Executives: Melissa Napier - Senior VP of IR & Treasurer Dirk Locascio - CFO Pietro Satriano - CEO, President and

Director
Analysts: Shane Higgins - Deutsche Bank AG Marisa Sullivan - BofA Merrill Lynch Bill Kirk - RBC Capital Markets, LLC John Ivankoe - JP Morgan Chase & Co Vincent Sinisi - Morgan Stanley Karen Short - Barclays PLC Kelly Bania - BMO Capital Markets Equity Research John Heinbockel - Guggenheim Securities, LLC Edward Kelly - Wells Fargo Securities, LLC Jared Garber - Goldman Sachs Group Inc. Ajay Jain - Pivotal Research Group LLC Bryan Hunt - Wells Fargo Securities, LLC Karru Martinson - Jefferies

LLC
Operator: Good morning. My name is Natalie, and I'll be your conference operator today. At this time, I would like to welcome everyone to the US Foods Third Quarter Fiscal 2017 Earnings Call. [Operator Instructions] Thank you.

It is now my pleasure to turn your call over to Melissa Napier. Please go ahead.

Melissa Napier: Thanks, Natalie. Good morning, everyone. Thanks for joining us today for our third quarter fiscal year 2017 earnings call.

Joining me for today's call are Pietro Satriano, our CEO; and Dirk Locascio, our CFO. Pietro and Dirk will provide a business update and speak about our performance in the quarter and for the year-to-date. We'll take your questions after management's prepared remarks conclude. [Operator Instructions] During today's call and unless otherwise stated, we are comparing our third quarter and first 9 month results to the same periods in fiscal 2016. 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 latest Form 10-K filed with the SEC for potential factors which could cause our actual results to differ materially from those expressed or implied in those statements. And lastly, I'd like to point out that during today's call, we will refer to certain non-GAAP financial measures. Reconciliations to the most comparable GAAP financial measures are included in the schedules on our press release. I'll now turn the call over to Pietro.

Pietro Satriano: Thanks, Melissa, and good morning, everyone. Thank you for joining us. Let's get right into it and start with the highlights outlined on Page 2. We are very pleased with our performance for the third quarter, delivering adjusted EBITDA growth of 9.4% or 10.1% if we normalize for the impact of the hurricanes. Financial highlights for the third quarter include continued acceleration in our volume growth with Independent Restaurants registering 4.1% organic growth and 6% total growth with independents; continued strengthening in gross margin per case, this is the result of our growth with Independent Restaurants, and increased penetration of our private-label products as well as the continued and positive impact of CookBook; and third, continued progress against our portfolio of cost-reduction initiatives.

Underpinning these financial results is the continued impact of our Great Food. Made Easy. Strategy, presenting innovative products and industry-leading technology to help Independent Restaurants compete. As a result, we are raising several of our guidance ranges and tightening other ranges for the 2017 year. And Dirk will review these with you in a few minutes.

Let's turn for a review of volume on Page 3. As I mentioned, growth with Independent Restaurants, our primary target, continues to accelerate. Organic growth with Independent Restaurants was up for the quarter to 4.1%, the first time growth was above 4% since Q2 2016, and organic growth would have been around 4.4% had it not been for the impact of the hurricane. Our performance with Independent Restaurants reflects

three factors: first, the outlook for Independent Restaurants remains positive; second, our differentiation strategy of product innovation and leading technology continues to resonate with customers; and third, we remain very focused on improving talent and execution to raise the performance of our lower performing markets. Total growth with Independent Restaurants after M&A was a very healthy 6%.

Growth with our other target customers, health care and hospitality, continued at the rapid clip of over 5% for the second consecutive quarter. And the category of all other customers was down in negative territory as a result of flat performance on the part of existing customers and the expected exit of lower-margin chain accounts, which we discussed on our last call. Overall, we are very pleased with our volume performance, especially with our target customers. Our growth with target customers is fueled by our differentiation strategy. And on Page 4, we have summarized our continued progress on the most critical elements in support of our Great Food.

Made Easy. strategy. Let's start on the left with our innovative products featured in our 3x per year Scoop campaign. To remind you, these are products that help operators stay on trend or remove labor out of the kitchen. Trial of our new products continues to increase from approximately 20% earlier in the year to over 30% in the most recent Fall Scoop.

In the middle graph, e-commerce penetration had the biggest increase in over a year as we continued to focus on individual sellers with below average e-commerce penetration. And just as we do with Scoop, we continue to drive for better results because of the benefit e-commerce provides in terms of customer retention as well as the benefit in terms of seller productivity and operating expense. And on the right, placements of what we call value-added services grew by 50%. This includes placement of any one of our own or third-party applications that helps our customers run their business more effectively and includes solutions to drive traffic, to engineer menus or to schedule labor. We continue to believe in the power of these solutions, seeing as they address major pain points for customers, reinforcing the Made Easy.

Part of our Great Food. Made Easy. Strategy and contributing to increased stickiness from customers. Moving to Page 5. In conjunction with the fall edition of the Scoop, we announced our very exciting partnership with world-renowned chef, Marcus Samuelsson.

