Earnings Call Transcript - USFD Q3 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the US Foods Third Quarter 2020 Performance Review. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Ms. Melissa Napier. Thank you. Please go ahead, ma'am.

Melissa Napier, Speaker

Thanks Cara. Good morning, everyone. Welcome to our third quarter fiscal 2020 earnings call. Joining me on today's call are Pietro Satriano, our CEO; and Dirk Locascio, our CFO. Pietro and Dirk will provide an overview of our results for the third quarter and the first nine months of fiscal 2020, as well as provide some details on volume trends that we saw during the month of October. We'll take your questions after our prepared remarks conclude. Please provide your name, your firm and limit yourself to one question. During today's call and unless otherwise stated, we're comparing our third quarter results to the same period in fiscal 2019. Our earnings release issued earlier this morning, and today's presentation slides can be accessed on the Investor Relations page of our website. References to organic financial results during today's call exclude contributions from Smart Foodservice, which we acquired in April of 2020 and also exclude contributions from the Food Group for the time period prior to the anniversary date of the closing of the acquisition. In addition to historical information, certain statements made during today's call are considered forward-looking statements. Please review the risk factors in our 2019 Form 10-K and our last quarter's 10-Q filed with the SEC for these potential factors, which could cause our actual results to differ materially from those expressed or implied in those statements. Lastly, during today's call, we will refer to certain non-GAAP financial measures. All reconciliations to the most comparable 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. I'll now turn the call over to Pietro.

