Earnings Call Transcript - USFD Q2 2022

Operator, Operator

Good day, and welcome to the 2022 quarterly earnings call. Today's conference is being recorded. At this time, I would like to turn the conference over to Snehal Shah. Please go ahead, sir. Thank you, Tracy. Good morning, everyone, and welcome to US Foods Second Quarter Earnings Call. Speaking on the call today, we have Andrew Iacobucci, Interim Chief Executive Officer; and Dirk Locascio, our Chief Financial Officer. Additionally, Bob Dutkowsky, our Executive Chair, will join for our Q&A session. We will take your questions after our prepared remarks conclude. Please provide your name, your firm and limit yourself to one question. 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're comparing our second quarter results to the same period in fiscal year 2021. In addition to historical information, certain statements made during today's call are considered forward-looking statements. Please review the risk factors in our 2021 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 are not providing reconciliations to forward-looking non-GAAP financial measures as indicated therein. Thank you for your interest in US Foods, and I will now turn the call over to Andrew.

Andrew Iacobucci, Interim CEO

Thanks, Snehal, and good morning, everyone. Thank you so much for joining our call. As I mentioned last quarter, my commitment as interim CEO is to continue the momentum coming out of our first quarter and to deliver on our long-range plan, which we introduced in February. Today, I'm pleased to report that US Foods continues to make progress against our plan and delivered strong earnings growth in the second quarter. Let's turn to Page 3, where you will find 3 key takeaways from the quarter. First, our Q2 results demonstrate good progress on executing our long-range plan. I'd like to thank our hardworking associates across the country for being a critical part of this progress and for continuing to serve our customers despite the challenges facing our industry. Second, US Foods continued its market share momentum from Q1, again delivering market share gains in key customer types. And third, our results further reinforce our confidence to deliver strong results despite the challenging macro environment affecting our industry. While US Foods and the industry as a whole continue to face headwinds related to inflation in food costs and fuel, as well as a challenging labor market, we remain well positioned to win in this marketplace. On Page 4, you will see key highlights from the second quarter. First, net sales for the quarter grew at 15% year-over-year, and we saw continued gross profit per case strength, driven in large part by progress on our long-range plan initiatives that we will discuss momentarily. As a result, adjusted EBITDA grew 11% on the quarter. On supply chain optimization, we continue to make significant strides as a result of the investments we are making in the business. We continued the implementation of new warehouse selection technology in our facilities, and we're on track to complete this in September. Additionally, freight income per case continues to gain momentum as our inbound logistics initiatives progress. Lastly, we're driving month-over-month improvement in our service levels to customers, while operating in a very challenging and fairly stagnant vendor supply environment. Our customer service levels, although still just shy of pre-pandemic levels, have improved nearly 120 basis points through the start of the year. Moving on, we continue to invest in enhancing the customer experience. US Foods has led the industry for over 10 years in this area, and digital is paramount to our success. We are launching our next-generation digital tool, which we call MOXe, which is all about increased speed, confidence, and control for our customers. This is a step change to the customer experience from performance and ease-of-use perspective. MOXe will begin rolling out in the third quarter, and we are excited to bring you more updates in the coming quarters. In Q2, we continued to expand our CHEF'STORE footprint, as well as assortment on our US Foods direct online marketplace. And last but not least, our team-based selling approach and value-added services continue to be differentiators and are helping us drive share gains in key customer types. A recent example is renewing our strategic partnership with Toast. This collaboration demonstrates our commitment to building deeper relationships with our customers by providing the right technology solutions to save time and improve the customer experience. Finally, I want to focus on the significant continued progress that we're making on environment, social, and governance, or ESG. We recently launched a partnership with Kalera, one of the world's leading hydroponic indoor vertical farming companies, to expand our portfolio of local farms that we source from to support our served local program. Launched in 2018, the served local program is designed to better connect US Foods' customers with local farmers, producers, and manufacturers. Additionally, we remain committed to reducing the environmental footprint of our operations, and recently announced a science-based climate goal to reduce absolute Scope 1 and 2 greenhouse gas emissions by 32.5% by 2032 from a 2019 base year. We are working to reduce emissions by optimizing routing to reduce miles driven, deploying new lower carbon footprint vehicle technologies, and investing in alternative fuels. Plans include converting our compressed natural gas vehicles, or CNG, to renewable natural gas and introducing 42 new CNG vehicles to our fleet by the end of 2022. In addition, our California broadline distribution center fueling stations have been converted to provide renewable diesel fuel for our Vista, Corona, Livermore, and La Mirada diesel fleet, and our newly opened Sacramento facility leverages renewable diesel fuel at its onsite fueling station. We also plan to introduce 30 new electric trucks into our La Mirada, California fleet by 2023. In our facilities, we continue to optimize the efficiency of our building operations by investing in renewable energy and adopting energy-efficient equipment and technologies. Page 5 illustrates why we believe US Foods is well positioned in the current environment. It starts with our diversified customer mix. Specifically, while restaurants represent over half of our sales mix, we are very focused on other customer types such as Healthcare and Hospitality to continue to propel our business forward. Healthcare and Hospitality were about 1/3 of our business prior to the pandemic, and we