is it unreasonable to think that EBITDA growth could accelerate from here and maybe can you just discuss the puts and takes around there I mean, I know you had mentioned that the operational environment.
You know, it's still it's still more challenging so.
Just your thoughts sort of on on how we should be thinking about the back half and a bit more detail.
Sure. Good morning, So I think.
Yes, as we said we expect the back half EBITDA growth to be similar to Q2 and im confident our ability to meet our guidance I think the.
Do you think there's always puts and takes in any quarter in any year and just as an example in the second half so fuel moves from being a modest headwind to not and so theres theres.
Things like that that that helped a little bit, but ultimately again, we still expect the strong results like we had in Q2 I think when we think about second half overall sort of volume.
We have pretty good visibility there, especially on the larger customers because of the pipeline.
And I think that remains.
Consistent with what we've talked about very pleased with our gross profit performance and then ultimately in Opex. What we reflected is the more difficult environment and the higher cost comps that you're really will be there.
For the foreseeable future as the environment remains tight I think on that case, if there were to be some stronger our outperformance it would likely be an opex as.
We've talked about a number of initiatives around supply chain such as if we were to over deliver on some of those areas again coming back together just feel good about the outlook for the balance of the year.
Great. Thanks, guys.
Your next question is from the line of Kelly Bania of BMO capital.
Your line is open.
Hi, good morning, Thanks for taking the questions.
I guess in terms of the financing for for S.G., I guess moving forward with that.
Seems to signal some sort of.
Confidence it and not closing that we just haven't seen before so I was just hoping you could explain that in a little more detail are you. How can you finance this without certainty as to potential divestitures, maybe just explain that a little bit and then I guess related to that I guess rates have pulled back quite a bit in the last year, so any thoughts on how.
Got it that impacts your expected accretion from the transaction. Thanks.
Sure. Thanks for the question Kelly, So I think.
We are launching today you two comments is.
As Petro commented, we expect the transaction to close in September . So therefore, we have more certainty on the timing markets remain favorable and so there for one of your ready to go. So we will launch the financing it wouldn't draw until the transaction closes so its really thinking about being ready to go.
From a structure the structure of the transaction Thats a variable rate so ultimately what that.
Decrease in interest rates that would.
Then for 2020, we would include this guidance and our overall company guidance when we give that early next year.
Thank you.
Again, if you would like to ask a question Press Star then the number one on your telephone keypad. So last question is from the line of Jeffrey Bernstein from Barclays. Your line is open.
Great. Thank you very much.
Two questions one Pietro I know in your prepared remarks, you talked about a tough operating environment I wasn't sure. When you make that reference if you're referring more to the sales or the cost side, maybe you can give some directional or qualitative color there.
I was just trying to Chuck just oppose that with the I think you said some of the industry data remains positive I was assuming you're referring to sales, but wondering maybe what segments, specifically youre, referring to and then I had one follow up.
Okay.
Sorry for that the lack of clarity.
So I was referring to the cost side of things when we talk about the operating environment, We're talking primarily about distribution and so what we're referring to specifically is the very low unemployment rates that we continue to see resolved in.
More wage pressure.
And higher turnover, which then results in impact on productivity and training and tie it back to ads question that's why.
Derek talked about the.
Continued pressure from a cost perspective on the operating side of things which is.
Mitigating some of that good benefits, we're seeing from from the in the initiatives. We've made so it's purely in a nutshell its on the cost side.
Got it and the industry data that you referred to that you mentioned remains positive I was wondering is that there's a broad comment around kind of what technomic is talking about are nap and black box Scott what gives you the confidence in terms of that industry data.
Yep, so everyone sees.
Black box and Knapp track, which is as you know.
Really about larger chain competitors.
And that one has been as I said.
Spotty yields over the last period of time.
The impact on US is is much less because those larger customers tend to have lower margin profiles.
So what I was referring to in terms of positive outlook, what was the industry being consistent no change.
What I was referring more to the environment and outlook for independent restaurants, where.
You know we look at Technomic, we look at NPD data, we'll look at it by geography, and we really don't see significant change in the outlook I think I mentioned tectonic took their short term outlook down 30 basis points for an amount of restaurants from 1.8 to 1.5.
Thats really.
You know almost in the margin forever from our perspective so.
At this point our outlook for the industry and for independence in particular remains consistent with what we've seen so far.
Understood. Thank you very much.
Again, if you would like to ask a question Press Star then the number one on your telephone keypad.
Your last question. Your next question is from the line of Andrew Wolf from Loop capital markets. Your line is open.
Hi, Good morning, I wanted to ask about the gross margin per case.
The increase so if you could parse it out a little more in terms of well, there's mainly benefit of improved mix.
Oh or some of the operational initiatives, particularly I think you've been talking about central procurement started to become additive.
Sure. Good morning, So it's it's predominantly from the different initiative and focus areas that we've had and the two big areas that contribute to that are the although logistics or freight work that we've done as well as the private label continued growth in that which has a much higher margin profile and then.
Customer mix as a secondary contributor of that but they all contribute I think that as we look back over the last three years and the continued strong performance there.
Heard us refer I'd oftentimes a self help plan and so although there are some market factors the bulk of what drives the continued operating leverage gains are just internal initiatives and focus areas.
Thanks, and just I wanted to clarify something on one of your slides on ecommerce retention being 5% higher.
Just want to make sure I clearly understand that so.
Let's say the typical retention just make up a number is 90% or insurance had.
Oh for ecommerce it would be 95% with a 5% churn or is it just 5%.
Just a little better or is that actually that full 5% just trying to make sure I understand it accurately yet it's the former so you know in your hypothetical example, 10 versus five.
That's it for me thank you.
Thank you.
Your last question is from the line of Kelly Bania from BMO capital. Your line is open.
Hi, I forgot to ask one more here.
Just on the comments about X gene a with the reference to the operating results I think I think the references out there they continue to be strong.
Just curious if you have a sense for this state of some of the other smaller regional than private companies that you compete with is is that she had actually a an exception there in terms of their performance <unk>. It seems like you must be gaining some share from.
The smaller players at least in the independence. If if you kind of agree with that you know 1% to 2%.
Right there that technomic is throwing out there just curious your thoughts on that thanks.
Yep. So it does appear like we're gaining share when we look at our own case growth versus.
The two industry sources that I cited it's it's fairly consistent across the country.
And we don't know how the other players are doing and we assume that our share gains come from.
A variety of players in it just really depends on on the local competitive environment as to whether it's coming from you know.
In some cases larger players in other cases smaller players.
There is no when we do our conversations with the field to to support.
What we see quantitatively with some qualitative analysis, there is no real patterns that emerge Kelly.
Thank you.
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As for questions.
Operator.
There are no further questions presenters. Please continue.
Great. Okay. So thanks, everyone for joining us appreciate the questions.
And I wish everyone a good rest of the week. Thank you.
This concludes today's conference call. Thank you for attending you may now disconnect.