US Foods Holding Corp.

Good day and thank you for standing by. Welcome to the Q2 earnings call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference If you are required and for your assistance, please press star zero. I would now like to hand the content over to our speaker today, Ms. Melissa Nathier. Please go ahead.

Thank you, Angelica. Good morning, everyone. Thank you for joining us today for our U.S. Foods second quarter earnings call. Pietro Cetriano, our CEO, and Dirk Lacascio, our CFO, will provide an overview of our results for the second quarter and first six months of fiscal 2021. We'll take your questions after our prepared remarks conclude. 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 and first half results to the same period in fiscal year 2020. References to organic financial results during today's call exclude the contributions from Smart Food Service through April 23rd, 2021, as the acquisition closed on April 24th. 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. is review the risk factors in our 2020 Form 10-K for those potential factors which could cause our actual results to differ materially from those expressed or implied in those statements. And 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. And I'll now turn the call over to Pietro.

Thank you, Melissa. Good morning, everyone, and welcome. So during today's call, we are going to cover three main themes, just like last time. First, the industry recovery that we spoke of on our last call continues to progress. Restaurants are welcoming customers back into their establishments as restrictions have been lifted across the country. And U.S. Foods continues to participate in this recovery in a meaningful fashion. Second, a great food made easy differentiated platform is helping to drive market share gains with both small and large customers. And third, our financial results are continuing to recover to pre-pandemic levels. Our improved results are being driven by a recovery in case volumes, improved margins, and the performance of our recent acquisitions. So let's begin on slide three. Restaurants are recovering at a rapid pace. As evidenced by the foot traffic, at food away from home establishments, shown in the chart on the left. The traffic for the industry has continued to increase over the last several months and is very close to returning to pre-pandemic levels. This nearly full recovery in foot traffic has occurred despite the fact that some markets across the U.S. are still ramping up, which is shown by the chart on the right. This shows our own restaurant volume for markets that have opened less than three months ago versus markets that have been open six months or longer. Restaurants and markets that have been open the longest are showing growth rates in the high single-digit range compared to 2019, while restaurants and markets that have recently reopened are still down compared to 2019. We believe our view to be representative of what is happening in the country, which indicates that even with volume above 2019 levels, there's still some headroom for growth for restaurants. Moving to slide four. The benefit of markets reopening can be seen in the improvement in total case volume that we experienced during the second quarter. In the chart, you can see that restaurants continue to trend ahead of 2019 levels, with both independents and chains ahead of 2019 by roughly comparable margins. We expect this to continue, supported in part by the growth from the recently reopened markets that I just spoke about. Most of July was also in line with May and June, but we did see in the last two weeks a tick down of about 100 basis points. It is too early to say whether that small change is due to the impact of the Delta variant. Moving to other customer types. The reopening and the related increase in travel is also benefiting our hospitality business, which is now running about at more than 70% of 2019 case volumes and a large improvement from the first quarter. Leisure travel has returned in a very meaningful way this summer and is driving a large part of the improvement. We expect this improvement in that customer type to continue as other customer types within hospitality catch up to leisure travel. First, even within leisure travel, some large parks are still operating below maximum capacity. Second, large conventions, which have in part returned, typically require considerable lead time of up to a year. And third, as we've discussed before, there is a little bit of uncertainty about the future level of business travel. When we consider the impact of these trends, we expect hospitality to recover later in 2022. And when combined with our market share gains, we do expect our hospitality volume to return to pre-pandemic levels. Our healthcare business has remained steady throughout the pandemic. different factors are impacting different customer types within healthcare. With senior living, for example, occupancy rates are still down in the mid to low single digits. But with aging demographics, we do expect demand from senior living facilities to recover over time. With acute care, some employees are still working from home, and it is yet unclear where this will settle over time. Similar to hospitality, when we consider the above trends, combined with our market share gains, we do expect healthcare to return to pre-pandemic levels as well sometime later in 2022. So in summary, based on what we know today about trends within each customer type, combined with our recent market share gains and our strong pipeline of new customers, our best estimate is that we will return to pro forma 2019 total case volumes later in 2022. I am now on slide five. Our great food made easy strategy