Pietro Satriano, CEO

Thank you, Melissa. And good morning, everyone. Before we get started, I would like to thank all our associates for their dedication and commitment that they have displayed in helping our customers navigate this challenging environment. Their efforts have truly been second to none. I'm going to begin on Slide 2 with an executive summary of what we'll cover today. First, as evidenced by the continued appetite of consumers to eat out and take out, as well as the ingenuity of restaurants across the country, we remain confident that our industry will return to pre-COVID levels over time. Second, the third quarter saw a marked improvement in our business. Case volumes have steadily improved, and we are profitably gaining market share. Third, recent acquisitions of Food Group and Smart Foodservice have performed in line with expectations, and the integration of Food Group is on track. And finally, the steady improvement in our case volume combined with our cost reduction actions led to adjusted EBITDA that was a marked improvement over the second quarter. Dirk will cover this fourth point in his review of the financial results, and I will cover the first three. Starting with our perspective on the industry. Moving to Slide 4, the chart on the left compares consumer visits at food away from home establishments like restaurants to visits at food-at-home establishments like grocery stores. As you can see, pre-COVID food away from home visits were roughly 50% of total consumer visits. After stepping down in late March and April, consumer visits at food away from home establishments have consistently increased and are trending back towards the 50% level that the industry experienced pre-COVID. This recovery illustrates the desire of the consumer to purchase from food away from home establishments, a habit that has been shaped over decades, and helps affirm our belief that our industry will ultimately recover to pre-COVID levels. One of the drivers of this recovery has been off-premise dining, which continues to grow in importance. As we said on our last call, for full-service restaurants, 55% of traffic in June was off-premise compared to 19% pre-COVID. A more recent survey states that 68% of consumers in this country are taking out at least once a month post-COVID compared to 45% pre-COVID, an increase of 51%. The continued growth in off-premise dining also gives us the confidence that restaurants in the colder climates will be able to navigate the winter months. Over the past several months, we have seen restaurants embrace those kitchens, also known as virtual kitchens, a way by which operators can use their kitchen space to create new brands focused solely on takeout and delivery. In addition, some operators are experimenting with tents, igloos and heaters as a way to prolong outdoor dining, and others are promoting air purification mechanisms such as UV lighting as a way to build consumer trust for indoor dining. The ingenuity of restaurant operators has checked the permanent closure rate at a low level. And we've even begun to hear about some well-run and well-capitalized operators looking for opportunities to open new restaurants as the external environment improves. Let's now go to Slide 5 and take a look at our own volume performance across different customer types. Throughout the third quarter and into the early part of the fourth quarter, we have seen a steady improvement in case volume across most of our customer types. The green line on the chart shows total restaurant case volumes, including both independent and chain restaurants. The uptick you see in the month of August and September is both a result of an improvement in the industry as well as US Foods gaining share. Organic restaurant case volume for the week ending October 24th was down just under 10% compared to the prior year, which was remarkable given that we were down almost 60% at the beginning of the pandemic. When we compare independents to chain over the last few weeks, organic independent case volume has been down approximately 11% to 12% year-on-year, while organic chain case volume has been down approximately 7% to 8% year-on-year. Moving to other customer types, our case volume with both healthcare and hospitality has also improved. Healthcare designated by the blue line has picked up as hospitals have started allowing visitors to return in a limited fashion. Hospitality designated by the yellow line has also picked up, as hotel occupancy rates have improved, especially in some geographies and formats, as leisure travelers have substituted one kind of travel for another. Last quarter, I commented on the $500 million of new business we had won in the first half of this year. This business is now fully onboarded, and I'm happy to report that on an annual run rate basis, we are on pace to onboard a total of over $800 million of new business by the end of this calendar year. Several of the new wins since we last spoke are in the healthcare arena, demonstrating the strength of our new business pipeline across multiple different customer types. The pipeline remains strong. And as we look ahead to next year, we expect to continue to gain market share. As we have previously discussed, the new business win across these multiple customer types had good contribution margins, helping us grow overall profitability. Let's move to Slide 6 and a discussion of the factors that have led to these market share gains. As we see it, US Foods has four distinct advantages over many competitors. The first is our scale and our scope. Our national footprint and consistent approach to servicing multi-geography customers are particularly appealing to large customers who are looking for a stable distribution partner like US Foods. Second is our digital leadership. Our e-commerce offering has been particularly important during these times as customers are able to shop our extensive product offering and place orders online. Third is our suite of value-added services or CHECK Business Tools. One of our more popular value-added services has been ChowNow, a platform that allows customers to do takeout and delivery with much more favorable economics than competing services. Since the pandemic began, the number of customers using ChowNow has increased by 50%. Now, not only does this drive more loyalty to US Foods, but we have seen that customers who use ChowNow are buying more, approximately 80% more than customers who are not using that platform, which also confirms how much off-premise dining has grown in importance. A new addition to our portfolio of value-added services is our Ghost Kitchen playbook, supported by proprietary analytics, and this has helped customers mitigate the impact of COVID by extending their off-premise reach, both geographically and into new menu concepts that are particularly suited for delivery. And the fourth advantage is our growing portfolio of innovative products. In September, we launched our Fall Scoop, focused on off-premise dining. The launch featured new items such as tamper-evident containers, cleaning and sanitizing products, and individually packaged ingredients that allow restaurants to create home meal kits. Response to this food launch was just terrific, and customer penetration was comparable to rates that we used to see pre-COVID. Last week, we launched our Holiday Scoop, which features more new items, many in keeping with current customer needs, including the only EPA-registered 2-in-1 sanitizer that is effective against the virus that causes COVID-19, thereby helping operators keep their environment safe and building trust with diners. This Holiday Scoop also features items for off-premise dining with solutions that are perfect for family meals, including several sustainable items to add to an already strong line of products that serve the platform. These differentiated products and solutions are a great example of how we continue to be the leading and most relevant distributor to operators. Lastly, on Page 7, I want to provide an update on our two recent acquisitions. As we discussed last quarter, the Food Group's national chain business continues to perform well, benefiting from some of the recent favorable QSR trends we have seen play out in the industry. On the integration front, systems conversion required to enable some of the expected synergies are also progressing well. In August, we completed the first systems conversion in the Seattle market, and that went without a hitch. Over this past weekend, we completed our second systems conversion and early signs point to another successful conversion. As a result, we have made up most of the temporary pause due to COVID, and we are on pace to achieve the previously communicated $65 million of annual run rate synergies on the original timeline, of which we expect to realize $10 million of those synergies this year in 2020. Moving to Smart Foodservice, case volumes continue to outperform our delivered business, with comps down in the low to mid-single digits over the prior year. The cash and carry business typically performs well in economic downturns as customers look to the value offering it provides. The Smart Foodservice stores are also open to the public, and this has allowed us to capture some of the shift to food-at-home over the last several months without changing our business model. Adjusted EBITDA remains on pace with our expectations, and we expect to achieve the synergy target that we have previously discussed. Lastly, I'm pleased to announce the opening of two new Smart Foodservice stores in the fourth quarter of this year. This is just the beginning of our store expansion plan, with the ultimate goal to double the existing store count. I'll now turn it over to Dirk for a discussion of our third quarter financial results.

