Performance Food Group Co Q2 FY2023 Earnings Call

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.

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 a 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 three 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 three 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 three-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 three 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 in the 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 are related to the 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, focusing 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%, 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 independent restaurant cases 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 helping 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, with outbound 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 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 is 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, the high-quality sales and profit results, despite a slower recovery in the theater channel, speaks volumes 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 two quarters of the fiscal year, with inbound rates now in the mid-80s and outbound rates in the high 80s. Suppliers have indicated that better access to raw materials and stability in the workforce are producing improvements 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 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 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 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 three-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 hopeful 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. While there is still some uncertainty in the broader macroeconomic environment, we believe our outlook for the 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.

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 three 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 three 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 two 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 six 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 six 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 six 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 are 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 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 in 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 two 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 three 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 reflects our confidence in the underlying business momentum and consistent execution from all three 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 three-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 three 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.

We'll take our first question from Edward Kelly with Wells Fargo.

Nice quarter. I want to first discuss the gains in procurement inventory. Can you elaborate on how these gains in Q2? I understand they are down compared to last year, but how do they compare to what you would typically consider normal? Additionally, as you move through the second half of the year, can you provide some insight into what the potential headwind might look like and when the productivity gains could offset that?

Yes. First of all, I would say that last quarter was fairly normal for inventory gains. Below normal for Core-Mark. We think it makes sense for us to call these out. We have always had them. We've been very aggressive because of the inflation that's been out there, and we've done a pretty good job of anticipating where these increases would come and carrying additional inventory. So, I think we're in an unusual period for last year and for this year. And that's the only reason we call those out, but they're part of, I guess, I would call it our quarterly life around here. As far as the back half of the year, the quarter that we're in now was very good last year, higher than normal for inventory gains. Q4 a little more so, and then Q1 of next year was when we peaked. And as I've mentioned before, those come from sequential inflation, not really from inflation from the previous year. And the sequential deflation that we've had the last couple of quarters is what's kind of tempered that. But we still made some very good buys. And then in the Convenience area, we have one that we did last year that we recognized the profit in Q2 that we'll be recognizing the profit in Q3, this year. As far as how those are going to affect our results, they're certainly built into the guidance that we give. And we're in a little bit of a race here that during the period of time where we had additional inventory gains above and beyond normal. We also had very high operating expenses, particularly overtime and temporary health. And those are dropping at a pretty good rate right now, unfortunately, not as fast as we would like to see it drop. So, will that balance each other out? I'm not sure. But we're not expecting that in our guidance for them to balance out. We're expecting to have a couple of quarters at least, where our inventory gains are not as good as last year, but I want to stress that, that is in our guidance.

Great. And just a follow-up on the guidance. I mean, you've had a very nice beat in the first half of this year versus how you initially thought the year would play out. The back half, I guess, along the way, you really kind of haven't touched. I'm just kind of curious as to how you're thinking about the business now going forward versus sort of like what your initial expectation would have been. I thought I heard you at the beginning of the call when you talked about this acceleration in January. I thought I heard a little bit of a tone of optimism, I guess, that moving forward. So maybe you could sort of wrap that into how you're, I guess, really feeling about the business now moving forward in the back half and then as you progress into the next fiscal year?

Yes. Well, everything we hear concerning the macro can be confusing. But all in all, the industry is not doing really well right now. So we figured that we’re better off to be cautious about what kind of guidance we give for the second half of the year. A little bit to do with the inventory gains, not as much. January, the thing about January in our industry and certainly in our company is we've had really good Januaries and just had average Q3s, and we've had bad Januaries like last year and ended up actually with a good Q3 because about half our earnings occur in March. So yes, definitely an optimistic January, very optimistic actually in all of our businesses. The first week of February, excluding the parts of the country that were really negatively impacted by weather, also very good. I look back at last year and it seemed to be that Valentine's week when we started to really improve, and March was a fantastic month. So much more difficult comparisons. So that's it in a nutshell, Ed. We're just trying to make sure that we're giving guidance that we have a strong belief in.

And we'll take our next question from Jake Bartlett with Truist Securities.

