US Foods Holding Corp. (USFD) Q2 2018 Earnings Report, Transcript and Summary

Good morning, everyone. My name is Jan, and I will be your conference operator today. At this time, I would like to welcome everyone to the US Foods Update Call. [Operator Instructions] Ms. Melissa Napier, you may begin your conference.

Thanks, Jan, and good morning, everyone. Welcome to our conference call. Today, we’re excited to announce US Foods agreement to acquire SGA’s Food Group of companies as well as present our second quarter 2018 earnings results. Joining me today are Pietro Satriano, our CEO; and Dirk Locascio, our CFO. Pietro and Dirk will first discuss the transaction, following will be discussion of our second quarter fiscal 2018 results. And then following those remarks, Pietro and Dirk will take your questions. As noted in our press release, today’s call will take the place of our previously announced earnings call scheduled for August 7. During today’s call, and unless otherwise stated, we are comparing our second quarter results to the same period in fiscal year 2017. Our earnings release issued earlier this morning as well as our acquisition announcement and today’s presentation slides can be accessed on the Investor Relations page of our website. In addition to historical information, certain statements made during today’s call are considered forward-looking statements. Please review the risk factors in our latest Form 10-K 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, I’d like to point out that 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 schedule on our earnings press release. Thanks again for accommodating the time change, and I’ll now turn the call over to Pietro.

Thank you, Melissa. Good morning, everyone, and thanks for joining us on a short notice. I’m actually here in Scottsdale, Arizona home to the corporate headquarters of the SGA Food Group. I’m thrilled to talk about the exciting combination of US Foods and the SGA Food Group. Today’s announcement builds on the strong foundation we’ve established at US Foods, and is clearly aligned with the growth strategy that we have put in place. SGA Foods Group is one of the most well regarded regional distributors and it will strengthen our collective position as a world-class food service company. Ultimately enabling us to provide our customer with even better products, service, expanded capabilities in order to deliver accelerated growth and value to our shareholders. Let me start on Page two by summarizing why SGA Food Group is an absolutely ideal fit for us. With the complementary geographic footprint and capability, SGA Food Group enables us to significantly enhance our position across the attractive and growing Northwest region as well as adding to our presence in the West. Our strategic priorities are aligned, with the similar focus on independent restaurants, leading technology and private brand. Given our common customer-centric culture, this combination will provide us with the opportunity to leverage our respective best practices in order to become an even better company from a financial perspective, the transaction is expected to be accretive to top line growth and adjusted EPS. In addition, strong combined cash flow will support rapid deleveraging. Finally, we expect to realize the benefit of $55 million, an attractive and achievable synergy opportunity. Let me now provide some additional detail on the transaction, the company and the strategic rationale for this exciting acquisition. So moving to Slide three. Here are a few highlights of the transaction, which Dirk will then expand upon later in the call. We are acquiring all of the shares of the five subsidiary entities from SGA and an all-cash transaction valued at $1.8 billion. The transaction provides – represent 12.5 times adjusted EBITDA multiple based on SGA’s estimated 2018 adjusted EBITDA of $123 million and giving effect to the tax benefits from the acquisition. Net of the approximately $260 million tax benefit and the $55 million in annual run rate cost synergies, this price reflects a 2018 adjusted EBITDA multiple of 8.6 times. From an IRR perspective, the deal well passes our internal IRR hurdle. We expect the transaction to become accretive to our adjusted EPS, excluding amortization in the second full year following close. We expect $55 million in annual run rate cost synergies by the end of fiscal 2022, primarily driven by savings in distribution, direct and indirect procurement and back-office administration. Following the close of the transaction, which is subject to regulatory approval and other customary closing conditions, SGA Food Group will form the core of a new 6th Northwest operating region for US Foods. Let me move to Page four. SGA Food Group is one of the most attractive regional distributors in the U.S. And for those of you who are not familiar with them, they are a large food service distributor comprised of five operating companies, each of which is a leader in its field, and I’d like to spend a minute or two providing a quick overview of each of these operating entities. At the top, Food Services of America, which accounts for roughly 75% of SGA Food Group’s total revenue. Serving 16 states in the West and Midwest, FSA operates nine distribution sectors leveraging world-class technology and state-of-the-art operation system. FSA also has an attractive business mix with almost 40% of sales to independent restaurants. Systems Services of America, which operates three distribution centers serves multi-unit food service operators, including casual and fast-casual dining establishments and regional and national chain. AmeriFresh is a business with a strong produce sourcing and marketing capabilities, including 6th sourcing office in key growing regions in the country. AmeriStar is the provider of custom meat products, three specialty meat cutting facilities, in ways very similar to our own stockyards operations at US Foods. And GAMPAC focuses on supply chain, planning and logistics similar to our own internal logistics operation. These five operating entities work seamlessly together to deliver superior solutions for SGA Food Group’s diverse customer base. Like US Foods, the company has a strong focus on serving independent restaurants, employees a forward thinking approach to technology and has a very strong focus on private brand. With these assets and these capabilities, a diverse customer base with the strong focus on independent restaurants and a strong culture focused on customer service, the SGA Food Group is a very high quality company and we’re very excited of the prospect of combining the two. So let me move to Slide five and talk about that fit in greater detail and the rationale for the acquisition of the SGA Food Group, which will as I said, enable us to accelerate our growth strategy. On the left, you see the strengths of US Foods that US Foods brings to this combined entity. As you know, we have a national footprint, albeit 1 that has a limited presence in the Northwest. We have national scale that supports our procurement efficiency, and we have well-developed industry-leading innovative products and technology. In the middle you can see what you see that SGA brings to this combination. A well-established footprint in the Northwest, where as I said, US Foods does not have a significant presence as well as adding to our existing footprint in the West. Secondly, SGA brings highly developed capabilities in center-of-the-plate including the three specialty meat cutting facilities, I referred to, and strong produce sourcing capabilities. And as we have talked about, those two categories are very important to our growth strategy. And last but not least, SGA Food Group has a track record of operational excellence and a deep commitment to customer service. All of these will be strong additions to our business. On the right, you can see how the combination also provides us with clear, meaningful and achievable synergy opportunities. Approximately, $55 million in annual run rate cost synergies that we expect to be achieved over time and completed by the end of fiscal 2022. These synergies were largely driven by distribution, including reducing miles on routes where we drive long distances as well as bringing greater efficiency to our logistics. Secondly, direct and indirect procurement as a result of our increased scale. And thirdly, back-office administration, including a reduction in redundant headcount cost and processes. Moving to Slide six to provide a little further detail on one of the points behind the rationale. You can see on the map, how SGA Food Group strengthens US Foods' network and expands our presence across the attractive and growing Northwest region, with approximately 33,000 customers, 12 distribution centers and three specialty meat manufacturing facilities. So in closing, we believe that combining the best of both companies assets and capabilities, along with the potential to allow our leading portfolio of innovative products and suite of technology and value-added services to SGA’s customer base will drive increased growth. With that, I’ll hand it over to Dirk to share some of the financial details on the transaction, and after which, we will go and discuss our second quarter 2018 results. Dirk?