Dirk Locascio, CFO

Thank you, Pietro. I'd like to begin on Slide 9, where I'll cover the highlights for the quarter before taking a deeper dive into our financial results. Our third quarter results showed significant improvement from the prior quarter and highlight the work we've done to position the business for success post-COVID. As Pietro mentioned, we saw consistent improvement in case volume as the quarter progressed. This improvement is attributable to our ability to gain market share as well as improvement in the underlying fundamentals of the industry. Our adjusted gross profit margin improved 70 basis points from the second quarter and was stable throughout the quarter. We expect our adjusted gross profit margin will continue to improve as our case volume recovers and our customer product mix returns to pre-COVID levels. On the cost side, we enacted a series of permanent cost reductions in the second and third quarters that will position the business for higher EBITDA margins post-COVID. On an annualized basis, we eliminated approximately $180 million of fixed costs from the business, and we'll continue to manage our variable costs in line with case volumes. These fixed cost reductions are mostly in the corporate and back office areas of the business, and I'm pleased to report that we continue to see strong collection efforts on our outstanding accounts receivable. As a result, we’ve further reduced the uncollectible account receivable reserve by $30 million again this quarter. Our incremental COVID-related uncollectible account reserve now sits at $65 million and we have not seen a degradation in the quality of our receivables since COVID began. Moving to Slide 10. Our third quarter financial results improved significantly from the trough we experienced in the second quarter. Net sales compared to the prior year were down 10.5% for the quarter, driven by a combination of lower case volume and negative customer mix, which is a significant improvement from the 29% year-over-year net sales decline we saw in the second quarter. Inflation for the quarter was 220 basis points, primarily driven by inflation in the beef and cheese categories. Our adjusted gross profit margin was down 100 basis points compared to the prior year but improved 70 basis points from the second quarter. Changes in our customer and product mix and lower inbound logistics income were the drivers of the year-over-year decline. Lower inbound case volume resulted in us needing to re-optimize our freight network to compensate for the loss of scale that we benefit from at higher inbound case volume levels. This work is in process, and we expect our inbound logistics income to improve as the re-optimization works take effect and inbound case volumes improve. As I previously mentioned, we expect our adjusted gross margin to increase as our case volume recovers and customer product mix returns to more normal pre-COVID levels. Gross margin at the customer level remains similar to pre-COVID rates, and we continue to see a rational competitive environment. Adjusted operating expense increased 20 basis points compared to the prior year. However, this was a 100 basis point improvement compared to the second quarter. We experienced a 20 basis point year-over-year increase despite experiencing fixed cost deleverage from lower case volume. During the quarter, we successfully managed our variable cost to be in line with case volume while enacting the permanent cost reductions I discussed earlier. In the third quarter, there were a couple of items that had a net benefit to adjusted operating expense of approximately 20 basis points, the largest of which was a $17 million gain on the excess land in Southern California. We don't expect these items to repeat in the upcoming quarters. Even with the benefits factored in, we're extremely pleased with the work we've done on the cost side. Our cost structure remains flexible, allowing us to quickly adapt to changes in our case volume. On Slide 11, I thought it would be helpful to spend a few minutes discussing our operating leverage and adjusted EBITDA margin. Prior to COVID, our adjusted EBITDA margin, which is the difference between adjusted gross profit and adjusted operating expense, was running in the mid-4% range and increasing annually. At the trough in the second quarter, this delta shrunk to 190 basis points, but has quickly expanded again to 3.6% in the third quarter. This is a direct result of the improvement in our customer mix and the cost actions we've taken. If you notice, our adjusted operating expense as a percent of sales in the quarter is largely in line with where it was pre-COVID. This is despite the fixed cost deleverage from lower case volume. As our case volume improves, we expect the organization to operate at lower adjusted operating expense levels than we did pre-COVID. On the adjusted gross profit margin side of the equation, the recovery in our independent restaurant case volume is helping us to drive improvements. As I just mentioned, we continue to work to re-optimize our inbound freight network. This work and an increase in our independent case volume will help adjusted gross profit recover to be in line with pre-COVID levels. The net effect, we believe, will be an expansion of our adjusted EBITDA margin post-COVID. Moving to Slide 12. Our adjusted EBITDA results for the third quarter improved meaningfully from the second quarter in both dollars and EBITDA margin. Adjusted EBITDA was $209 million for the quarter, which means based on this run rate, the business is generating approximately $800 million of adjusted EBITDA on an annualized basis despite case volume being down in the high teens. This is another indication of the flexible cost structure and operating model that exists within the business. In the third quarter, we returned to positive earnings, generating $32 million of adjusted net income and $0.15 of adjusted diluted earnings per share. Since we had a GAAP net loss for the quarter, the additional preferred equity shares are not included in the share count for the third quarter. When we do return to positive GAAP net income, those shares will be factored in to the earnings per share calculations. If these were included in the Q3 earnings calculation, our adjusted diluted EPS for the quarter would have been $0.13. Turning to Slide 13. The business remains in a strong liquidity and cash flow position. We ended the third quarter with $1 billion of cash on hand and $2.7 billion of total liquidity. In the second quarter, we had a large working capital benefit, which we expected to reverse in the third quarter. As of the end of the third quarter, this reversal is largely complete. During the quarter, we reinvested in inventory to support current case volume levels and return vendors to a normal payment schedule. Going forward, we'll manage working capital in line with the recovery in case volume. In the current case volume levels, the business is cash flow positive, and we expect to return to the strong cash flow levels we experienced pre-COVID as case volume continues to recover. We remain focused on reducing our net debt balance and lowering our net debt leverage ratio, which stands at 5.9 times at the end of the third quarter. Over time, we expect to reduce our leverage ratio through both an improvement in EBITDA dollars and a reduction in our outstanding debt, as we've consistently demonstrated the ability to do in the past. Overall, I'm extremely pleased with the progress we've made during the third quarter and the benefits we expect the business to experience from a continued recovery in case volume. With that, operator, we can now open the call up for questions. Thank you.

