Performance Food Group Company (NYSE:PFGC) Q2 2023 Earnings Call Transcript
Performance Food Group Company (NYSE:PFGC) Q2 2023 Earnings Call Transcript February 8, 2023
Bill Marshall: Thank you and good morning. We're here with George Holm, PFG's CEO; and Patrick Hatcher, PFG's CFO. We issued a press release regarding our 2023 Fiscal Second Quarter Results this morning which can be found in the Investor Relations section of our website at pfgc.com. During our call today, unless otherwise stated, we are comparing results to the same period in our 2022 fiscal second quarter. As a reminder, in the second quarter of fiscal 2022, we changed our operating segments to reflect how we manage the business. The results discussed on this call will include GAAP and non-GAAP results adjusted for certain items. The reconciliation of these non-GAAP measures to the corresponding GAAP measures, can be found at the back of the earnings release.
As a reminder, in the fiscal first quarter of 2023, we updated our segment reporting metrics to adjusted EBITDA, from the prior EBITDA metric. Accordingly, the segment results for the second fiscal quarter of 2022 have been restated to reflect this change. Our remarks on this call and in the earnings release contain forward-looking statements and projections of future results. Please review the cautionary forward-looking statements section in today's earnings release and our SEC filings for various factors that could cause our actual results to differ materially from our forward-looking statements and projections. Now, I'd like to turn the call over to George.
George Holm: Thanks, Bill. Good morning, everyone and thank you for joining our call today. The momentum we saw in the fiscal first quarter carried through in the second quarter with solid top line results and larger-than-anticipated margin gains which drove a nice profit beat compared to our published expectations. We are also experiencing, very encouraging signs in the more recent weeks, with an acceleration in our case growth, particularly in the independent restaurant channel. Some of this improvement may be related to the impact from Omicron in the prior year period. However, we believe there are signs of more stable landscape to begin calendar 2023. Our business units, are also operating at a very high level, producing outstanding top line results while driving efficiencies to fuel our profit growth and margin expansion.
This aligns with our 3 main objectives which include consistent profitable top line growth, adjusted EBITDA margin expansion and leverage reduction. As you can see from our fiscal second quarter results, we are making progress on all 3 of these fronts. Which we believe will drive long-term shareholder value. This morning, I will provide a few thoughts on our business results, economic factors and our vision for the future. Patrick will then review our financials and guidance assumptions. As you will hear from Patrick, we are pleased to be raising the bottom end of our fiscal 2023, adjusted EBITDA guidance range, just the month we moved from the increase we announced at the ICR Conference. We also reiterated, our 3-year outlook and believe we are very much on track to achieve these targets in fiscal 2025.
In a moment, I will talk through the reasons that we feel confident in our outlook for this year and beyond. We have designed our business to be successful in a range of operating environments, with 3 distinct operating segments. Each with its own model characteristics and growth opportunities. We are already seeing the benefits from this structure and believe it makes us unique in the marketplace. A few thoughts on how each of these business units are achieving success. I will begin with our Foodservice segment. Strong operating results in Foodservice in the fiscal second quarter, were similar to trends fiscal first quarter. Our independent restaurant case growth outpaced independent industry growth yet again, offset by softer chain restaurant business.
As we have described, some of the softness and changes related to business we have exited. In addition, there is softness in foot traffic, that is producing lower same-store sales for our customer base. We believe, we have struck a good balance within the national chain account business, with a focus on profit contribution and return on capital. In the independent restaurant area, our results continue to impress. Our organic independent restaurant cases grew 4.3% and in the fiscal second quarter, just below the 4.6% growth, we experienced last quarter. We have high expectations for our independent case growth and are working hard to improve upon these numbers. However, in the context of the operating landscape and the market share data we receive, we are very pleased with our performance compared to the industry trends.
Once again, our growth in the independent restaurant case came from the addition of new accounts. In fact, new account growth exceeded case growth which is rare for our company. We are pleased with the pace of new account additions and believe that these customers will provide a long runway for volume, sales and profit growth in the future. Furthermore, in the month of January, independent case volume was quite strong. Which was certainly encouraging. However, we do feel our comparisons were impacted by Omicron last year. We're also seeing success in our performance brands which continue to do exceptionally well and once again achieved record levels of independent restaurant penetration. Company-owned brands have filled an important need for our customers, providing high-quality products at a good value and help with customer retention.
This helps offset persistently high year-over-year inflation without sacrificing quality. We continue to expand our company-owned brands with new product offerings and new categories. Inbound and outbound fill rates for Foodservice have continued their steady march forward. By the end of fiscal second quarter, inbound fill rates were approximately 97% for Foodservice, without bound fill rates approaching 99%. We believe there is still room for improvement on the inbound side. However, we are getting increasingly close to historic levels from our supplier community. Before moving on, I wanted to speak to the inflationary environment in Foodservice. Once again, during the second fiscal quarter, inflation decelerated month by month and ended the quarter at 9.6%, for our Foodservice products.