I wanted to ask about the strong performance you observed in January and the underlying momentum of the business. Could you compare that to the three years before COVID? From what you've reported on organic independent case growth, it seems there was a slight acceleration in independent organic growth compared to 2019. I'm curious if that trend continued in January, as I estimate about 20% growth. Can you confirm whether it actually accelerated in January, allowing us to set aside the disruptions caused by Omicron?

It's why we mentioned earlier that we were encouraged by January. Once again, it's January. There was an acceleration over the fiscal '19 numbers, though it wasn't as extreme as the acceleration over fiscal '22 numbers. In our Q2, while we were slightly less than Q1 for independent growth, we were ahead of it going into the last two weeks of the quarter. Occasionally, the holidays fall on a Sunday in our business, which can negatively impact Saturday night, typically a strong night for us. Even though Saturday night on New Year's Eve was probably quite good, Saturday nights are generally good regardless. We anticipated this, and it may have been a bit more than usual, but it's just one of those occurrences in our business. From Q1 to Q2, we saw a slight acceleration, and comparing Q1 to Q2 against the share numbers we receive, we experienced a nice acceleration. When we look at the three-year trend from fiscal '19 to fiscal '23, we feel excellent about that.

That's really helpful. I'm curious about the sales guidance for the third quarter. At the midpoint, it appears to be slightly lower than in the second quarter. Historically, it seems that Convenience tends to have a seasonally weaker third quarter. Could you clarify if this small decrease at the midpoint is mainly due to seasonal factors or if it reflects some broader macroeconomic challenges? I'm trying to determine if there's an unusual slowdown or if it's primarily seasonal.

Yes. All of our businesses, the third quarter is typically the lightest revenue quarter. But also a big impact too is that tobacco is really declining at a pretty heavy rate right now, which all in all, is not a bad thing. It's not a big margin producer, but it certainly has a big impact on the top line. And I would say that's probably it. Our national account growth, where I mentioned, I think it was two calls ago, by fiscal third quarter, we'd be running growth. I'm not so sure that's going to happen. We've played out from an account standpoint exactly, I mean exactly as we had wanted it to go, but there's some real softness in that account base. So that's probably a little bit of it too.

And we'll take our next question from John Heinbockel with Guggenheim.

So George, I want to start with why do you think independent case growth is less than new account growth, right? And within the context of that, your thoughts on salesperson bandwidth and capacity, right? Because they're doing a lot more volume than they did three years ago. Where are we on that? And do you think you need to grow the sales force faster to see a pickup in independent case growth?

I believe the key reason the accounts are growing faster than the cases is our focus on acquiring new business. We've actually seen an uptick in this area, although overall, we're conducting less business with our existing customers compared to the previous year, on average and independently. Even though we’re selling slightly more SKUs to these customers, it reflects a decline in volume at the account level. In January, the growth was largely driven by new accounts, but we also saw better penetration within existing accounts, resulting in positive performance for that month. I attribute some of our growth to the impacts of Omicron from the prior year. Additionally, we have made significant investments in our salesforce over the past few quarters, having realized that we were somewhat behind. Currently, our growth in the number of salespeople is the highest it has been in several years.

Okay. And maybe for Patrick. Given your closeness with Vistar, right? So Vistar profitability, at least this period, was several hundred basis points above where it's kind of been running. Your thoughts on the source of that? And then where do you think, right? It looked like it was settling in maybe in a 5% to 6% range which was higher than pre-COVID. Is that still sort of where we're settling at? Or maybe it's higher than that now?