We chose Chef Samuelsson because we knew he would challenge us to raise the bar on innovation, and he would burnish our credentials with the most demanding of Independent Restaurants. Chef Samuelsson is a five time James Beard award winner and he is the founder/owner of 32 different restaurants. We collaborate with Chef Samuelsson on a number of exciting products featured in the Fall Scoop, products which have been very well received by customers, products such as Marcus' Uptown Par-Fried Chicken, inspired by his very grandmother. Moving to Slide 6. This chart, introduced in our last call, marks our progress against our portfolio of gross profit and operating expenses initiatives.

I will cover some highlights that are new since the last call. On the gross profit side, the centralization of replenishment continues to advance. Close to 3/4 of cases shipped were essentially repurchased by the end of the third quarter, and completion is on track for the end of the first quarter. Private label grew approximately 100 basis points year-on-year, continuing our progress with respect to what we see as one of the biggest gross profit levers on our P&L. On the operating side of the ledger, we continue to make good progress as well.

Selling expense in the form of the number of sellers continues to come down. We now have about 10% fewer sellers than we did at the end of the last year as we migrate business from the least productive to the most productive sellers who best represent our brand. In shared services, we have now identified and mapped out several end-to-end processes where we see an opportunity to streamline how work is done, and we are already beginning to see some savings as the streamlined processes means not having to replace attrition in some of these highly transactional processes. And in supply chain, where we have the biggest opportunity, we are beginning to see promising results from a number of pilots that increased warehouse productivity and reduced mileage. These will begin to have a positive impact on operating expense as we start to roll these out across the network.

Lastly, on the M&A front, we are actively pursuing a number of targets in the pipeline as well as working to integrate the 5 companies that were acquired earlier in the year. Let me now turn it over to Dirk, who will walk you down our P&L and our balance sheet.

Dirk Locascio: Thanks, Pietro, and good morning, everyone. As Pietro commented, we had a strong third quarter. Our operating income increased $75 million to $190 million, and adjusted EBITDA increased 9.4% as reported or over 10%, excluding the estimated hurricane impact.

We also experienced strong case growth with our target customer types and continued de-levering of the balance sheet. Let's walk through our results in more detail. On Slide 7, third quarter net sales were $6.2 billion, an increase of 6.2% over the prior year. This increase was a result of our 2% case growth combined with approximately 4.2% from year-over-year inflation and mix. Our case growth for the quarter was strong with our target customer types as Independent Restaurants grew at 6%, and health care and hospitality grew over 5%.

In the third quarter, we saw significant year-over-year inflation, primarily in commodities such as pork, poultry, produce and seafood as well as modest inflation in several grocery categories. Year-over-year inflation will remain for the fourth quarter as we lap a deflationary period in the prior year. On a month-over-month or sequential basis, we are expecting very little inflation in the fourth quarter. Now to gross profit performance, which you see on Slide 8. We continue to deliver good gross profit results.

For the third quarter, gross profit was $1.1 billion, which is $66 million or 6.4% increase over the prior year on a GAAP basis and up $49 million or 4.8% on an adjusted basis. This is on a 2% case volume increase, meaning we expanded the gross profit per case. As a percentage of sales, gross profit was 17.7%, which was flat to the prior year period on a GAAP basis and down 30 basis points from 17.6% to 17.3% on an adjusted basis. Gross profit as a percent of net sales was negatively impacted approximately 15 basis points from higher inbound freight cost as well due to the impact of the hurricanes. I'll discuss this impact along with the hurricane impact to adjusted EBITDA in greater detail in a few minutes.

Adjusted gross profit dollars grew both as a result of the volume increases we discussed as well as a very strong rate per case expansion in the quarter. As Pietro mentioned earlier, the elements of our strategy focused on gross profit margin expansion continued to make good progress with our gross profit per case up double digit cents per case again this quarter. One of the drivers of gross profit margin expansion that Pietro talked about is private-label penetration, which we continue to see increase. It was over 34% for the third quarter and has good growth momentum. Year-to-date, gross profit increased 3.9% in dollars over the prior year from volume growth and the benefits of our margin expansion initiatives, partially offset by an increase in our LIFO charge.

On an adjusted basis, gross profit increased $159 million or 5.3%. Adjusted gross profit as a percent of sales is flat to the prior year. As a reminder, it is important to note that as we continue to move from a lengthy period of deflation to year-over-year inflation, there is an impact on basis point comparison to the prior year for gross profit and OpEx percent of sales measures. In a few minutes, I'll talk about year-over-year gross profit and OpEx rate per case performance, which we feel is a more accurate reflection of the underlying trends in the business. Moving to operating expenses on Page 9 -- Slide 9.

Operating expenses decreased 0.9% or $8 million for the quarter from the prior year to $909 million, primarily resulting from lower restructuring charges, and a reduction in our depreciation and amortization expense due to the full amortization of a customer intangible asset in Q2 and productivity gains. These gains more than offset the additional expenses related to higher case volume. As a percent of sales, operating expenses were 14.7% in the quarter, which is a decrease of 100 basis points from the prior year. Adjusted operating expenses increased $26 million or 3.3% for the quarter. Adjusted operating expense as a percent of sales was 13%, a decrease of 40 basis points from the prior year.

The increase in adjusted OpEx dollars was primarily due to higher case volume combined with some wage inflation. Year-to-date, operating expenses increased 0.9% or $24 million to $2.8 billion. As a percent of sales, operating expenses decreased 60 basis points to 15.2%. Adjusted operating expenses increased 4.3% year-to-date and were 10 basis points ahead of the prior year as a percent of sales. As you can see on Slide 10, our adjusted gross profit per case expansion has been significant this year and accelerated in Q3.