would expect them to return closer to that level as these 2 customer types fully recover. We are also driving market share gains in key customer types; independent restaurants continue to perform well, and case volumes are well above 2019 levels. As you may recall, US Foods is relentlessly focused on growing with the right customers, leading to ongoing optimization of our customer mix to ensure we are gaining market share profitably. And as a result, we continue to exit a small number of lower margin and/or more complex primarily chain customers and typically replace that business with more profitable and more flexible IND, Healthcare or Hospitality business, as well as chain business that is a better fit and less complex. We are continuing to improve margins of our existing chain business to reflect the current operating environment. In Healthcare, we are pleased to report a positive trend in the case growth relative to 2019. This is a result of new business wins and improved bed occupancy rates in the Senior Living segment, as well as retail shops reopening in hospital settings. In Hospitality, we continue with significant year-over-year growth. Given the recent macro backdrop, we will be closely monitoring development in this customer type as the increased inflation levels and work-from-home trends impact customers' willingness to travel. As a pure-play U.S.-only business, we are well positioned to leverage our differentiated tools and capabilities to support the growth of our diverse customers. As I mentioned earlier, this differentiation has historically enabled us to win share in our key customer types and we expect it will continue to enable us to do so. Customers are telling us that they appreciate our service and commitment to helping them grow and to fight through these difficult times. To them, US Foods does much more than just deliver groceries. Additionally, as a reminder, in rising inflationary periods such as these, US Foods is able to pass much of this inflation through via our contracts and pricing tools. Also, as the Healthcare and Hospitality customer types continue to return to 2019 or normal levels, we will benefit from these tailwinds via top line growth and supply chain efficiencies. And lastly, it's important to note that US Foods has a track record of resiliency during challenging economic times. For instance, during the recession of 2008, 2009, US Foods maintained essentially flat earnings and saw our case volume hold up reasonably well, declining only by mid-single digits. With that, let's turn to Page 6 to walk through how our strong performance in the quarter translates into progress on our long-range plan to drive profitable share gains, expand margins and improve operational efficiencies. We are on track to meet or exceed our targeted growth rate of 1.5x the market. We are continuing to win in the marketplace as demonstrated by our share gains in key customer types. As I noted earlier, the US Foods' team-based selling approach continues to be a differentiator relative to our competition and is an important ingredient in our customers' success. The continued expansion of our cash-and-carry business, CHEF'STORE, illustrates the power of our omnichannel strategy. During Q2, we opened a new store in Lynchburg, Virginia. We expect still to open 4 to 6 stores this year, and are building our capabilities to accelerate that pace in future years. This strategy allows our broadline customers to fill urgent needs between deliveries during the week to help meet demand. It is also an excellent way for potential customers and consumers to get to know the outstanding lineup of US Foods private label products and high-quality fresh offerings. Turning to the margin expansion or optimization pillar, we had strong gross profit results again this quarter. As we shared on our last call, we are seeing significant momentum with our inbound logistics program initiatives. This program continues to drive significant efficiencies and meaningful freight income expansion. Additionally, US Foods continues to grow its exclusive brand penetration rate. For Q2, organic penetration grew by approximately 80 basis points versus the prior year. Our Cost of Goods program is also performing well and ahead of schedule, with approximately 25% of our total vendor spend already under consideration. Turning to operational efficiencies. We are making solid progress in the midst of a very challenging macro environment. First, as a result of our continued focus on routing optimization and network planning, cases per mile across our network are modestly above 2019 levels despite case volume being down mid-single digits compared to 2019. While that is a significant achievement, we still have significant opportunity ahead. As I mentioned earlier, US Foods is on track with our warehouse selection technology rollout, which is expected to be completed later this quarter. I'm excited about this rollout as it will continue to support our warehouse team members and enhance the selection process, leading to better productivity and job satisfaction. Similarly, our outbound service levels to customers continue to deliver month-over-month improvement, which is a testament to the hard work of our associates, given that vendor fill rates remain challenged. It's important to note that the warehouse labor environment remains challenged for us and our industry. However, we are confident that we have the right plans in place to address turnover and associated productivity headwinds. On Page 7, you will see a summary of our strategic imperatives as we enter the second half of 2022. We are encouraged by our LRP momentum and we'll continue to update you on the performance of our three pillars of profitably growing market share, optimizing gross profit, and improving operational efficiency. We are and remain relentlessly focused on building upon our first-class customer service program and platform. We will continue to make investments in our business to provide an enhanced and differentiated service platform at US Foods. And finally, as we create value for our shareholders, we will remain prudent around our capital allocation priorities. Our focus continues to be investing in the business, reducing our leverage, returning cash to shareholders, and pursuing tuck-in M&A opportunities. We will continue to execute against these priorities and focus on driving long-term growth ahead, and thus, expect to create significant shareholder value. We've made strong progress against our plan to date, and expect to continue building on this momentum. And with that, I'll pass it over to Dirk to review the financial performance.