is the primary reason that we win new customers. The great food piece of our differentiation strategy is anchored by Scoop, our product innovation platform. Given the labor challenges restaurant operators are facing, the latest edition of Scoop features a number of labor-saving products that are very much on trend, as well as a number of fresh grab-and-go items. We've also begun rolling out the food group's tender by design beef products to the legacy U.S. foods markets. Tender by design is a specialized process that produces high-quality cut steaks for customers. The rollout has been met with rave reviews by customers. Our leading technology solutions and expert support are the backbone of the made easy part of our differentiation strategy. In past calls, we've talked about our ghost kitchen playbook, which have played a big part in helping operators generate additional revenue. The following is a quote from an owner of an Italian restaurant outside Chicago who used the ghost kitchen concept to diversify into chicken wings. We survived the first hundredth day of the shutdown, but I don't think we would have survived this one if we didn't have our ghost kitchen of bakewings.com. It has literally been a lifesaver for us." End quote. Most recently, Our ROCs, Restaurant Operations Consultants, have been focused on a series of webinars to help customers navigate the challenging labor environment, including topics such as payroll management and doing more with less staff. Thanks to the benefits of virtual technology, we're able to leverage our best ROCs and food fanatic chefs across a number of geographies, and customers can easily schedule one-on-one consults by simply scanning a QR code. Finally, on the topic of technology, I would like to welcome John Tonneson to the US Foods team. John was recently announced as our new chief information and digital officer. He brings extensive experience leading IT organizations in the distribution space. Most notably, the last 10 years as CIO of one of the largest tech distribution companies globally. John's mandate is to continue to enhance our leading e-commerce platform while working with Phil Hancock, our chief supply chain officer, to make our supply chain the most effective and efficient in our industry. Moving to slide six. Last quarter, we spoke about the challenging operating environment for customers, distributors, and manufacturers alike. And while labor and product supply challenges continue to persist, our actions have helped mitigate these challenges. On the labor side, we have made good progress in hiring warehouse and transportation associates We filled over a third of the open positions that we discussed last quarter, and we expect to continue to close this gap. Our hiring and retention incentives have contributed to improving the pipeline and to reducing churn. In addition, we do expect the labor market to continue to improve. In those states that have ended supplemental unemployment benefits, we have seen a dramatic increase in applicant rates. Lastly, in some select markets, we have made some hourly wage rate increases, especially for entry-level wages. Taken together, these incentives and wage adjustments are having a modest impact on the P&L, which Dirk will discuss shortly. On the product supply side, service levels from vendors are still well below 2019, as a result of manufacturers experiencing the same labour and freight challenges that we are. Here are the products we need to effectively serve our customers. Our net promoter surveys confirm that we are faring as well as or better than our competitors on this front. Lastly, moving to slide seven, both the Smart Food Service and SGA Food Group acquisitions are performing at or above expectations, beginning with cash and carry. Same-store sales at our nearly 80 chef stores open at least one year are ahead of 2019 levels. Recall that part of the rationale for the Smart Food Service acquisition is that the cash and carry market was growing at roughly twice the delivered market with higher margins. As the reopening continues, we're seeing these pre-pandemic trends take shape again. We are bullish on the outlook for ChefStore and expect that 2021 EBITDA levels will exceed those of 2019. The other rationale for the smart food source acquisition is the long runway of growth that we see for ChefStore. We expect to have three new stores open in 2021, all in existing markets. to begin to expand our footprint, ultimately doubling our store count, making Chef's Store a meaningful part of our growth story. Turning to food group. With dining restrictions recently lifted in food group markets in the Pacific Northwest, we are starting to see volume return to those markets. Combined with the introduction of our differentiated scoop, e-commerce and team-based selling, we expect these markets to be poised for growth in the future. By way of a recall, we have completed four warehouse systems conversions and now expect to have the remaining systems conversions completed by early 2022. Synergy capture remains on track, and we expect to fully achieve the previously announced $65 million of synergies in 2023. As I mentioned a few minutes ago, we are extending food groups centered by design process to legacy U.S. foods locations. In addition, we are also extending food groups fresh produce capabilities to the rest of our customer base. Both of these initiatives will bring synergies to the legacy of U.S. Foods Network by providing customers with one of the highest quality product options in the industry in two very important categories, center of the plate and produce. I will now turn the call over to Dirk to discuss our second quarter results and full year financial outlook. Dirk?