Thank you, Pietro, and good morning, everyone. I would just like to reiterate how truly excited we are about this acquisition. I’ll start on Slide seven by showing some additional details pertaining to the acquisition. And then Pietro and I will discuss our second quarter fiscal 2018 performance before Pietro wraps up our prepared remarks and we open up for Q&A. Building on what Pietro outlined, this acquisition enhances US Foods' network and better positions us to even more seamlessly service our customers. The combination also strengthens our mix for highly attractive independent customers, which we continue to see as an attractive and growing market. As Pietro mentioned, we’ll also benefit from $55 million in run rate synergies that we expect to achieve by the end of fiscal 2022. The left-hand chart on seven, shows the pro forma net sales for the combined company, and the right side, the pro forma adjusted EBITDA from the combined companies using 2018 estimated numbers and the run rate synergies. The combination of SGA Food Group’s 2018 adjusted EBITDA and run rate synergies would add approximately 15% to US Foods' adjusted EBITDA on a pro forma basis, in addition to the outstanding strategic value of the transaction. On Slide eight, you can see our calculation of the deal multiples and the compelling returns this offers. This represent a multiple of 12.5 after taking into account the impact of the tax benefit and 14.6x without the tax benefits. The tax benefits are real cash savings and are outside the operating cash flows of the business. We estimate the net present value of the cash tax savings at approximately $260 million. As you can see, the deal multiple after adjusting for tax benefits and the run rate synergy is 8.6 times. We’re pleased with both the strategic and financial aspects of this acquisition. Moving to Slide nine. You see Slide nine outlines the details of the acquisition financing, our expected pro forma leverage profile, which continues to be strong and healthy post acquisition. We expect to fund the $1.8 billion purchase price, primarily through a $1.5 billion incremental term loan B, and the remaining needs will be met by our existing US Foods liquidity resources. A lender group led by JPMorgan and Bank of America Merrill Lynch has committed to the financing. As far as our pro forma leverage profile goes, we expect the day one net leverage of approximately 4.1 times versus 3.2 times, which we finished at the end of the second quarter. We anticipate maintaining our current strong credit profile and we’ll use the cash flow driven by the underlying strong EBITDA growth and realization of synergies resulting from the acquisition to reduce our leverage over time. Additionally, we don’t expect any changes to our planned investments in our own facility, fleets and systems as a result of this transaction. Given our focus will be to reduce leverage to approximately three times by the end of 2020 or postponing our prior plans to begin share repurchases later in 2018 until at least later 2019, at which time, we’ll reevaluate. Now, I’ll turn the back over to Pietro to discuss our Q2 fiscal 2018 earning results.