Dirk Locascio, CFO

Thank you, Andrew, and good morning. I'll walk through some highlights on our second quarter and then spend time on several key macro considerations that continue to be a factor in our industry and the broader economy, as well as on our 2022 outlook. I'm on Page 9. Overall, we're very pleased with our second quarter financial results. They demonstrate the continued progress we are making against our plan initiatives and outcomes. Adjusted EBITDA grew 11% from the prior year to $368 million for the quarter. In addition to strong EBITDA dollars, our adjusted EBITDA per case was above Q2 of 2019. Q2 adjusted EBITDA was the best quarter relative to 2019 since the pandemic began. So we're very encouraged with the outcome, which we believe demonstrates the actions we're taking are truly delivering results. Adjusted diluted EPS increased as well, and was $0.67. Q2 net sales were $8.8 billion, which was an increase of 15% over the prior year. Total case volume was flat to prior year and food cost inflation was 15%. Our Q2 year-over-year case growth was negatively impacted roughly 375 basis points by the mid-2021 exit of the grocery retail business, we temporarily added during a pandemic and a small number of strategic exits. As you'll recall, Q2 2021 was also the strongest quarter from a volume perspective since the pandemic began with a very strong recovery. I'll talk more about volume on the next page. We continue to drive robust gross profit dollar growth again this quarter. Our adjusted gross profit dollars increased 14% from the prior year, and we generated strong adjusted gross profit per case for the quarter. OpEx remained higher as we continue to invest in staffing and work on improving supply chain employee retention. Reducing turnover remains a top priority for us as we face the challenges higher turnover presents, similar to many other companies. Looking at Page 10. Within volume, independent cases were flat to prior year after growing nearly 80% in the prior year. We had 35% Hospitality growth and 2.4% Healthcare growth, offset by 8.7% lower chain volume and the retail exit impact I noted earlier. Our chain decline was driven largely this quarter by a smaller number of lower profitability and more complex strategic exits. We expect volume to improve through Half 2. The combination of the retail exit and the lower margin strategic exits was about a 375 basis point negative impact on total case growth and had a small impact on net EBITDA. We continue to focus on the health and quality of our customers and on the opportunistically growing with chains while increasing our margins. We delivered share gains again this quarter in key customer types. Specifically, for independent restaurants, Q2 share gains were among the strongest we've seen since the pandemic began, demonstrating we are winning in the market. I talked about volume compared to 2021. However, I know most of us continue to focus on volume relative to 2019 as well as a key anchor of a normal environment. Q2 2022 total case volume was approximately 6% below 2019, which is a more than 200 basis point improvement from Q1. Independent case growth was 4% above 2019. Healthcare cases were about 7% below 2019, demonstrating continued improvement. And hospitality was approximately 15% below 2019, which also has further improved from Q1 results. We're continuing to improve relative to 2019, and are encouraged by the continued share gains in key customer types. On Page 11, through Q2 and as we look at half 2, the macro environment remains challenging for our entire industry and our customers. Starting with labor. The labor market continues to be better than it was in 2021 from a recruitment perspective. In the second quarter, we continued to hire for expected volume growth. Our markets are broadly in a very good position when it comes to staffing. As I talked about last quarter, the primary challenge remains retention, which is not unique to us. Turnover remains higher than it's been historically. For reference, our warehouse turnover is nearly double what it's been historically, and roughly half of that workforce has been with us for less than a year. New associates are significantly less productive than tenured associates. Anecdotally, our understanding is that our retention challenges are very similar to other companies. A positive is that it likely isn't permanent, and we are taking steps to address it, such as limiting hours worked for new hires to allow them to ease into the job and retraining our frontline supply chain managers and supervisors on effective management and employee engagement practices and processes. As planned and as Andrew noted, we're finishing the deployment of our new warehouse selection technology and deploying processes, leveraging our continuous improvement team to make the jobs a little easier. With turnover remaining high, we aren't making as much progress on productivity improvements as we expected. However, we are focused and are seeing a number of signs of improvement throughout our network, some of which Andrew discussed earlier. Inflation, whether fuel or food, is something we are watching closely. Food cost inflation continued in the quarter with year-over-year inflation of 15%. Year-over-year inflation has slowed and sequential inflation continues to be below the peaks of mid-2021, which is a positive. Inflation in Q2 has been more in the grocery categories and other categories, and we've continued to be successful in passing it through to customers. We don't expect the supply chain challenges that remain for our industry more broadly that they are likely to be resolved in the near term. We've made continued progress improving our service levels to customers through Q2 despite stagnating vendor service levels. Our Net Promoter Score data indicates our service levels continue to be as good or better than others as we continue to identify and act on ways to improve service for our customers. Overall, volumes remain solid. However, we will continue to watch for behavioral changes. Week-to-week results can vary, and we're watching for trends. Independent growth versus 2019 has continued to be 3% to 4% above 2019 in recent weeks. Healthcare continues to slowly improve and has been roughly 6% below 2019 in recent weeks. Hospitality remains mid-teens below 2019 and has shown continued improvement in recent quarters. We are strategically taking share in key customer types and continue to watch the macro environment for changes in demand. The macro environment remains a challenge. However, our business and industry has recovery tailwinds from Healthcare and Hospitality, and we are seeing share gains in key customer types. We also benefit from serving many customer types and eating away from home as a staple in most people's routines, which makes it quite resilient, potentially even more than in prior downturns. We are pleased with the strength of our Q2 results and we expect to continue making meaningful progress and specifically on actions to improve the continued high turnover in supply chain. We're reaffirming our 2022 fiscal adjusted EBITDA, adjusted diluted EPS, CapEx and net leverage guidance provided in February. However, we now expect higher interest expense to be $245 million to $255 million for the year as a result of the Fed's more aggressive interest rate increases through 2022. And finally, we still expect to achieve the higher end of the earnings outlook range, assuming there's not another Omicron-like wave or macro slowdown. I talked about our Q2 earnings, macro factors, and our outlook. Now on Page 12, I'll just spend a moment on our capital structure. We reduced our net leverage compared to the second quarter of 2021 as well as the first quarter of this year. Our net leverage ratio was 4.2x at the end of the second quarter, which is a 1.2x reduction from a year ago and 0.1x reduction from the first quarter of this year. Net debt dollars are relatively flat as we've continued to necessarily invest in working capital via increased receivables from inflation, as well as additional inventory due to the vendor supply challenges we and the industry continue to face. Leverage reduction is one of our four components we outlined as part of our capital allocation strategy, Andrew noted earlier. We continue to make progress toward our leverage goal of 2.5x to 3x net leverage, and are committed to achieving it. Our business has strong cash flow generation, which we expect to use for debt reduction in our other stated priorities. Just in closing, I'm pleased with the significant progress we're making, which we demonstrated in our Q2 results. Now back to Andrew.