Operator, Operator

Your first question comes from the line of John Heinbockel with Guggenheim Partners.

John Heinbockel, Analyst

Pietro, I have two things I'd like to discuss. How much of the $180 million did you see in the third quarter? Is that now a run rate starting in the fourth quarter? Additionally, how did you ensure that it didn’t affect the field at all, particularly in terms of safeguarding that wouldn't impact your top-line?

Pietro Satriano, CEO

You talk about the $180 million in cost reductions, John?

John Heinbockel, Analyst

Yes.

Pietro Satriano, CEO

Yes. The primary focus has been on the back office. We made some small reductions in the sales force back in April to align its size with the anticipated long-term customer count. As a result, we have gained market share and successfully brought on large customers, showing that these reductions have not affected us. We have learned to operate in a leaner and more agile manner due to COVID. Over the mid to long-term, we believe this will lead to a higher EBITDA margin. Dirk, do you have anything to add?

Dirk Locascio, CFO

I would just add, Pietro is just, again, a reminder on the sales reduction that Pietro mentioned were the ones that happened earlier in the year, and the more recent reductions were mostly back office types of roles. And John, to your point, we do expect to be at a full run rate here in the fourth quarter.

John Heinbockel, Analyst

All right. As a follow-up, it seems logical that the business would achieve a higher profit margin given the $180 million synergy. When considering a return to pro forma sales and profitability, how quickly do you think profit might recover? It appears that profit could bounce back faster than revenue. Is that reasonable? Do you think profitability could return a year earlier than reaching the pro forma revenue figure, given the $180 million synergy?

Dirk Locascio, CFO

So with that, John, I think it is a reasonable assumption that it would come back quicker. It's hard to predict exactly how much quicker. But to your point, as volume recovers, that does help profitability. But given the actions we've taken on cost that go into effect essentially now, it is reasonable to expect the profitability would come back quicker.

Operator, Operator

Your next question comes from the line of Kelly Bania with BMO Capital.

Kelly Bania, Analyst

Just a couple of questions. First on the Smart Foodservice and SGA. Wondering if you could just talk a little bit more about how those are performing and the contributions there? It sounds like Smart Food performing quite strong. And then just another question on the efficiency as you're bringing on some costs back as trends improve and how you see that trend continuing?

Dirk Locascio, CFO

I can start and then Pietro can add as appropriate. As Pietro indicated earlier, the acquisitions are performing well relative to the current environment. To your point, Smart is holding up quite well as a business. Starting with Food Group, their sales were slightly better than those of US Foods, driven by a higher mix of chain business. The overall EBITDA decline was somewhat better than the organic business, largely due to some synergy benefits that have started to come through. Additionally, as Pietro noted, with the successful second system conversion, we're making good progress on the integration of that business and are pleased with the pace at which we've reaccelerated our efforts. Regarding Smart Foodservice, you're right; that business has also held up well for several reasons that Pietro discussed. Case volumes have been down in the low to mid-single-digit range, and EBITDA is not far off from last year's levels. We remain excited about what this means for our existing footprint as well as for expansion opportunities in this highly profitable business. We are pleased with both segments and are continuously working to strengthen our footprint and increase our penetration in them while building on our progress.

Pietro Satriano, CEO

The only minor point I would add is that the performance we've seen with Smart Foodservice in terms of the low to mid-single-digit negative comps is very much in line with our CHEF'STORE in a different part of the country. This reaffirms the resilience of this channel and its appeal, especially in more challenging economic times.

Kelly Bania, Analyst

Perfect. And just the efficiency, just as you've kind of brought back some costs as sales have improved, and just if you can just tie that in maybe with the size of the sales force of where it is now? And how much of that contributes to the $180 million in cost savings?

Dirk Locascio, CFO

Sure. The reason we separated the $180 million from variable costs is that our distribution labor is adjusting based on results and case volumes in various markets. We are actively managing this and will continue to do so to align with volume changes. This is where we see significant labor fluctuations. Regarding selling and administrative roles, we have reinstated some sales staff from previous reductions. Overall, we are satisfied with our current size, and as we have mentioned before, we will bring back sellers to profitably increase sales as demand improves in certain markets. However, the majority of the $180 million pertains to administrative and back-office roles, which we expect to remain stable as recovery continues.