Dirk Heuvelin Thank you, Pietro, and good morning, everyone. I'll begin on slide nine. Our second quarter financial results improved significantly compared to recent quarters, driven by continued volume recovery and strong gross profit results. During the quarter, restrictions on restaurants were lifted and leisure travel increased, as Pietro noted. This resulted in improved case volume with both our restaurant and hospitality customers and contributed to the significant increase in our adjusted EBITDA. During the second quarter, we also experienced record food and cost inflation across a number of different categories. Our teams did an excellent job of managing that inflation and passing it through to customers. This resulted in very strong gross profit dollar and per case performance, which also was a significant contributor to our increased second quarter EBITDA. As Pietro mentioned, the operating environment remains difficult but manageable. We've had success filling many of our open warehouse and driver roles, but we, like many other companies, still have work left to do in order to get to full staffing levels, especially as demand increases further. Inbound product supply from vendors also remains a challenge. We have the processes and the tools in place to manage through these challenges and focus on minimizing the impact on our customers. However, we do expect these headwinds to persist at least through the end of 2021. Moving to slide 10, net sales for the quarter were $7.7 billion, up 68% from the second quarter of 2020. Food cost inflation for the quarter was 8.2%, driven by product shortages and disruptions in the supply chain. We experienced inflation in almost every major product category, with the largest increases in poultry, pork, and disposables. Adjusted gross profit for the quarter was $1.3 billion, up 73% from prior year, and our adjusted gross margin improved by 50 basis points. Adjusted gross profit dollars increased faster than net sales despite the high food cost inflation, highlighting our very strong gross profit per case performance in the quarter. As a recall, inflation benefits our gross profit dollars, while it is typically a headwind to gross margin rate. As I just mentioned, we had over 8% food cost inflation in the second quarter, with much of it in commodity categories. This means our gross margin as a percent of sales is compressed, yet our gross profit per case is by far the best we've had since COVID began, and in fact was ahead of 2019 second quarter on our legacy U.S. food business. This high level of inflation and our ability to effectively manage it increased our second quarter gross profit by approximately $25 million. And as inflation moderates, or if we see deflation, we don't expect this gain to continue in Q3 or Q4. We're very pleased with our gross profit performance in second quarter, especially given the freight headwinds, which we expect to continue at least through 2021. Adjusted operating expenses in the second quarter worth $940 million, up 46% versus the prior year. As a percent of sales, adjusted operating expense was 12.3%, down from 14.2% in the prior year. While food cost inflation is a headwind to our gross margin rate, it is a benefit to our operating expense as a percent of sales. Just as a point of reference, our OpEx as a percent of sales for our legacy U.S. foods business is about 60 basis points lower or better than it was in the second quarter of 2019, largely due to the significant food cost inflation I just spoke of. Pietro mentioned earlier that we are seeing additional supply chain labor inflation this year, primarily related to signing and retention bonuses. The additional inflation this year is about $20 to $30 million and is above and beyond the approximately $50 million of normal annual supply chain labor inflation we experienced. As the labor market normalizes, we anticipate not needing to use these bonuses to the same extent and therefore expect most of these costs to be transitory. We increased the use of these bonuses during the second quarter and as a result, didn't have the full run rate in our second quarter numbers. We have made a lot of good progress hiring warehouse and driver associates, however, are still in the process of filling open positions as our business continues to recover. On slide 11, adjusted EBITDA was $332 million for the quarter, a very strong rebound from the second quarter of 2020. Adjusted EBITDA as a percent of sales was 4.3%. Earlier, as Pietro mentioned, our current best estimate is to return to pro forma 2019 case volume levels later in 2022. We also expect to return to 2019 pro forma adjusted EBITDA, expect that to be later than the return of case volume. During 2022, we expect the recovery in restaurant volume plus market share gains will make up for the slower recovery in hospitality and healthcare volume. While our category gross profit rates are well on their way to recovery, we expect logistics headwinds to continue into 2022. For distribution costs, the two years of wage inflation plus the temporary incentives and potentially some higher wage inflation that will require additional productivity and customer margin improvements to offset. For fixed costs, we still expect the $130 million of permanent cost reductions completed in 2020 to flow through to the bottom line. As Pietro said, the integration of food group and smarter on track, including expected synergies. Overall, we are very confident about achieving pro forma 2019 EBITDA levels, but the continued uncertainty with respect to freight and labor markets makes the specific timing less certain. We know the actions we have and continue to take will result in us being a stronger company going forward than we were pre-pandemic. Finally, on this page, adjusted net income in the second quarter was $146 million, and adjusted diluted EPS was 58 cents compared to a loss in the prior year. We are now reflecting the additional shares from the preferred equity transaction in our adjusted diluted earnings per share calculation. With these shares reflected, our outstanding adjusted diluted share count is approximately 250 million shares. I'm now on slide 12. Operating cash flow for the first six months of the year was $250 million. In the first half of 2020, we had a significant benefit to operating cash flow from working capital. This was a result of reduced inventory levels and extended accounts payable days during the early stages of the pandemic. In the first half of 2021, working capital has been largely neutral to our operating cash flow. Our business generates a significant amount of operating cash flow each year, as evidenced by the $250 million we generated in the first half of this year, despite our business being in a recovery phase. We will use this cash to reinvest in our business, and reduce our total outstanding debt. In the second quarter, we proactively paid down $200 million in total debt in addition to our standard debt repayments. Our leverage ratio dropped by more than two turns due to the pay down and significant adjusted EBITDA improvement. Our target leverage ratio remains between two and a half and three times, and we expect to continue to make progress against this target over the balance of this year via additional debt reduction and increased EBITDA. We had a very strong second quarter and are focused on the continued recovery of our business. Looking ahead, we expect both Q3 and Q4 EBITDA dollars to be below Q2 as a result of not repeating the approximately $25 million of inflation benefit from Q2, as well as the increased OPEX related to the full run rate of supply chain sign-on and retention bonuses put in place during the second quarter and the impact of our continued reinvestment in sales resources, as we've discussed previously. Our industry is rapidly recovering, and we are participating in that recovery in a meaningful way. Our volume is recovering well, our gross profit is strong, and we are focused on effectively managing the supply chain challenges we and the industry are facing, and our acquisition performance is on track, resulting in improved results, and we're using the cash flow generated to invest in our business and reduce debt. Finally, the actions we took during the pandemic have positioned us to continue to gain share with both large and small customers. Operator, at this time, we can now open the call for questions.

