US Foods Holding Corp. (USFD) Q2 2023 Earnings Call Transcript

Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the US Foods Second Quarter 2023 Quarterly Earnings Conference Call. Thank you. Adam Dabrowski, Director of Investor Relations. You may begin your conference.

Thank you, Rob. Good morning, everyone, and welcome to US Foods second quarter fiscal 2023 earnings call. Speaking on the call today, we have Dave Flitman, Chief Executive Officer; and Dirk Locascio, Chief Financial Officer. We will take your questions after prepared remarks conclude. Please provide your name, your firm, and limit yourself to one question and one follow-up. Our earnings release issued earlier this morning and today's presentation slides can be accessed on the Investor Relations page of our website. During today's call, and unless otherwise stated, we are comparing our second quarter results to the same period fiscal year 2022. In addition to historical information, certain statements made during today's call are considered forward-looking statements. Please review the risk factors in our 2022 Form 10-K for a detailed discussion of these potential factors that could cause our actual results to differ materially from those anticipated in those statements. 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, except that we have not provided a reconciliation of forward-looking non-GAAP financial measures as indicated therein. Thank you for your interest in US Foods, and I'll now turn over the call to Dave.

Thanks, Adam. Good morning, everyone, and thank you for joining us today. It's hard to believe that I've already been at US Foods for seven months. During this time, I have continued my focused effort to get deeper into the business and interact with more of our associates, customers, suppliers, and investors. I'll start today by sharing highlights for the quarter and progress against our strategy and long-range plan before I hand it over to Dirk to review our financial results and updated fiscal 2023 guidance. We remain intensely focused on executing our long-range plan, and it showed in our strong financial results again this quarter as we delivered record adjusted EBITDA of $432 million. We achieved 17% adjusted EBITDA growth through a combination of profitable volume growth and margin expansion. Additionally, we delivered healthy total case growth of 3%, led by 5% independent case growth, underpinned by 5.5% growth with broadline independent restaurant customers, along with 7% healthcare and hospitality growth. This is the ninth consecutive quarter our team has gained independent market share. Finally, we accelerated cash flow generation through our earnings growth and working capital improvement. Our strong cash flow year-to-date has allowed us to invest in the business for organic growth, prepay additional term loan debt, and return capital to shareholders via share repurchases. As a result of our strong performance for the first half of the fiscal year and continued momentum, we are increasing our full year earnings guidance, which Dirk will share later. My expectation is that we will continue to execute our plan and build upon our strong momentum. Now let's turn to Slide 4. Our strategy guides how we operate and what we focus on to win at US Foods under our four pillars of culture, service, growth, and profit. Last quarter, I introduced the simplified model, which is much clearer for our associates, so we can be more action- and outcome-oriented across the company. These changes are resonating with our organization and are helping us remain focused, which contributed to our strong second quarter results. The other key change I made was to our organizational structure, bringing our four region presidents onto my management team, and that change has been outstanding. Having them at the table has improved communication between our functions in the field and streamlined our decision-making regarding the execution of our broader strategy. I'm going to briefly focus on second quarter progress points against the culture and service pillars, and then Dirk will talk about the growth and profit pillars later. Turning to Slide 5. The first pillar is culture because our culture and our people fuel our strategy. Instilling a stronger safety culture has been a focus since the day I arrived at US Foods. I am pleased to say that we have made very good progress in just seven months. Our second quarter year-over-year results improved approximately 20% compared to the prior year through a combination of tone from the top and focused programs to drive results. We have good early momentum with significant opportunity remaining. On a related note, I would like to recognize the 13 US Foods drivers who were recently named to the International Foodservice Distributors Association Truck Driver Hall of Fame. This prestigious accolade is only awarded to those who have exceptional safety records, including 25 years of service without an accident. What makes this year even more special is that Alicia Seyler, one of our drivers based in Loveland, Colorado, with 27 years of service, was the first-ever female driver elected to the IFDA Hall of Fame. We are proud to have these world-class drivers dedicated to safety at US Foods as we strive to provide our associates, customers, business partners, and the communities we operate in with a safe and hazard-free environment. Additionally, we recently published our 2022 Corporate Social Responsibility Report and I am proud that we have made continued improvement across our three focus areas of people, product, and planet. I encourage you to go to our website to read about our progress from our sustainable products, the US Foods scholar program to our compressed natural gas trucks and Scope 1 and 2 emissions reduction. Moving to service on Slide 6. As a reminder, our research tells us that the most