Operator, Operator

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

Edward Kelly, Analyst

I would like to begin by discussing the current trends in case growth and would appreciate any additional insights you can share about what you're observing at the moment. It appears that, as of the week of October 24, total organic cases may have decreased by a significant margin. Have you noticed any recent changes, especially in light of the increase in COVID cases and the onset of cooler weather? Additionally, we are seeing a rise in global restrictions, which might start to affect the U.S. Do you believe we could experience a setback in recovery as we move further into fall and winter?

Pietro Satriano, CEO

It's Pietro. In terms of the pattern, we've observed a slow and steady increase throughout the fall. While this increase has decelerated a bit compared to this summer, it remains consistent. Regarding the potential headwinds you mentioned, I encourage you to also consider the positive tailwinds. For instance, when assessing the rise in COVID cases, we noticed a second wave in the Sun Belt this summer. We analyzed sales in states like Georgia, Florida, Arizona, and Texas, and while there was a temporary dip in sales, they ultimately rebounded to a higher level than before that wave. This suggests that the long-term and mid-term trends are still upward, and although consumers may pause for a bit, they tend to return in even larger numbers. While colder climates limit outdoor dining, the increasing significance of off-premise dining, whether through takeout or delivery, is a positive factor. Restaurants are adapting to ensure diners feel comfortable with indoor dining and are extending outdoor dining opportunities. There have indeed been recent restrictions in some areas, and places like California still have ongoing limitations. These factors may balance out across different regions. In the short term, I believe the positive tailwinds could match the headwinds you noted. Looking ahead, the medium to long-term trajectory remains positive.

Edward Kelly, Analyst

Okay. And then I was curious, I guess, Dirk, if you could provide some color on the cadence of sort of EBITDA by month. And I'm asking this question because just taking a step back, the Q4 consensus estimate looks to be around $270 million or so, which to me seems a little high. I'm just kind of curious as to how we should be thinking about Q4?

Dirk Locascio, CFO

Sure. The overall cadence wasn't very different. We saw a bit of a stronger EBITDA as volume picked up throughout the quarter. Beyond that, there's not much more to add. We do expect to see a bit more of the cost savings reflected in Q4. As for the timing of the cadence in the quarter, there's nothing specific to highlight beyond that regarding the timing.

Edward Kelly, Analyst

So where you were sort of running end of Q3, maybe a sprinkle in a little bit more cost saves, and that's kind of how we think about EBITDA by month in Q4. Is that fair?

Dirk Locascio, CFO

There are always factors related to seasonality and timing. However, if you consider the core business, that’s a solid approach. We understand there’s interest for the upcoming months, and we are working to manage that appropriately while also making decisions that prepare us for success in the post-COVID environment. Pietro mentioned our success in gaining market share with both small and large customers, and we have seen strong results in recent months. We will continue to push forward to further strengthen the business in both the near-term and mid-term.

Edward Kelly, Analyst

Okay. If I could just squeeze one more and this for you Pietro, I guess. You're optimistic that profitability can exceed pre-COVID levels. Some of this depends, I guess, probably on making the right decisions on the business that you take in today. Can you just talk a bit about how you're balancing the desire to drive near-term EBITDA growth, with sort of the focus on post-COVID margins and the $800 million that you brought in, those margins kind of look similar to what the company would earn pre-COVID? Just curious as you're thinking about all that.

Pietro Satriano, CEO

Yes. As I mentioned earlier, the margins for our new business are quite strong, although margins for large customers tend to be lower compared to independents or smaller customers. However, when we look at the upper quartile of our large customers, their margin profiles align well with what we've historically seen. We are being careful about the pace at which we onboard these customers. The factors influencing customers' choices in selecting partners are related to the advantages we offer, such as our scale, stability, and value-added services, particularly for smaller multi-unit local customers. These value-added services are significant in driving our profitable market share gains.

Operator, Operator

Your next question comes from the line of John Ivankoe with JPMorgan.

John Ivankoe, Analyst

I wanted to revisit the $180 million in cost savings, which you mentioned is primarily coming from the back office and corporate areas. That’s a significant amount, as you’re aware. Are there any future investments or functionalities that you've decided to deprioritize due to these cost cuts? Additionally, were there any major department consolidations or other structural changes that contributed to achieving that $180 million? Lastly, just in case I lose my chance to ask, some companies have discussed regionalizing their business and altering how their sales force is compensated as part of a broader restructuring. Is that something you are considering or ruling out? Where do you stand on that?