No, I'm going to go ahead and take that. John, just because needless to say, Pat has been very busy the last quarter. Our return on sales or our EBITDA margins in Vistar has always been more volatile than us as a company. And I've explained this before, but I think I should do it in a little bit more detail. We have parts of our business in Vistar that have very high case cost, very low gross margin, very low expense ratios, and low EBITDA margins. We have parts of our business that are low case cost. They are high margin, they are high expense ratios, and they are high EBITDA margins. Then we have our pick and pack business, where there's a lot of eaches out of those, particularly the three distribution centers totally dedicated to that. That is a high margin, high expenses, high EBITDA margins. Then we have a fulfillment business which we feel we're going to show some real growth in a couple of quarters with, but there we do not get involved in the accounts receivable on that product. We’re fulfilling those orders, most often for the manufacturer or the online site. So all we're billing is our fee. So there is extremely low case cost average and almost all of it is margin. So it has extremely high margins. And then, inventory gains can change quarter-to-quarter based on what kind of job we did anticipating increases. And so there's a lot of volatility in there and there's a lot of volatility in the EBITDA margins. But when it comes down to how we do as far as the percentage of the gross profit dollars that we put to the bottom line, it’s pretty stable. And John, I don't see that changing. Actually, I would like to see our fulfillment business become a much bigger part of our business.

And we'll take our next question from Alex Slagle with Jefferies.

Just following up on the previous questions that the restaurant industry traffic seemingly still subdued. I wonder if you could talk about your incremental efforts to drive an acceleration in the new customer wins and independent business and what you're doing to drive that? It does sound like ramping the sales force a little bit more and maybe any comments on how you're incentivizing your sales force or other levers to drive further acceleration in that?

Yes. We really don't offer up promotional activities that are national or things that we go to our people with. It's really all around growing our sales force. And we've always found that if we're doing the right training and we're hiring the right people, then we're going to grow our business faster than we grow our sales force. It's pretty simple but that's how we look at it. And I think that we've been able to hire some good people of late. We got some intense training going on. A lot of them have already been cut loose, and we're ready to let them all cut loose. I guess it's just no different than that.

Got it. Regarding productivity and your efforts to align staffing levels with the seemingly volatile and unpredictable volumes, do you see any opportunities for improved tools or processes that you're working on to enhance productivity? Hopefully, the volume trends stabilize more in February and March, but do you have any thoughts on that?

Yes. Patrick is going to take that because he's much closer to what we're doing there.

Yes, thank you for the question. First of all, regarding labor, we are quite pleased. Progress has been slow, but it is improving. Our leadership in the field is working diligently every day on hiring, retention, and training for our warehouse staff and drivers. We are really happy with the progress they are making, even though it is gradual. The one area where we want to see more improvement is retention. However, due to their success so far, we have mostly eliminated temporary labor from our system, and we are also seeing a reduction in overtime. As George mentioned earlier, while it may not align perfectly, we believe that in the upcoming quarters, what has been a headwind will turn into a tailwind, helping to counterbalance the challenges we will face with inventory gains. So, we view this as a positive development moving forward, and we are very satisfied with the progress we've made to date.

And we'll take our next question from Mark Carden with UBS.

So to start, it sounds like you guys have made some really nice progress on fill rates. Presumably, on the inbound side, it's picked up a bit across the industry. Given that, have you seen any smaller competitors taking any more aggressive efforts to maybe win back some of the share that they might have given up when inbound fill rates are more challenging? Do you see that being much of a risk? Or has the new business that you've gained really just proven to be pretty sticky?

I think that nothing's really changed from the competitive landscape. There's probably a little bit more activity going on as far as short-term procuring of an account or picking up some business within account but we've done some of that ourselves in the past, and it seems to do exactly that. It works pretty good short term and doesn't have an impact long term. So we're just kind of continuing to do business the way we do business and price the way in which we price, and we really haven't seen any difference in the marketplace.

Okay, great. And then as a follow-up, it sounds like overall, some nice progress on new business, good market share gains overall. How about from a category perspective? Are you still seeing strength really across the board in independents? Do any categories in particular stand out? Just what you're seeing on that front?

Yes. Casual dining, obviously, the chains, a lot of them are public in big season, numbers not doing real great. But the casual dining independent seems to be doing really well, and that's been a good part of our growth. Pizza has definitely slowed down in the last year, but we're continuing to gain share, and we're very excited about that business. Hispanic seems to be doing real well, although we don't play hugely in fine dining, fine dining seems to be doing well. And center of the plate has been a big hit for us. I mean, our margin growth has really been around our change in mix just in and mix of customers, mix within our channels, but product mix has been a big contributor to that too. Some of our highest profit per case items have been where our growth has been good.