Yes, sir. As a reminder, you ask a question, you will need to press star one on your telephone. To withdraw your question, press the brown key. Our first question comes from the line of Alex Schlegel from Jeffrey. The line is now open.

thanks good morning um just a question and thinking about some of the incremental headwinds from the accelerated hiring and retention efforts it sounds like you expect these headwinds to continue for a few more quarters at what point do you think the acceleration these costs sort of peaks and move toward a more moderated case of the cost increases good morning i'll take that it's hard to know exactly what's your point i would expect uh just

based on some of the early evidence that we've seen in states that have ended unemployment. And as we continue to make good progress in hiring, that as you get toward the end of the year, we should be quite a ways there. So it's hard to know exactly there. But at this point, best estimate would be as we get toward the end of the year into 2022, you begin to see that moderate. and begin to return to a more normal environment. What I will tell you, though, is in this environment with some of the labor challenges and supply challenges from vendor, it's also been a really good opportunity for us to engage in discussions with a number of our customers about margin and just other operational factors to improve our ability to serve them. So overall, you know, really partner with us as best we can.

Sounds good. Thank you.

Our next question comes from the line of Peter Salley. The line is now open.

Great. Thank you very much. I believe last quarter, you guys were talking about, you know, the labor shortage. And I think you had mentioned you were about a thousand drivers and selectors short of where you'd like to be. Can you guys give us an update on where you are today in terms of, you know, getting up against that goal?

Yeah. Hi Peter. This is Pietro. So we, As I mentioned in my comments, we've covered over a third of that gap. And that gap, just to clarify, is relative to what we anticipate as peak needs in the future, not necessarily the gap today. So we're making really good progress. What I would say is we've really wrapped up the hiring machine for selectors and drivers today. we're hiring exactly the right number that we are looking for. The challenge right now is just reducing the churn rate. I'm sure you've seen in the press that quit rates are an all-time high, and so part of the measures we're putting in place are really aimed at reducing the churn so we can continue to close the gap that we talked about.

All right. Thank you very much.

Our next question comes from the line of Nicole Miller from Piper Sandler. Your line is now open.

Thank you. Good morning. Also on labor inflation, my question is, why just yourself specifically or the industry at large, do you feel like it's transitory? The total cost might not come in the form of bonus, but why does someone want to net make less? I'm just curious of what circumstance would you see where it's just a total benefits you know conversation and you try to make it whole going forward in that way and then at what level would you pass it on um the answer to the first question on the call having uh engaging the customer would lead me to believe that perhaps that's happening now thank you yeah so i'll start uh and i'll start the second part of your question so

As you mentioned and as Derek mentioned, we have been passing on some of the inflation that we have seen, certainly on the product side, but also where possible on the labor side. In terms of your question as to why it's transitory, I think there's a school of thought that is shared by many about the labor supply imbalance is in itself transitory, right, with the speed of recovery probably faster than many expected. We've seen the demand for labor go up faster than supply. I think the partial evidence for that is what I noted in those markets where supplemental unemployment benefits have ended. the hiring pipeline is several times better than it is in those markets where supplemental benefits are still in effect. And so those are some of the reasons why we believe these are transitory in nature.

Thank you. Our next question comes from the line of Edward Kelly from Wells Fargo. Your line is now open.

Yeah, hi, guys. Good morning. Hey, Derek, I wanted to get back to the color that you gave around EBITDA for Q3 and Q4. And what I was hoping that you would do is maybe just a little bit more color to sort of bridge, you know, like the 332 of this quarter to the expectation. You gave some numbers that I think were annualized, but I'm not sure. Maybe some of them were quarterly. And I don't think you talked about a number around sales resources. So maybe just help us bridge how we think about the back half. And I also am not sure what you're assuming for volume within that, what you're assuming for inflation. So just any color that would be helpful.

Sure. I'd be happy to. So it's the reason we wanted to provide the additional insight that I did is really because in the second quarter, we really benefited from the strong inflation. And as you see, our ability to pass that through with really the gross profit per case being above 2019 is And I think the important takeaway on that one is our second quarter results were strong with or without this additional inflation benefit. And so the thing we wanted to call out with the $25 million is that is the piece that for the quarter alone helped, that we, given that there's not an expectation from many in the industry and outlooks for continued inflation and even some modest deflation. So, you know, I think that $25 million, if we stay sort of more, modest or kind of flattish on inflation is the piece that we would not expect to repeat in Q3 or Q4. I think that if you look at the sales resources, we haven't talked about a specific amount. We've continued to hire kind of second quarter, third quarter, fourth quarter. So I think we probably can get close enough there with an estimate there on the impacts per quarter as we continue to ramp up. We're We're well on our way there from adding resources. And then in supply chain, that $20 to $30 million is largely what we expect in-year this year, with a portion of it in the second quarter and then the rest of it through the balance of this year, and most of that being in the form of these retention and sign-on bonuses that I talked about. From a volume perspective, we do expect volume, so putting aside any impact that often they have but looking at the trajectory that the business was on we expect uh volume recovery to continue there so there there's nothing that i was intending or that we are calling out that's what i would say derailing the strong recovery as opposed to just some things to keep in mind uh that are not as recurring so hopefully that helps okay and then i wanted to ask you about um

sales growth versus case growth? There was a 14.5% gap, 8.5% of that was inflation, but the rest was mixed. What's driving that mix? And is there incrementality within that mix that's actually positive to gross profit dollars? So maybe we should be thinking about sort of case growth plus that. And how does that look going forward as well?