important services to our customers are on-time, correct orders, and high-quality fresh products. Our product service levels to our customers are back in line with pre-COVID levels. Vendor service levels to US Foods have also steadily improved. However, they remain slightly below pre-COVID levels. This progress is yielding positive results from a service level perspective and is also helping us reduce our working capital. Our routing initiative continues to make progress. And in the second quarter, we delivered the best cases per mile metric in the last three years. We are also preparing for a pilot of our new routing software later this year, which will significantly increase our capabilities. I look forward to our learnings and the progress we will continue to make. Finally, MOXē, our digital customer platform has now been fully rolled out among our local customers and feedback continues to be very positive, as are our Net Promoter Score results. Turning to Slide 7. I'll walk through our second quarter highlights in a bit more detail. We grew adjusted EBITDA by 17% despite essentially no sequential inflation and, in fact, modest year-over-year product cost deflation, driven by center-of-the-plate categories. Our adjusted EBITDA margins also increased 60 basis points from the prior year as our initiatives continue to ramp up, and we gained operating leverage this quarter. Year-over-year, total case volume growth was healthy at 3%. Case growth was led by 5% growth in independent restaurants and 7% growth in both healthcare and hospitality while chain cases were down 4%. Our independent case growth was negatively impacted about 70 basis points from slower growth in our CHEF'STOREs as we work through a systems conversion which is largely behind us now. This means our broadline independent customer case growth was 5.5% for the quarter. The software chain results this quarter are primarily due to no longer lapping Omicron, the softer macro, and the impact on same-store sales across most of our chain customers. Healthcare and hospitality continue to demonstrate strong growth, driven in large part by helping net new business. We are pleased with how our target customer types continue to outperform the industry, resulting in share gains. With that said, we still have the opportunity to improve performance as we focus on more consistent execution. We have good momentum and expected to further accelerate. Moving to our customer experience. We again gained year-over-year market share in our target customer types as we remain focused on executing our differentiated strategy. For independents, this is the ninth consecutive quarter of share gains, which demonstrates the progress we continue to make. I am happy to report that MOXē is fully rolled out to our local customers, reactions continue to be very positive, and we are releasing regular updates based on customer and seller feedback to improve this industry-leading platform. We are now beginning to roll out MOXē to our national customers. This platform, combined with our other leading digital tools and service model, will enable us to continue to service our national customers well and build it and convert a strong new business pipeline, especially in our target customer types. We also actively expanded customer usage of VITALS, our technology suite for healthcare customers, to leverage added capabilities and help our customers more effectively manage their overall costs. Very importantly, we continue to make progress on our supply chain excellence journey during the second quarter. In addition to our improved momentum in safety, our productivity performance also improved year-over-year and sequentially for both delivery and warehouse, which is very encouraging. I am pleased with the progress we are making and expect us to further accelerate that progress in the back half of this year and into 2024. Our flexible scheduling and seven-day delivery pilots are progressing well, demonstrating results in line with our expectations, including a double-digit percent reduction in turnover in each of our pilot markets. As I called out last quarter, our near-term focus will be to expand flexible scheduling broadly. We only roll out seven-day delivery opportunistically where capacity is constrained. Our team is actively working to expand the flex scheduling approach and we expect to have more than half of our locations live on flex scheduling by year-end, which we believe will further improve associate satisfaction and retention. Finally, we continue to strengthen our capital structure and prudently allocate capital to fuel long-term growth. Through earnings growth and additional debt reduction, we lowered our net leverage to 3x, which is the first time we've been in our target range since it was established. Our debt ratings were upgraded by both rating agencies, demonstrating our strong progress and underlying business momentum. In parallel to the continued leverage reduction, we spent $166 million on share repurchases. Shortly after the end of the quarter, we closed on our first tuck-in acquisition in six years, Renzi Foodservice. As part of our continued investment in Renzi, we are slated to break ground on the expansion of our Renzi distribution center this month, which includes approximately 10,000 square feet of construction, providing additional loading dock space for 8 new refrigerated loading bays to support our growing customer base in the area. We are excited to welcome the Renzi associates, and I look forward to working closely with this high-quality team to drive future growth. Each of the actions we've taken on deploying capital in a balanced manner reinforces our commitment to being responsible stewards of capital to drive long-term shareholder value creation. With that, I'll hand it over to Dirk to go over our financial performance and guidance in further detail.