We are very pleased with these results since we are making significantly more per case than a year ago. This progress can get lost in year-over-year basis point comparisons, especially when significant portions of the inflation has common commodity categories that are, in large part, fixed fee markups per case. Meaning at times of inflation, the rate per case profit you make does not change, but it looks like a decline in profitability in basis points. From an adjusted OpEx perspective, our focus here has been and continues to be in controlling OpEx growth, so that it is significantly less on a rate per case basis than the gross profit growth in order to continue to drive our operating leverage, which we have done successfully this year. I'm now on Slide 11.

You can see we've made solid improvement in our key profitability metrics. Adjusted EBITDA was $267 million in the quarter as we mentioned, up 9.4% on a reported basis and up 10 basis points over the prior year, to 4.3%. We estimate our reported third quarter adjusted EBITDA results were negatively impacted approximately $2 million or 80 basis points related to the hurricane as a result of modestly lower volume and higher inbound freight costs as a result of significantly higher third-party freight rates post the hurricanes. It appears the increase in third-party freight rates in September is related to significant trucking industry capacity being redirected to hurricane relief efforts and away from what I will call ordinary course hauling. Year-to-date, adjusted EBITDA was $768 million, which is an increase of $61 million or 8.6% versus the prior year.

Operating income in the quarter increased $75 million to $190 million and year-to-date has increased $94 million to $392 million. The increases are primarily a result of the aforementioned stronger business results. Finally, on the far right, third quarter net income decreased $96 million compared -- or decreased to $96 million compared to $133 million in the prior year period. Our pretax income increased $92 million year-over-year as a result of strong business results and lower interest expense. However, this was offset by $130 million higher income tax expense.

As a reminder, in the prior year period, we had a large valuation allowance release that resulted in the large prior year income tax credit. Adjusted net income increased $2 million over the prior year period on essentially the

same drivers: strong business results offset by higher income tax expense. On a year-to-date basis, our net income improved $55 million to $188 million as pretax income increased $211 million, offset by higher income tax expense. Adjusted net income also increased to $214 million from $201 million in the prior year. Turning now to cash flow and net debt.

Operating cash flow year-to-date was $506 million compared to $440 million in the prior year for a $66 million or 15% increase. Net debt at the end of the third quarter was $3.6 billion, a decrease of approximately $120 million from the same period a year ago. And our net debt leverage stood at 3.4x at the end of the third quarter, down from 3.8x in the prior year period. We expect to continue to de-lever the business toward our midterm target of approximately 3x leverage and are pleased with the continued progress. Moving to Slide 13.

We do have some updates for our fiscal 2017 guidance. We're narrowing our case growth guidance to 2.5% to 3% and increasing our sales range to 4.5% to 5%, largely as a result of the significant year-over-year impact of the 2016 deflation. We're also narrowing our adjusted EBITDA ranges for the year to 8% to 9%, and more specifically, we expect fourth quarter adjusted EBITDA growth to be in the 7% to 8% range. The core business is performing well. However, as I noted earlier, we're seeing pressure on third-party carrier rates, which is negatively impacting us in the form of higher inbound freight costs.

We expect that to continue through the fourth quarter and have reflected that in our Q4 outlook although are beginning to see improvement quarter-to-date. We expect total case growth to slow further in Q4 by approximately 100 basis points as we lap several large customer wins from the prior year and the customer exits that we discussed on our Q2 call continue to occur. We do not expect any slowdown in our Independent Restaurant growth and expect its momentum to continue. Health care and hospitality will slow some as we last several prior year large wins. However, it remains a very healthy part of our business and future growth.

All other customer volume will remain negative in Q4 as a result of the exits. We're also lowering our interest expense outlook to $170 million to $175 million and are tightening our depreciation and amortization range to $375 million to $380 million. We're increasing our net income growth range to 20% to 25% largely as a result of the third quarter LIFO benefit we experienced combined with improved business results. And finally, we're increasing the lower end of our adjusted diluted EPS range for a revised outlook of $1.35 to $1.40 per share. Our business continues to perform very well as we had expected, and we're pleased with our overall performance so far in 2017.

With that, I'll turn it back to Pietro for some closing comments.

Pietro Satriano: Thank you, Dirk, and just before we turn to Q&A, I'd like to take a moment to recognize our 25,000 employees who continue to demonstrate the spirit of what we call second to none, and the most perfect example was how thousands of employees overcame the adversity imposed by hurricanes Harvey and Irma, working tirelessly to serve our customers, to support each other, to help those in need in the communities we belong to. I could not be more proud of our employees. Operator, with that, let's turn it over to questions.

Operator: [Operator Instructions] Our first question comes from the line of Shane Higgins from Deutsche Bank.

Shane Higgins: Hi, guys. Thanks for taking the question. Dirk, I think you said you guys were expecting 7% to 8% fourth quarter EBITDA guidance. That's obviously a modest slowdown. Is that primarily a function of the higher freight costs that you guys saw there in the third quarter?

Dirk Locascio: Shane, so freight is the biggest driver of that.

