US Foods Holding Corp. (USFD) Q3 2021 Earnings Report, Transcript and Summary

Good day and thank you for standing by. Welcome to the Quarterly Earnings Call Conference Call. At this time, all participants lines are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. [Operator Instructions]. I would now like to hand the conference over to your speaker for today, Ms. Melissa Napier. Please go ahead.

Thank you. Good morning and happy Monday. I am joined for our call today by Pietro Satriano, our CEO; and Dirk Locascio, our CFO. On today's call, we will provide an overview of our results for the third quarter and first nine months of fiscal 2021. We'll take your questions after our prepared remarks conclude. Please provide your name, your firm and limit yourself to 1 question. During today's call, and unless otherwise stated, we're comparing our third quarter and nine-month results to the same period in fiscal year 2020. Our earnings release issued earlier this morning 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 2020 Form 10-K for those potential factors which could cause our actual results to differ materially from those expressed or implied in those statements. And lastly, during today's call, we will refer to certain non-GAAP financial measures. All reconciliations to the most comparable GAAP financial measures are included in the schedules on our earnings press release, as well as in the appendices to the presentation slides posted on our website. I'll now turn the call over to Pietro.

Thank you, Melissa. Good morning, everyone. Third quarter results were in line with expectations. Volume for the quarter was up 18% over prior year and 6% below 2019 as the industry continued to recover. EBITDA margins were up slightly as we continue to successfully manage through both higher-than-normal product and labor inflation. This performance resulted in strong cash generation, which contributed to further deleverage from the prior quarter. Since the industry is demonstrating that it is well on its way to recovery, we are shifting our discussions and our goals to be more in line with our pre -pandemic strategy. First, to profitably grow market share with our Great Food Made Easy differentiation. Second, to optimize gross profit margins. And third, to execute with an intense focus on operational efficiency. But first, let me start, as I usually do, with a brief update on the industry on slide 3. Industry foot traffic at restaurants in the third quarter was largely in line with the prior quarter despite the surge in COVID cases due to Delta. This underscores our view that industry demand is resilient, and that demand for eating out or taking out at restaurants is largely past COVID. In fact, as seen by the chart on the right, Technomic is now calling for the entire industry to recover to pre-pandemic levels across restaurants and other customer types alike by 2024. Based on our own current trends, we are confident that US Foods will recover ahead of the industry with our volume returning to 2019 levels some time in 2022. This reaffirms our continued ability to gain market share. Now let me turn to our volumes on slide 4. Restaurant volume for the third quarter was generally in line with the second quarter, and a slight dip in growth rate that you see in the third quarter is attributable to COVID-related staffing challenges in a handful of markets. If not for these challenges, we believe we would have achieved higher volume and market share gains, gains that are fueled by our differentiated Great Food Made Easy platform. October volumes to restaurants are trending slightly higher than the third quarter. Hospitality volume continues to recover, while volume to healthcare was flat for the reasons that I mentioned on our last call. Some lingering restrictions on visitors has hurt food consumption in hospitals, while Senior Living has yet to recover to pre-pandemic occupancy rates. We think recovery in Senior Living is simply a matter of time, given the favorable demographics of an aging population. Lastly, we continue to have great success finding larger multi-geography customers across healthcare, hospitality, and chains. For the two years combining 2020 and 2021, we are on track to add $1 billion in net incremental business across these three customer types, some of whom will onboard in 2022. This $1 billion is net of any exits over the last 2 years, including strategic access as we continue to optimize our portfolio. The single most important reason cited by these large customers for switching to US Foods continues to be our service model, which makes it easier and simpler for customers to do business with us. I will now update you on the elements of our strategy starting on Page 4 -- sorry, Page 5, with how Great Food Made Easy will continue to drive market share gains with target customers. Recall that Great Food Made Easy consists of 3 elements: Innovative products, industry-leading technology, and a selling and service model based on a team of experts that support our sellers, what we call team-based selling. Let's start with innovative products. We had yet another successful Scoop launch, featuring labor-saving products that are highly relevant to customers in this tight labor market. This was the tenth anniversary of Scoop, and since then we have launched 540 exclusive, innovative products, of which 80% are still sold somewhere in our network, a remarkable stick rate. Also of note, on the product side during the quarter, we rolled out Tender by Design, an innovative and proprietary beef program that we inherited with the acquisition of Food Group. In the sub-category that we launched, we saw a 300-basis-point increase in market share, and we expect further market share gains as we expand the lineup. Turning to technology for the second element of Great Food Made Easy platform. We continue to expand our leadership position with frequent releases of enhancements, including a recent update that provides customers with real-time