Thanks, Dave, and good morning, everyone. Let's turn to Slide 9. We are very pleased with what we accomplished in the second quarter and the strong momentum we continue to have at US Foods. Adjusted EBITDA grew $64 million or 17% from the prior year to $432 million, which was a record quarter for US Foods. In addition to strong EBITDA dollars, we expanded our adjusted EBITDA margin 60 basis points from the prior year as our gross profit grew significantly more than OpEx. Finally, adjusted diluted EPS grew 18%, which is also a record. Within our results, net sales were $9 billion in the second quarter, an increase of 2.1% over the prior year. Total case volume increased 2.7%, partially offset by year-over-year food cost deflation and product mix impact of 0.6%. As Dave mentioned, case growth was healthy overall and especially in our target customer types. Case growth slowed from the first quarter, largely as expected since we no longer had a year-over-year benefit from Omicron lapping in the second quarter. We faced a headwind to case growth in the second quarter, primarily from a system conversion at CHEF'STORE. However, we have largely worked through it at this point and are seeing sales improve. We are pleased with the 5.5% broadline independent case growth. We did see modest year-over-year product cost deflation, and it was driven by center of the plate as groceries still showed year-over-year inflation in the quarter. Essentially, we had no sequential inflation and still are not seeing deflation in grocery categories, which is encouraging. Since grocery categories are predominantly a percent markup and more impacted by deflation compared to center-of-the-plate categories, which are largely fixed markups and not as impacted by deflation. We continued our strong gross profit performance this quarter as our adjusted gross profit dollars increased 9% from the prior year. Most of the strength is due to the excellent progress we have made over the past year on our long-range plan initiatives across cost of goods, logistics management, and pricing. Our initiatives have been critical in mitigating the increased operating costs we and the broader industry have faced. OpEx was above the prior year for the second quarter, albeit significantly less than the increases we saw in the past two years. The second quarter year-over-year increase in OpEx per case was largely driven by increased seller compensation and higher incentive compensation costs as distribution cost per case was better than the prior year. We continued our progress against both the growth and profit pillars, and I'll spend a few minutes on each of these. We are focused on profitable growth and share gains in our target customer types, by leveraging our differentiated service model, digital capabilities, and unique products. We are on track to exceed our 1.5x goal for restaurant volume growth for the full year led by strong independent case growth. In the second quarter, we drove year-over-year share gains in each of our target customer types and continue to develop a strong healthcare and hospitality new business pipeline. As Dave mentioned, this was our ninth quarter in a row of independent share gains. As we grow faster with our target customer types, it helps our customer mix and drives profitability. Next to profit on Slide 11. In addition to profitable growth, we continue to make progress on our initiatives to increase EBITDA margins. Our team effectively managed a relatively volatile quarter for commodity categories as we leverage our processes and maintain our strong gross profit per case. At the same time, we further progress on initiatives such as cost of goods or COGS improvement by working jointly with additional vendors. We remain on track to address a total of 60% of COGS by the end of fiscal 2023. We continue to advance our efforts to drive operational efficiencies as productivity improved year-over-year and sequentially for both delivery and warehouse. Our flex schedule and pilots are progressing well and demonstrating good results. This powerful initiative has a twofold impact. It gives associates more scheduled flexibility and provides US Foods with better associate engagement and retention. Ultimately, this adds up to a win for our customers through stronger service. Finally, we are progressing with our indirect procurement work and have identified a number of opportunities, which we are pursuing and will ramp up further value creation in 2024. I'm now going to pivot from earnings to cash flow. Turning to Slide 12. We continue to increase our strong cash flow and expect to build upon this as we grow earnings. Our strong cash flow allows us to continue reinvesting for growth and to further strengthen our capital structure. We have and will continue to prudently allocate capital against our core priorities to invest in the business, reduce leverage, return capital to shareholders, and pursue accretive tuck-in M&A to strategically expand our distribution network. Year-to-date, we have invested approximately $200 million of cash CapEx and fleet leases, including projects to expand fleet, improve analytic insights, and enhance technology and supply chain and sales to enable further organic growth. I'll talk further in a moment on reducing leverage. In parallel with the debt reduction, we repurchased $166 million of shares in the second quarter, $150 million of which came from the KKR stock sale. Following this repurchase, we have $286 million remaining on our $500 million share repurchase program. In early July, we completed the acquisition of Renzi Foodservice, and are excited to welcome the Renzi team to the US Foods family. This is our first tuck-in acquisition since 2017, and we are thrilled about the quality of this business and associates. Moving to Slide 13. We meaningfully reduced our net leverage compared to year-end 2022 through a combination of net debt reduction and earnings growth. You can also see on the slide the significant progress over the past 12 months. Our net leverage ratio was 3x at the end of the second quarter, which is the top end of our target leverage range. We continue to prioritize debt paydown and prepaid an additional $60 million of term loan in the second quarter, bringing us to $125 million of prepayment year-to-date. Our overall debt structure is in good shape as we don't have any maturities until 2025. That said, we are looking ahead to the 2025 maturity and expect to proactively address that in the next quarter or two. Actions this quarter resulted in credit upgrades from both rating agencies. We remain focused on creating value for shareholders and allocating our capital prudently across the four parts of our capital allocation strategy. Now turning to guidance on Slide 14. As a result of our strong year-to-date results and outlook for the full year, we are raising our full year adjusted EBITDA range to $1.51 billion to $1.54 billion and our adjusted diluted EPS range of $2.55 to $2.65 per share. We remain on track to reduce leverage to below 3x by the end of the year. We are well positioned to deliver against this guidance and expect to be at the higher end of the earnings guidance if the macro environment remains similar to what we're seeing currently. With that, I'll pass it back to Dave for his closing remarks.