The other piece is as we lap some of the large customer wins from a year ago and volume slows down a bit, that does have a modest impact as well on the fourth quarter. Just as a reminder, the other piece of that, as the chain exits occurs that impacts our top line more than it does our overall EBITDA. So those are not a real big impact for the quarter. But other than those first 2 things, the core business continues to perform very similar to what it did in Q2 and Q3.

Shane Higgins: Okay, and are there any calendar impacts to call out? I know that your year-end is on December 30 versus December 31 last year.

Dirk Locascio: Nothing significant that we'd call out.

Shane Higgins: Okay. And then just one more from me. On the independent organic case growth. It looks like it did pick -- it's been picking up the last couple of quarters.

Is it running above the third quarter 4.1% run rate so far into the fourth quarter?

Pietro Satriano: I'm not sure we're able to...

Dirk Locascio: So we're not going to talk about the fourth quarter, but I think just what I will reiterate is Pietro and I both commented on, is we feel very good about the health of our Independent Restaurant business and the momentum that it's been demonstrating.

Operator: And our next question comes from the line of Marisa Sullivan from Bank of America Merrill Lynch.

Marisa Sullivan: Good morning. Thanks for taking my question.

Just quickly, did you disclose the e-commerce for the total -- e-commerce sales for your total business?

Pietro Satriano: We talked about the increase. We did not disclose the actual number. It's very close to 60%. I believe it's 59% or so.

Marisa Sullivan: Got it.

And then I'm curious you had a really nice pickup in kind of across the key metrics in terms of Scoop, trial rate, e-commerce penetration and the value-added services. Is that -- what's driving that? Is that initiatives on your part? Or is -- are there dynamics in the marketplace that are making customers more receptive as well?

Pietro Satriano: So we have what I would call a catalog interesting use of an old-world term to describe new-world apps, of solutions. Some of them are completely digital. Some involve some support from our Restaurant Operations Consultants and they're aimed at helping restaurant operators with what we consider to be or what they say are their three major pain points. As I talked about, these can be around labor scheduling, and we see particular appetite for these in states where there's labor shortage; menu engineering is a second one; and the third is around driving traffic.

And in other calls, I've talked about our partnership with ChowNow as a way to help operators drive traffic.

Marisa Sullivan: Got it, but there wasn't anything in terms of inflation or wage pressure that picked up that also helped to accelerate that?

Pietro Satriano: No, I would say not. I mean, the pain points that customers experience are very situational to their particular opportunities or threats, and those vary from one restaurant to another.

Marisa Sullivan: And then just last for me, last one for me, independent case growth, how much of that was existing customers versus new customers?

Pietro Satriano: So what we've always said is we look at independent -- the growth of independent restaurants across the

three levers: reduced churn, penetration and new accounts. And where we are performing most favorably is where we see a very good balance of growth coming from the three buckets.

Dirk Locascio: Marisa, this is Dirk, just one thing I want to clarify is our total company e-commerce penetration is north of 70%. So Pietro talked about it in the 50s for Independent Restaurant and north of 70% for the total business. So very similar to what we disclosed prior.

Pietro Satriano: Thanks Dirk.

Operator: And our next question comes from the line of Bill Kirk from RBC Capital Markets.

Your line is open.

Bill Kirk: Good morning, everyone. I had a question. On the sector, it seems it's experiencing more food inflation than many of us expected. Is this level of food inflation; is it too much for the foodservice vertical to handle?

Pietro Satriano: So we have been -- we haven't seen an impact on volume or on cross-category trade-offs, which is where you would expect that.

There's I think restaurants over the course of time have gotten more adept at dealing with some of the volatility they experience in certain categories. Again this is where we help them literally make it through -- we have something called the Farmer's Report that helps them get ahead of changes in food costs, through the various levers they have and again through our menu engineering and the restaurant operation consultants, that's where we also help them. So I believe that the industry is managing through the changes you referred to so far pretty well.

Operator: And your next question comes from the line of John Ivankoe with JPMorgan. Your line is open.

John Ivankoe: Thank you. First, just a clarification on the comment you made, Dirk. Expect total case growth to slow a further point from 3Q to 4Q. Is that correct? So something around 1% for the fourth quarter?

Dirk Locascio: That's correct. As we lapped the large -- few large customers’ wins from a year ago and the chain exits that we've been talking about go into effect.

John Ivankoe: Yes, understood. So that is where I wanted to go. So independent case growth you're remaining strong, maybe health care and hospitality slowing a little. So let's focus on that all other. What percentage of total case growth, maybe I could just figure it out with some quick algebra here, but what percentage of total case growth is all other not of case growth but total cases is all other?

Dirk Locascio: Yes.

It's about 1/3 of our case volume.

John Ivankoe: Okay. And how -- like what would you say the lower limit is of that? So in other words, as we begin to think about our 2018 forecast, I mean is that kind of a layer of business that you think has stability after these current losses? I mean is that something that you want to stabilize? Is it something that you want to grow? Obviously that is a big enough part of the business that it does influence the total case numbers that we need to model at least from a top line perspective even if it doesn't have the same impact to profitability.

Pietro Satriano: I guess I mean -- why don't you add some specific and I'll give some general comments, Dirk.

Dirk Locascio: Sure.