inventory visibility during the ordering process, which is critical in this environment of supply volatility. Recent third-party research with customers reaffirmed our lead in technology in our industry with customers rating the US Foods mobile app significantly better with a Net Promoter Score several times higher than the competition. Representative quotes from the survey include, easier to navigate, most logical setup, and able to show all breadth of products and ways to save money. Lastly, on the third element of our differentiation platform, our team of experts. Fast Company named US Foods one of the 95 brands that matter in recognition of the seminars, playbooks, and expertise that we delivered to customers to help them navigate the pandemic. Having now just covered how Great Food Made Easy is driving EBITDA growth and market share gains, I'm turning to page 6 to cover the second and third elements of our strategy that is optimizing gross profit margins and driving operational efficiency. Let's start with our efforts to optimize gross profit. As Dirk will cover shortly, gross profit per case for the quarter was the highest it has been in recent years. Despite some headwinds from unfavorable customer and product mix, considering to this expansion in gross profit has been: First, our ability to manage and pass-through inflation; second, continued growth in private label brands; and third, the continued optimization of terms and customers in our portfolio. For the quarter, private label as a percent of total sales in our legacy US Foods broadline business was 36.6%, which represents almost 140-basis-point increase compared to Q3 of 2019. And we still see plenty of opportunity for further growth in private label penetration, which will further expand gross profit margins. We also continue to optimize our portfolio of customers, negotiating better terms, bringing on new, more profitable business, but were warranted exiting customers at the low-end of the profitability range. For new business in healthcare, hospitality, and national chains that I referred to and that we brought on this year is coming in at margins that are 3 times higher than the existing base. Still on page 6, I want to update you on the third and last element of our strategy, an intense focus on operational efficiency. In supply chain, while the challenging labor environment persists, we have made significant progress in our hiring, and our headcount for drivers and selectors as now above 2019 and close to our staffing targets. The resulting high penetration of new warehouse and driver associates, not surprisingly, was a headwind to productivity in the quarter. But we do expect to return to 2019 productivity levels by mid-2022, as the tenure of the workforce returns to more normal levels. In addition, we continue to make progress on our supply chain efficiency roadmap. Since the beginning of the year, we have reduced assortment by 15%, which not only contributes to higher service levels for customers but also to higher productivity in the warehouse. With staffing now in a better position, we have resumed the deployment of our new picking technology, which we started in 2019, and we now expect to complete that by the middle of 2022. This technology has demonstrated to improve productivity, especially of new associates, as well as service to customers. And lastly, we have resumed the roll out of more efficient receiving methods, which we had also paused. On the delivery side, with greater stability on the customer ordering front, we can now put greater focus on continuing to optimize routing. Taken together, these efficiency initiatives will help bring distribution expense closer to historical levels. Lastly, on the sales and administrative side, we still expect to retain 2/3 of the $180 million in fixed cost savings that we announced last year, with most of the investment -- of the reinvestment showing up as an expansion in our sales force, which will drive market share. We're very pleased with the level of sales talent we are attracting. Our tools, our unique products, and our culture make us a very attractive choice for sellers. I will now move to slide 7. For a quick update on the Smart Foodservice and SGA Food Group acquisitions, which are both performing at or above expectations. We call that, the rationale for the Smart Foodservice acquisition was two-fold: 1. The opportunity to expand our presence in the Cash & Carry market, which is growing at roughly twice the delivery market with higher margins. On that front, we continue to secure real estate for expansion into new geographies, and 2. The revenue synergies that, come from existing customers in existing markets. The fact that, same-store sales at our nearly 80 Chef's Stores, open at least 1 year, are ahead of 2019 levels provides some support for that thesis. And on the synergy front, we are beginning to see reductions in cost of goods and improvements in private label penetration. Lastly, we expect 2021 EBITDA for our Cash & Carry business to exceed 2019. Turning now to Food Group. Recall at the rationale for that acquisition was to complete our footprint in the important and growing Pacific Northwest region. It was note, we recently won a significant national customer due to our strong presence in the Pacific Northwest, which was the result of this acquisition. We have now completed 6 warehouse system conversions and all have gone fairly smoothly. We expect to have 7 warehouses completed by year-end and all complete by early '22 with the continued progress on integration, Synergy capture remains on track. And by the end of 2021, we will have captured approximately $40 million of the projected $65 million in Synergies. And as I mentioned earlier, we are now starting to see some of the revenue benefits across the entire US Foods Network from centers plate capabilities that came with this acquisition. I will now like to turn the call over to Dirk to discuss our third quarter results and our outlook. Dirk.