Andrew Iacobucci, Interim CEO

Thanks, Dirk. In conclusion, US Foods continues to make progress in executing our long-range plan. Despite ongoing challenges in the macro environment, we continue to deliver positive results. This is a testament to the hard work of all our associates at US Foods, and I thank all of them for their continued focus on execution and dedication to serving our customers. With that, operator, please open up the line for questions.

Operator, Operator

We will now take our first question. Please go ahead, caller. Your line is open.

Lauren Silberman, Analyst

This is Lauren Silberman from Credit Suisse. I wanted to ask about independent case growth. Volumes up 4% versus '19, I believe you said, which looks like an acceleration from 1Q. So can you talk about what's driving that underlying acceleration? How much is coming from new customer acquisition versus wallet share is where are you running with independent customer accounts versus '19? And then you mentioned, I think, case growth remains 3% to 4% above '19 in recent weeks. Can we assume you're not seeing any meaningful shift in customer behavior trends?

Andrew Iacobucci, Interim CEO

Yes, Lauren, it's Andrew. Thanks for the question. I'll try and remember the parts to it. So remind me if I miss any of them. Yes, I think overall, we feel very good about the momentum we're seeing in our independent restaurant growth. And I would say that the growth is being generated through, I'd say, a pretty balanced mix between increasing penetration with the existing customers, as well as going after new. We are still slightly down in terms of our customer count versus '19, but we are seeing a significant improvement in our share of wallet as we move forward. That momentum and sort of the improvement, I think, you would attribute to really, given the market itself, has probably been largely flat from 1 to 2. We've actually seen a pretty sizable, as Dirk mentioned, one of the best share improvements we've seen and certainly significantly better than we were in Q1 in terms of our market share in the IND segment. So feeling, I think, really good about the momentum. We haven't seen, as Dirk mentioned, a meaningful change in behavior, although obviously, that is something we're monitoring very closely. But the fact that we've been able to gain share in this environment also gives us some optimism that we will be able to mitigate the impact, if any, of any slowing of demand on the independent segment. Did I cover all your questions? Or was there any...

Lauren Silberman, Analyst

Yes, you did. You're great. If I could just ask one more. Does on the long-term targets, I know a lot of uncertainty in the environment, should we see a more challenging consumer environment? What gives you confidence in delivering on the longer-term guide or to what extent is sort of that macro uncertainty being factored in?

Dirk Locascio, CFO

Lauren, this is Dirk. So ultimately, I think the important thing to come back to is our focus in the plan, which is control the controllables, and we put a plan in place that we feel very good about. We're continuing to execute. Our last 2 quarters have really shown good progress against that. And I think that the thing that we've learned during COVID is you need to be agile, nimble, or if you want to put it. And so as we see the environments adjust, we'll adjust accordingly, but we're continuing to execute against our plan and very pleased with the progress we're making.

Operator, Operator

We will now take our next question. Please go ahead, caller. Your line is open.

Edward Kelly, Analyst

It's Ed Kelly from Wells Fargo. I wanted to follow up on case volumes. Can you provide more detail on the decision to exit some of the lower margin contract accounts? This has been part of your strategy before, so it's not new. However, you still have volumes below 2019, and I'm curious about the reasoning behind that. Additionally, as we look towards the second half of the year, I recall Dirk mentioning that you expect case volume to improve. Can you clarify if you anticipate organic total case volume to increase in the second half?

Andrew Iacobucci, Interim CEO

Ed, it's Andrew. I'll begin and then ask Dirk to provide additional details. Regarding case volumes, we aim to achieve profitable growth, and we have been collaborating closely with our customers, especially the larger chain groups, to ensure our agreements align with the current environment. Our focus in these discussions is to keep moving the business forward together. However, in some cases, if we cannot establish a suitable operating model with certain customers, we have made the choice to exit, but this is usually a last resort. Now, I'll pass it to Dirk to discuss our outlook for the second half of the year.

Dirk Locascio, CFO

Sure. So Ed, we would expect to see continued improvement relative to 2019 from where we've been trending, assuming a stable macro environment and continuing to improve against that. I think the other point is we're very pleased with the strength of our independent volume and the continued share gains that Andrew talked about. On the chains and then a small number of education customers, this has been part of the plan. And so I think we've been deliberate. Of course, there is the retail business that we picked up during COVID that I talked about last quarter. So there should be no surprises on that. But on the chains and the education, I think on that one, our focus has been to be opportunistic on those who were the right fit from a financial and complexity perspective. And I think even as one of our competitors has talked about, and you see where they have dedicated chain facilities, they are breakeven. It really is one where being opportunistic versus just growing for the sake of growing in a particular area is the right answer. And we're seeing that show up in higher EBITDA per case. We're seeing this show up in earnings growth and continued improvement there. So we believe our strategy is the right one, and we're going to continue to focus on growing with independent Healthcare and Hospitality and then be very thoughtful and opportunistic on the other customer types.