Dirk Locascio, CFO

I can begin by discussing some of the initial costs, and then Pietro can address some of the aspects of our business model. Regarding the $180 million, most of that consists of people-related costs. I want to emphasize that we aimed to strike a balance to ensure we were not making decisions that could harm our customer service capabilities. In fact, our focus on customer service has intensified over the past three to six months compared to prior to COVID, and in some instances, we have even increased our inventory to enhance this aspect. As we navigated through these changes, we've utilized a lens that allowed us to evaluate different areas, recognizing that certain administrative costs can be reduced when volumes decrease. We have successfully identified opportunities to streamline processes through our continuous improvement initiatives. As for our major investments, we have established a prioritization strategy that safeguards our future objectives and key priorities, ensuring we do not compromise them for the sake of these costs. We remain confident in our ability to maintain and strengthen our leadership in several areas as we emerge from this period.

Pietro Satriano, CEO

Yes. And then in terms of some of the other things you've said, are they on or off the table, John. I presume you're referring to a couple of things. One is, move to multi-site area. And you'll remember, we moved to that management model in 2015. We're very happy with it. We think it served us well. Most areas have a presence that overlooks two markets, we think that's the right number, and we aligned our region structure at that time to be consistent with that span. So we think we did that work a number of years ago, and we're happy with the results of that work in terms of our operating model.

John Ivankoe, Analyst

And anything on the sales facing part of the business just in terms of how the customer is being served, whether it's rethinking the way that they're being compensated or what the coverage are and how the territory managers are integrated just within the selling organization. I mean, if there are any changes that the customer could see that could also make you more efficient?

Pietro Satriano, CEO

Thank you for the reminder. The team-based selling approach is one we've had in place for several years. A couple of years ago, we made some slight adjustments to our compensation strategy. We want to ensure those changes take root. One notable difference in the current environment is the effectiveness of our restaurant operations consultants. We have specialists focused on the product, along with restaurant operation consultants dedicated to the back office. We've successfully expanded their reach using webinars and virtual technology. Instead of having just one or a few ROCs trying to learn everything about key issues like the reopening blueprint or applying for government support, we've been able to enhance their specialization and reach, which improves the customer experience. I believe some of this approach will continue, as it allows us to provide a better experience for our customers. Regarding the product specialists, who are more hands-on, I don't anticipate significant changes in that area.

Operator, Operator

Your next question comes from the line of Lauren Silberman with Credit Suisse.

Lauren Silberman, Analyst

Can you dimensionalize organic independent case growth for the impact of restaurant same-store sales declines versus net new restaurant customer acquisition versus wallet share gains? So to what extent have seen store sales decreases amongst existing customers and closures been offset by wallet share gains and on-boarding of new customers?

Pietro Satriano, CEO

What I can say, Laura, is that some of the gains have come from increased market share, and we've recently begun to analyze that more closely. While the data isn't comprehensive yet, we're starting to improve our understanding. Some customers, particularly where indoor restrictions still apply, have seen declines in same-store sales, but others have made up for that through off-premise dining, especially during the summer and in colder regions. There are several factors at play, making it difficult to generalize. I think we don't have all the necessary data to provide a clear answer to your question.

Lauren Silberman, Analyst

Fully understood. Just to follow-up on the near-term organic case growth. It looks like restaurants about down 10% the last few weeks. So I know you felt some of the near-term headwinds. But as we think about further sales gains from here, are they largely predicated on increases in capacity restrictions? Or do you really see the most meaningful opportunities for continued recovery near term, assuming the current environment is status quo?

Pietro Satriano, CEO

I believe that over the next two to four months, the current environment may improve or possibly worsen, depending on various regions. There are just as many potential positive factors as there are challenges regarding the near-term outlook. My focus is more on the medium to long-term scenario, where we expect consumers who may currently be hesitant, possibly not replacing dining out with off-premise options, to revert to their previous habits, especially once a vaccine is available. What is particularly encouraging is the gradual and consistent improvement in organic performance, despite the second wave and other challenges. We are seeing a steady increase in organic performance among new tenants, which is promising for the medium to long-term.

Lauren Silberman, Analyst

We've seen a pretty significant disparity in performance in urban and suburban market. So what's your relative exposure concentration in urban versus suburban areas?

Pietro Satriano, CEO

I don't know that we're able to quantify that, alright, but I think you do raise a point. That's another example of where some of the more urban markets have been hit hard, but we've seen the offsetting shift to some areas. And again, when you cover the country like we do, it's like a very well-diversified portfolio of stock, a bunch of puts and takes and we're making sure our local leaders to make sure they shift appropriately, whether it's to different menu types that are more resilient, or different sub-geographies that are experiencing growth.

Operator, Operator

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

Alex Slagle, Analyst

I wanted to follow-up on the margin commentary. And gross margin improved a solid 70 basis points quarter-over-quarter this quarter. Just wondering how we should think about the dynamics heading into the 4Q, which historically is a pretty high-margin quarter. Obviously, this year faces some unusual circumstances. If there's any factors we should consider in our 4Q view?