Thank you, Pietro. And good morning, everyone. I will start on Slide 9. Our third quarter financial results were in line with our expectations and demonstrate the strength of our business. Sales increased compared to Q2, our volume was in line with the prior quarter. As Kettner mentioned, a slight decrease in the third quarter restaurant volume growth versus 2019, is attributable to COVID related staffing challenges that impacted our industry and also impacted our business. Our Q3 trends was similar to traffic trends for various industry data sources and commentary from several restaurant chains. During the third quarter, we also experienced additional food cost inflation, namely in protein categories such as, beef and pork. In addition, after seeing food cost inflation moderate in July, these costs accelerated again in August and September. Our team continued to do an excellent job of managing that inflation in effectively passing it through to the customers. This resulted in continued strong gross profit per case performance. In fact, even stronger than Q2 and as Pietro noted was the highest gross profit per case in recent years. During the quarter, we successfully filled most of our open warehouse and transportation roles, and as Pietro said, also are close to hiring and staffing targets. We are focused on increasing the productivity of those hired in recent months. Our supply chain costs is expected to be high in Q4, given the large number of more recent new hires with significant improvement in costs by mid-2022 as productivity improves through training and experience. Inbound product supply from vendors also remains a challenge. Strong gross profit is offsetting some of the labor cost headwinds that we and others in the industry continue to face. Our operating cash flow was strong for the quarter and we use that cash to further reduce our debt and leverage. We're focused on effectively managing through the challenging COVID environment and related supply chain labor and product availability challenges. At the same time, we're balancing that as we look to the future by continuing to enhance our digital platform, supply chain technology, and processes to our operating model and continuous improvement focus in line with our pre -pandemic strategy. We saw improved restaurant volumes that October, which indicates there is strong underlying customer demand to accelerate our restaurant growth further, as we also continue to recovery back to 2019 levels in healthcare and hospitality. Moving to slide 10, net sales for the quarter were $7.9 billion up 35% from the third quarter of 2020. Food cost inflation for the quarter was 11.5%, driven by further inflation mainly in proteins. Adjusted gross profit for the quarter was $1.3 billion up 30% from the prior year. And our adjusted gross margin decreased by 70 basis points as a result of the inflation and most of it being in proteins. We generated strong gross profit per case, again this quarter, as we continued to experience product cost inflation. As I mentioned last quarter, inflation benefits our gross profit dollars, while it's typically a headwind to gross margin rate. With over 11% year-over-year food cost inflation in the third quarter, primarily in commodity categories, our gross margin as a percent of sales was compressed, yet our gross profit per case, is the best we have seen in recent years. That's ahead of 2019 and even stronger than Q2. We're pleased with our gross profit performance, again in Q3, especially given the freight headwinds impacting us and others in the industry. The actions we're taking on pricing, growing private label, and optimizing our customer mix are showing up in our results. As long as food cost inflation continues, we expect to manage through effectively to increase gross profit dollars. Adjusted operating expense in the third quarter was $988 million, up 28% versus the prior year. As a percent of sales, adjusted operating expense was 12.5%, down from 13.2% the prior year for an improvement of 70 basis points. While food cost inflation is the headwind to our gross margin rate, it is a benefit to operating expense as a percent of sales. Just as a point of reference, our OpEx as a percent of sales is about 50 basis points lower than it was in the third quarter of 2019, largely due to the significant food cost inflation. We continue to experience additional supply chain labor inflation this year, largely as expected coming into Q3. During our last call, I mentioned that we expected additional labor inflation this year of about $20 million to $30 million, mostly in half too. Above and beyond, the approximately $50 million of normal annual supply chain labor inflation we experienced. The $20 million to $30 million in half too or $40 million to $60 million annualized for ' 22 is still our best estimate of the incremental inflation. We continue to use hiring and retention bonuses, and have increased wages in additional markets during the quarter, driven by the broader market wage rates increasing in those markets. We now expect most of this year's incremental labor inflation to be permanent, and we expect the impact we are seeing to be comparable to others in and outside of the industry. We continue to think that, inflation in future years, however, will revert to more normal levels. And thus, the higher inflation in the current year to be transitory. We do expect productivity to offset some of the incremental inflation. In this environment, we're also having success with margin increases on a number of customers and ultimately expect the margin increases to offset most of the incremental permanent labor inflation. We will continue to optimize customer terms to offset the labor inflation. On Slide 11, adjusted EBITDA was $291 million for the quarter, a 39% increase from the third quarter of 2020. The P&L outcome was largely aligned with our expectations. Gross profit did outperform our expectations since we didn't initially plan for the level of additional food cost inflation in our outlook. And that was offset by higher OpEx from increased supply chain costs largely due to the productivity impact from the higher number of new hires and hire insurance costs. Adjusted EBITDA as a percent of sales was 3.7%. As I mentioned earlier, we are seeing improvements in case volume growth in October and expect the 2022 recovery in restaurant volume at select markets plus market shares will make -- market share gains will make up for the slower recovery in hospitality and healthcare volume. On volume, we're optimistic the October re-acceleration continues as COVID cases continue to decline. As we look ahead to Q4, we expect the EBITDA drivers to be similar to Q3 with good gross profit as long as inflation continues and continued high supply chain costs. That said, we expect total EBITDA dollars at levels below Q3, largely because Q4 is typically a seasonally lower volume quarter until much lesser extent on higher supply chain costs due to the on-boarding of many supply-chain new hires and the impact of the signing bonuses and continued on-boarding of new sellers that we've talked about previously. Specific to volume, historically, we've sold roughly 6 to 7 million fewer absolute cases in Q4 than Q3. And this year we also have an incremental negative volume impact of about 100 basis points in the quarter, if you're comparing to 2019 due to the way New Year's holiday falls on the calendar, which helps Q1 2022. The seasonally lower volume and holiday timing impact, is significant in terms of EBITDA impact when it comes to comparing Q4 EBITDA expectations to Q3. We and others in the industry, typically see an improvement in gross profit per case, due to the additional holiday business and related product mix. We aren't sure how much volume. We are the industry, we will see in Q4 from holiday gatherings, potentially impacting the significant benefit we can have on volume and gross profit rates. So we're watching that closely. Likely to be better than 2020, but not back to the levels in 2019, meaning gross profit not likely to see quite the rate tick up this year that, we have historically experienced versus Q3. Just as a reminder, if you're comparing Q4 volume to 2020, also remember that 2020 had an extra week in the fourth quarter. Earlier, Pietro mentioned that our current best estimate continues to be a return to pro forma 2019 case volume level sometime in '22. We also have our sights firmly on returning to 2019 pro forma adjusted EBITDA, and then growing from there based on M&A, synergies, top-line growth, including the $1 billion in net new customer [Indiscernible] as Pietro referenced, [Indiscernible] GP expansion and cost-savings. Finally, adjusted net income in the third quarter was a $119 million and adjusted diluted EPS was $0.48 compared to $0.19 in the prior year. Turning to slide 12, operating cash flow for the first 9 months of the year was $520 million compared to $533 million in the prior year. The prior year still had the benefit of working capital management actions we took when COVID set in and that had not fully unwound by the end of Q3. Year-to-date operating cash flow in 2021 is in line with the pre-pandemic amounts through the first three quarters of 2018 and 2019, demonstrating we are effectively converting our EBITDA to operating cash. Our business generates a significant amount of operating cash flow each year and we expect to grow that cash flow with EBITDA. We'll use this cash to reinvest in our business and reduce total outstanding debt. In the third quarter, we proactively paid down an additional a $100 million of total debt. Incremental to our standard debt payments, and have reduced our net debt approximately $300 million in nearly three turns year-to-date. Our leverage ratio decreased further in Q3 to 4.8 times due to the net debt reduction and the significant improvement in adjusted EBITDA. Our target leverage ratio remains between 2.5 and 3 times, and we're well on our way towards that target. We expect to continue to make progress against the target via additional debt reduction in increased EBITDA. To close, we are focused on the continued recovery of our business. However, as Pietro said at the outset, since the industry has demonstrated its well on his way to recovery, we're shifting much more of our focus back to our pre-pandemic strategy: 1. To profitably grow market share with our differentiated and Great Food Made Easy, 2. To smartly optimize our customer margins and mix, and 3. To bring an intense focus to operational efficiency. We expect this focus will lead to our volume recovering well ahead of the Technomic outlook and further improving our gross profit OpEx, resulting in healthy earnings growth and a strong capital structure. We will continue to use the strong cash flow to invest in our business and reduce debt, as we look to 2022 and beyond. We're optimistic on our ability to profitably grow our business and deliver value for our shareholders. Operator, at this time, we can now open the call for questions.