And we'll take our next question from Brian Harbour with Morgan Stanley.

Yes. Is there any way you're able to quantify kind of the impact of some of the business that you said you had exited? And then just kind of to the point you just made, is the softness more on the casual dining side that you've seen in the most recent quarter or anything else that you would call out there?

To answer your last question, casual dining is where we are seeing the most slowness. Regarding exited business, there are different interpretations of that term. It is extremely rare for us to inform a customer that we no longer wish to do business with them. However, we have needed to secure a higher price to continue handling some of that business, and in certain cases, the customer is unwilling to do so. I've mentioned before that excessive overtime and a high number of temporary staff can turn what is usually a marginally profitable business into an unprofitable one. That’s the situation we faced, leading us to scale back on pursuing certain business as vigorously as we did in the past. We believe we are moving towards a point where we can be a bit more aggressive, but we are still dealing with significant costs, which makes it challenging to take on business that won't grow if the customers themselves aren't expanding. This is why we've seen some stagnation or declines in our national account business. Our primary focus has had to be on independent businesses, although we still value all types of business and customers. Additionally, Core-Mark has been growing in their non-tobacco sector, achieving mid-teens growth, which has positively contributed to our overall growth.

Yes, it makes sense. Okay. And could you remind us where just kind of your owned brand penetration is and how that's kind of driven some of the margin performance that you've seen recently?

No. That's one of the best things we have going for us right now. We just finished a month where it was 51.9% of our independent business, and it's not a number I expected us to reach. So it's been really good. Almost all of our branded business goes to independent restaurateurs. We're really focused on that, and it's doing well. Customers seem to respond positively to it.

We'll take our next question from Jeffrey Bernstein with Barclays.

George, you mentioned in your prepared remarks the more stable landscape to start calendar '23. I think you alluded to it being beyond just a favorable January compare bounce. You've also noted that the industry is not doing really well right now. So I was trying to just contextualize because it seems like most of the chains we talked to are talking about surprising resilience in the business and the consumer and whatnot. So I'm just trying to bifurcate between the more stable landscape relative to the industry not really doing well right now? And then I have one follow-up.

Yes. Data from third parties indicates that the industry is experiencing very slow growth, almost at a standstill. I see the same mixed signals. Some chains are performing well and are optimistic, unaware of any downturn, while others are genuinely struggling. The reason we describe the situation as stable is that we've been in a phase of single-digit loss in our business, which has always been our goal but we could never fully achieve. This involves accounts we lost last year and did not reacquire this year, whether they went out of business or we lost them for other reasons. This stability is something we haven't experienced to this extent before, which is where our terminology originates.

Understood. And then just on the commodity inflation or less of it, it sounds like you're expecting continued easing. Just wondering where you think that goes, whether we'll be talking about low or mid-single-digit inflation over the next quarter or two. And thoughts on whether or not that could turn to deflation. I know most have not conceded that, that was really, very likely but just wondering how you change, how you manage your business differently if that inflation ease more quickly and actually turn to deflation?

Yes. We still have fairly high inflation in Vistar and somewhat in Core-Mark, but we're not overly concerned about deflation. They usually raise their prices consistently and work hard to secure those increases. It’s stable, though they might occasionally skip price hikes. In our Foodservice business, particularly with independents, we're closely monitoring things. Currently, our case growth and pricing are nearly aligned, which is a recent development. This doesn’t mean there won’t be variations in our mix when we analyze inflation at the end of the quarter. Right now, inflation in our independent Foodservice business seems to be trending toward very low single digits. As for deflation, I believe we’re well-prepared to manage it now. We didn’t handle it effectively during the Great Recession, but we have improved systems and a more experienced sales team, so we feel confident.

And we'll take our next question from Kelly Bania with BMO Capital.

George, I wanted to go back to something that you said at ICR about the comment about renegotiating terms with most customers, I think, almost every customer, and I believe that's on the contract side. And that's pretty consistent with what we hear across the board. But I was just curious if you can help us understand the changes in the way that the contracts are structured and negotiated today versus maybe a few years ago and how that may impact the future of how the business performs in the future? And I guess, I'm particularly just curious if there's any changes or ways that we should be modeling as we transition here from this higher inflationary environment to a possibly lower inflationary environment.