Thank you, Dirk. And let’s now move to the second quarter, I understand that the acoustics from where I am aren’t ideal, I apologize for that. So now let’s go to the second quarter call. Just give me a second here. Okay, so we’re now going to start with Page 11. So we had a solid second quarter, but one that was below our expectation. The growth of adjusted EBITDA was 4.9%, about 100 basis points below where we had anticipated. And contributing to these results was two things: softer volume and freight, which although was better than first quarter, was still had win from a year-on-year perspective. On the positive side of the ledger, we saw very good management of both gross profit and operating expense. Gross profit grew $0.06 year-on-year, as a result of continued growth of our private brand portfolio and outsourcing efforts. And thanks to strong cost control, operating expense grew $0.07 year-on-year. This resulted in a $0.09 increase in the spread between gross profit and operating expense, demonstrating continued ability to grow EBITDA margins. Looking forward, we expect total volume to approach flat for the full year. And we expect some headwinds on operating expense due to rising fuel prices, that Dirk will discuss later in the call. So as a result of the above and the softer-than-anticipated second quarter that we will talk about, we are calling for 5% to 7% EBITDA growth for the year versus the 6% to 8% that we called for in our last call. So let me move to Page 12 and a discussion on volume. IND growth was 3.8%, with organic growth, a disappointing 2.7%. Several factors contributed to slower IND growth. The first factor was a little weather which we have talked about early in the last call and happened early in the second quarter, which accounted for 30 basis points. The second factor, and more important factor, was operational challenges, both fill rates and on-time delivery, in some parts of the country. Fill rates to customers some geographies were lower as a result of three factors.: low fill rates from vendors, which appear to be at historically low levels; late in bound trucks, as a result of the tightness in the freight market; and in fresh categories, where turns are very quick thus you can see can negatively impact fill rates; and then lastly, the transition to centralized replenishment that we have talked about before. So the first two factors: vendor fill rates and late inbound trucks are fairly self-explanatory and somewhat external. The move to centralized replenishment, which you will recall is aimed at improving gross profit over time, however, coming when it did has made it more difficult to mitigate some of the external challenges that I just described. These external challenges reduced the margin forever, that is required with the transition of this magnitude. Resulting in some dips to customer fill rates in some geographies. The good news is the transition to central replenishment is 95% complete, when we look at both lines and cases. And in those markets or regions that have been deployed the longest, we see growth back to normal levels. So we expect to have worked through this transition in all parts of the country by the end of the year. The other operational challenge is late deliveries in some geographies, and I’m referring to late deliveries to customers, which have occurred as a result of staffing shortages due to very tight labor markets in those geographies. Now tight labor market is nothing new, what is a little new is the number of tight labor markets across the country. And so we are redoubling our efforts to mitigate this headwind by working on better recruiting, onboarding and retention programs for selectors and drivers, which impacts our ability to serve our customers. We believe we can work through these issues and get back to the 4% organic IND growth by the end of the year. Healthcare and hospitality came in a flat. In our last earnings call, we had called for 2% to 3% in the second half, primarily due to a strong pipeline. We are now calling to tame the lower end of that range, the 2% to 3% range that I just described, and closer to the fourth quarter. As a result of having to delay the launches of a couple new large hospitality customers. These are signed customers with material and positive impacts to growth with our customer type that are delayed approximately one quarter. Transitions of new customers requires a fair amount of coordination, especially when it comes to assortment and order guide, and we want to ensure a smooth cutover. For the all other group of customers, growth was in line with expectations we’ve previously outlined. We have called for growth to approach flat in the back half of the year, as we lapse some of the excess that we initiated last year, and we’re still on track with our target. We have a good pipeline of desirable prospects for this customer type. So while we are disappointed with this quarter’s volume, across several of our target customer types, we believe that the factors underpinning this performance are transitory in nature, and we are confident that we will be back with the type of growth we have demonstrated in the past. I will now turn it over to Dirk to walk down the rest of the P&L.

