US Foods Holding Corp. — Q2 2018 Form 10-Q
Reporting period: 13 and 26 weeks ended June 30, 2018, compared with periods ended July 1, 2017. US Foods distributes food and related products to foodservice customers nationwide and reports as one business segment.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net sales | $6.158bn | $6.159bn | $11.981bn | $11.947bn |
| Gross profit / margin | $1.114bn / 18.1% | $1.054bn / 17.1% | $2.106bn / 17.6% | $2.045bn / 17.1% |
| Operating income / margin | $205m / 3.3% | $127m / 2.1% | $308m / 2.6% | $203m / 1.7% |
| Net income | $126m | $65m | $193m | $92m |
| Diluted EPS | $0.58 | $0.29 | $0.89 | $0.41 |
| Adjusted EBITDA | $300m | $286m | $523m | $501m |
| Operating cash flow | $119m | $246m | $311m | $368m |
| Free cash flow | $58m | $208m | $193m | $260m |
Q2 case volume declined 0.9%, while independent restaurant case volume grew 3.8%. First-half case volume fell 1.6%; independent restaurant volume grew 4.0%. At June 30, cash and cash equivalents were $100m, total debt was $3.599bn, and shareholders’ equity was $3.020bn. The company had $1.154bn of available borrowing capacity under its ABL and receivables facilities, based on borrowing-base limits.
Changes and drivers
- Q2 sales were essentially flat; first-half sales increased 0.3%. Pricing and inflation lifted sales per case, while lower case volume—including selected planned chain customer exits—offset that benefit. Acquisitions also contributed to sales.
- Gross margin improved year over year, supported by margin initiatives, acquisitions and favorable LIFO comparisons. In Q2, the LIFO adjustment reduced cost of goods sold by $11m, compared with a $30m increase in the prior-year quarter. Higher inbound freight partly offset first-half margin gains.
- Operating expenses declined, primarily because amortization fell after completion of amortization on a customer-relationship intangible. Operating income rose 61.8% in Q2 and 51.8% in the first half.
- Interest expense increased as benchmark rates rose, partly offset by lower debt. A June term-loan amendment lowered borrowing-rate margins; related costs and write-offs added approximately $3m to interest expense.
- First-half operating cash flow fell $57m, reflecting a $35m incremental pension contribution, higher income-tax payments and working-capital movements. Capital expenditures were $117m in the first half.
Outlook, risks and unusual items
- Management said its fiscal 2018 outlook, as presented in the 2017 Annual Report, was unchanged. It cited continued focus on growth, customer differentiation and operational improvement. Expected 2018 capital additions were $330m–$340m, including approximately $80m in fleet capital leases.
- Management expected cash generation and borrowing availability to cover debt service, operations, working capital and capital spending for at least the next 12 months. The company reported compliance with debt covenants at quarter-end.
- Approximately 43% of debt bore floating rates after hedging; a 1% change in LIBOR and ABR was estimated to affect annual interest expense by about $15m. Fuel-price exposure remains: contracted diesel purchases covered about 29% of projected needs for the contracted periods, and a 10% adverse price change on uncommitted volumes could add about $6m in fuel costs.
- The first-half effective tax rate was 14%, including discrete tax benefits, notably a $17m benefit related to an IRS consent to change an accounting method. These items helped lift reported net income and are not necessarily recurring. Q2 effective tax rate was 22%.
- The company contributed approximately $70m to defined-benefit and other postretirement plans in the first half, including $35m above its original plan. The incremental contribution reduced the pension obligation by approximately $33m through remeasurement.
- On July 28, 2018, after quarter-end, US Foods agreed to acquire SGA’s Food Group Companies for $1.8bn in cash, subject to customary conditions and regulatory approvals. A $1.5bn senior secured term-loan commitment was arranged to help finance the deal.
- Commitments included $753m of product purchase orders and contracts for the remainder of fiscal 2018. Legal proceedings arise in the ordinary course; the company said adverse outcomes could exceed recorded provisions, though it did not expect an overall material adverse effect.
Important facts for investors to verify
- Whether case-volume trends and planned chain exits stabilize, and whether independent restaurant growth continues.
- How much margin improvement reflects durable initiatives versus inflation, acquisitions and LIFO timing.
- Whether operating cash flow recovers after weaker working-capital movements, taxes and pension funding; track capital spending against guidance.
- Debt-service sensitivity to floating rates, covenant capacity and the availability of borrowing-base collateral.
- Regulatory approval, financing, purchase price and integration risks for the announced $1.8bn acquisition.
- The recurrence of discrete tax benefits and the ultimate resolution and possible cost of legal contingencies.