I don't see, at least within our world that there's really any changes in how they're structured. We just needed to get most of that as a fee business and we needed to get a higher fee because of our expenses, and we try to do a good job of making sure that we are recouping what we felt were kind of those long-term expenses. Obviously, the operating expenses that we had through the severe part of COVID is not something that you want to pass on to a customer; you're just going to cause yourself problems down the road. But we were fairly successful, I would say, very successful. We have a good customer base and where we weren't successful, we lost some business. And that's just the way it goes. But no, I just don't see a big change moving forward. And if we go through a deflationary period of time, those customers will benefit from lower costs, and they'll probably, in the end, be good for our business, good for our industry.

Okay, that's helpful. And maybe just a follow-up on fill rates. Very helpful color there. I think you gave us for Foodservice in Vistar. Just curious if you have a sense of how you think those compare, both on the inbound and outbound metrics, to the rest of the industry and your competition?

We don't have a good feel with that. I mean, I guess the only thing that we get is the complaints from customers around fill rates have gone down and gone down a lot. Our Foodservice was almost back to normal, very close. Core-Mark and Vista are still struggling more with inbound. And what I look at because it's hard to judge in this type of environment has been hard to judge is what our inbound rate is versus our outbound. And are we converting the inbound to a better outbound at kind of a percentage standpoint, what we used to when the supply chain was normal, and we've been able to do really well there. So I would say that we're probably at least at par with the industry. I think it helps, too, that we are purchasing people at each of the distribution centers and they're really tied tight to the sales force and many of the customers, particularly the larger customers, and I think that's helped us.

And we'll take our next question from Andrew Wolf with CLK.

I wanted to ask you to elaborate on your perspective and outlook regarding labor productivity. From what I’ve gathered from your comments, George, it seems that labor costs are decreasing, possibly on an hourly basis as you replace some of the costly labor with more standard labor. However, what are the current trends in labor productivity, especially considering that you might still be in the early stages of training? What is the forecast for labor productivity, and where do you see it needing further improvement? It appears that the issues might be more related to warehouse operations rather than delivery, which seems to be advancing more quickly.

Well, it needs to improve everywhere, but I'm going to kick that one to Pat. He's closer to it.

Yes, that's a great question. As I mentioned earlier, we have excellent systems in place. Once we onboard new employees in the warehouse and provide them with training, these systems enable them to be highly productive. The key issue we are facing is retention, which is a challenge not just for us but for the entire industry. However, we are beginning to see positive progress, as I noted before. Our team is doing a fantastic job of recruiting and training new staff, and we believe that over time this will become a significant advantage for us.

And we'll take our next question from William Reuter with Bank of America.

The sequential commentary about your inventory gains over the last year and which are the toughest comps was very helpful. I was wondering if you could share the magnitude in totality of these gains on an LTM basis. Because it sounds like you think that largely, these are going to be offset with productivity savings. So trying to get a sense of what you're expecting on that?

Yes, this is Patrick again. We began noticing inventory gains in the third quarter of 2022, which increased in the fourth quarter and again in the first quarter of 2023. As George mentioned, in this quarter, we actually experienced year-over-year gains, although we were comping negatively. We can't provide a specific quantification of that at the moment. Additionally, as George noted, we are unsure whether the productivity gains will completely offset the timing of these inventory gains, but there is significant opportunity on the productivity front. In our outlook, we anticipate that inflation will continue to slow down and that the inventory comparisons will become more challenging. However, all of this has been incorporated into our guidance.

Okay. You've been focused on reducing debt, and your leverage is now within your target range. Are you at a stage where you would consider additional mergers and acquisitions, or do the higher interest rates in the current environment discourage this kind of activity?

Well, yes, as you mentioned, we are within our leverage range, and we're obviously very happy about that. And again, we reduced our leverage to 3.3x in the quarter. When we think about uses of cash, we're certainly, as I mentioned, focused mostly on investing in the business and building our capacity to support the growth of the business. We're always looking at strategic M&A. So I'll leave it there unless George wants to add anything to that.