Thank you, Pietro. As Pietro said, we had a solid quarter, but one that was behind our expectations, mainly as a result of lower case volume growth. Our adjusted diluted EPS increased 54% year-over-year to 57% for the second quarter and adjusted EBITDA increased $14 million, or 4.9% for the quarter. We also continue to improve our operating leverage as Pietro mentioned with a $0.09 per case improvement in the second quarter compared to the prior year, as adjusted gross profit per case improvement again significantly outpaced the adjusted OpEx increase. I’m going to start on Slide 13 where you can see second quarter net sales were $6.2 billion and flat to the prior year. We experienced 90 basis points of year-on-year inflation and mix impact for the quarter, offsetting the impact of inflation and mix was a case decline of 90 basis points, as Pietro talked about. We saw continued moderation in year-over-year inflation in the second quarter compared to what we saw in March of 2017. The year-over-year inflation was for modest inflation in diary and grocery, partially offset by a deflation in poultry, pork and produce. On Slide 14, you can see we continued to deliver strong gross profit results. For the second quarter, gross profit was $1.1 billion, which was a 5.7% increase over the prior-year period on a non-GAAP basis, and up $19 million or 1.8% on an adjusted basis. As a percentage of sales, gross profit on a GAAP basis was 18.1% and 17.9% on an adjusted basis. This is 100 basis points higher than the prior year on a GAAP basis and 30 basis points higher on an adjusted basis. The parts of our strategy focusing on gross profit rate expansions, such as private brand penetration and sourcing continued to make good progress, with gross profit per case up a very strong $0.16 per case this quarter. We continued to face a freight headwind in Q2, however, it was less than Q1. It had about 100 basis point negative impact on our adjusted EBITDA growth for the quarter. The third-party freight market capacity remained tight as demand continue to outstrip supply. We’ve continued to make progress on mitigating the freight rate headwind through the action taken with respect to working with vendors and working to continue to optimize our freight lanes, that I talked about on our Q1 call. Capacity is expected to remain tight, however, we don’t expect it to be a year-over-year earnings headwind for half two, assuming a similar environment for the balance of the year. Moving now on to operating expenses on Slide 15. You can see operating expenses declined 2% from the prior-year quarter to $908 million, primarily from a reduction in our amortization expense and decreased 30 basis points as a percent of sales to 14.8%. Adjusted operating expenses increased $8 million or 1% over the prior-year quarter. And as a percent of sales, were 13.1%, which is an increase of 10 basis points in the prior-year quarter. We did begin to see increased fuel cost in the second quarter as a result of a significant increase in diesel prices during the quarter. We expect a negative impact from that price increase to be more significant to our year-over-year comparisons in half two, and based on the industry outlook data, fuel cost is likely to have a negative impact of 200 to 300 basis points on our adjusted EBITDA growth rate. On Slide 16, as I mentioned earlier, our operating leverage or current contribution margin gain was $0.09 per case, as a result of gross profit per case increasing $0.16 and operating expense per case increasing $0.07. It was consistent with the operating leverage gains we achieved in fiscal 2017. Our focus remains on improving our operating leverage by growing gross profit per case meaningfully faster than OpEx per case to further increase our EBITDA margins as we have. Now on Slide 17, we made solid improvements in all of our key profitability metrics. As I mentioned previously, adjusted EBITDA was $300 million in the second quarter, which is up 4.9% over the prior-year period. As a percent of sales, adjusted EBITDA increased 30 basis points to 4.9%. The combination of gross profit expansion as a result of initiatives such as private brand growth and solid cost control continues to grow EBITDA margins. Adjusted diluted EPS improved $0.20 or 54% to $0.57 per share for the quarter due to lower amortization, lower federal tax rate in 2018 and improved business results. And finally on the far right, net income approximately doubled to $126 million, and adjusted net income increased almost 50% to $124 million. Turning now to cash flow and net debt. Our operating cash flow year-to-date was $311 million compared to $368 million in the prior year. The decrease was due to an approximately $40 million increase in tax – cash taxes this year, as expected, and an incremental $45 million contribution to our defined benefit-pension plan to take advantage of the tax law change. As a reminder, our defined benefit-pension plan is largely frozen and is nearly 100% funded now. So this will not be an ongoing impact and will have the additional positive impact of reducing contributions in 2019 and 2020 to offset most of the incremental 2018 cash impact. After these two items, our operating cash flow increased approximately $20 million or 6% from the prior-year period. And net debt at the end of the quarter was $3.5 billion, a decrease of $79 million from the prior-year period and $140 million from the fiscal year-end 2017. Our net debt leverage ratio decreased again to 3.2 times at the end of the quarter compared to 3.5 times for the prior-year period and 3.4 times at the end of fiscal 2017. Moving now on to Slide 19, we do have several updates to our previously provided fiscal 2018 guidance. As a result of a lower first half volume, we’re adjusting our case growth and net sales growth guidance. Our outlet for fiscal 2018 total case growth is to approach flat for the year from the previous guidance of approximately 1%, and we expect net sales growth of 1% to 2% as we are seeing and have an outlook for deflation and more kind of commodity categories than previously projected. Specifically by customer type, we expect 2018 organic, independent case growth to accelerate from the Q2 growth rate and achieve a full-year organic growth rate near our fiscal 2017 organic growth rates. As Pietro mentioned, we expect healthcare and hospitality to achieve growth at the low end of the 2% to 3% growth rate in second half, but don’t expect of that until closer to Q4. And for all other, we expect that to approach flat by the end of have two. We’re also updating our guidance for depreciation and amortization expense to $330 million to $340 million. And finally as a result of lower volume and higher fuel cost in the second half of the year, as Pietro mentioned, we now expect adjusted EBITDA growth for fiscal 2018 of 5% to 7%. Other elements of our guidance remain unchanged. Our business had a solid Q2, albeit, modestly below our expectations. We continue to have a positive outlook for the business, and are focused on working through the challenges, Pietro discussed to accelerate our growth. And with that, I’ll turn it back to Pietro.

Thank you, Dirk. So let me make a couple of closing comments before we open up to questions. So as Dirk said, despite a disappointing quarter on the volume side, we believe that the underpinning root causes are transitory in nature, and we are very pleased with the rest of the P&L and the growth in EBITDA margins. With the strength of our strategy and even keener focus on execution, we remained committed to our midterm guidance for 2019 and 2020. We’re also incredibly excited by the acquisition of the SGA Food Group that we announced today, an acquisition that strengthens our geographic footprint in that part of the country, where we have the greatest opportunity for growth and with the company that is like minded and it’s focused on customers, and in the way it has embraced technology, private brands and innovative merchandising platforms. So with that, we will now open it up to questions.