So I think that area, we expect it to remain negative in the fourth quarter and through 2018. I think and we'll provide more specific guidance as we come out of the fourth quarter and give our 2018 guidance. But I think the -- we're not going to bound it at this point because what we're focused on is really doing the right thing for our business of improving our profitability. And it doesn't mean that in that 1/3 of business, none of its good business. There's plenty of good business that's in there, and we're going to continue to pursue good business.

So those where it is negative is where they were modestly or negatively profitable for us as a business. So more to come on that. I think John as we guide for 2018.

Pietro Satriano: I think the other thing, John, I would add is just if you step back and as you said, as you model the future, what I would encourage everyone to do is go back to some of the initial comments we made early last year around the time we went public around the guidance we gave by each of those customer types. So it's a bit of a refresher but I think a helpful reminder.

With independent restaurants, the primary target, we see ourselves growing 2x the market, and clearly we've continued to do that. And in fact, I would say that's the minimum expected performance that we have set for ourselves. With health care and hospitality, what we have said is we would grow at the market. Those two groups of customers are growing a very healthy pace, and we expect to grow at the market. And then when it comes to the all other as we called it, we expect to over the course of the midterm, to be flat except for the comments Dirk made with respect to next few quarters as we lap some of exits we've made.

The other thing we haven't talked about is within that All Other segment, we are actually bringing on some very good business, and the business we are bringing on is 2x to 4x more profitable than the business we've been exiting in that bucket. So still less profitable than the target customer types that we are pursuing actively, but there's an optimization going on of the portfolio of all other customers that is aimed at, over time, improving the profitability and the return on capital associated with those customers. But the general micro guidance I gave earlier is what I would use. And what happens is because of the size and the lead time associated with the larger customers in health care and in all other, you do get a little bit of volatility from quarter-to-quarter, which is what Dirk talked about earlier.

Operator: Our next question comes from the line of Vincent Sinisi from Morgan Stanley.

Your line is open.

Vincent Sinisi: Hey, great, good morning guys. Thanks for taking the question. Just wanted to circle back for a second on inflation. I think we're all kind of getting the differing effects on the margin dollars and percent.

But can you just, and I'm sorry if I missed it earlier, but just where inflation came in for the quarter versus your expectations? And then maybe since between yesterday and today, that seems to be maybe a bit higher than most folks expected, can you give any kind of further color on what you're seeing by category and then also maybe some changes that you are expecting just kind of slight inflation in 4Q?

Dirk Locascio: This is Dirk. I'll take that. The categories that we've been seeing it, so when we talk about year-over-year inflation, it's really a lot of it was because of the significant amounts of deflation we saw in the second half of last year. And so as prices and cost moderate in some of these largely center-of-the-plate and commodity categories, very similar, that's what's really driving it. I think on the sort of the grocery side and we talked about broad-based, it's very -- very modest inflation that we're continuing to see.

I think from a Q4 perspective, sort of from a sequential, so further in inflation, we don't expect it to change a whole lot. But when you think of year-over-year, it probably won't look all that dissimilar to what we had in Q3, but I think to Pietro's point earlier, we're effectively trying to manage through it and help our customers make sure they effectively manage through it. And I think we've done that with the significant GP per case improvement now for the last two quarters.

Vincent Sinisi: Yes, okay. And then just a quick question on the M&A comments from earlier.

I know you said kind of strong pipeline, pursuing different things. Can you just give us a quick update maybe with some of the more recent transactions that you have done, how those are going? And then maybe just any color around whether some of the potential future things might be more around geography and/or assortment?

Pietro Satriano: So the strategy we've outlined for M&A, Vinnie, continues to endure. The bull's eye of these concentric circles is broad line tuck-in with high Independent Restaurant penetration. And we have a number of those that we're in discussions with in the pipeline. And then secondly and then maybe this is where you were going with assortment, beefing up our capabilities, no pun intended, in COP and produce in terms of just-in-time or processing, making sure we have a strong network to support our broad line facilities.

And in some parts of the country, we're very well served. In other parts of the country, less well served, and that's what we're targeting those acquisitions, and we have a few of those in the pipeline as well. And the pace for it that we experienced in 2016 and 2017 of around five or so acquisitions are -- continues is a good pace, and we are working towards making sure we achieve that next year. You're --.

Vincent Sinisi: Yes, and what you did, yes.

Pietro Satriano: And so I guess, sorry, the first part of your question around performance. We're pleased with the performance of our acquisitions so far. We monitor the sales retention associated with those customers. We monitor the productivity and EBITDA relative to the pro forma as we continue to move forward, and we're generally pleased with the results. And I think as I've mentioned before, part of the playbook we are bringing to acquisitions that we've brought last two years that we didn't have before is that integration team that is solely focused on working with the field to integrate these acquisitions in a seamless manner and to replicate this playbook across acquisitions as we make them.

Operator: Your next question comes from the line of Karen Short of Barclays. Your line is open.

Karen Short: Hi, thanks. Just to clarify something on the other in terms of the case decline. Is it fair to say that 4Q is kind of the trough? Or is that not a fair statement? And then I had another question.

Dirk Locascio: Good morning. Karen, this is Dirk. I wouldn't necessarily call it the trough. I think we're going to continue as we go through 2018 to be again smart about those customers where it makes sense for us to continue to partner with, and those where it doesn't. And we'll provide more specificity on 2018 as we come out of our Q4 earnings release and then a little more color also just on how you can think about it throughout the year at that point.