Sure. So the mix, to your point, it can be a category or types of products people are buying as well as customer types. So I'll use the example with restaurants recovering faster than, say, healthcare and hospitality. That's been a net positive when you look at sales. So there's not as directive a math correlation that you can do from sort of the sales percentage of that mix versus gross profit. However, the thing to take away is with the strong performance, especially as you look at the independence and such, there is some benefit in our gross profit. And so that's part of the reason that even with our – strategy in recent years of growing these more attractive customer types so as independents grow faster than the broader business they are more creative and so that that helps the overall business so on that one i think that the mix it has been positive it's going to be more influenced by some of the external factors as healthcare hospitality and such continue to recovery and depending on the pace of that but overall gross profit dollars and rate good trajectory and we feel good about the pace of that recovery.

Okay, thank you.

Our next question comes from the line of John Glass from Morgan Stanley. The line is now open.

Thanks. Good morning. You mentioned that freight and labor is going to stick around, so you may need some additional productivity. I think that's what I heard. Do you have line of sight? Is there actually work going on now to increase the productivity that you've already experienced, the $130 million net? And if so, where does that come from? Can you just talk about if you're looking for new areas to save? And specifically just on the cost of inflation, this is a quick follow-up. Are you actually seeing the rate of inflation beginning to come down? Is it just your expectation it will, but it hasn't yet, just so we understand kind of where you are exiting the quarter in July on inflation?

Sure. You've packed a lot of that question.

Yeah.

So I'll start with the second one because that's the quicker. So we have seen the rate of inflation slow. We're still seeing some modest inflation in some categories, but then seeing some meaningful deflation in other categories that are netting out closer to zero. So it's these last kind of four or six weeks. So that is sort of the assumption is sort of how that and what we've been seeing more recently there. As far as your question on productivity, so yes, I'll just remind, I put out there the number that we sort of incur in a normal year on inflation in the supply chain. And we typically, in a given year, we'll focus on mitigating as much of that as we can through productivity. And as you can expect, so we do have some things that are underway in supply chain in particular. However, not near at the pace that we would have in a normal year. And as you can probably appreciate. We and others in the industry are directing a lot more energy to running the business and really providing as good of an experience for the customer as we can during this challenging time. And so, therefore, it leaves a little bit less time to focus on productivity. So you do end up with a slowing of sorts there, but we do still have some things going and feel confident in our ability to ramp that up faster under our new people, Hancock's leadership, as we move ahead. Hopefully that helps. Okay. Thank you.

And just to add, Dirk, John, the 130 you were referring to was in terms of fixed costs, no change to that, as Dirk said. The productivity initiatives that Dirk was just referring to in his answer on the variable side of things were, as he said, the focus on customers and the onboarding of a large number of new associates has slowed down the productivity that we typically see on the variable side.

Very helpful. Thank you.

Our next question comes from the line of John Ivanco from JPMorgan. Your line is now open.

Hi, thank you. The question is in the context of your gross profit dollar per case ahead of the second quarter of 2019. Obviously, dollar profit is what matters to this business, but I'm curious if there are any market share battles that are going out there that some distributors, given obviously profitability recovery across the space, or perhaps using these gross profit dollars to gain share, whether to existing customers or new customers, and whether you think that's actually an opportunity over time for you to use GP dollars per case to drive case volume. Thanks.

Maybe I'll start because we're really talking about market share and volume. So we've continued to make market share gains, John, but I think We and others, and you've probably read about this, those market share gains have probably been held back a little bit by the challenging labor staffing environment. You know, just the desire to make sure that we serve customers in the way that is what they expect has probably held us back a little bit in terms of making even more aggressive market share gains over the last couple of months. And when I say I, I mean probably everyone.

I was just going to add, John, that I think from a pricing – so we, as part of the way we run our business – The team is always looking at it. It's balancing volume and margin. And so, you know, driving those share gains smartly. And there are categories that from time to time we will choose to invest in that we think are accretive to the overall basket. So as you summarized well, it's about, you know, driving more gross profit dollars ultimately. to the bottom line, and that's what we're really trying to balance. And in this period, made progress in gaining market share with small and large customers and very good gross profit results at the same time. Thank you.

Our next question comes from the line of Mr. John Heinbockel from Guggenheim. Your line is now open.

I want to start with where do you guys think your capacity is now? And with volume recovering, is this a good time to think about accelerating the culling of less profitable accounts, and are you doing that?

So it depends how you measure capacity, John. I think what the capacity that's been talked a lot about is, again, as I mentioned in the card question, capacity uh as a result of staffing so if you're short drivers there's only so many um uh trucks you can get out uh so they said that that has uh hampered our ability to grow even more than we have um but we still we still see us making we still see we've made market share gains and so as that as that kind of stabilizes continue to close the gap we believe we have the opportunity to to continue to gain market share. We've had in a very small number of instances done some optimization in terms of resetting terms with customers or in a handful of cases, probably there's been a little bit of press on that. You can see that the impact in our results has been de minimis when you look at the volume growth versus 2019.

Maybe secondly, I know you were investing in sales. I thought the number was $50 million, but you filled the third of the open positions. Were you on the sales investment? Then the two-thirds left to go, you said that's out in the future. It doesn't sound like that's a front-loaded investment. That may stretch out into next year. Is that fair?