[Operator Instructions] We have our first question from Mr. John Heinbockel. Your line is open.

So two things, let me just start with the SGA acquisition. What has been their recent growth rate, if you think about local cases, EBITDA, any color on that? And then you didn’t talk about revenue synergy, so I’m curious when you put scoop and cookbook into their business. Does that have the potential to accelerate their growth? And what do they have that might flow your way and have a revenue impact for US Food?

I’ll let – I’ll give Dirk the option to respond on that financial aspect of that question, Dirk?

Sure. So it’s – good morning, John. So there recent growth rates have been solid, and they haven’t disclosed them specifically, but their growth on The Street has not been that dissimilar to what we have achieved over the last year, so and has been positive. Their earnings growth have been solid as well the last couple of years. And we believe that we will continue to grow at a similar rate. Pietro, do you want to take about the case growth or would you like me to talk about it or the revenue synergies?

No Dirk.

Okay. So I think, John, there’re two things that I would call, is, so we do believe as you pointed out that there are revenue synergies between the companies both from putting our technology and products in. We have to be able to overachieve what we’ve outlined there. The other piece is the produce and meat capabilities that’s SGA as we believe can bring some benefit to US Foods. So without setting a specific number, we would agree with you that we think there is a lot of opportunity there to cross learn and leverage each other’s advanced skills and capabilities.

Okay. And then secondly, you talked about their multiunit business. So I’m curious how you look at that supply chain in the context of your – like your broader supply chain initiatives? And is that, because you guys had dedicated facilities and moved away from that. So what do you do in their case? And I guess, you are committed to that multiunit business going forward, correct?

Yes, of course. It’s Pietro, John. Thanks for the question. So we have some multiunit business as well as we’ve talked about, and the strategy we’ve had over the last few years is to find the multiunit business that is on the right terms for us and the customer. So that doesn’t change. And in terms – so we’re committed to the business, the multiunit business that we are acquiring. In terms of the distribution side of things, again, here too, the strategy that they’ve adopted is not that dissimilar to ours. When you refer to our dedicated facilities, we used to as you just said have separate brand for our multiunit business, but we still have in our business, one or two of those in the US Foods system. And really comes down to what best for geographic area. So in highly dense geography that’s where the multiunit distribution center makes the most sense, and that’s where we have ours and they have theirs. And then when you get to the less densely populated areas, which the Northwest is probably the best example in the country, that’s where you combine the two. So on the surface because of the branding they have, their strategy probably looks more different than it actually is in substance in respect to where we are today.

Okay, thank you.

Our next question comes from the line of Ms. Karen Short. Your line is open.

Hi, thanks. A couple of questions, hopefully, you can hear me, image. I guess the first thing is can you just explain the timing of the accretion? So are you saying first, full year as in your fiscal 2019 or are using saying fiscal 2020? And then may be if you could you give a little timing or color on timing of the closure of the acquisitions? And then I have another follow up.

Sure, Karen, this is Dirk. So what we said it would be beginning to be accretive in the second full year. So that would be if you assumed later 2018 that would mean 2020. And then the accretion builds from there – from that time on, as we work toward our full synergy realization by the end of 2022.

Okay. And do you have any further color on what the actual amortization component is?

Yes. You know, it would be we’ve done our internal estimates, but I think externally, we’ll talk more about them once it gets further along and we finish the actual purchase accounting and the like.

Okay. And are there any restrictions on the utilization of the annuals on your end?

There should not be any tax challenges now. We believe the benefits from the step up, which are the very attractive $260 million, again those are pretty certain. It’s really just a matter of claiming them over the time frame. So that’s why we feel so strongly and so good about those benefits as well.

Okay. And then just last question, on the actual capacity with the acquisition, where are you guys at in terms of excess capacity on each facilities in terms of your ability to actually expand and grow sales further?

We believe each of these facilities are well-positioned to expand and if needed in the future, many if not all could be expanded to continue to growth. So we don’t believe capacity will be a challenge for us.

Okay, great thanks.

Thanks.

Our next question comes from the line of Edward Kelly. Your line is open.

Hi, guys. It’s actually Stephanie Chang on for Ed Kelly, thanks for taking my question. Just a follow up on acquisition, would you expect the cadence of the $55 million in synergies to be over the next few years? And can you give some detail on how that will be allocated between the three buckets you mentioned the distribution, the procurement and the overhead?

Sure. At this point, we’re not going to be able to provide any additional detail. We will as transaction gets further along, it becomes more certain of a closing time frame, and we have more wholesome guidance going forward, but it will ramp up over the four years. And the thing that we’re going to do is make sure that we integrate in the right way to ensure we achieve it. So not a lot in the first year and even early second year, and then begins to ramp up from there. But again, more specifics to come.

Okay, great. Thanks. And then can you provide some detail on the cadence of case growth this quarter? And what you’re seeing so far quarter-to-date for Q3 in terms of both overall case growth and case growth by segment?