Thanks you. The floor is now open for questions. [Operator Instructions]. Your first question comes from the line of Edward Kelly. Your line is open. Please go ahead.

Yeah. Hi. Good morning, guys. So, profit per case, this quarter was obviously very good. Case growth was a little bit lighter than what we and I think probably others expected. I was just hoping you could talk a bit about the cadence of case growth during the quarter versus kind of where June was? Maybe give a little bit color by customer type, including independents, and then talk about the staffing challenges and the impact that that had, and is it possible to quantify sort of like what amount of volume is being left on the table by that to give us a better sense as to where the business really should be run rating right now?

Sure, Ed. Good morning. This is Dirk. I'll start with that. So ultimately through the quarter, if you look at the way Q2 continued, actually our – and then into Q3, our cadence is not that dissimilar than what you've probably seen from industry traffic data sources and a number of the chains where June was the strongest, and then July, similar, and then some softening in August and early September, and then really some pick up toward the end of September, and then that's continued into October. So ultimately, that's similar across a number of our -- sort of -- especially around the restaurants and hospitality. But really, what we're seeing is almost all of our sort of -- I'll call it slowing of the volume recovery, is around staffing challenges in certain of our markets. And really, the end demand perspective, or any impacts on end demand from Delta variant appears to be pretty insignificant. So, from that perspective, as COVID cases decline, our staffing continues to improve. We're optimistic that, the re-acceleration we're seeing in October continues through the balance of the year and then of course into 2022. So that's positive as we look ahead.

And is there any way to quantify the staffing component impact?

So, we're not going to comment on a specific impact of foregone volume. But I will tell you though is, it doesn't -- what we're seeing in our markets is that, the customer demand and consumer demand appears to be there, the challenges we've had don't appear to be that dissimilar to others, and we are seeing in markets where we’re -- where our staffing and where lower COVID staffing challenges that we saw during the quarter, we have a number of our markets growing in double digits. So, we're confident that as we get further through this and past this, there's plenty of business out there and that we can meaningfully accelerate our growth rate.

Great. Thank you.

Thanks, Ed.

Your next question comes from the line of Rahul Gretta Poly (ph). Your line is open. Please go ahead.

Good morning, guys. Thanks for taking my question. Just going back to slide 6, this initiative sounds familiar. What is an evolution or enhancement of an existing project versus what are the new projects with their own paybacks embedded within these initiatives, and also wanted to check if these projects require investment before return or can improvement and be expected without incremental near-term investment in these initiatives?

This is Pietro. So a number of -- in distribution, the leverage you're going to go after in terms of warehouse productivity, delivery productivity are levers that we continue to push on and continue to improve on, which is why probably there's a certain amount of familiarity to what we talked about. However, what I would call out is, especially on some dimensions, the assortment rationalization, some really good progress compared to historical norms. In terms of your question about investment, the 1 or 2 technology that I talked about in terms of picking technology really are very modest investment and the payback is pretty immediate.

I understand.

Your next question comes from the line of Lauren Silberman. Your line is open. Please go ahead.

Thanks for the question. Just on gross profit per case up year-over-year and sequentially, you guys called out inflation private label and optimization in terms and mix. So how are you thinking about the sustainability of gross profit per case from here, just thinking into 2022 as perhaps you see some inflation come down for customer mix shift? And then I understand your commentary on the uncertainty around the holiday performance. Would you expect fourth quarter gross profit per case to be at least as high as 3Q?

Hi, Lauren, thanks for the questions. I think that's -- we do believe that the higher gross profits is sustainable, TBD and the exact same -- or the exact level to your point based on what happens with inflation, but we think the combination of the things and also just even the environment that we're in and with the higher labor cost challenges all contribute to stronger gross profitability – to maintain stronger gross profit per case. So we're confident in our ability to maintain a higher level there even though it may move around a little bit from quarter-to-quarter. And I think you've seen over the years even leading up to the pandemic, we were successful in expanding gross profit and expanding our operating leverage as we improved our EBITDA margins. I think specific to the fourth quarter, I’m not going to speculate any exact amount. I think the -- with holiday timings, I guess the way I would suggest thinking about it is, in the holiday product mix, etc., whatever it shapes out to be is really a Q4 2021 and doesn't change how we think about and probably how the industry thinks about the recovery into 2022 and beyond. I think the positive is, it seems like from what we and others are preparing, it seems there probably will be more activity, so that's an encouraging sign from a demand and people getting out more. I think that all bodes well for the continued recovery into 2022.

Great. And then, it just looks like sales per case was up a bit more than gross profit per case this quarter. Anything you can share about the dynamics there and what's driving that?

That's really more around the categories in which the inflation came in. So just because in the third quarter a lot of it came from proteins and as -- if I remember from what I talked about in the past is more of those categories tend to be a fixed markup per case or per pound. So, you don't necessarily get gross profit to go up quite at the same level as sales, so there's nothing that I would call out that's fundamentally different.

Great. Thanks so much.

Thanks.

Your next question comes from the line of Mark Carden. Your line is open. Please go ahead.

Good morning. Thanks a lot for taking my questions. So on the inflation front, is there a point at which you would typically become concerned that, elevated inflation could start leading to demand destruction? Do you see this being much of a risk and that, if inflation just hit a certain point for a certain period of time that, customers basically shift more their spend food at home? Thanks.