Thanks, Dirk. I will close where I started. Seven months into my role, I couldn't be more excited about US Foods and the opportunity ahead for our business. Slide 15 summarizes our investment thesis and why I am so bullish. US Foods is a strong company, and we continue to get stronger. We are a leader in a highly fragmented industry in a pure-play U.S.-only based distributor focused on broadline distribution. Our business is resilient across various macro backdrops and US Foods offers further stability through our laser focus on controlling the controllables and executing against our long-range plan. We are targeting independents, healthcare, and hospitality for growth where we believe our differentiation adds even more value and we are seeing the results in our outsized growth and continued share gains. This progress has been driven by the quality of our strong team, our service model, and our digital capabilities, including MOXē. I believe these are all compelling reasons to invest in US Foods. We are focused on building on the company's core strengths while finding ways to more effectively execute our strategy and accelerate our rate of improvement. I am confident this combination will lead to a very bright future for US Foods and all of our stakeholders. Finally, I would like to thank our 29,000 associates for their continued dedication and the excellent work they do each day to help our customers succeed. Our associates are critical to our success which underscores why they matter is a very important among our cultural beliefs. With that, Rob, please open up the call for questions.

And your first question comes from the line of Mark Carden from UBS.

So to start, it looks like you took meaningful market share in the independent channel, albeit with a bit of a slowdown in case growth relative to last quarter. Outside of some of the disruption with CHEF'STORE, which it sounds like you've largely worked your way through, what are you seeing with respect to the health of this customer overall? And any changes on how you're thinking about the channel's contribution to your growth in the coming periods?

Yes, I appreciate the question, Mark. We are seeing strong health of the operator and independents. And if you recall, I mean, we were expecting the performance that we had in the second quarter. If you recall, we had the Omicron lap go away here in the second quarter. And as we provided color last quarter, we saw some softness in March that led into April. May and June got sequentially stronger. And while we don't give quarterly guidance, I can tell you the start of the third quarter has been at or slightly above what we saw exiting the second quarter trajectory. So we feel very good about the health of the operator, but more importantly, our ability based on our differentiation to continue to take share in that segment of the business. And then besides that, healthcare and hospitality remain very, very strong. We're taking share in both of them, and we have very strong pipelines across the board.

That's great. And as a follow-up, just on deflation, how much did deflation intensify as the quarter progressed? How much risk do you see it ultimately impacting your grocery category sales? And then when you think about next year and the $1.7 billion EBITDA target, is that contingent upon a return to a more normalized inflation backdrop? Or do you have enough with your initiatives to get there in a variety of scenarios?

Mark, this is Dirk. So overall, the inflation-deflation picture was pretty similar across the quarter. So you saw it changing really as you were lapping prior year. But if I think of it through the quarter, grocery overall still continued to see for the quarter a little bit of inflation. So we still haven't seen deflation popping up there. And in the proteins, a lot of that is coming from the lapping of much more inflation a year ago. And as I said in my prepared comments, we'll take that because those tend to be more fixed markups and our teams have very good processes to manage through it. So even in this environment of very little inflation or modest deflation, we think we're very well positioned to manage through it. And as you've heard me say a number of times, as we focus on controlling the controllables, the strong gross profit growth we've driven is really predominantly been from a number of the initiatives we've executed.

Your next question comes from the line of Edward Kelly from Wells Fargo.

Nice quarter. I wanted to start with the cost side. You mentioned that distribution cost per case is better than in 2019. I think the progress in operating expenses per case has been very good. Looking ahead to the next couple of quarters, it seems like the year-over-year growth in operating expenses per case might be minimal, suggesting that we could be entering a stable period. Can you explain what is driving the decrease in cost per case on the distribution side? Are we expecting this rate to continue? Clearly, there are various factors at play with wage inflation. Any insights on this would be appreciated.

Yes. I appreciate the question. I'll start at the higher level and give Dirk a chance to win in any of the specifics. But as we've said the last couple of quarters, we feel very good about the momentum we're getting on productivity, both in our warehouse and delivery. And you heard me say on the call there, we had sequential improvement as well as year-over-year improvement in both. And so the initiatives we're driving, we're very excited about. We expect those to continue to get traction in the back half of this year. And I would point out to your point, this is five or six quarters in a row where our operating expense growth continues to decline. And that's based in large part by the good work our team is doing, particularly in supply chain.