Just one reminder on that is again as I understand you guys are all trying to model the volume, and I think the important thing to remember is these are modestly or not that profitable a customer. So case volume impacts do not impact the healthy momentum in adjusted EBITDA growth and other metrics that we're seeing in the business.

Karen Short: Right. That was going to be my follow-up. So in general though, there is still a little bit of stranded costs issue even once you exit, right, the customer? So it is that what we're seeing in 3Q? And then the idea is that in 4Q, the EBITDA margin expansion will be a little bit better because you've kind of passed the point of having these stranded costs.

Is that fair?

Dirk Locascio: You're talking about Q3 and Q4 versus 2017?

Karen Short: Yes, because when you look at your implied guidance for EBITDA margin expansions in the fourth quarter, it looks like the margin expansion's going to be better than it was in the third quarter. So I'm wondering if that's a function of kind of passing -- getting past the stranded costs issue with the exit.

Dirk Locascio: The overall performance in the fourth quarter is going to come from a variety of levers that we're pulling. I think the -- from the stranded costs with these, as some have exited, some will continue to exit as we go through the fourth quarter, we work actively to make sure that we can get the cost out except for the nominal amount of stranded costs. So that will have an impact.

I think the other thing that this allows us for stranded costs is it frees up spaces from whether it be proprietary inventory, delivery routes, et cetera, to continue to accelerate growth with our target customer types, which we expect to continue to do.

Karen Short: Okay. And then I just had a question. Pietro, you commented on how to think about kind of growth within the independents, health care and then other going forward, and it sounds like that's kind of more like a long-term plan as opposed to just how to think about growth goals through 2018. So I guess, what I'm wondering is, it sounds like as we look through to the next three years, like beyond 2018, nothing really changes in terms of how you think about your business model overall.

Is that a fair statement?

Pietro Satriano: I think that's a good headline, and the comments that I made, Karen, were just a reminder of how we position ourselves with respect to our growth targets across those three customer types. And as we look forward, we're doing a lot to ensure that our strategy evolves and stay relevant to those primary customer types that we continue to standardize our business to ensure that we become more cost-effective and even more reliable than we are today. So there's a lot underpinning that general statement. But the general statement that we've made in the past continues to apply over the future.

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

Your line is open.

Kelly Bania: Hi, good morning. Thanks for taking my question. Wanted to ask just again about inflation in maybe a different way. I think this quarter; you had expected a -- maybe a sequential moderation in inflation.

And given a pretty significant acceleration I guess I'm just curious how you feel about the tools that you have in place for your MAs in CookBook and so forth and how they executed against a volatile inflation backdrop? Or are there any areas where you see some areas for improvement? Or are you happy with the way that was executed?

Dirk Locascio: Sure. I'd say we're generally pretty happy with the way tools and the processes that we have come to light. I think the -- for the quarter, not a lot of sequential inflation as you pointed out. It was really the significant deflation as last year went on. Between -- you've heard us refer a lot to CookBook.

So that is our pricing tool that helps our sales reps price and ensure in times of inflation and deflation, we're appropriately passing through those changes. We also have a number of business processes around that, that focus on commodities and key value items for customers to make sure that we're priced right on those things because part of helping our customers make it approach is making sure that we're helping them as well manage through these periods. And so between the tools and the process we have in place, I think we've been able to effectively do both for the quarter. So pretty happy with it. Obviously, any process and tools are always subject to improvement.

We're always looking at that in our revenue management function and team, as they're working with sales, are continuing to find opportunities where we can be better and better, and we don't expect that to change.

Kelly Bania: And so was all of the inflation able to be passed on this quarter?

Dirk Locascio: We were pretty happy with the level of inflation that we were able to pass on. Like I said, the thing that I spent a lot of time talking about, and it's -- I think because it's important is, there's a difference when we talk as an industry about 1% to 2% healthy inflation across the entire business versus so much of the inflation that we've seen has been in this commodity categories where there are the fixed fee markups. So it looks in those cases like you are making less per case, but in that situation, you're making the exact same amount. That's why we talk so much more about our per case.

And if you look at our gross profit per case, it's up $0.11 year-to-date, and that accelerated year-to-date in Q2. We're very pleased with the progress we've made on all the gross margin levers.

Kelly Bania: Perfect, and then I just had one more. The comment about the all other category where you're able to bring on some new business that's in the range of 2x to 4x more profitable than what you've been exiting. If you go back over your history I mean how many cycles have you seen this kind of dynamic where you're able to replace this kind of low-margin business with some more profitable business on the chain side?

Pietro Satriano: I think we just see -- maybe the best way to answer the question is just looking forward, we see lots of opportunity to continue to optimize our portfolio of customers.

And what's happening within that portfolio is obviously, the smaller customers present a more attractive profile. They value more what we do, and there are more of those to be had than there are of the larger ones. So we just see an opportunity to continue to optimize the portfolio over time.

Operator: Our next question comes from the line of John Heinbockel from Guggenheim Securities. Your line is open.

John Heinbockel: A couple of things. The 10% reduction in sellers, is that the total sales force, total size of the sales force?

Pietro Satriano: That is the sales force that is focused on locally managed sales.