So -- this is Pietro, so we haven't seen that. I mean, as you've seen from the industry data and our own data, consumer demand continues to be very healthy. The increase in digital ordering and take-out has helped demand with food away from home. I think there's a couple of other data point, I would point to that, that lead us to believe that, from an outlook perspective, we're confident that the sector is very healthy. 1. Is if you look at the growth in food away from home relative to food away -- food at home, continues to close the gap and the expectation by one of the industry analysts is that the lines will cross sometime in 2022. I believe early 2023, in terms of more dollars being spent away from home than at home. And then third thing, if you look at inflation between food the way at home -- food away from home and food at home, the GAAP has really narrowed over the last several quarters. So the inflation we're seeing, especially in the proteins as their commented on it, is inflation that's being seen in both food away from home and food at home. And I think if there's any substitution that happens, that it will happen within the sector, or perhaps less with the expensive proteins and more towards some of the less expensive proteins. So we feel pretty good about the outlook.

Great. And then from an optimization standpoint, have you guys have to call many incremental independent locations while optimizing your trucking routes throughout the last quarter? Thanks.

Do you mind repeating the question? Was it about adding --

Sure.

-- independent locations?

Yes, just in terms of have you guys -- with some of the hiring challenges in the driver front, have you guys had to call many independent locations just to optimize your trucking routes throughout the last quarter?

I understand. Okay. So that's what I was referring to, in a handful of markets, we had to rationalize the amount of demand we were able to serve that was sometimes due to driver shortage, sometimes due to selectors. And I think as I mentioned, it was less about the storage and we had a number of facilities, unfortunate disproportionately large facilities, where COVID just went through the facility and we had a 1 or 2 weeks setback in terms of our ability to serve those customers. But by the way, we also benefited from that in other markets where it happened to other competitors. And when we look at those other markets, we had some pretty good increases in market share.

Great. It's very helpful clarity, and best of luck.

Thanks.

Your next question comes from the line of Nicole Miller. Your line is open. Please go ahead.

Thank you. Good morning. I might have understood on the 4Q. I think you said, EBITDA commentary about down sequentially. So before I ask some long with it question, the restaurants traditionally, have a better 4Q and I don't see that historically in your numbers, so did I misunderstand that?

No, you did not. And that's -- in our business, historically back to pre-pandemic, just Q1 and Q4 absolute volume, is lower for us than Q2 and Q3. And I think that's the thing that's -- and some of the outlooks that, people have considered them, it's looking new at more as restaurants as opposed to our industry and our business has historically worked.

And you talked about like 6% to 7% sequentially, seasonally on that absolute volumes, and there was 1 other item. Can you address that 1 other item, I was trying to understand if that was more one-time or not? And then does this translate all the way down to EBITDA then being lower in the fourth quarter than the third quarter?

Yes. So my comment was -- I'll start with that we do expect -- we expect the drivers to perform very similar to Q3, but we do expect Q4 EBITDA to be below Q3, not because of the change in the core business, but because of the seasonal labor we're buying. So if I go to the volume piece of it, yes. So in Q4, I gave as a reference, typically we sell 6 to 7 million fewer cases in Q4 than Q3. And then the other thing on top of it this year, if you're comparing, say at 2019 is, New Year's and Christmas both fall in that last week of 2021. So it has a negative -- additional negative impact of about a 100 basis points in the fourth quarter of this year that, will then help in Q1 of next year. So again --

Okay.

that is timing. And even the downturn in volume is really again, it's just seasonal, not a change in the actual business outlook.

And then on the sales leverage or I guess, I shouldn't call it that. But I guess, on the sales or just the business in total returning to normal at some point mid-2022. To the degree that you talked about that being a function of labor, where are you hiring from? I'm thinking about if it's in industry, is this a productivity unlock of learning your new enhanced technologies, or are you hiring outside of the industry and it's just teaching the basics around your process and procedures?

Just to clarify, Nicole. When we talk about 2022, we are talking about the volume outlook. And that's a function of hospitality still being 2/3 of what was in 2019, but you see the continued growth. Healthcare being around 10% of that below 2019 and some of the occupancy rates returning back to prior levels and Senior Living. That's what we refer to in terms of 2022. In terms of the part of your question, I think we're in terms of where labor is coming from. So as you know, selectors and drivers are very different occupations. Drivers, commercial license, these are experienced drivers and there has been a headwind in terms of driver supply going back to before the pandemic. And so what we're doing there is really aggressively recruiting. And as well, we've credit programs were by our selectors can train to become drivers and that's a great path upwards and retention vehicle. Selectors, it's different. They most often come from other warehouse environments, not necessarily in food distribution, but they come from other warehouse environments. And there the -- ours is a very fast-paced, high-volume environment [Indiscernible] And so it's training them on the method in our warehouses, in our industry that might be different from where they come from, but at least they have a sense of what their environment they'll be working in. Hopefully that answers your question.

It does. Thank you for that. Appreciate it.

Sure.

Your next question comes from the line of Jeffrey Bernstein. Your line is open. Please go ahead.

Great. Thank you very much. I have two questions. The first one from a top-line perspective and then second on the inflation side of things. But from a sales perspective, I think you mentioned Technomic suggesting the industry would get back to 19 sales levels by '24, which does seem overly conservative. I know you mentioned you'd achieve that by '22. I'm just wondering, as you think about it relative to your forecast, relative to Technomic? I'm just wondering, whether you would prioritize the biggest benefit being further penetrating existing accounts or is it the net new business you are adding entirely, or maybe is there some expectation for M&A opportunity, or I'm not sure if that's even an option for you near term with the elevated leverage? We're just trying to prioritize why you believe yours will recover faster than the broader industry in terms of the different buckets available to you?