Well, we've always been opportunistic acquirers. And I would say that we always will be, so that something could happen there. We don't have anything that's actionable right now, but paying down debt, that's important to us. So is adding capacity. We would rather reduce our leverage by having more earnings as opposed to reducing anything for that matter. We want to grow. And fiscal capacity, I would say that's probably the most important thing to us today, but we'll always be an opportunistic acquirer.

And we'll take our next question from Joshua Long with Stephens Inc.

Could you provide an update on the overall strength of the supply chain? It seems like there have been improvements, particularly in fill rates. Can you give some context around the overall supply chain for the string business? Additionally, regarding the fill rate comments, how do you view the situation? While the fill rate percentage has increased, what does that mean in terms of the actual number of items or the assortment compared to pre-pandemic levels? Is this even a significant point in the current environment?

That's a good question. The supply chain is improving quickly at the moment. We learned a lot during COVID. It was a finely-tuned supply chain, especially for perishable products. When such a finely-tuned system faces disruption, it can happen suddenly and take a long time to recover. Our Foodservice division is getting close to normal. One challenge with our fill rate in Vistar and Convenience is that many items were no longer being produced. Customers continued to order them, but we're starting to see those items being manufactured again. Additionally, suppliers who served both retail and Foodservice were focused more on retail and let many Foodservice items fall by the wayside. As more food consumption shifts back to Foodservice, those suppliers are re-engaging. It's challenging for them to return after customers have had to seek alternative sources, but they are coming back. I believe the supply chain isn't fully back on track yet, but we are seeing significant improvement. We closely monitor the number of items sold weekly at our distribution centers. Most of our companies are still selling fewer items than before, but the situation is improving rapidly.

That's helpful. Looking at the overall strength of the business, considering case growth and new customer acquisitions, it's impressive. I assume there is a significant amount of investment happening behind the scenes, not just in the sales force but also in capacity and warehouse capabilities. Can you discuss this further and share your perspective on how well you're positioned to maintain or support continued growth at these levels moving forward?

That's a good question. And as we talked about just in the last six months, we've invested $98 million in CapEx. And when we talk about our priorities, that's really the number one priority is to continue to invest in the capacity of the business to help it grow. As we just mentioned, another priority is to also reduce leverage. But the number one use of our cash is going to be continuing to invest in the business, and given the results of the three segments and their strength, we're going to continue to do that because they're doing some really nice job of generating some really solid growth.

We'll take our next question from Carla Casella with JPMorgan.

It's Carla Casella from JPMorgan. You've made good progress reducing the revolver this quarter. I'm curious if you are considering your leverage and targets moving forward. Is there any intention to be out of that facility by year-end or a specific target for when you would like to exit, especially considering the current high interest rates?

Thank you for your question. I wanted to share a couple of points. As we mentioned, we use interest rate swaps, which means part of the ABL is floating. However, we've fixed 76% of our total debt, and the ABL has a very attractive rate of LIBOR plus 125 basis points. While interest rates are indeed rising and impacting the floating portion of our ABL, we've effectively managed our interest expenses. Therefore, we do not anticipate retiring that facility at this time and will continue to manage the interest rate environment effectively with those swaps.

And we'll take our next question from Peter Saleh with BTIG.

I want to return to the discussion about the Foodservice and restaurant industry. George, you noted that pizza sales have decreased over the past year, while fine dining continues to perform well. Do you think this indicates that lower-income consumers are pulling back? There has been considerable discussion and concern about this in the industry, and I’m curious about your perspective on the consumer in this context.

That's a tough question. Quick service restaurants seem to be performing well. We have limited exposure to that segment, but it looks strong. Regarding pizza, as more options have become available, consumption has decreased. There might be what some call "pizza fatigue." Despite its strong performance during the COVID period, I don't have a definite answer for you. However, we see that lower-end consumers are engaging in more value store business through Vistar, which is performing well. We would likely do even better if there were more product availability. This suggests that consumers are opting for more affordable options. Overall, I would describe the situation as mixed.