Dirk Locascio, CFO

Sure. When I discuss the core customer margins, I noted that they have remained quite stable, and we are observing a rational competitive environment. At this time, there's no indication that we need to consider any changes. The key factor is really the mix, which doesn't seem to be deviating from historical trends or recent performance. Regarding the core underlying health, there’s nothing specific to address. We anticipate that gross margins will continue to improve as volume and mix recover, similar to recent months. As I mentioned during the second quarter call, we've seen improvements in the last two months of that quarter compared to now, as volume and mix have rebounded. While it's difficult to predict exactly how this will unfold in Q4 versus the upcoming quarters, we are experiencing positive trends as volume increases.

Alex Slagle, Analyst

And then a follow-up on the Smart Foodservice business. It sounds like you opened a couple of stores so far in the 4Q. Do you have a rough idea on what you think the pace of development will look like into '21?

Dirk Locascio, CFO

We have successfully opened one store and plan to open another soon. While we haven't provided a specific timeline for the near term, we have more locations planned for next year. As Pietro mentioned earlier, our long-term goal remains to double our footprint. We are working on integrating this expansion into our business model, which will strengthen our omni-channel presence, making it challenging for competitors to keep up. Additionally, our smaller CHEF'STORE locations have been beneficial, as they not only generate additional business but also encourage customers to spend more. As we continue to grow, we expect to see positive outcomes from this strategy. The future looks promising for Smart Foodservice as part of the US Foods family.

Operator, Operator

Your next question comes from the line of Carla Casella with JPMorgan.

Carla Casella, Analyst

I'm wondering, given the changes that you've made, the new contracts that you've gotten and the acquisitions, can you give us a sense for the breakdown of your business, what percentage of your sales overall are to key categories like either the restaurants, the independents versus hospitality and healthcare?

Pietro Satriano, CEO

Do you mind repeating that one more time, please?

Carla Casella, Analyst

I'm looking for the business mix where it stands today, given the acquisitions and the new business you've added, if you could break it out. If it's changed dramatically between restaurants, hospitality and healthcare? Or you can tell us how much of the business is still independents?

Pietro Satriano, CEO

At this point, we haven't specified the exact numbers. However, there are some shifts due to current changes in volumes, particularly with hospitality being lower. We believe that, when looking at the core business and customers over time, we don't expect a significant change compared to historical trends. Hospitality may see slightly lower spending than before as it is recovering, but the recovery is taking longer than anticipated. Overall, when considering the long-term recovery of the business, the mix should remain similar to what it has been in the past.

Dirk Locascio, CFO

So what we've talked about is we've said I'm trying to remember that roughly, Melissa, you have to keep me honest here, is it roughly…?

Melissa Napier, Speaker

About a third to independents, about a third to healthcare hospitality, about a third to what we would call all other. And then, Carla, we've also said about 50% of sales are to restaurants, so that would be independent as well as chains.

Operator, Operator

Your next question comes from the line of Jeffrey Bernstein with Barclays.

Jeff Priester, Analyst

This is actually Jeff Priester on for Jeff Bernstein. Two questions for you. Can you just give us a sense of how your inventory levels and inventory management is trending kind of as you've rebuilt your inventory following the second quarter, maybe kind of positioning it relative to your pre-COVID levels? And then second, do you have a sense of whether or not your customers on average are still running simplified menus? Are they back to running their full menus, maybe through SKU count per customer or any other metrics you want to provide?

Dirk Locascio, CFO

Sure. As I mentioned earlier, we're actively managing our inventory due to the pace at which certain items are moving. We're currently a couple of days higher on days inventory on hand, but the difference is not significant. Our replenishment sales teams are closely monitoring the situation, and we're balancing inventory levels with service levels. Due to some vendor challenges in receiving products on time, we've decided to invest a bit more in inventory to better serve our customers. This situation is a bit elevated, but still manageable, and we're keeping a close watch on it. Regarding your question about menus, it shows that customers are still leaning towards more simplified menus, which seems to be a strategy for managing their own inventory and minimizing risks of loss or spoilage in the current environment. I expect this trend to continue until we see a return to a more stable situation.

Jeff Priester, Analyst

Got it. Is there any update on the number of your customers who are currently not taking deliveries, whether due to temporary or permanent closures?

Dirk Locascio, CFO

We expect the level of closures to remain in the single digits. We will work with our sellers, recognizing that some closures may be temporary and others permanent, but we anticipate that closures will still be in the single digits for now. Over time, it becomes more challenging to predict how this will trend. One thing we've observed is that operators are demonstrating resilience. As we discussed earlier, operators are expanding their offerings through takeout and delivery, which positions them better than when we first faced COVID, especially in terms of managing the uncertainty and restrictions in place.

Operator, Operator

Your next question comes from the line of John Glass with Morgan Stanley.