Thanks. I think at part is, because that's where we've seen so far. Jeffrey, we've seen our restaurant business recovered more quickly than the broader industry. So it's based in large part on the evidence so far in our market share gains. And again, as I said, that the two sectors that have still the most opting for recovery around healthcare and hospitality, but we're very optimistic about that. In terms of the type of business or where the growth will come from, I think it's really around the right business. Whether it's existing customers where we can grow share of wallet or new business, it's around business that, has a right to get fit with our footprint, a good fit in terms of the SKUs we cover, and part of the work we've done over the last 3 to months in terms of optimizing the portfolio that I referred to, and that's been a combination of renegotiating terms as Dirk referred to [Indiscernible] some customers where we couldn't find the right fit. It's really about growing in a healthy fashion and in a way that expands margins, both in terms of absolute dollars from growth and expands the EBITDA margins.

Understood. And then to follow-up is more on the inflation side of things. I know you mentioned that the margin percentages are down, but more importantly, the dollars are up. I'm just wondering a lot of investors see the Foodservice distribution category is a good place to be in a hyperinflation environment because it does seem like the messages that you're able to pass along pretty much all the inflation to customers. Just wondering whether your confidence is still high in the ability to continue to pass through. Or maybe there's some concern as the inflation now approaches, or is now in the low double-digits. So just wondering whether you are still confident being able to pass it along or maybe you can share your expectation for inflation in the fourth quarter, thoughts going into '22 relative to that 11% plus that we just saw in the third quarter. Thank you.

Sure. Hi, Jeff, it's Dirk I'll take that. I think that ultimately, we are confident our ability to pass it through, as you've seen now for two quarters in a row, our processes and our customer base in the way contracts are setup, set us up well for that. So pleased with the performance across these, and I think we expect as long as inflation continues, that we'll continue to operate effectively and passing it through. I think your point is so what we did see is we saw inflation, or are seeing inflation moderate a little bit into October. But just as I said on the last quarter call, we saw that in July. So at this point, we're going to continue to watch what happens. And Pietro made reference earlier, but operators are -- they're very thoughtful, they're creative, and can go with different options as to how they think about if you have higher inflation in certain categories to be able to manage their food costs. And that's where our differentiated model also can help with them from a sales and service perspective. I think as you go into '22, it's harder to know exactly what happens. Our focus is, like I said, helping operators manage through it, and at the same time, making sure that we have our processes running well, so that, we can pass it through. I think as you've seen with your opening comment and how it's an ability to pass through, that is one of the advantages that our business has, that lot of others don't is on food cost inflation. It is a pretty direct pass-through on -- in our case, about 70% of our customer base, and that's one of the key enablers of such strong gross profit in Q2 and then again in Q3. With Q3 being a lot of the highest we've seen or the highest we've seen in recent years.

Got it. And the idea that, you said, you are seeing some moderation in commodity inflation in the fourth quarter. Thinking about it from a year-over-year perspective, you would therefore think the third quarter might have been the high point than we would see inflation on a year-over-year basis subside in the fourth-quarter if trends were to continue like this? Or is there something unusual in the [Indiscernible] last year that might still have the inflation percentage actually be higher in the fourth quarter versus that 11% you saw in the third.

I don't know that it's subsides, I just using October as a data points. It indicates that what we saw in the month is not a lot of incremental growth above where the third quarter exited. So I think it's hard to know and like others, we'll continue to watch as we go to the fourth quarter.

Understood. Thank you.

Thanks, Jeff.

Your next question comes from the line of John Glass. Your line is open. Please go ahead.

Thanks very much. Just going back to your comments about going back to business as usual, the pre - COVID, and you talked about optimizing customer mix, and then you talked about those two initiatives in the warehouse [Indiscernible] receiving and picking and packing. Can you -- is there a way to quantify what you think those can do from a savings perspective? Or in the case of the gross -- is the customer mix? What have you already started to realize in gross margins, as you've shed maybe unprofitable customers? Is there a way to think about how that could benefit the margin structure in the business?

We haven't specifically and don't expect right now, to have to quantify the specific impacts of these. However, a few things that I can share is, a number of these things are the pieces that are helping and driving. Ultimately, what we're trying to balance each year is that, top-line growth. That also margin expansion, which just go back a reference from 2015 to 2019. So leading up in the pandemic, we expand our EBITDA margins by about 90 basis points. So it's really pushing each of these levers. From a customer mix perspective, although we are seeing some negatives in a certain healthcare and hospitality is still being down some, the improvements in the net new business wins that Pietro talked about in the higher-margin there and some of the pricing actions and the types of customers we're serving on the local customers have had a meaningful positive impact on our margins and ultimately on our EBITDA for the last few quarters. So we expect to continue to move on those, I think on the other pieces that Pietro had on the page there, it's a private label as we continue to focus on growth there, that's almost twice as profitable as manufacturers brands. So that is an opportunity that we've made significant progress in recent years and we would expect to continue to because we have a lot of opportunities still that remains there. And then from the supply chain perspective that we're kind of midstream on a number of those things. Rational -- assortment rationalization is a great one because it helps simplify our operation. And in this environment of product availability challenges with vendors, actually a better experience for customers as well. It's a good win-win, and we're to continue to strike this balance in order to improve or grow our EBITDA.

Okay. Thank you. And just 1 follow-up. You cited inefficiency of new workers coming on, and so that's going to still take time to work through. Is there a way to quantify it? Like what percentage of your sales force or your drivers are new today versus what they were new -- what the regular percentage of new employees are like in pre-pandemic, just so we understand that that that opportunity and challenge?

Sure. So we haven't broken out the specific percentages now or historically. It is meaningfully more, because of that sheer amount of hiring we've done in recent months. To tell you as you think about ramp up. So warehouse and selectors contend to be in the neighborhood of 3 to 6 months until they get closer to that level. Drivers can take a little bit longer, but as Pietro said, since we are at the level of staffing and that we were in 2019 and our focus remains at a few select markets, we feel that, we're well-positioned really to work on reducing our supply chain costs, improving the productivity, as we move ahead to mid-2022. Also, most importantly, being able to continue to serve more profitable customers and continue to grow EBITDA.

Thank you.