And the only thing I would add is, in the quarter, as I commented, overall distribution cost per case was lower than it was a year ago. And the two areas that really drove our increase were seller compensation, which is driven by the strong gross profit results we've had. And then secondly, incentive compensation, which is a good place you're going to have higher costs because it drives team to continue to perform at a stronger level. So we feel, as Dave said, very good about the progress and the path ahead and our ability to effectively manage costs and gain leverage.

And then just a follow-up on gross profit per case. The 6% gain this quarter with some deflation is obviously very encouraging. As we think about the quarters ahead, is there any reason that you shouldn't at least be gaining in that gross profit per case? I mean, just where you stand today, it doesn't seem unreasonable at all that you had at least a low single-digit year-over-year gain there continuing. But maybe just some color there and where do you think you stand in terms of like the innings in terms of the upside here?

Sure. Good question. For the second quarter, adjusted gross profit dollars increased by about 9%, which is encouraging. Looking at year-over-year performance, you might see smaller increases because we are comparing against strong gains from the previous year. As we aim for a more normalized environment, I still feel optimistic about the durability and strength of our gross profit per case. We will keep focusing on increasing gross profit, with the goal of driving margin by growing gross profit faster than operating expenses. Our overall EBITDA growth hinges on achieving profitable growth, particularly among our target customer segments. We are pleased with the progress we've made and see plenty of opportunity ahead.

Your next question comes from the line of Brian Harbour from Morgan Stanley.

Yes. Can you maybe just comment also on the chain restaurants? I know it's kind of not the customer focus at this point, but any change in trends with case volumes for chains?

Yes, I appreciate the question, Brian. To revisit some points from our last quarter, I mentioned that when we were slightly below the market, it’s important not to read too much into that. This primarily relates to the changes in competition within our portfolio. Additionally, we were not surprised by the effects from Omicron that we anticipated in the first quarter. Furthermore, the overall situation in the chain segment has deteriorated as the year has progressed. For instance, Technomic data originally estimated growth of about 200 basis points back in January, but they revised that to flat growth in May. Recent Black Box data indicated that changes in the second quarter have decreased by about 2% to 3%, with a specific decline of around 2.7% noted in July. The primary challenge in chains is traffic, and as you pointed out, that isn’t our main focus. We intend to seize opportunities in chains while remaining committed to healthcare and hospitality independents, and we will continue to implement our strategy effectively.

I think, Brian, hopefully what you continue to see here in the second quarter is in a pretty normalized operating environment has recovered. The fact that our overall independent is still growing at 5.5% in the broadline which, as I said in the first quarter call, we think sort of in the mid-5s, that's a very strong case growth. We're taking share. Healthcare and hospitality is not by chance that we're growing still at 7%, well above market. And so those are the things that we're going to continue to control the controllables despite the macro backdrop, we feel good about where we stand and our outlook.

The deflation rate you experienced in the second quarter, do you anticipate it will remain consistent in the second half? Additionally, will the LIFO benefit from lower inventory values continue to impact the third and fourth quarters?

Sure, I can address your questions in reverse. Predicting LIFO can be challenging due to the effects of deflation or inflation. Just to clarify, our adjusted figures account for this, so it doesn't benefit our adjusted EBITDA, although it does aid our overall GAAP numbers. Regarding the second half of the year, the second quarter showed stability. If we continue to experience some deflation, particularly driven by the center-of-the-plate categories, we feel optimistic. In grocery, we haven't observed significant deflation yet. Even with potential modest deflation in proteins, we are confident in our ability to maintain strong results.

And your next question comes from the line of Jeffrey Bernstein from Barclays.

Great. I have two questions. First, regarding the total case growth, we've discussed that independents performed better while chains lagged. Overall, there seems to be a slight slowdown. I'm curious if there are concerns about a slowing economy or what your expectations are for total case growth in the second half of the year based on your updated guidance for 2023. Dave, you mentioned the upper end of the earnings guidance assuming the macro environment remains stable. What does that imply for total case growth in the second half or for the entire year?

Yes, I appreciate the questions. I would point to the comments I made earlier around the stability in the independent space and the health of the operator holding up quite well, particularly as we put the calendar here into the early part of the third quarter. Importantly, our ability to continue to take share. I'm getting nothing but more confident around that, given the strength of our team, our ability to lean in, in a local market basis and provide the best value and product offerings and really understand where we can target those independents. That continues to get very, very strong. All that's contemplated in our back half outlook. So we would say we're in a very stable environment, and we will continue to take share there. I already commented on the chain space and our focus there. Dirk?