John Glass, Analyst

First, if I could just go back to gross margin. You had last quarter provided some helpful detail around year-over-year change related to volume declines, acquisition puts and takes, customer mix, et cetera. Do you have those details for this quarter, what the pressures were by those sort of various buckets?

Dirk Locascio, CFO

Certainly. I would say that the roughly 100 basis points change is completely driven by a combination of product mix and the effects of sales inflation. The impact from acquisitions was minimal this quarter. Therefore, it really comes down to those factors of mix and inflation. As I mentioned earlier, our customer margins and overall balance remain quite stable in the current environment. This stability gives us a positive outlook as we see volume levels continuing to improve. We've also noted an improvement in mix during the third quarter as those volumes have recovered.

John Glass, Analyst

As a follow-up, do you have any insights on how your wallet share has changed among independent customers? Some companies mention gaining wallet share with existing customers while potentially sidelining new customer acquisition. Can you provide an estimate of the improvement in wallet share, particularly if it indicates that customers are switching from a secondary distributor to a primary one? Please share how you assess wallet share among independent customers.

Dirk Locascio, CFO

Sure. So we haven't talked about a specific number, but we do believe we are gaining share among the independents. And there is, as Pietro commented earlier, not great industry data. There's some industry data through NPD that we use that does on a more blind basis, our share in each of the markets compared to others. And that data indicates in the more recent months that we are gaining share versus the rest of the industry, pretty broad-based across our regions in the independent space. And then with the larger customers in national sales, with the wins that Pietro talked about, also believe we're gaining share on that as customers continue to engage with our team about conversions.

Operator, Operator

Your next question comes from the line of William Reuter with Bank of America.

William Reuter, Analyst

I just have two. In your prepared remarks, you talked about how permanent restaurant closures seem to be relatively benign at this point. But I guess, if you could talk about sequentially between the second and third quarter, if you did see an acceleration of some of those closures? And then you discussed gross store openings that you've achieved this year. Are there any offsetting customer losses that were meaningful? That's all from me.

Dirk Locascio, CFO

Sure. So in that case, from a closure, there's nothing that I would call out as far as any meaningful change from Q2 to Q3. And I think, in fact, in many cases, operators that were closed in Q2, we started to see some openings as they adapted through the environment that we're operating in. So it's nothing meaningful to call out specifically there. And then, do you mind repeating your second question again, please?

William Reuter, Analyst

Yes. The second question was just you gained 800 gross new doors, the 500 of chains. And then if there's any losses to offset those?

Dirk Locascio, CFO

Sure. I believe the figure is around $100 million that balances that out. Overall, this has been one of the strongest years for our national sales team in quite some time. As Pietro mentioned earlier, we take the profitable growth of sales very seriously. Our recent successes are not just about increasing case volume; they reflect favorable economics and the distinctive advantages our sales team brings through scale, operational consistency, and effective tools. We are very pleased with the growth and the strong levels of new business in the pipeline.

Operator, Operator

And your final question comes from the line of Carla Casella with JPMorgan.

Carla Casella, Analyst

I have a follow-up regarding cash flow. You're currently paying your preferred dividends on time or picking them. Do you expect to continue this practice? Additionally, you sold some assets in the quarter, and I would like to know if you have more assets planned for sale and what you sold.

Dirk Locascio, CFO

Sure. We expect to handle the first year as outlined in the agreement, and after that, we plan to be paying in cash, which is one of our main focuses. Over time, we have consistently shown our commitment to deleveraging, and we aim to return to our target of 2.5 to 3 times debt, a level we reached just before our recent acquisitions. We intend to leverage strong cash flow post-COVID to achieve this. Regarding the property sale, we sold an excess piece of property in California that we purchased years ago. Occasionally, we acquire properties for potential distribution centers, but we assessed our needs and decided we no longer required this location. Fortunately, the market improved since our purchase, resulting in a $17 million gain, which we retained in our operations. We periodically buy and sell excess properties, realizing gains or losses, and we aimed to clarify this in our earnings script and release. In response to your question about additional sales, I wouldn't anticipate many. Typically, we might have one or two each year, and there are a few smaller properties currently on the market. If there are any developments with those, we will provide updates as we progress.

Operator, Operator

And there are no further questions at this time.

Dirk Locascio, CFO

Thank you. Unfortunately, toward the end there, Pietro was disconnected from the call. In closing, I hope you take away three key points. First, the industry is resilient and expected to return to pre-COVID volume levels. Second, our company's scale and differentiation are leading to market share gains. Third, our financial results have significantly improved from the low point in the second quarter. I want to express my gratitude to all of our associates who have worked tirelessly since the beginning of this pandemic to serve our customers. Thank you all for joining our call today. That concludes our comments. Have a good day.

Operator, Operator

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