Your next question comes from the line of John Heinbockel. Your line is open. Please go ahead.

We'll start with a more strategic question and then I have another. When you think about the supply chain opportunity. So how aggressively can you get it that and I'm thinking also balancing top-line market share potential. You don't want to go too fast and impact the customer experience. May we talk about balancing that, how quickly you can go at it? And then in sizing it right, you may not give us an exact number, but I think about the proactive cost outs a year ago. Is the ultimate supply-chain opportunity in that ballpark eventually or is it much smaller?

So I'll start and maybe Dirk can chime in. Look, we think we have great opportunity in terms of both operational effectiveness and efficiency. And we think the addition of John Heinbockel and John Tennyson (ph) as CI over the last 9 months will help us get at that opportunity in aggressive fashion. I don't know that there need to be trade-offs, John, between the customer experience. The example I talked about in the prepared remarks is the level of assortment. What happens with you build your assortment too broadly. While on the surface that may look like helping driving sales that necessitates greater inventory. The tail typically is harder to forecast and so you end up with a lower customer service experience. So we believe that the opportunity for a better serving our customers and getting out the operational efficiency, and effectiveness actually go hand in hand together. And I could give you 4 other examples in addition to the assortment ones. The work we did last year and prior to that, when we consolidated the single-site area divisions into multi-site areas, those were all on the administrative side. Whereas what we're talking about on the fixed cost side, what we're talking about now in terms of opportunity, is primarily on variable costs in terms of operations. And as Dirk mentioned, part of it is just the natural evolution we have an equal number of drivers and selectors who are new. And so there will be some natural productivity benefit. And then on top of that, we layer on some of the initiatives that we've talked about historically, some of them are new, and some we have to pause during COVID, putting new technology in place, picking perspective when you're short staffed could make things worse. So that's why now we feel given our way back to 2019 levels, we feel that we're in a good position to resume some of that work that we were talking pre-pandemic.

Okay. The -- is there a to size the ultimate supply chain opportunity? And does it rise to the level of the cost as you did last year or no?

It's significant material. But it's -- we're not prepared at this position at this point to size it. But stay tuned.

Alright. Okay. And then lastly, what are you seeing with lines per stop and pieces per stop? Maybe --

Good news on those

Yes. Go ahead.

I'm sorry, John. Yes. So good news. We're seeing both lines per stop increased and we're also seeing cases per line increase. And as I've said, historically, the lines per stop or a good proxy for our ability to gain share of wallet, and the cases per line are a good proxy for customer or operator demand. And we've seen both of them go up over the last few months, which I think is a function of both us, the quality of the new customers we're bringing on and as well continue to optimize our portfolio of existing customers.

Okay. Thank you.

[Indiscernible]

Your next question comes from the line of Alex Slagle. Your line is open. Please go ahead.

Thanks. Good morning. You mentioned some freight pressures, just wondering if you can comment on the magnitude of that headwind in the third quarter, and how you're seeing this evolve into the fourth quarter in ' 22? And then within that, anything different about how you hear managing these headwinds versus what you've done in the past? And maybe the portion of inbound freight where you're using third-party on the stock market? Any color there would be great.

Sure, Alex. Good morning. So freights continues to be a headwind, not that different than recent quarters, and it's really largely driven by just tightness in the overall freight market. So when you ask about impact, so it's meaningful but less than the impact of just the overall, I'll call it separate supply chain labor and its impact on volume even though a lot of the logistics is largely -- it's all labor challenge. What I will tell you is we learned a lot back in 2018 when the freight market really tightened up. We put a number of plays in place there. We've executed against those in 2021 and it's been challenging, especially in this part of the business because those freight costs have continued to increase so it's not a steady target you're working against. So we've made significant progress and are closing sort of some of the, call it headwind, as the year has gone on, and we continue to work through those and feel like we'll be very well-positioned as we get to a more steady environment through there, both from a cost perspective, but also from a service perspective. We're balancing both of them. So we want to make sure it's about getting that product, whether it's some of it we pick up with our own trucks, some of it we contract with third-parties. And in this environment, we've really leaned out a lot of the strength for the third-parties with the partners that we have out there, that we're trying to make sure we're getting our loads picked up and into our facilities on time. So it's probably -- based on what you read out there, it's not something that's going away imminently, but it continues well into ' 22, And we can't control the end of it. The thing we can control is making sure we're getting our product and continue to make progress on the P&L side of it as we work through this. And that will continue to be our focus.

It's helpful and I had a follow-up just on the inflation. Is that -- when the product starts to drop, is there some ability to capture incremental margin as there's probably short lag and when the contracts reprice and perhaps the timing of the re-pricing with the non-contracted customers.

Yes, there is, there is a little bit when it's on the decline. I think the thing over time, our industry and our business, we like kind of slow and steady inflation could does help grow gross profit dollars. But yes, in a period of call it volatility are up and down, it does create some opportunities to -- to take -- to take some pricing. During this environment, it's really trying to strike that balance again of pricing fairly to our customers. And just managing for the against the tight supply backdrop that we're we're all experiencing.

Thank you.

Your next question comes from the line of Peter Saleh. Your line is open. Please go ahead.

Great. Thanks for taking the question. I wanted to come back to the conversation around reduced assortment. I think that was mentioned a several times on the call. Are you actively reducing assortment and SKUs? And and if so, how early are they -- are you in the process? Should we expect more reduction in the fourth quarter into ' 22, or as sales come back to 2019 levels, do you expect that the assortment comes back into the warehouses? And I have a follow-up.

So assortment is one of those things that, like customer optimization or certain optimization is ongoing. And we put up, particularly push this year and part of that was prompted by the supply volatility we experienced part was prompted by the opportunity from an operational efficiency perspective. But that's an ongoing opportunity that never ends. I think you said, you had a follow-up, Peter, as I remember.