Sure. What I would say is, so far, again, really very in the quarter is consistent with what the expectations, that Pietro and I laid out for the balance of the year guidance. So no big surprises at this point.

Okay, thanks guys.

Your next question comes from the line of Mr. Vincent Sinisi. Your line is open.

Hi, good morning guys. Thanks very much for taking my question. First one just on the current business, then second one on the acquisition. So it sounds like as you mentioned, kind of the near-term headwinds. It seems like the – kind of the two that are surprises this quarter were the centralized replenishment and then the late delivery. I know you said kind of centralized replenishment, you expect it to normalize by the end of the year, but could you just kind of give a bit of color kind of how those two things in particular progressed through the quarter. And then so far, have you seen improvement with either 3Q to date?

So I would say, Vinnie, is what we’ve looked at is the growth per by market, the time of pre-deployment to post-deployment. And for those regions that have been deployed the longest. Going back to, I believe, the middle of last year, those are the regions that are back to the kind of growth they were at pre-deployment. I mean, in the end, it’s not unexpected to have some bumps in the transition of this magnitude. And so what when we talked about our expectation of being back to where we want or we expect to be by the end of this year, but buying some of that – some of those same growth curves that we know from the oldest experiences if that makes sense or the one we started with to the markets that are post-deployment, but more recently. And so that’s how we get to our expectations. It’s, to be honest, it’s hard to talk specifically about within a quarter because there are so many other things that can impact the volume growth kind of week-to-week.

Okay. And then just on, I guess, more on just the delivery and with that tight labor markets, Pietro. I know you said kind of more concentrated effort on the labor and have you made some progress so far?

Yes, we have. It’s – we have made some progress. We have better routines and processes than we’ve had. So again one of the things that you have or putting in place is a more centralized approach to talent acquisition so that we can transfer best practices more easily. And so while we are putting those in place and we are seeing progress. It’s just that we are in an environment right now, as you well know, where labor markets are very tight. And so we’ve just got to be a lot better than we’ve historically been to get to the same place from a labor-management perspective.

Okay. And then just quickly if you guys don’t mind, just on the SGA acquisition. You had that one slide showing kind of the heap map in the Northwest. Can you just give us a little bit more color in terms of distribution, in terms of customer overlap or product overlap, like as the deal seems like probably late this year sort of closing kind of how you do think you can kind of leverage of the two platforms? How much maybe kind of brand-new for you?

Yes, so I’ll start, and may be Dirk has additional detail. So if you look at the distribution facilities, there are many markets where they have a distribution facility, where we do not even have a facility of our own. And that’s why the synergies around distribution and miles is so attractive. We drive in that part of the country, long, long distances, for example, we have a facility in Salt Lake City, that drives all the way to Boise. And so the addition of their footprint and our footprint really helps us and the many geographies where we don’t even compete today. From a customer perspective, obviously, we don’t know and are not able to comment at this point. And I feel like, I’ve missed third part of your question, Vinnie, may be you can remind me.

That was pretty much – it was more kind of a distribution of the customer and then just kind of the product overlap, I guess, that’s kind of the third leg.

Right, the product overlap. Thanks, thanks for the reminder. So we believe there is a lot of product overlap, but we also know that particular on the meat side and on the produce side, they do some things very well, we have the ability to expand our assortment. We also know they do local sourcing very well especially in along the coast in the Northwest with those restaurants that’s particularly important to them. And so back to John Heinbockel’s question, we have not really factored in any benefit from adopting those best practices [indiscernible] entire enterprise.

Alright great. Thanks Pietro, good luck guys.

Thank you.

Our next question comes from the line of Mr. John Ivankoe. Your line is open.

Hi, thank you. The question, I guess, is a philosophy question. A lot of times when companies see a little bit of a road block in their core business with some execution issues that you pointed out, it sometimes not the time to be making such a big transformational acquisition. So I just wanted to get a sense, organizationally, additional functionality, that you’ve added. How you feel about the integration teams and the success of integrating one business, while you basically are fixing your core?

Yes, that’s a good question, John. So first thing, I would say, in terms of to use your words, fixing our core, you know, we have some hotspots across the country, number one. And there is one particular function with respect to the move to centralized replenishment that we need to optimize. So if you use the analogy of renovating a house, it’s not like we’ve got the entire house, there’s one room that is still under renovation. So the rest of the house is working pretty well, number one. Number two, one does not get to choose the timing of when to make an acquisition, and given how attractive this particular one is in this part of the country, I think, it was the wise, the best move for us to take advantage of it. And then number three, in terms of how to manage through both of those, we need to – we have started to put some thought in how we manage the integration when it does happen, but it’ll be sometime before that happens. And like I said, we expect to be through our problems or issues, challenges that I just discussed through by the end of the year. So it actually may work out quite well from a sequential perspective. And then will be based on our experience with integration planning of acquisitions of large magnitude two years ago, we have a very good sense of how to approach this. You know, we will have teams that are with folks from both companies focused on the integration and those will be teams that are dedicated and focused on this. But we’ll have plenty of capacity and bandwidth to run the existing core business. Does that help?