Operator, Operator

We will now take our next question. Please go ahead, caller. Your line is open.

John Glass, Analyst

It's John Glass from Morgan Stanley. First, if I could just further clarify in cases and then I would add a real question. Is this the last quarter you're going to be lapping the grocery exit so that shouldn't be a factor in the back half? And can you quantify what the impact of those chain restaurant exits? Because I assume that will impact future, 4 quarters or 3 quarters. So just what's the quantum of that? And the question is what you're doing to reduce labor turnover, improve efficiency, I understand about training in hours and et cetera. But is there something more meaningful? I mean, your biggest competitor talked about going to a 4-day work week, for example, is one way to do that. Are there bigger ideas that can really advance that turnover and efficiency and lifestyle to make this more attractive job that you're contemplating?

Dirk Locascio, CFO

I'll begin with the first part, and then Andrew can discuss the second part on retention or turnover. For this quarter, there will be some impact, but it will be lesser in the third quarter due to the retail exit, which will be the last quarter affected. For reference, out of the approximately 375 basis points impact in Q2, about two-thirds is from retail and one-third is from chain exits. This gives you an idea of the impact. Additionally, it's important to consider year-over-year trends, especially with the chains. For example, last year in Q2, we were at a peak with chains as we had onboarded some new customers and hadn't yet exited some planned exits. This is all part of our strategy moving forward. Andrew, do you want to address retention?

Andrew Iacobucci, Interim CEO

Yes, certainly. Regarding our staffing situation, we are quite satisfied with our current levels of staff across nearly all markets. The ongoing challenge, as Dirk pointed out, is managing turnover. We are actively looking into and implementing flexible shift lengths to accommodate our employees' scheduling needs. Additionally, we have taken significant steps to shorten the shifts for new hires, as this group typically experiences the highest turnover due to the demanding nature of the work. By minimizing the length of these early shifts, we believe we are helping new employees acclimate better to their roles. Importantly, since turnover is greatly influenced by leadership, we've made substantial investments in training and development for our frontline leaders, supervisors, and managers. Their effectiveness is crucial in markets where we've observed improved turnover rates linked to strong leadership. While it's still early to see major outcomes from our efforts, there are already promising indications coming from the leadership training, and we anticipate this trend to continue.

Operator, Operator

We will now take our next question. Please go ahead, caller. Your line is open.

Peter Saleh, Analyst

It's Peter Saleh from BTIG. A number of restaurants have talked about seasonality returning to the industry, something that they haven't had since 2019. Are you guys seeing that as well? Are you seeing seasonality? Did you feel like trends maybe slowed a little bit during the summer? And are you expecting that to kind of pick up and get back to normal seasonality as we head into the fall?

Andrew Iacobucci, Interim CEO

Pete, it's Andrew. I think we would say it's a little hard to tell given the volatility that still is out there. But overall, I think there is certainly a little bit more normalcy returning to the rhythm of our business, which I think is a positive sign. But again, I think right now, it's a little hard to declare it as a trend.

Peter Saleh, Analyst

Great. Regarding food cost inflation, it was 15% this quarter, which is a few hundred basis points lower than the first quarter. What are your expectations for food cost inflation in the latter half of the year?

Andrew Iacobucci, Interim CEO

It's difficult to predict our future expectations. While we have noticed a slower rate of increase, we do not anticipate deflation in the near term. We are closely monitoring the situation from both the cost of goods perspective and the effect it has on demand and our customers. We are confident in our organization's ability to pass on inflation costs through our standard cost-plus pricing in contracts. Additionally, we have made significant progress collaborating with our customers to navigate the inflationary environment. This support has proven beneficial as we assist them in adjusting their menus to avoid heavily impacted categories and consider portion sizes and other elements. This commitment aligns with the values of US Foods, which we take great pride in.

Operator, Operator

We will now take our next question. Please go ahead, caller. Your line is open.

Nicole Miller, Analyst

This is Nicole Miller from Piper Sandler. The first question, you've addressed turnover. But I was wondering to compare and contrast kind of the truck driver, DC selector, and also the salesperson tenure and turnover. And the real question is, when they work in concert, when you're at your best in any one market locally or in terms of execution, what kind of wallet share gains can you achieve versus where you stand at average?

Andrew Iacobucci, Interim CEO

Nicole, it's Andrew. Regarding your first question about turnover among drivers, selectors, and sellers, I can tell you that our sellers have experienced very consistent turnover, and in fact, it's slightly lower than what we've observed in previous years. The turnover rate for drivers has also increased only slightly compared to pre-pandemic levels. However, the selector area is where we've noticed a significant increase, with turnover rates now at twice what they were before the pandemic. This is where we see the majority of our turnover issues. Your second question is an excellent one regarding the relationship between the three. The connection between drivers and sellers is incredibly important, as both play a significant role in our customer experience. This is why the recent decrease in turnover within the driver community, which was already at a low level, is very positive. We have also started to focus on building a working relationship between drivers and sellers to ensure that feedback from either party is communicated to the other. This approach is notably enhancing their relationship with our customers as a result.

Nicole Miller, Analyst

And then just how would you characterize the inbound fill rates to you, the outbound sell rates to your customers? And is there an opportunity to backhaul with your drivers?