And you just come back to Dave's comments that he made in his prepared remarks just around the lapping of Omicron. I mean that is 200 basis points or 300 basis points across much of the business. And so when you think of Q2 being a very normalized environment, I think the business is still growing at 3%. When you have a lot of businesses that are really going backwards pretty meaningfully. And the fact that we are growing much faster than that in these target customer types, which are more value-added, more profitable, et cetera, that Dave said we feel very good about. So where we are, what we saw in July and the stability of the overall macro.

Understood. And a follow-up just on the EBITDA margins. I know you talked about the 60 basis points of expansion to the 4.8%. I think you previously noted that for full year '24, so a year from now, you would hope to get back to at least 4.6%, which was pre-COVID levels. I know the seasonality at play and it's difficult to compare the second quarter of this year to kind of a full year guidance for next year. But Dave, if you were just taking a step back, I mean, how do you assess the ultimate potential for those margins over time? Whether you look at comparable peers or whether you're looking at historical trends, just trying to get a sense because, again, at least this quarter, you're already above kind of that pre-COVID level, again, stripping out seasonality, but just your thoughts on the EBITDA margin going forward.

I feel good about our ability to control what we can control, not so much concern to your point around what our peers are doing, but what we're doing inside our company. And as you've heard Dirk say here a couple of times this morning, we're focused on initiatives and things that we can control, and we think there's still a lot of juice in the squeeze. And so I'm feeling increasingly positive about my comments last quarter around our ability to deliver against that $1.7 billion plus or minus in 2024. And obviously, we'll have to say about that as we get further into the year and provide guidance for next year. But nothing gives me a reason to pause. I have just continued to gain confidence around our ability to execute and ramp up both our growth and profitability.

And your next question comes from the line of Kelly Bania from BMO Capital Markets.

I just wanted to talk about EBITDA margins. I guess, historically, your second half EBITDA margins in total are a little stronger than your first half, but your guidance, I think, seems to imply a little bit of the opposite, maybe a little bit lower in the second half. So just curious if you can talk about how much of that is conservatism or other factors that might be impacting the margins in the second half or any change in maybe seasonality that we should be thinking about as we think about the second half?

Sure. Kelly, this is Dirk. So overall, pleased with the progress we've made on the overall margins. I think as we think about the outlook for the year, even what's embedded in there, especially in my commentary about the higher end that includes being in a normalized environment, pretty healthy EBITDA growth rate still in the second half of the year of high single to low double digits. So I feel good about ability there. I'm not going to comment on specifics within the different lines. But what we do expect is we do expect to continue to still make progress on our EBITDA margins. And I think there's still, as Dave commented, plenty of opportunity ahead. We feel good about where we stand at the halfway point and our outlook for the balance of the year.

Okay. That's helpful. And maybe just to follow up. I don't think we have your sales outlook for this year or have had that. But I guess, just curious if or to what magnitude deflation has impacted the outlook for this year and next? Or is that really was already in your expectation for the year? Or if you kind of had to internally make any changes to your outlook given kind of where food pricing is? Help us kind of understand how that evolved into your expectations for this year and next?

Sure. I think that just because inflation and deflation have been harder to predict. So it may impact the sales dollars, but it doesn't really impact overall given it's come primarily in the protein categories our strategy and what we've executed against. So there's not been a whole lot we've had to adjust. What we are focused on, as you know, is really the case growth and the strong case growth that we have and continue to have across the business. I think that we do watch the different categories very closely and where we may see inflation and deflation is showing up. But in the current environment, we're going to stay the course and we think that will generate the continued momentum that you've seen over the last four or five quarters.

And your next question comes from the line of John Heinbockel from Guggenheim Securities.

I wanted to start with the broadline independent growth, right? If you think about growth in distribution points, right, growth in locations served versus drop size. I'm curious how they relate to each other? Which one is bigger? And then maybe, Dave, your thought on wallet share. And we're not giving numbers, I guess, but thoughts on how high is up? Because it still seems that for you and others, it's way too low versus what it should be.

Yes. John, we feel good about it, again, with the backdrop of the health of the operator that I mentioned earlier. Our ability to take share is strong. I'm pleased with our rate currently of new account generation. But I do believe there's an ample opportunity for us to continue to penetrate our existing customers while we're bringing on new ones. And then ramp up the penetration of those new customers through the course of time. Our team gets that algorithm very, very well and is extremely focused on it. And in the quarter, I would say the new account generation was a bit stronger in that penetration to the first part of your question, but we're squarely focused on both and have a lot of confidence in both going forward.