Okay. That’s helpful. And secondly, could you make a comment, on the independent restaurant segment in general, whether you think you’re still taking the share, I think, in excess of two times that you previously anticipated or if you actually saw may be on centralized rep replenishment or some other issues that may have been unique to you, that you may have actually lost a slight amount of share in the quarter?

So as you know, John, there is not great data on share in the industry. So we believe that the slowdown we experienced is primarily due to internal factors. There is a little bit of weather, and we do not see a material if any slowdown in the environment, which then says, we were gaining share before and the rate at which we are gaining share is less at the current time, and we expect to go back to our share gains towards the end of this year. I don’t know that we are in fact losing share, but that’s again, hard to validate. We slowed, the market feels the same, and we’ll get back to the kind of growth we’ve experienced before.

Thank you.

Your next question comes from the line of Kelly Bania. Your line is open.

Hi, good morning, thanks for taking my questions. Just a couple on SGA. First, you mentioned the transaction will be accretive in the second full year excluding the amortization. So I was just curious if you could give us what to that amortization amount is? And what you expect the impact to be to earnings on the first year?

Sure. This is Dirk. So we will talk more about the specific amortization amount as we get further into the process and do the more formal purchase accounting versus the estimates that we’ve come up with. But in – so in year two, second full year, it is modestly accretive and then builds from there. And so, again, in year one when we give our more formal guidance, we’ll give specifics, but same thing, it would be modestly dilutive in year one, really around some assumptions of some modest customer loss and alike in that first year.

Okay. And then in terms of the synergies, I think it’s about 1.5% to 2% of sales from what you’re expecting here. And then just curious if you could put that into perspective to what kind of past M&A you’ve done, how that compares? And if you’ve assumed or typically experienced any customer losses with a large transaction like this?

Sure. So from a synergy, this is just – it’s a different one altogether, because of this year share size of it and that the much larger corporate function overlap, et cetera. So from a synergy perspective, the synergies here would be more significant than we would have experienced on other transactions even relative to the size. We feel very good about the synergies we’ve outlined, and our ability to achieve them. I think from a customer loss, as I said, we have modeled some level of customer loss and we’ve seen in the most recent acquisition, it will be gamut or even hard to compare to so much smaller. This is, what we think is a very reasonable estimate of any losses for that first year or so.

Okay. And then in terms of the two external issues that you called out with the late deliveries from the vendors and so forth. Are you expecting that to improve in the second half? Or how is that tracking now?

So, it’s hard to say. So we’ve had several discussions top-to-top with vendors in terms of trying to weight its level of accountability to their commitments. We’ve also made a lot of progress in terms of changing the carriers we work with to ensure we get better service from those carriers, and as well modifying some of our operational practices to be more carrier friendly, which is more important today than it was a few years ago. But I think that the reason for the confidence in the improvement is we’re just going to – we’re putting practices in place and programs in place to just to be better at mitigating some of the things I talked about because we don’t necessarily control those, but we can – we can’t control some of the things we do to make sure that we can get better mitigate some of the challenges that I referred to.

And Kelly, the thing that I would just add on to that is, you guys have heard us talk about day- over-day routing as an supply chain initiative and sales initiative that we have going on, that is targeted taking miles out improving customer reliability. So from our delivery to customers, that helps with that. And then just back on the inbound side, Pietro said, just as day-over-day frees up some drivers, we can deploy those drivers to go pick up the product ourselves. And then also working with our contract carriers and restructuring those agreements to focus a lot more on reliability, which has been successful. Our spot rate usage in, as we get to the end of the second quarter for contract carriers is significantly less than it was at the beginning of the year.

Okay, that’s very helpful. And then if I could just ask one more, may be as you maybe a little early, but as you think about – as we think about modeling for 2019, is there anything that we should think about? Any reason that the business can’t get back to its kind of targeted EBITDA growth ranges that you would expect whether it’d be freed or labor or any other factors that would maybe a headwind to that? Or should we think about 2019, may be getting back to a normal year?

No, we don’t have any changes to our midterm guidance for 2019, 2020. And we think we have the right initiatives in place to drive the accelerated growth over that time frame. So committed to the those numbers as they stand.

Okay. Thank you.

Our next question comes from the line of Mr. Andrew Wolf. Your line is open.

Thanks. Just wanted to ask with respect to deal regulatory approval risk. I am – I haven’t had time to go through whole contract. When is the deal termination date that US Foods would have to pay the termination fee, if that warrants extended. And second, within the contract, is there a sales or EBITDA divestiture like a threshold that if it were above that, that you guys could terminate the deal and not have to pay the termination fee?

Dirk, you want to talk about the timing, if you can?

Sure. So the 8-K will have a lot of that information on the specifics. What I would say is, we do have a – roughly a year or so timeframe in there, but we would expect to work aggressively to complete much sooner than that. And then there is a breakup fee in there that is approximately $100 million, that’s outlined in there.

And if the deal had a sort of share rate, does it have a threshold by which you guys can terminate deal and not pay the fee? Or is it just a – is that not part of the agreement?