I'll take that. It's on the sales. So we're, you know, as I mentioned with Ed, we're going to talk about a specific number. We're a good way through that journey as well and making progress and expect to get to that full investment run rate this year, yet later in the year. I think from a supply chain perspective, we would expect to get to that kind of full staffing level yet in 2021. Obviously, you know, the market will dictate, but the thing, remember, probably all the way back to our fourth quarter pause, I was talking about that, or third quarter pause last year is just, the thing that we want to make sure is we're continuing to press hard on staffing especially given that the challenging market that's out there and knowing that our business is recovering we continue to you know have good customer wins and share gains so do expect to get to that level of staffing at some point later in 2021. thank you our next question comes from the line of caledonia from vmo capital your line is now open

Hi, good morning. Thanks for taking our questions. Just had a quick one on the current inflation environment and the comment that sounds like it's maybe moderating a little bit. Just curious if there's an opportunity to kind of pass those smaller costs on at a more slower rate and maybe capture some margin as costs moderate, or if that's happening across the industry or if you have any opportunity to do that, just given where some of the elevated supply chain costs are.

Hi, Kelly. Yes. So there is some moderate opportunity to do that, but that ends up being relatively short in time frame because of as you remember us talking about a large portion of our business is based on contracts and so it automatically happens when those contract resets which can be from weekly to monthly generally speaking so a little bit of opportunity the reason i wanted to call out in the second quarter was just The combination of the inflation plus product shortages, et cetera, really combined with our processes and tools enabled us to have really outsized gross profit gains. Very pleased with that. And just highlighting that although that was really strong and the quarter was strong with or without, that we wouldn't expect that level of gain to continue going forward.

Got it. That's helpful. And just another one in terms of gross margin. We were kind of estimating gross margins about maybe 100 basis points below pro forma levels with the acquisitions. Is that accurate? And can you help us maybe think about just the factors that get back to that kind of full gross margin?

Kelly, do you mind clarifying what you're saying, estimating 100 for the current quarter or –

Yeah, just the 16.5, you know, we were thinking that's kind of about 100 basis points below the kind of full pro forma estimate for the total company. Just curious, you know, what are the factors, how far below is gross margin today relative to kind of full potential, and what are the factors that get that back over time?

Thank you for clarifying. So the thing that makes it a little harder to talk about specific just with the outsized inflation we've had and the amount of commodity is it actually it makes gross margin look worse than it really is, because with a lot of this inflation being in these categories that have fixed cost markups or where you are passing it along and they look like there's compression, even though you're making more per per case. What I will tell you is if you look at, you know, So we would expect gross margin to largely return to 2019 levels over time, again, as you see inflation moderating. But it's when you think about it from a per case, which is sort of more what we really make for every case we ship. is even though the level of inflation gain doesn't continue, inflation, as you know, does benefit us over time. So that's helpful. The customer and product mix headwinds we talked about continue to improve as case volume returns. So we expect that to return. And then logistics or freight is the other big piece that's you know, as we look at it, we've made some progress there, but would expect also just as we return to a more normalized environment for that to revert, you know, at or close to 2019. So at this point, there's not anything that gets in the way of us getting back to and then growing from the 2019 gross profit per case. I think the thing on gross margin, even just to put it further into context, I'll say is if you stripped out the... the impact of inflation on sales is outsized. Actually, even gross margin would be above for the second quarter above 2019. So it's a harder question to answer right now, given the inflation we're seeing, but I feel very good about gross profits, dollar and per case growth over time. And I think the inflation as that sorts out will help us be able to provide more visibility on what that does to gross margin. But I think that the last thing to remember is Any impact that it has negative on gross margin has an equal positive impact on output. So it isn't really a net impact on adjusted EBITDA. And as you saw, we improved that in the quarter as well.

Thank you. Our next question comes from the line of Lauren Silverman from Credit Suisse. Your line is now open.

Thank you. So industry supply challenges and shortages, well documented. You spoke to them. Are you seeing customer stockpiling inventory just given concerns on the supply chain and a related question to that? I think you noted 100 basis points ticked down in restaurant case volume over the last two weeks of July. Do you think that stockpiling has anything to do with it, or do you see it more related to underlying deceleration of it?

Hi, this is Pietro. I don't believe there's stockpiling happening. There's not enough inventory to be stockpiled. I think the 100 basis of the last two weeks that we talked about is premature to call one way or the other in terms of what's driving that. I don't think it's stockpiling. I think there's a chance it may be related to Delta, but it's very hard to say at this point. We haven't seen restrictions go up. There may be a small portion of consumers who are affected. But I think here's what we do know. Whenever we've had a wave of COVID, things tend to bounce back even better than they were before that wave and more quickly.

Great, thanks. And if I could just do a follow-up on the inflationary commentary. You had a pretty big LIFO reserve adjustment in the quarter.

Can you just talk about how we should be thinking about the impact to adjusted gross profit dollars

or I guess gross margin in future quotas, is that all?

So you're right. I think the, as you saw, I think in my 12 years here, I don't recall a LIFO charge in a quarter being anywhere near where it was.