And then maybe a totally different topic. Obviously, gross margin was healthy when we had inflation, it should be also right healthy with deflation. But if I look at the vendor management or procurement that set of opportunities versus mix, both product and customer, which one do you think is bigger, let's say, looking out 12 to 18 months, is not vendor management piece larger? Or you think they're equally sized?

I'm not sure I've given not to either one of those at this point. To your point, John, we've got a lot of activity going on in both areas and there's still a lot of room for improvement in both.

I believe, John, that this is really a continuous journey. When considering the customer mix, our focus has been on outpacing growth with these targeted customer types due to the added value. We believe we can enhance the overall profitability that comes with that.

And your next question comes from the line of John Ivankoe from JPMorgan.

I know in previous calls, we've kind of talked about maybe some opportunities around indirect spend, low-hanging fruit, I think maybe some unaddressed previously was previously used. Where are we in that journey? I guess how much is kind of showing up that you actually might want to consider? And is this just maybe getting more out of your current spend? Or is actually reducing total dollar spend part of the opportunity?

Thank you for the question, John. We have made progress and identified several opportunities that we are starting to pursue. We expect to see some modest financial results later this year, with a ramp-up throughout next year. This is positive progress since our last discussion, and it primarily revolves around optimizing our existing expenditures. As we have mentioned, we aim to counteract cost inflation through improved productivity, and this initiative is one of those strategies. We believe there is significant potential ahead.

Dave, as you have joined us and observed the previous structure of US Foods, what insights have you gained as you've spent more time in your role? Are there any thoughts emerging beyond the regional changes you've implemented? Regarding your ongoing engagement with CHEF'STORE, do you anticipate that this segment will require increased capital investment over time, or is that still under consideration?

Yes. So I feel very good about the momentum that we've got. CHEF'STORE. I'll just take that one quickly. Obviously, the complication around the systems conversion that we've had here has made it a little difficult to get a handle on underlying volumes and those sort of things. Still believe very much in the value of the business case and the synergies with broadline and we'll be looking as we get the system stuff behind us to get the right data leakage to prove that to ourselves. But opportunistically, going forward, as I've said last quarter, I see a lot of opportunity really in all areas of the P&L. Importantly, I'd point you to what I said last quarter, is that we ramp up this thinking around continuous improvement in productivity and efficiency in that 3% to 5% range. We'll have more to say about that. But as Dirk just highlighted, the intent to offset inflation by getting more efficient and productive every year is a constant theme that you will see us talk about here going forward in the business. And I believe that's a fairly significant change in the organizational thought process here. But more to come on that in the future.

Your next question comes from the line of Alex Slagle from Jefferies.

Just a couple of follow-up questions. One, I wonder if you could clarify how the new routing software benefit to come, I guess, in '24? Is that already contemplated in your views of being able to get toward that previous $1.7 billion EBITDA target for '24? Or could there be upside relative to that or related to this?

Yes, there always could be upside, but that was contemplated as part of the long-range plan when the company put that out in the $1.7 billion target for next year.

Got you. And on turnover and retention, I guess any additional color there on the progress through the 2Q, I guess, driver turnover you've gotten that back toward '19 levels already and warehouse turnover was still above. But maybe just some updates on how far you've gotten, where that goes next?

Really good progress in both areas. The turnover in the warehouse and on the outbound side continues to persist a little stronger than delivery. To your point, we're not quite back to where we hope to be at this point in 2019 levels. However, we've got three quarters in a row now of continued reduction in turnover and improvement in productivity, both in delivery and warehouse and to our discussions around things like our flexible scheduling initiative and the significant ramp-up that we've got on that in the back half of the year being in more than half of our markets after this pilot phase here in the first half gives me a lot of confidence that we will continue to drive significant improvement there and at getting back to where we hope to be. So really good momentum and more to come.

Your next question comes from Andrew Wolf from CL King.

Taking into account the market share you are capturing with independents, what challenges are you encountering? Could you share your perspective on whether the independent sector for foodservice distribution is growing or not? What are you using as a comparison?

Sure. Andrew, this is Dirk. As we've discussed externally, we rely on Technomic data since it is more accessible to you and other investors. Internally, we utilize an NPD data set on a monthly basis because it offers more detailed and actionable insights. When we mention our share gains on a quarterly basis, we base that on NPD data, which covers about 80% to 90% of the industry. Therefore, we are observing share gains according to that data, as they evaluate everyone consistently. According to Technomic, this year’s outlook indicates that independent restaurants may decrease by a couple of percent, while chains are expected to remain relatively stable overall. In contrast, our strong independent segment is growing at a rate of 5% to 6%, while chains are growing more slowly. However, our main focus will continue to be on growing at a much faster pace within the independent healthcare and hospitality sectors.