John Heinbockel: So I don't know if you want to say where that's down to, but how much further do you think you can reduce that? And what else when you think about the org structure today, is it where you -- pretty much where you want it to be? Or are there some further changes you'd like to make to get more efficient?

Pietro Satriano: You're talking generally, John, in terms of the org structure?

John Heinbockel: Well, yes, I'm talking sales, the op cos, right? The entire org structure.

Pietro Satriano: Okay. So just clarifying.

So on the sales force, look, we continue the -- it's a little bit like the point I just made on large customers, right? We continue to optimize the sales force and what Jay Kvasnicka, who runs our local sales force and field operations, has brought since taking on this role a few years ago is just a real discipline for account management and ensuring that we have the best people on our business supported by the right train and the right routine. So obviously, there's a point at which we reach the optimal number. And we're not sure what that is yet, but we still see opportunity to reduce the variability of performance. The biggest opportunity in our business generally is to reduce variability through greater standardization, better talent management and better routines. With respect to your point overall on the org, John, we've made a lot of progress over the last 2.5 years, right? When we relaunched the company under what we call Act 2 of the transformation, we said we were doubling down on the differentiation strategy and bringing a greater perspective, a greater focus on costs.

You've seen on the administrative side us reduce the number of leadership teams from 60 to 26, consolidate the back office. So that work is -- we're very pleased with the results of that. We did some similar work at corporate. The next frontier that I talked about in my comments is around shared services, just bringing better process management, better discipline to drive more consistency and lower cost in terms of those highly transactional processes like payables, receivables and any number of those that you can imagine. On the selling side, it's a bit of a journey, and we've been at it the longest, so we're in the late innings of that one and the one that presents the biggest opportunity as I've talked about is supply chain.

We have a new supply chain leader. He's been with us for six months, and he's quickly getting a point of view on what the opportunities are, right? That cost bucket represents around 55% or 60% of our operating expenses, and it's the one where we have the greatest room to travel.

John Heinbockel: Okay. And then just shifting gears, the COP initiative and the rollout of that has been a big effort. Where does that stand today? And has that been impacted at all in any way by the ramped up inflation we've seen here?

Pietro Satriano: Right.

So two separate questions. So good memory, John. We talked some time ago about different opportunities where we could catch up with respect to others in the industry, and one of them was what we call the win at produce and win at COP strategies. The win at COP is further along. What we found is that, too, is a journey of continuous improvement.

And one of the things we're looking at is whether it's time now to do a second touch on -- as we bring on new sellers, as we have some new leaders, it's probably a good time to do something that we've identified here internally to kind of kick start those two win-at strategies. In terms of the impact of inflation, I mean, inflation affects all restaurants and all competitors in a similar fashion. So the impact of inflation really hasn't, I would argue done a lot, hasn't really had impact on the win-at strategies except that it really makes it even more important to ensure that our sellers have the right training to help our customers navigate through that inflation.

Operator: And our next question comes from the house of Karen Holthouse from Goldman Sachs -- sorry, actually it's going to be Edward Kelly from Wells Fargo. Your line is open.

Edward Kelly: Yes, hi, good morning, guys. Pietro, I wanted to ask you going back to this sort of like multiunit exit initiative of yours. Has anything changed over the past year here? I know when you went public obviously; there was business that you were exiting at the time for a similar reason. I think a lot of us kind of felt like that were more of a onetime event. But has anything changed industry-wise or within your thinking internally that's leading to a bit more of this today? Or is it just continuation of the initial strategy?

Pietro Satriano: A good question, Ed, and I remember those conversations and in fact, at that time, we had talked about cutting off some branches and then moving to some pruning.

That's probably some of the comments you refer to. So those big branches that we cut, there aren't a lot of big branches left to cut. Really, it's continued pruning. And I would say the only thing that's evolved is our refined understanding of the profitability of those customers. We have better profit models than we did two, three years ago in terms of the direct allocation of costs to those customers.

We've also in the intervening time stood up the revenue management organization, kind of 2.0, which is also working hand in hand with the sales team to do a better job of looking back on how we're performing against those contracts. So the goal is still the -- so the general headline is, more is the same than different. The approach is still around optimizing. The tools we have are a little bit better than those we had when we embarked down this journey three years ago, and we just have greater discipline around it than we might have had two, three years ago.

Dirk Locascio: Ed, this is Dirk.

I think the only thing I would add is on a few occasions we've talked about that, we called those out because they were significant, but that it's been - it's an ongoing process. We're behind the scenes. We're constantly looking at less profitable customers, and some we're able to optimize to find a better outcome for us and them. Other ones we exit, and what we've said is where they'll be larger, we'll make sure to call them out so you have better clarity around those. And we -- if I steal Pietro's term of the journey, we view this as a journey and as we get better and our business grows with our target and more profitable customer types, the bar continues to get raised on those lower profitability customers.

So we continue to make progress and make what we think is the best decisions for the business and our investors.

Edward Kelly: All right. And just one quick follow-up for you on the topic of inflation. If we look at your gross profit per case, obviously, it's accelerated throughout this year. You put up your chart with $0.11 better, but it actually, I think anyways, probably improved each quarter.

Yet inflation has accelerated, and we've seen a similar trend, by the way, at Sysco. And I know that this is kind of a delicate topic. So I want to ask it appropriately, but is it safe to say that inflation is just not bad for this business?