And it really is directly related to the same thing with the sheer amount of inflation that we had in the period Just because of the way LIFA works is you're still valuing that inventory at the, you know, sort of first-in type of cost. It just results in a charge. And so what I think you would – I don't think I would correlate that anymore to sort of from an adjusted gross margin, gross profit, et cetera. It is because there are different inventory methods. So when you – Think about that. I'd focus on that the inflation is a positive to our gross profits and gross profit dollars per case. In LIFO, what will happen is if we see inflation moderates, it stays pretty neutral. If you start to see some deflation, it's likely you would start to see some form of an offsetting credit to that in the second quarter. Sorry, second half of the year.

Thanks. Our next question comes from the line of Mr. Mark Hardin from EVS. Your line is now open.

Good morning. Thanks so much for taking the questions. How is the competitive environment shaking out as the recovery has ramped up? Have you seen any smaller distributors finally start to go out of business given less flexibility on inventory and fluctuations in food away from home demand? And have you seen any meaningful wallet share increases in your independent customers? Thanks.

So the competitive environment has, I would say, been pretty stable in terms of the number of competitors. Again, the recovery happening as quickly as it did over the course of the last year, I think it's helped a lot of smaller competitors. You know, when we look at our net promoter score, there's clearly some competitors that are more challenged than others with respect to being on time or fulfilling the orders that customers have. In terms of – can you remind me of the other part of your question, if you don't mind?

Just in terms of any meaningful wallet share increases in independent customers.

Yeah, wallet share. Yeah. Thank you. Yeah. So we are seeing – so our cases per line are up about 7% on prior year, which is quite good. I think that's probably a combination of things. It's a combination of probably some wallet share gains as well as the recovery. We've also seen lines per customer go up a little bit with independence, which is probably a good proxy for while share gains, otherwise restaurants continue to expand their menus. There's a little bit of that going on. So same overall story, as I would say, as a result, driven by a combination of the recovery and our market share gains.

Got it. That's really helpful. And just one quick follow-up. There's been some news that unemployment benefits are less likely to get renewed past September 6th. Could you see this having a meaningful impact on food away from home demand?

I mean, that one is a hard question. I think we've really focused on the end of unemployment benefits, and obviously there's some associated savings with that having an impact on the labor market. I think what we've seen is that these habits that are decades in the making of consumers They're really well embedded and entrenched, and the combination of digital ordering, the vaccine has allowed these habits to reestablish themselves. So I think there may be some potential in the long term for food away from home to continue to increase share at the expense of food at home, just as we've seen over the course of time.

Got it. Thanks so much.

Our next question comes from the line of Jeffrey Bernstein from Barclays. The line is now open.

Great. Thank you very much. One follow-up clarification and then a question. I just wanted to clarify, Derek, I know you mentioned the third quarter, quarter to date, that it was strong to start July but slipped 100 base points the last couple of weeks. I think you mentioned the second half of the year, the volume recovery is going to continue this, which I guess would imply the 100-base point pullback is viewed maybe as a blip. I'm just trying to understand what the common themes are maybe that you've seen out of that recent pullback, whether it's by market or what would give you the confidence that it's not something more sustainable, I guess, and then follow it.

Sure. So you're right. As Petra noted, it's seen that little bit of decline. And I think the The way to bridge those two comments is, you know, if there's an impact from Delta or such, that's one that's harder to know. So if you kind of put that aside, and I think on that one, the impact from Delta that I come back to, as what Pietro said, is we've seen this in multiple waves as even though it could have a shorter-term impact, the demand is there, and we would expect the recovery to be right back on track, even if there's a bit of a delay. I think overall, just the demand externally seems to continue to be there. We have seen consistently in the markets, that chart that we included here, that as reopening occurs, we're seeing continued demand increases and improvements. We still have a number of markets that have only reopened in the last three months or so. closer to full capacity. And we would expect those, the demand in those markets to continue to increase. So I think from our perspective, uh, overall, you know, expect, uh, you think of independence as an example, expect, you know, that to continue to, uh, strengthen as that demand gets there, uh, more and more markets and overall, again, no matter if there's a short-term impact from Delta or not expect that it's, it's really just timing and not, um, whether the demand is there and the return is there, that strong demand we expect to be there and the growth to continue.

Understood. And then the primary question was, I guess, Pietro, if I look back a year, it seems like you've achieved that with, I think you said, your cases per line up 7%. Otherwise, there was hope for, obviously, adding new accounts who might shift to a larger distributor just for comfort in using one of the bigger players. and or maybe aid in growth by M&A. So I'm just wondering on those latter two fronts, if you'd shy away from the latter in the short term. Thank you.

Right. Yep. I think where we've really demonstrated that is with the large accounts. Like we talked in the prior call about a billion dollars of new business. Given the pipeline we have, and that's with respect to large customers, And on the smaller customer side, we're seeing our new accounts and net accounts pop nicely.

Again, as I mentioned, the temporary staffing challenges we've seen have held us back a little bit in terms of being able to grow market share a little bit more the way we would have liked or as aggressively as we would have liked. And M&A, you're right, that's been one of the the things that perhaps didn't pan out exactly as you would have expected in terms of further consolidation or further distress. I think IOE, which has been good for the industry. But there have been some select markets where we've seen some distressed competitors, and we've really taken advantage of that, you know, in terms of hiring their sales force and going after their customers. So we've kind of found a different way to take advantage of perhaps a slightly less distressed situation than we envisaged in the beginning. Interested. Thank you.