Andrew Iacobucci, Interim CEO

Yes. So we have seen continued improvement in our customer service level, which is the thing we're most concerned about. And what I think is most sort of positive in that trend is that we've been able to do so with vendor fill rates that have been largely flat relative to where they were to start the year. There's been a bit of an improvement, but not significant. And it's been, I think, a real achievement on the part of the replenishment organization to be able to drive that continued month-over-month improvement in our service level to our customers despite the fact that we are still seeing pretty poor service from an inbound. And the particular challenge there is that the nature of those fill rate challenges tends to change from day to day and week to week. It's not always the same categories and so a little bit of a moving target. But generally speaking, I think we feel very good about the progress that we've made in handling that.

Dirk Locascio, CFO

To your second part, regarding the backhaul, we backhaul a significant portion of our inbound cases ourselves. This, along with several other initiatives, is contributing to the strong results we've observed in our inbound logistics or freight income this year. However, it remains a focus.

Nicole Miller, Analyst

And just the last one, deflation. I mean, it may sound silly now because it would require supply our shipping demand and really easing labor conditions, and none of that seems likely. But can you just remind us what happens like by type of contract? How does deflation flow through gross profit? How does it flow through OpEx, et cetera?

Dirk Locascio, CFO

Sure. So if it's a product deflation, it doesn't flow through OpEx as much versus it shows up and up in gross profit. And the portion of our customer contracts that are a fixed markup per case or per pound, et cetera, in that case, you're still making the same markup, so it doesn't impact profitability at all. If you see it in the portion of our contracts that are a percentage markup over, if you have deflation, it can decrease that profitability a little bit. What we see over time though, oftentimes is a lot of the center of the plate is fixed, which can be more volatile. So that means over time, that's can be a little volatile if it goes up or down, but over time is a meaningful impact. And then on the grocery, a lot of the suppliers over time, they tend to go one way from the ultimate manufacturers. So I think when we think through that, we are watching it closely, we have a playbook that we run for inflation and deflation to manage it. But as we noted earlier, don't expect inflation to show up sort of broad scale in the near term.

Operator, Operator

We will now take our next question. Please go ahead, caller. Your line is open.

John Heinbockel, Analyst

John Heinbockel, Guggenheim. So guys, let me start with drop size. Really focused on comparable restaurant locations, right? Whether they be independent or chain. What are you seeing with drop size, right? I imagine it's up, right, because locations are down, I think. Is it up low to mid-single digit? And then obviously, that's probably 2x the incremental margin. Is that a material benefit to the P&L now and kind of going forward, meaning, I don't know if it's tens of millions of dollars, but is it a material benefit as we sit here today?

Andrew Iacobucci, Interim CEO

John, it's Andrew. You may have to repeat the second half of your question just to make sure I got it. But on the first half around drop size, I would say we are seeing a small increase in our drop size, as I think we've reported for the reason that you mentioned. Remind me the second half of your question.

John Heinbockel, Analyst

Well, the incremental margin on that, right? It's not your gross margin. But it's got to be 2x, 2.5x normal margin. So that is a clear benefit to the P&L as we sit today, and do you think that will continue?

Andrew Iacobucci, Interim CEO

Yes, definitely a clear benefit. We won't quantify the range of it, but it's certainly significant given the incremental cost of those additional cases or the marginal cost of those additional cases are relatively low. As far as continuing, that's certainly an area, as I mentioned, our share gains, especially in the IND space, have been a pretty good mix of growing share of wallet and new. And we do expect that to continue. And certainly, a big focus of the independent seller organization is to continue to grow our penetration with existing customers.

Dirk Locascio, CFO

John, just one other thing I would add. I think the other opportunity that still lies ahead is as you see volume continue to come back in Healthcare and Hospitality. A lot of that shows up with existing customers. And so that helps from a drop size perspective for those customers, which are already pretty attractive from the drop sizes they tend to have.

John Heinbockel, Analyst

What makes this environment somewhat different from the past is the tightness in labor. If we experience disinflation, do you think the timing will align, with top line revenue decreasing at the same time labor costs are easing, or does the overall macro environment need to create that easing? Alternatively, do you need to prepare for potential cost reductions if revenue decreases while labor costs remain steady? How do you view this situation?

Dirk Locascio, CFO

Sure. I believe there are two separate factors at play here. The revenue side tends to operate more automatically, while management is required to navigate through it. As we've mentioned, we anticipate that for the foreseeable future, there will be modest inflation and probably no deflation. This is likely to appear more quickly on the cost side, which requires a more proactive management approach compared to the gross profit side. Reflecting on what I mentioned earlier, our experience during COVID highlighted the importance of being agile. We have solid strategies in place for managing both inflation and deflation on the product side, and we continuously seek effective ways to manage costs across various categories.

Andrew Iacobucci, Interim CEO

But John, maybe just to address the question on labor tightness being a benefit. That certainly will be. I mean, one of the challenges that we face with the turnover levels that we are seeing right now is just the costs associated with the recruitment, hiring, and onboarding of those associates, as well as the impact that it has on productivity. So I think that will certainly be an important aspect if we do start to see some loosening in that labor environment.

Operator, Operator

We will now take our next question. Please go ahead, caller. Your line is open.