Dirk Locascio: That's right. I mean, we've talked about inflation sort of modest inflation tends to be healthy for the industry, and it's able to be passed through typically in that case. I think what I would say is in this case; the continued improvement in gross profit is not just an example of broad-based inflation that's passing through in the form of higher markups, given so much of its coming in these commodity categories.

There's a number of active things that we continue to focus on, whether it's the 100-basis-point improvement in private label that Pietro talked about, and we've commented before we make two extra profit on that, and that's a great way to kind of a win-win with our customers as well as sourcing gains and partnering with our vendors and things like that. That all contributes to the increasing growth. So I think inflation to date has not been, as Pietro commented earlier, stunted growth for us or customers and managed through effectively so far.

Pietro Satriano: Ed, just quickly again, what I would say is we have contract business and noncontract business. And the contract business sometimes benefits from inflation, depends on which categories it comes from.

On the noncontract side, analytics show that over time, gross profit per case tends to revert back to the mean of that category regardless of the price level. And so where CookBook comes in is trying to raise that mean regardless of the level of pricing based on the price sensitivity or elasticity of those customers. So we try to manage those two books of businesses very differently to make sure that we maximize the profitability associated with each of those two books of business.

Operator: Our next question comes from the line of Karen Holthouse from Goldman Sachs. Your line is open.

Jared Garber: Hi. This is actually Jared Garber on for Karen. A number of restaurants have talked about some sort of conservatism in the current quarter after the December we had last year. If you guys could you just talk about, sort of about your holiday outlook and any maybe cushioning guidance you're seeing versus current trends, that'd be great.

Pietro Satriano: Yes.

So our outlook remains positive. Typically, the publications that you see, that you're referring to, are often with respect to the larger chains. We typically are more focused on the independents because of the more material impact on profitability, and our outlook remains consistent and positive.

Operator: And our next question comes from the line of Ajay Jain from Pivotal Research. Your line is open.

Ajay Jain: Yes, hi, good morning. At this point, I just had a quick housekeeping question. The revised guidance mentions 2.5% to 3% unit growth for the year, and I just want to confirm that what you're now referring to as unit growth with the latest guidance that that's comparable to the case growth guidance at the beginning of the year, I think that prior range was 2% to 4%. So I assume when you're talking about units and case growth in the guidance, you're talking about the same thing, and there's nothing I'm missing in terms of nuances. Is that right?

Dirk Locascio: You are correct.

They're one and the same.

Operator: Our next question comes from the line of Bryan Hunt with Wells Fargo. Your line is open.

Bryan Hunt: Thank you. Just wanted to follow up on the inflation question or the line of them.

When you look across whether its food products, packaging, freight, what's your capability of passing on each one of those measures of inflation? And how do you think they're likely to accelerate or decelerate going into 2018?

Pietro Satriano: Yes. I don't know if we have a view on the inflation outlook, and the simple answer is I'll go back to the answer I gave Ed, which is on the contract side of the business, we have an ability to pass that on, as Dirk said, when it's nonvolatile it contractually it makes it easier -- the mechanisms make it easier to pass on. And then with noncontract business, we work with our sellers through a variety of processes to make sure that we maximize the profitability regardless of the environment whether it's inflationary or deflationary and regardless of where it comes from, whether it's packaging or cost of goods or freight.

Bryan Hunt: Yes, and my next question, and I appreciate your time, is you've talked about your leverage target over the medium term. Is there a ceiling you all would be willing to hit on the leverage if there was a material pipeline of acquisitions that made sense for the business in the short term?

Dirk Locascio: Good morning.

This is Dirk, not necessarily. I think though there is two buckets that I would put them into. One is from the continuation of the type of acquisitions we've been doing. I think in that case, as Pietro said on a few occasions, we feel like the 5-ish that we've been doing is the right pace. So given that, the cash flow of our business is very adequate to fund that.

I think the bigger impact would be if there was a strategic larger opportunity that came up, we would consider increasing leverage for the right target. As we've said before, out of the top 10 or so, they're -- kind of out of -- many of those, they're not all attractive, but there are a few that would be attractive to us if they became available.

Operator: Your next question comes from the line of Karru Martinson with Jefferies. Your line is open.

Karru Martinson: Good morning.

My apologies if you mentioned this, and I missed it but just on the freight rates increase from the hurricanes, has that eased? And what's kind of the time line if it hasn't?

Dirk Locascio: So we did not mention that much, but we have seen it rebound a bit as we've gone into the fourth quarter. I think the -- it's still early. So the ultimate timing really is kind of a TBD, I think, but it's been encouraging as we moved into the fourth quarter.

Karru Martinson: Okay. And just in terms of the acquisitions, when you look at the kind of the pace of five or so, are those still being done at the same multiples, kind of all-in with the synergies?

Dirk Locascio: Yes.

Not a lot has changed there. It's very similar to what we've talked about, and we just don't see a whole lot of change in the marketplace on those. So our outlook remains very similar.

Operator: There are no further questions at this time. I'll turn the call back over to the presenters.

Pietro Satriano: Okay. So everyone thanks for the questions and for the engagement. Always appreciate your focus on the business, and as well call out to our 25,000 employees who have just done a terrific job of generating the results, of which we're very happy with. Thanks very much for your time this morning.

Operator: This concludes today's conference call.

You may now disconnect.