Yes. The other question would be, just on the assortment reductions so far, have you seen any sort of sales impact to-date? Or -- and do you expect anything going forward?

We have not -- typically what we go after from a store and perspective is either the duplication in the middle of that curve or some of the tail. And we work closely with our salespeople. We work closely with our customers in terms of identifying those opportunities. So we have not seen any impact from that work from a sales perspective.

Thank you.

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

Hi. Good morning. Thanks for taking our questions. Good morning. Wanted to just ask a little bit about the hospitality segment and correct me if I'm wrong, but it looks like it came in at Q3, pretty similar to where you had-exited the second quarter. I think down about maybe 29% or 30% and pretty stable to that. So just curious how that compared to your internal expectations. what kind of cadence or pace of recovery you're expecting from here, and how you're benchmarking the performance of that segment. And then just also what kind of seasonality, if any, there is expected in that segment as we look into Q4?

I'm looking at the chart here on Page 4, and it does show continued progress on hospitality segment parks 2019. We'll continue to see that some of the factors that need to work themselves out. I believe I mentioned on last call, so we have some customers who have some very large parks. They are staffing challenged just like other customers and manufacturers. And so that is limiting the amount of guest that they can accommodate so that's one. There has been less travel in-bound into the U.S. Now there has been more domestic travel, but how those [Indiscernible] is hard to tell. Then I think we've mentioned this as well the return to office or the lack of business travel, which seems to be picking up as also been one of the factors that have held us customers coming back. But we see all 3 overtime coming back to pre-pandemic levels and we see that yellow line continuing to get back to pre-pandemic levels. And as well, too the other thing too, I think I mentioned last time is we've had now that, the hospitality segment is opening up and people are willing to talk about business opportunities and working with us as opposed to other distributors. We think, any potential shortfall that, exist from an industry perspective is, if even if there is one, we will more than make up with our pipeline and our ability to gain share in this setting.

We have a follow-up question from Edward Kelly. Your line is open. Please go ahead.

Hey, guys. Thanks for letting me back in. I wanted to ask about the added cost associated with labor, which you've talked about now, I think it's 40 to 60 annually. That's what you think will be a more permanent cost. How's visibility on that? I mean, obviously the anxiety out there on the investor side is just sort of the labor front and the level of inflation that's out there and the impact that it had. What you've got your labor force where you need it to be. Do you feel visibility on that number is now good?

Thanks Ed. Good question. So yes, we do feel like the visibility is quite good. And that was really one of the things that we're taking feedback from various others last quarter where people were, as you can imagine, sizing, could this be a $10 million issue could this be $100 million or as you try to put some context around it. And although we don't know exactly where it lands on, we think that that is a very good range. And I think the other thing that we're continuing to gain confidence is the success we're having in margin improvements with customers. And so, again, we don't know any of that amount, depending on where and what lands as permanent. But we do expect that, most if not all of that permanent increase or higher level of inflation in the current year that, we will be able to offset with customer margins through the things we've already negotiated and are starting in those that will -- we expected to go to progress on in 2022. So from an overall earnings power of the business, as we get through this next year, we don't think that, it's a permanent inhibitor as opposed to something that's more temporary or transitory over this next year.

And just to, I'm trying to bridge to OpEx per case in ' 22, is the best way to do that versus '19 would be to take $50 million in annual labor inflation, add the $40 million to $60 million, but then subtract some. You have the savings of $130 million like subtract some of that savings and that gets me to an OpEx per case number versus 19 or are there other things that I would need to do there?

Yes. I think that you've got the big pieces. You're right, inflation as well as the normal inflation and plus the incremental inflation, you'll continue to have some higher cost on top of that next year as we get back to 2019 level of productivity through this first half of the year, as Pietro talked about. And then you're right, we do expect to drive some incremental productivity through the things that Pietro referenced along with some initiatives that we have underway. I think those are the main things. Out of 130, there is a little bit of that, that is in distribution fixed. But those cost reductions, 130 is really more about fixed cost, not the variable distribution which should be driver selectors, etc. So I would attribute very little of the 130 to that as opposed to the pieces that I just talked about.

And then just last question for you on the contract side. I mean, obviously it takes time to pass through higher -- things like higher labor costs. But at the same time, the industry is in a situation today, right? Where it's just hard to get product. Is that helping you at all in like, accelerating what would be, let's call it normal pass-through?

Maybe, I'll separate it into 2. So there's the normal pass-through that, happens automatically for food cost inflation. That is pretty quick as you probably remember from prior comments, I made that, can happen when contracts reset weekly to monthly-ish, so pretty quick. And then on the non-contract again, because of the product supply issues, those pass - throughs are happening quite quickly. On the labor side, what we are doing and have been doing is, actively engaging with a number of our customers to really try to discuss with them the opportunities to improve margins and in this labor environment, it's resulting in some very constructive discussions. Because it's not a different conversation or in almost all cases, not different than than what they are experiencing. And so we've had good success with close to half of that 40-ish $1 million number that, we've already reached agreement on, that either is in place or what will be going in place over the coming months. So just for context, good progress and expect to continue through there, and that's what gives us the confidence that we'll be able to mitigate most, if not all, of this year's incremental inflation through pricing.

Great. Thank you.

All right. Thank you.

There are no further questions at this time. I would like to turn the call back to Mr. Pietro Satriano for closing remarks. Please go ahead, sir.

Thank you. So I'd like to close by thanking our 26,000 associates who amidst what is still a difficult environment, have continued to do a phenomenal job of serving our customers and generating the results that we discuss today. Our three-pronged strategy of possibly growing market share by leveraging Great Food Made Easy, 2. Optimizing gross margins and 3. bringing a relentless focus to operational efficiency continues to show progress. And that is the result of the great work by our management team and all our associates. Thank you for joining us today and have a great week.

This concludes today's conference call. Thank you all for joining. You may now disconnect.