Brian Mullan, Analyst

Brian Mullan, Deutsche Bank. My question is on the strategic vendor management opportunity. I believe this is an important component of the long-term plan. Maybe could you just speak to what the organization is doing differently today versus how it managed this area of the business prior? And then just zooming in a bit. Just wonder if you could speak to your degree of confidence in this sitting here in August, maybe relative to how you felt earlier this year. How are the strategies progressing? Are your partners being receptive? Are you finding win-win situations in your negotiations? Just any color.

Andrew Iacobucci, Interim CEO

I feel optimistic about the progress of our initiative and we are ahead of our schedule. The current opportunity seems different from the past for a couple of reasons. The volatility over the last few years has made it challenging to accurately benchmark our cost of goods like we used to. A significant aspect is ensuring we remain competitive, considering our scale. And I think in terms of the confidence we feel today versus earlier this year or last, I think, has grown as a consequence of the really very productive nature of the conversations that we've had thus far. We have found significant opportunities for mutual wins. I think just given the way the world is right now, there are some opportunities to work more closely together to find ways that will not only help us ultimately from a cost of goods standpoint, but also help our vendors from a production efficiency standpoint. And those are the conversations that have really yielded the greatest fruit thus far.

Brian Mullan, Analyst

And then just a follow-up, just a question on the permanent CEO search. Understanding there's only so much you can maybe say, just can you comment on how that's going, if the pool of candidates is starting to narrow down in any way? And then related, is there a priority or a preference to find someone from inside the food distribution industry? Or is that not a particular mandate of the Board at this time?

Andrew Iacobucci, Interim CEO

Bob, do you want to take that?

Robert Dutkowsky, Executive Chair

Yes. It's Bob Dutkowsky. I think I'll try to take a shot at that. So we're really pleased with the progress that we've made in terms of searching for the next CEO. We quickly formed a search committee, we built a spec that we believe can lead the company into the future, we hired a search firm and started the process. We're really searching for a proven public company C-suite executive. It would be great if they had experience relative to US Foods, but a supply chain executive, for example, not in the food industry could be a very good candidate. We're really searching for an executive that has a track record of creating shareholder value, and importantly, one that embraces the culture of US Foods. So we have a really good plan. We're well into the process. The search firm has identified a very strong list of candidates, and we've begun the interviewing process. So we're really pleased with where we are with the process.

Operator, Operator

We will now take our next question. Please go ahead, caller. Your line is open.

Jake Bartlett, Analyst

This is Jake Bartlett from Truist Securities. My first question is about the chain business and the recent exit. It seems that just last quarter we were discussing the onboarding of the chain business. I'm curious if this might indicate that customers are experiencing fewer supply chain disruptions, allowing for better service. Is this a sign of pushback on pricing, or do you think customers feel more confident to explore better pricing options, and could this have a greater impact as we move through the year?

Andrew Iacobucci, Interim CEO

Jake, it's Andrew. First of all, I think it's important to say that our net new versus lost in chain is actually up slightly. So I wouldn't necessarily characterize this as a net negative. And it certainly doesn't signal in any way a move away from the right kind of chain business, which is where we've seen the growth coming from, chains that have more of an urban presence, as well as more of an independent restaurant-type offering, have been proven to be very attractive customers and the ones that we are quite happily brought on board. And in addition, as I said, exit is the last resort. We've typically worked with them to find opportunities for the vast majority of our existing customers that has been the outcome.

Dirk Locascio, CFO

Just, Jake, if I could add. This is Dirk. So actually, the exits that we're talking about in chain are where they are part of the strategic exit plan. Our regrettable losses remain quite low across our customer types and continue to have a good pipeline there from a growth perspective.

Operator, Operator

We will now take our next question. Please go ahead, caller. Your line is open.

John Heinbockel, Analyst

What I wanted to ask is how this environment may be different from the past, specifically regarding the tightness in labor. If we experience disinflation, do you think the timing will align, with the top line declining at the same time labor costs ease, or will the macro environment lead to that easing? Alternatively, do you think it's necessary to implement some proactive cost reductions in case the top line declines while labor costs do not? How do you view this situation?

Andrew Iacobucci, Interim CEO

But John, maybe just to address the question on labor tightness being a benefit. That certainly will be. I mean, one of the challenges that we face with the turnover levels that we are seeing right now is just the costs associated with the recruitment, hiring, and onboarding of those associates, as well as the impact that it has on productivity. So I think that will certainly be an important aspect if we do start to see some loosening in that labor environment.

Operator, Operator

We will now take our next question. Please go ahead, caller. Your line is open.

Brian Mullan, Analyst

Brian Mullan, Deutsche Bank. My question is on the strategic vendor management opportunity. I believe this is an important component of the long-term plan. Maybe could you just speak to what the organization is doing differently today versus how it managed this area of the business prior? And then just zooming in a bit. Just wonder if you could speak to your degree of confidence in this sitting here in August, maybe relative to how you felt earlier this year. How are the strategies progressing? Are your partners being receptive? Are you finding win-win situations in your negotiations? Just any color.

Andrew Iacobucci, Interim CEO

I think, first of all, as I mentioned earlier, we're feeling very positive about the progress of that initiative. We are actually ahead of our schedule on it. What stands out today compared to the past is a couple of factors. The volatility we’ve experienced over the last couple of years has made it challenging to accurately benchmark our cost of goods like we have in the past. Therefore, a significant part of our focus is ensuring we remain as competitive as possible considering our scale. And I think in terms of the confidence we feel today versus earlier this year or last, I think, has grown as a consequence of the really very productive nature of the conversations that we've had thus far. We have found significant opportunities for mutual wins. I think just given the way the world is right now, there are some opportunities to work more closely together to find ways that will not only help us ultimately from a cost of goods standpoint, but also help our vendors from a production efficiency standpoint. And those are the conversations that have really yielded the greatest fruit thus far.