As a reminder, to ask a question, you will need to press star one on your telephone. Our next question comes from the line of Edward Kelly. The line is now open from Wells Fargo.

Hey, guys. Thanks for letting me back in here. A couple things for you. I guess first, I just want to go back to commodity inflation and the expectation of, I guess, no Inflation in the back half of the year. I'm just kind of curious. I mean, really, the question is sort of how's that possible? Because it does seem like everywhere else, you know, CPG vendors, etc. Everyone's talking about inflation. I'm just kind of curious what we're missing here.

So the way that I would think about it is continued inflation, because it's that continued inflation that drove the incremental gains. And I think that when you if you look at if we don't have additional inflation, you still on a year over year basis, you will see inflation show up. But it's it's an incremental that sort of drives the kind of outside drove the outside gains in the second quarter. I think that what we've seen so far in the last few months is sorry, last few weeks. is you see some of your commodity categories. So the center of the plate is good examples where it had a lot of inflation in the second quarter, began to show some deflation in more recent weeks. And then you have some modest inflation continuing in a few other kind of grocery and other categories. So I think that's the piece that we'll kind of wait and see, but maybe that's kind of bridge the difference between what maybe some of their comments are and how I talked about it in the context of how it's increased our Q2 earnings.

I got you. So year over year, still some inflation, which should, by the way, benefit gross profit dollars. But to the extent that we solve it in Q2, that's not likely to continue at that rate.

Correct. And that's why we wanted to call out the $25 million. just to highlight that it's not that the business is worsening in the third or fourth quarter as opposed to that outside gain in the quarter. And like I said, with or without that gain, we're very pleased with the strong improvement we saw in the quarter versus Q1.

Okay, excellent. That makes sense. And then just one last one for you because you did sort of mention on the call post-COVID, And, you know, my question here is that I kind of calculate, you know, pre-COVID pro forma EBITDA at around $1.34 billion or so. You've got your cost saves, the synergies from the two deals, which, you know, combined is probably a little bit more than a couple hundred million. So we're kind of at like $1.5, $1.6 billion. And there's underlying inflation here, right? And by my math, every 1% increase in labor inflation in drivers and warehouse workers is in the neighborhood of like $17, $20 million. But there is share gain. There is market growth. I mean, is there just any reason to think that, you know, when sort of like all is said and done, and I'm not trying to, you know, nail you down on a date or a year, but when all is sort of said and done and the business is, you know, it's back to normal, that you wouldn't be in that level from an EBITDA standpoint?

Ed, I think you're thinking about all the right elements and all the right things that build to a number, to your point, that gets to that 1.3-ish billion and grows from there. I think the... And then I think that the piece that you called out that sometimes people don't focus on is just that cost inflation that will occur in a given year. So I think when you factor that in, and then it's really just the other piece that I talked about, just with all of the onboarding of new associates in the current market, just a little slower productivity than we would normally have in supply chain for this year-ish period. But we don't think there's a reason that we don't continue to get back to that. in a 1.3-ish number and then grow from there to the higher numbers that you were talking about. But I think you have a lot of the right numbers and pieces that you're thinking about you've captured in inflation as well. Okay.

And just the last thing for you. So, you know, when we go back to like this 1% increase in driver pay and warehouse worker pay, which, you know, again, I think is probably 17, you know, maybe $20 million, um, to offset that, that, you know, your EBIT margin pre COVID forget about incrementally the margin, but just regular EBIT margin, that's only about a percent, percent and a half of case growth over 19 levels. Um, So there are offsets even to underlying wage inflation if we are optimistic that the business will be higher from a case growth volume standpoint. Am I thinking about, like, those incremental numbers right?

You're definitely in the right neighborhood. And I think that, I mean, the way you're thinking about it, it's good logic. And I think the thing I'll come back to on that is just when you think about the incremental inflation, I think the key message to take away is – and I think it was – Lauren may have asked that earlier as well, but it's hard to know if all the pieces that we think on labor inflation are transitory. If you do get to some portion of it that remains permanent, as I said earlier in my comments, that we've had really good conversations with a lot of customers. And so it's an environment that customers are understanding they want. We're trying to be very good partners with them. They want to be good partners with us. And in some of those cases, It's really if they were discussing with them about either changes in the way operationally we serve them or, in a number of cases, some level of economics improvement in order to mitigate or offset portions of this. So it's not that we don't have any leverage. We actually think there are some good opportunities for us to offset at least a meaningful portion of that incremental inflation over time. Great. Thank you. Thanks.

This ends the Q&A session. I will now turn the call back to Mr. Pietro Satriano for the closing remarks.

Thank you. Maybe a couple of takeaways since we spent a lot of time talking about the P&L. Look, a very good quarter. Volume was strong, and we see a path to full recovery on the volume side. Margins, independent inflation, as Derek said, are in a really nice spot. There are challenges to our variable distribution costs, but we believe we have a handle on them, and acquisitions are performing well and we're paying down debt. So I think overall a very good news story. I want to close by thanking our 26,000 associates whose outstanding effort is responsible for the very promising results we covered today. Thanks to all for tuning in.

This concludes today's conference call. Thank you for participating. You may now disconnect.