We continue to believe that inflation normalization is healthy for the market, our customers and their consumers and we are pleased to see the year-over-year inflation declining. Still, we must manage the dynamics closely, to remain competitive in the marketplace while not sacrificing profitability. We have systems in place to accomplish this goal and feel comfortable that we can remain successful in a decelerating inflationary environment. In fact, during the second fiscal quarter, our inventory holding gains were down year-over-year due to the decelerating rate of inflation. This was true in both Foodservice, Convenience and as a total company. This is to be expected and how we have modeled our full year guidance. Our ability to grow profit and margins without the same level of holding gains demonstrates our company's ability to manage through this environment and should provide confidence in our profit path in the quarters ahead.
Turning to Vistar. The recovery continues in many of Vistar's channels which is reflected in another strong quarter for the segment. Total Vistar case volume was up in mid-single digits, compared to the prior year period, driven by growth in multiple channels, including office, coffee and vending. At the same time, the theater channel did not quite live up to the high expectations for December, with several blockbuster releases not generating as much office revenue as was originally expected. Again, in the high-quality sales and profit results despite a slower recovery in the theater channel, speaks volume about the execution of that organization. Another encouraging sign for Vistar is the improving inbound fill rates, while still tracking well below historic levels, fill rates have moved steadily higher throughout the first 2 quarters of the fiscal year with inbound rates now in the mid-80s with outbound rates in the high 80s.
Suppliers have indicated that better access to raw materials and stability in the workforce are producing improvement in fill rate levels. There is still room to go but there is another tailwind working in Vistar's favor, that we believe will help support top line momentum. Finally, a few comments on our Convenience business. We are pleased with the direction of this segment and see significant profit growth opportunities in the years ahead. In the fiscal second quarter, Convenience did see a moderate decline in profit due to the lower inventory holding gains, that I just discussed. Excluding the inventory gains in both years Q2, Convenience segment's adjusted EBITDA would have grown nicely compared to the second quarter of 2022. I will also note that Convenience results -- Convenience results in the month of January were excellent versus January of 2022.
The Margin expansion in the Convenience segment is being driven by several factors, including better top line mix and operating efficiencies. We are particularly pleased with the growth of our non-nicotine portfolio which experienced another quarter of mid-teens sales growth year-over-year. We believe, that if a significant amount of shareholder value derived from the Core-Mark transaction, will come from PFG's ability to grow food and Foodservice-related products due to the convenience channel faster than Core-Mark could have, as a stand-alone company. We are seeing this play out in the market but believe it is still early days. We have a steady pipeline of potential new business in the Convenience space which we expect to produce consistent top line growth for the segment.
We're also right on track to achieve our 3-year synergy target of $40 million. We remain very pleased with how the integration of Core-Mark has proceeded and are excited for what's to come within the Convenience segment of our business. In summary, we closed calendar 2022 with good company results, beating our previously announced profit expectations through a combination of high-quality top line growth, positive product and channel mix shift and consistent productivity improvements. The operating environment has provided some challenges, though, it was steady through the quarter and we are seeing some hope signs early in calendar 2023. Our organization has done an excellent job driving efficiencies which has produced consistent top and bottom line results for the company.
Photo by Eiliv Aceron on Unsplash
While there is still some uncertainty in the broader macroeconomic environment, we believe our outlook for future is bright and there remains significant opportunity to keep our growth momentum going. With that, I will turn the call over to Patrick, to review our financial results and outlook in more detail. The CFO transition from Jim to Patrick has been excellent. It is typically a challenge to enter a new role and often even more challenging to exit. Jim and Patrick accomplished a smooth transition which has been seamless for our organization. Patrick?
Patrick Hatcher: Thank you, George and good morning, everyone. Our business results in the fiscal second quarter of 2023 exceeded our announced expectations. With sales in the quarter at the top end of the outlook, we discussed on our first quarter earnings call and adjusted EBITDA nearly $30 million above the outlook we provided at that time. Our operating performance has allowed us to build upon an already strong financial position. As George mentioned, this is my first earnings call in the CFO role for PFG. I'm excited to continue to help lead the organization to new heights and have entered my new role with a strong business position. Our main strategic priorities are unchanged and we will focus on 3 areas to drive value: Sustained profitable sales growth, adjusted EBITDA margin expansion and lower leverage.
I'm pleased to report, that we once again, made progress in all 3 areas during the second quarter and we are optimistic that this will continue. Before reviewing some of the financial highlights from our fiscal second quarter, I'd like to review 2 important areas: cash flow and leverage. Our organization has been diligently focused on driving strong cash flow which is an important objective in our growth strategy. Over the first 6 months of fiscal 2023, PFG generated approximately $425 million of operating cash flow, through a combination of our solid business results and improvements in working capital. This was significantly higher than our cash flow in the prior year period, despite tobacco purchases that occurred towards the end of calendar 2022.
We expect these tobacco purchases to be cash generative, in the fiscal third quarter of 2023. With this operating cash flow, we invested about $98 million in CapEx during the first 6 months of fiscal 2023. These capital projects are vital to our long-term growth and are primarily focused on increasing our warehouse capacity, improving supply chain technology and streamlining our operations. Investment back into the business will remain one of our top uses of cash and sustains our long-term sales growth and margin improvement objectives. After taking capital spending into account, PFG generated about $326 million of free cash flow in the first 6 months of fiscal 2023. The vast majority of this cash flow went to reducing the outstanding balance on our ABL facility.