Operator, Operator

We will now take our last question. Please go ahead, caller. Your line is open.

Alexander Slagle, Analyst

It's Alex Slagle from Jefferies. First, a clarification on the guidance in the release, you talked about continued confidence towards the higher end of the EBITDA range, and wasn't sure if that also applied to the EPS guide or would the leaning on the EPS range move towards the lower end just with the higher interest expense or if there's an offset there?

Dirk Locascio, CFO

Sure. So yes, confident in the outlook for EBITDA. On EPS, I still expect stronger. I think that's not quite at the strength of the high end, given the higher interest expense, but still feel like a good strong EPS outcome that likely still leans sort of in the upper half, again, assuming an environment that remains similar to where we're in.

Alexander Slagle, Analyst

Okay. And then a follow-up question on freight and your work optimizing the vendor allowances and everything there and just to get additional color. How the progress in the second quarter compared to the first quarter, which seemed like it was a very solid improvement in the first quarter. And maybe if you have any comment on how your freight income per case compares to '19 levels.

Andrew Iacobucci, Interim CEO

Yes, Alex, it's Andrew. We're very pleased with the progress the team has made on freight. We’ve actually seen a slight acceleration compared to the strong progress in Q1 and Q2. This improvement comes from managing our arrangements effectively, allowing us to not only take over certain lanes when appropriate but also to back off when profitability doesn’t make sense. Additionally, we’ve made significant strides in regularly engaging our vendors, especially given the volatility in freight markets over the past two to three years. Finding ways to increase flexibility in the rate adjustments from our vendors, which used to occur only once a year, has been a key factor in our progress.

Operator, Operator

Just to advise, we only have time for two more questions. We will now take our next question. Please go ahead, caller. Your line is open.

Mark Carden, Analyst

It's Mark Carden from UBS. To start, are you seeing any changes in how customers are shopping our cash-and-carry stores? Do you see much of an uptick in interest over the past quarter just given some of the macro pressures that are out there? And then, are you seeing any major differences between your legacy Smart Foodservice locations and your legacy CHEF'STORE ones?

Andrew Iacobucci, Interim CEO

Mark, it's Andrew. I would say we haven't seen a significant change in customer behavior regarding the composition or the categories they are shopping. That has remained consistent throughout. In terms of the legacy foods CHEF'STORE compared to Foodservice stores, I wouldn't notice a large difference in their behavior. We are very pleased to welcome a new leader to the team who has a strong retail background and many great ideas. One of the top priorities is to find ways to accelerate the rollout of new CHEF'STORE locations because we are very satisfied with the performance of that business and are eager to expand it further.

Mark Carden, Analyst

Great. That's helpful. And then have you seen much of an increase in private label demand from restaurants and others to help reduce costs and offset some of the pressures that they're facing? Has penetration really picked up relative to the last few quarters? Or has demand remained pretty consistent across the board?

Andrew Iacobucci, Interim CEO

Well, as I mentioned, we saw an 80 basis point improvement year-over-year in exclusive brands. We think that is, in part, a function of the better value proposition that it offers our customers. And we are continuing to make sure we are driving that business as aggressively forward as we can. Supply challenges have been a bit of an issue in the past, but we are starting to see that ease up pretty considerably as we've been able to source as needed additional sources of supply for our exclusive brand products. So yes, definitely, we believe an opportunity in this environment and one we will continue to pursue aggressively.

Operator, Operator

We will now take our last question. Please go ahead, caller. Your line is open.

Kelly Bania, Analyst

This is Kelly Bania from BMO. Just wanted to ask a little bit about how you think case volumes might respond in a moderating inflationary environment? And do you think that inflation is depressing volumes today? And maybe just how you think about that by your different customer segments like, especially Healthcare and Hospitality, that might be less economically sensitive?

Andrew Iacobucci, Interim CEO

Kelly, it's Andrew. As we mentioned earlier, there hasn't been a significant change in behavior over the past few quarters despite the current inflation levels. Therefore, it's challenging to forecast the future or determine where any moderation might happen across different categories. Unfortunately, I don't have a solid answer for you on that. However, we are confident that we can continue to gain market share even in an inflationary environment, thanks to our excellent sales team and strong existing relationships, as well as our efforts to increase our share of wallet with those customers.

Kelly Bania, Analyst

Got it. And then just in terms of the Healthcare and Hospitality, or maybe more the Healthcare, I guess. What do you think is the catalyst to really get that back to where you think it can be?

Dirk Locascio, CFO

Kelly, I am Dirk. In this case, there's a lot of continued confidence in people's comfort levels with sending their seniors to Senior Living facilities, as bed occupancy rates have been gradually increasing. Additionally, hospital systems are continuing to expand their staffing and are able to reopen services like catering. Because we have a significant presence in Healthcare, our recovery may be slower compared to others. However, we are noticing steady improvement each quarter, which is very encouraging. We believe that as confidence grows, this positive trend will persist.

Operator, Operator

That concludes today's question-and-answer session. I would now like to turn the conference back to Mr. Shah for any additional or closing remarks. Thank you, everyone, for participating today, and we will follow up shortly after the call. Thank you, and have a great day. This concludes today's call. Thank you for your participation. You may now disconnect.