Okay. Regarding your sales associates, with increased sales, they will earn more money. Could you discuss the productivity of sales associates compared to hiring new employees as a factor in gaining market share?

Overall, when we assess market share, we consider our performance across different markets, categories, and types of restaurants. Underneath that, we have a process for managing individual sales representatives' performance. At the same time, we continue to actively hire, particularly in markets that are growing more rapidly. It's really a combination of factors. As we look at gaining market share, we anticipate that this will be influenced by our performance management efforts, as well as the ongoing recruitment of salespeople in these faster-growing markets.

It seems that we're seeing consistent results that are positive at the moment. Additionally, regarding your lower cost per case and distribution, this includes factors like fuel and mileage, correct? In examining the various aspects from the warehouse to delivery, it appears that the improvement is primarily on the delivery side. This is due to the advancements you're making in routing, along with the benefits of returning items and the impact of fuel costs. Should we consider the dollar value in this way to understand where the majority of these improved outcomes are emerging compared to just looking at it incrementally for the quarter?

I'll come back to where Dave talked about earlier in his comments on this is, while we're pleased with this, we're seeing productivity improvement in both warehouse and delivery. So they're both contributors. They each have impacts on, yes, on fuel, on routing, et cetera, and they each contribute. So without parsing out the individual, I think the more important takeaway is when we think upstream on the retention of the turnover, et cetera, seeing the improvement, and that's leading to overall lower cost per case, and that's demonstrating what we're doing is working, and we expect to do more of that.

And your next question comes from the line of Jake Bartlett from Truist Securities.

My question is about gross profit per case and the ability to maintain that. And you understand that protein in center-of-the-plate are generally priced on a dollar markup, so the deflation doesn't impact it. But my question is whether that could allow for greater price competition? So it seems to be the biggest risk is that competitors try to drive business more with price than service levels as they have over the last few years. So how would you assess that risk? Are you seeing any kind of more aggressive pricing out there? How do you expect to approach pricing going forward?

Overall, we feel good about the durability of our gross profit. I think for the last few quarters, we've been asked how we thought we would fare with lapping large inflation a year ago. And hopefully, what people have seen as we've demonstrated still strong gross profit results despite that. And that comes back to the focus we've had on our own execution of initiatives driving the results that we're seeing. I think that from a macro and competitive environment, it continues to be stable. It's really back to a pre-proven world where it's a competitive industry. And that's where we operate in, but we haven't seen a level of irrationality that any different than you would see in a normal environment. So quite healthy and we expect to continue with strong gross profit driving solid very good EBITDA growth.

And your next question comes from the line of Peter Saleh from BTIG.

Great. I just wanted to come back to the CHEF'STORE conversion issue. Can you just elaborate on what that system issue was? And is the 70 basis point impact fully consigned to the second quarter? Or do you think any of that will bleed into 3Q?

Peter, this is Dirk. So overall, we think through there is we had to convert off of a system under a new system by earlier this year as part of our purchase agreement, which we did. So all markets are converted. And it's not uncommon, unfortunately, for when you have conversions of this magnitude to have some challenges, which we did see. Let me just put it into context. So when we talk about some sales challenges there, it's down low single digits. But when you compare that to independents that are in the broadline are up 5.5%, it has a more meaningful impact there. And some of the challenges there were around us we do conversions resulted in issues where orders weren't fully going through, et cetera. So we had less product on shelves, et cetera. That's all been remediated. It has been for a few months, and we've been focusing on continuing to get customers back in the store to recoup that and do expect to get back to growth in the second half of the year.

Great. And then just on the leverage being around 3x. Currently, how are you thinking about capital allocation kind of going forward? Is it more debt pay down? Or do you think you'll shift a little bit more to share repurchase at this point in time as EBITDA continues to grow and the leverage kind of comes down naturally?

I expect, as Dave mentioned, that we closed early in the third quarter on the Renzi Foodservice acquisition, which will be reflected in Q3. In the near term, I anticipate a continued balance between debt reduction and share repurchase, as we view both as important priorities. This year, we've seen strong working capital performance, thanks to improved service levels from our teams. They have systematically identified opportunities to reduce excess stock that was added when vendor service levels were lower while still maintaining high customer service levels. This has allowed us to achieve even stronger working capital numbers this year, which has supported the funding of the acquisition. To directly answer your question, I expect a balanced approach, but we will also be pursuing our first tuck-in M&A, which we are excited about.

And we have reached the end of our question-and-answer session. I will now turn the call back over to Dave Flitman for some final closing remarks.

Thank you all very much for joining us today. Our business is strong, and I have great confidence in our ability to accelerate our momentum. Have a great day.

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