Appreciate that. And just a housekeeping question here. I think you mentioned Foodservice inflation was about 9.6%. And can you give us that number, what it was last year at this time and maybe on a three-year basis, that would be helpful.

Yes. We don't have that number. We can get it and have Bill get that to you. But I would want to comment that, that was what we did last quarter, and that we have seen a pretty significant deceleration in the last five weeks since the end of that quarter in food service.

And we'll take our last question from Fred Wightman with Wolfe Research.

I just wanted to come back to some of the cost benefits that you guys highlighted from the lower temporary workers. And over time, if we go back and look at some of the prior disclosures that you've provided about some of those onetime costs. Were those numbers only the temporary labor force, or was that the combination of the temp labor force and the higher overtime?

Yes. Thanks, Fred. This is Patrick. Those comments, those prior comments are really around the temp labor force, and we were just highlighting because they're unusual.

Okay. And then as we just think about the sequencing of those potential benefits going forward. If we look in Q4 of last year, you guys have started highlighting year-over-year benefits from lower temp workers. So how does that sort of piece together with the ability for some of these lower costs to offset some of those inventory gains, or the headwinds from lower inventory gains that you're facing here for the rest of the year?

Yes. I think the best way to think about it is, I think we have said that a lot of that temp labor has come out of the system. What we're focusing mostly now on is the overtime that we still have in the system, which is, again, just a function of us being able to hire enough workers and retain those workers. The productivity improvement that we're still really looking to see the biggest benefit from is the efficiency that you gain once you had an employee in their role for a little bit of time, and they really start to generate some good efficiencies in that role. So that's the next step, and that's what we're looking towards.

Perfect. And then just lastly, you touched on the private label penetration and independent specifically, but what is the outlook for that penetration, just given easing inflation and then also some of the higher fill rates that you're seeing from your vendors? Do you think that will hold steady? Can it continue to grow? Or maybe you guys are not penetrating that because of costs? Like what is driving that, I guess?

That's a good but challenging question. We have a few operating companies that are over 60%, in the low 60s. So that's a possibility, but I must admit I didn't expect us to be at 51.9% now. One factor that has definitely benefited us is that we monitor our inbound fill rate for our brands and our overall inbound fill rate, and it was significantly better throughout COVID for our brands. Our suppliers really stepped up. I'm not sure if the improved fill rates from other suppliers will impact us. What I can say is that I'm very pleased with the proportion of our business that's our brand. We certainly enjoy selling products that aren't our brand too, and that can be quite profitable for us. It fosters a better sense of loyalty, but it's really about the customer. When they provide us with much better inbound service compared to others, I believe it will continue to grow for us. However, I doubt we will see the same extraordinary growth that we've experienced over the past few years.

And we'll take our last question from Lauren Silberman with Credit Suisse.

Just a follow-up on the Foodservice inflation as a different way. Is your total cost basis staying relatively steady, while year-over-year is moderating? Or are you seeing that total cost basis declining as well?

It's slowing down. It's still high, but it's really slowing down.

Okay, I understand. I have a follow-up regarding independent customers. How significant are new restaurant openings for your goals in customer acquisition? Is there a sufficient opportunity and a large enough addressable market in relationships that you currently don't have, so that year-over-year positive unit growth in the restaurant sector is not as crucial?

Yes. We don't track that, unfortunately, probably should. I think it's probably been new customers has probably been more important in the last year, certainly as you think about these buildings there. For the most part, single-purpose buildings. And if somebody went out of business, it would be rare to see somebody other than another restaurant come into that building. So I would say it's probably been more important in the last year. But the rate at which you really need to grow your new customers to put the growth out that you need, you have to get existing restaurants on board. I think that's really important. I wish I had better numbers for you, but we just don't track it separately.

It appears that we have no further questions at this time. I will now turn the program back over to Bill Marshall for any additional or closing remarks.

Thank you for joining our call today. If you have any follow-up questions, please contact us at Investor Relations.

That concludes today's teleconference. Thank you for your participation. You may now disconnect.