This gets to another key priority, reducing leverage. Last quarter, we shared that we have reduced leverage to just below the top end of our 2.5 to 3.5x target range. We were pleased with this achievement, as we moved into our target range faster than we anticipated. This focus has continued to pay off and at the end of our fiscal second quarter, we achieved a 3.3x leverage ratio on a trailing 12-month basis. We believe that lower leverage, particularly in the current interest rate environment is a good value-creating use of cash flow for our investors and other stakeholders. Our balance sheet and debt position is strong. At the end of the fiscal second quarter, about 76% of our outstanding debt was at a fixed rate, including swaps we have in place against a portion of our floating rate ABL facility.
While our average interest rate on the ABL facility did move higher along with the broader market, we have mitigated a significant portion of our floating rate exposure. We are well equipped to manage the interest rate moves but keep in mind, that we would expect our average interest rate to move along with the market on the portion of our ABL facility that is not hedged. With that, let's review some highlights from our fiscal second quarter. As disclosed at the ICR conference, a month ago, PFG total net sales increased 8% in the second quarter to $13.9 billion which was at the very top end of the outlook we discussed during the first quarter earnings. Total case volume increased 3% in the second quarter, driven by growth of independent restaurants as well as gains in Vistar and a smaller contribution from an acquisition.
Total independent cases were up 6.6%, in the second fiscal quarter, while organic independent cases increased 4.3%. Outperformance in the independent case volume continues to reflect market share gains and new business wins in that important high-margin business. Total PFG gross profit increased 17%, compared to the prior year quarter. Gross profit per case was up about $0.81 in the second quarter compared to the prior year period. In the second quarter, PFG reported net income of $71.1 million and adjusted EBITDA increased 28% to about $309 million. Inflation continues to impact our business. And as George discussed earlier on the call, inflation continued to moderate to lower year-over-year inflation, in the Foodservice segment. Total company cost inflation was 10.3% in the quarter.
This included a 9.6% increase in Foodservice. Vistar inflation remained at the mid-teen level in the quarter while Convenience experienced inflation just above 10%. Inflation for both Vistar and Convenience, were very similar to what they experienced in the fiscal first quarter. We continue to expect lower levels of inflation through the remainder of fiscal 2023 which is the assumption embedded in our outlook. Our early read on January supports this view with inflation, particularly in the Foodservice segment continuing to slow. On a consolidated basis, inventory gains were lower in the second quarter of fiscal 2023, with a notable decline in Convenience and a smaller decrease in Foodservice, partly offset by a slight increase of Vistar. We are pleased with our total company profit result which more than absorbed, the lower inventory gains compared to the prior year.
We expect a similar dynamic through the rest of fiscal 2023 and into the first quarter of fiscal 2024. However, beginning in the second quarter of fiscal 2024, the comparisons eased considerably, based on our most recent results and expectations for decelerating inflation over the next 2 quarters. The company's second quarter adjusted EBITDA margins increased 33 basis points compared to the prior year period, a solid result in any operating environment. However, this margin performance was even more impressive considering the headwind from lower inventory gains. Excluding inventory gains in both periods, total company adjusted EBITDA margins would have increased even more year-over-year for the quarter. We expect net gains from worker productivity, including lower overtime and temp costs to help offset the inventory gain headwind over the next 3 quarters.
Diluted earnings per share was $0.46 in the second quarter and adjusted diluted earnings per share was $0.83. As you saw in our earnings release, we have reiterated our full year 2023 revenue outlook and raised the bottom end of our full year adjusted EBITDA range. This comes just a month after increasing the adjusted EBITDA range at the ICR conference and it reflects our confidence in the underlying business momentum and consistent execution from all 3 of our businesses. In the fiscal third quarter of 2023, we anticipate $13.7 billion to $14 billion, in net sales. We also expect adjusted EBITDA in the range of $270 million to $290 million in the fiscal third quarter. Remember that the seasonality of our fiscal third quarter typically reflects lower sales and profit in the months of January and February with an acceleration in March.
For the full year, we still anticipate net sales in a range of $57 billion to $59 billion. Adjusted EBITDA is now anticipated to be in a range of $1.27 billion to $1.35 billion, up from our prior $1.25 billion to $1.35 billion expectation. As George mentioned in his remarks, this keeps us on track to achieve the 3-year fiscal 2025 targets, we set at our June Investor Day. To wrap up, our company is in a great financial position which is reflected in our earnings results and financial outlook for the remainder of the fiscal year. We are making great progress on our 3 focus areas: sustained profitable sales growth, adjusted EBITDA margin expansion and lower leverage, while generating significant operating and free cash flow. Our organization is executing our strategy and we are well positioned to continue to create value for our shareholders over the long term.
Thank you for your time today. We appreciate your interest in Performance Food Group. And with that, we'd be happy to take your questions.
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