Of the agreement has all the customary things that you would expect in order to complete the deal. So we would expect to be able to complete the transaction.

And just in a more general sense, given your experience with Cisco. I mean, is your analysis – your legal advice that this is a much less concentration than that? And that’s why you entered into the agreement?

You know, at this point, we’re not going to talk about that. But what I’ll tell you is we have not all that you would expect us to do from an antitrust perspective, and we will work with the FDC as we move to the process.

Yes. Thank you.

The next question comes from the line of Judah Frommer. Your line is open.

Thanks for taking my question. May be first just on the deal. Can you help us a little bit with the background and the genesis of how things came together. I assume there was no competitive bidding, but any detail on the background and then your excitement specifically on Northwest geography?

Yes, so it was a competitive situation. And in terms of the – our excitement as I said, just to reiterate what I said earlier, there are just a lot of markets or geographies where they have facilities where we are not even present. And so this part of the reason we’re so excited is its highly complementary from a geography and service perspective. And then on top of that, almost as a bonus we get some capabilities that we believe we have the ability to extend across our entire enterprise.

Okay, thanks. And then may be just switching gears to earnings and kind of the transitory execution issues that you mentioned with independence. I mean, can you take it the next step for us. Is there any a loss of business going on with independence or issues selling into them? And is there anything to connect back to just kind of the aggressive rollout of technology that you can tie it with? Or is it more just freight and the like?

I think, it’s exactly what we described. And the best analogy I’ve used and we’ve used internally is we’re innovating this one room in the house, and that sometimes causes some bumps, and that’s what we’re experiencing. And what’s made it more challenging than we might have otherwise expected is the timing of the centralization, which was planned, one or two years ago. So as coincided with some more recent external challenges from an inbound pay perspective, from vendor fill rate perspective. And so you’ve got some new buyers in the roles, as we’ve moved where the work is done, and so that’s where the lack of the initial experience has made it more difficult to mitigate some of the external challenges that we’ve experienced.

Okay. Thanks.

Our last question comes from the line of Ajay Jain. Your line is open.

Yes. Hi, good morning. I first had a house keeping question on this year’s guidance, so based on the guidance revision for both revenue and on EBITDA. I’m just wondering what the offset is that’s allowing you to maintain the EPS outlook, is it at all tax rate driven? Or is it coming from revised D&A assumptions?

It’s mostly the D&A component that offsets it. You’ve got a little bit of over achievement in some other areas of the P&L, but the D&A is the main driver.

Okay. And I believe this is the second revision on sales guidance for the year. So just wondering what you would attribute some of the incremental softness in case growth? I understand the inflationary aspect of the sales revision, but in terms of the updated outlook for case growth, is that more a function industry-wide trends or might that part at least stem from competitive activity, particularly in relation to independence? Are you seeing any incremental competitive activity in that area?

Yes, so this is Pietro. So we have not seen any change in competitive activity, number one. As I said to John Heinbockel, the external environment seems to be fairly constant. And so really it comes down to, like I said, some of the not too unexpected bumps as a result of the transition combined with a more challenging operational environment externally. And the combination of the two has resulted in some of the challenges in some geographies that we’ve described. And like I said, the good news is when we look at those geographies that are – have had the longest experience with this newer model, we see those performing essentially where we’d like them to be performing.

Okay. I had one final question on the acquisition. Obviously, we’ve got a good snapshot of their current financial performance and I think in response to John’s question, you talked about the growth profile and that directionally earnings around and upswing there. Can you comment on other customer mix in terms of how different it is relative to US Foods? I’m wondering for example, if they do significantly more street account business versus chains? So just wondering if you can comment on customer mix and how different it is? And in terms of their recent margin performance, how would you characterize the margins. Are they stable? Or has there been any step back in terms of the financial performance? So the two questions just customer mix and margin trends in general, directionally.

Dirk?

Sure. So it’s from a mix overall, I think, Pietro made a comment earlier that in the materials that from the FSA part of the business, which is three quarters of it, roughly or almost 40% of that business is independent restaurants, so very attractive mix of business. And if you then add-in the FSA part of it, that means it’s almost 30% of the entire business. So very attractive mix of business. And what I’d say, from margins, what we’ve seen it appears they’ve been pretty stable. And SGA is a forward-leaning company, they’ve continued implement move forward on some technology solutions and process changes, et cetera to help them to continue to compete more and more effectively. So just again reiterating how excited we are both strategically and financially about this.

Great. Thank you.

There are no further questions at this time. Presenters, you may continue.

Okay, so this is Pietro again. So thanks for a few things, accommodating our short notice in order to cover both the news on the acquisition that we’re very excited about and as well our second quarter results. And appreciate the questions and as you can see, we feel very good about where our business is headed, despite some of the transitory issues, that I discussed. And we’re really, really excited about the prospect of the combination with the SGA Food Group and the opportunity that provides in terms of synergies, growth and capabilities and the opportunity to become an even better company over the time to come. Appreciate everyone’s questions and have a good day.

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