Performance Food Group Company
Q2 2018 Earnings Call Transcript

Published: 7 Feb 2018

[Operator:]

Good morning and welcome to the PFG Q2 Fiscal Year 2018 Earnings Conference Call. Today's call is scheduled to last about one hour, including remarks by PFG's management and the question-and-answer session. I would now like to turn the call over to Mr. Michael Neese, Vice President, Investor Relations for PFG. Please go ahead, sir.

[Michael Neese:]

Thank you, Maria, and good morning everyone. We are here this morning with George Holm, Performance Food Group's CEO; and Tom Ondrof, PFG's CFO. We issued a press release regarding our fiscal second quarter results this morning. The results discussed in this call will include GAAP results and non-GAAP results adjusted for certain items. The reconciliation of these non-GAAP measures to the corresponding GAAP measures can be found at the back of the earnings release. You can find our earnings release at the Investor Relations section of our web site at pfgc.com. As many of you know, on December 22, 2017 HR1, the Tax Cuts and Jobs Act was enacted. We will refer to the Tax Cuts and Jobs Act throughout our prepared remarks as the Act. I would like to highlight two items on Page 12 of the earnings release. Here you will see the tax impact to the revaluation of net deferred tax liability of $0.36 per share. This represents the per share impact of $37.4 million net benefit to deferred income expense, as a result of the changes in tax reform and the reevaluation of the company’s net deferred tax liability. The second item is $0.14 per share impact of the stock-based comp performance vesting. This represents the per share impact of $15.4 million access tax benefit recognized as a result of the performance metrics being met for stock-based compensation awards triggered by the exit of the company’s private equity shareholders. Our remarks in the earnings release contain forward-looking and cautionary statements and projections of future results. Please review the forward-looking statements section in today's earnings release and our SEC filings for various factors that could cause our actual results to differ materially from forward-looking statements and projections. Now, I like to turn the call over to George.

[George Holm:]

Thanks, Michael. Good morning, everyone, and thank you for joining us today. Our second quarter results were strong and came in line with our expectation. Our team’s consistent execution enabled us to generate total case growth of just over 4%. We continue to grow our topline with net sales growth of just over 6% and adjusted EBITDA growth of 12%. Second quarter top line results were again impacted as expected by the closure of our distribution center in the customized segment and as we've mentioned previously, this impact is expected to continue for the next two quarters. Focusing our segment results for a moment. Our Performance Foodservice continued to execute their strategic initiatives and delivered strong topline growth of 7.5%, independent case growth of 6.5%, and EBITDA growth of nearly 10%. In the early part of our second quarter, we faced some softness in the independent channel as a result of the two hurricanes. However, we recovered in December and independent sales were robust, it was the strongest month of this fiscal year. Vistar had a strong topline quarter with a growth of nearly 14%, our theater business performed very well, driven primarily by significant strength in the box office attendance with the release of the Star Wars. For the first half of 2018 fiscal year, Vistar's EBITDA was up over 9%. Turning to customized, net sales decreased 4.9%, due to softness in the casual dining environment, and the closure of our Georgia facility. Excluding the impact of the Georgia facility, net sales would have increased slightly. EBITDA was down nearly 12% in line with our expectations as higher operating expenses did not fully offset our increase in gross profit. For the first six months, customized EBITDA is up nearly 5%, driven by higher gross profit and will continue to rationalize the portfolio and customer base within customized to position this segment for future growth. A quick note on tax reform, Tom will go into greater detail. I want to briefly address that as I know it is on the top of minds of analysts and investors. Obviously, there is a big benefit from the drop in the corporate tax rate. We’re forecasting that the lower corporate tax rate will benefit our adjusted EPS and cash flow for fiscal 2018. Based on our strong results in U.S. tax reform changes, we increased our fiscal 2018 adjusted EPS outlook and now expect growth of 24% to 30% year-over-year. We also reaffirmed our adjusted EBITDA outlook. For healthy growing businesses like PFG, the tax benefit provides degrees of freedom to invest for future, which we plan to do and we’re already executing before the Act was passed. Our focused growth areas would include capital expenditures, investing in delivery and sales associates, and potential investments in M&A. So, very exciting time of PFG and I’m encouraged by our first half results. Our strategic investments are paying off and we are reaping the benefits as shown in our 15% adjusted EBITDA growth for the first six months. We’re confident in delivering our financial goals this year and continue to aspire to hit our three-year goal of 5, 10, and 15; which is 5% case growth, 10% adjusted EBITDA growth, and 15 basis points of adjusted EBITDA margin growth. Our private equity sponsors have exited the company and left us in strong financial shape. Before I turn the call over to Tom to discuss our financial details, I’d like to highlight one of our associates. Terrence Davidson, an inventory control manager at Vistar, Tennessee has served in the Tennessee National Guard for eight years. He holds the rank of sergeant has been deployed to both Kuwait and Iraq. Thanks to Terrence's nomination, our Vistar, Tennessee location recently received the patriotic employer award from the Department of Defense for its support of employees participating in America's National Guard or Reserves. We’re proud to have Terrence on our team and we thank him for his service. I would now like to turn the call over to Tom, who will discuss our second quarter results. Tom?

[Tom Ondrof:]

Thank you, George, and good morning everyone. Let me take you through our second quarter financial results, including some detail on operating expenses, cash flow and tax reforms changes as they relate to PFG. On the topline, net sales increased 6.4% over the prior year to $4.3 billion, due to strong case growth in Vistar and PFS, along with benefit from inflation and prior acquisition. Food cost inflation was approximately 2.5% during the quarter, driven by the meat, eggs, produce, and daily categories. Gross profit dollars grew nearly 10%, resulting in a 40-basis point expansion of our gross margin from 12.8% to 13.2%. The gross profit increase was fueled by an improved sales mix of customer channels and products, primarily in the independent channel, procurement gains, and pricing initiatives. Operating expenses grew 11.3% in the second quarter to $518.5 million. The increase was primarily due to growth in case volume and the resulting impact on variable operating expenses, as well as one-time charges totaling approximately $18 million, acquisition integration cost within Vistar, and an increase with the number of sales personnel. A significant majority of the one-time charges, most of which were non-cash related to the exit of the company's private equity shareholder during the quarter. Excluding these non-recurring charges, operating expenses would have increased approximately 8%. Our adjusted EBITDA increased 12.2% to $105 million in-line with our expectations and reflects the impact of solid growth in PFS and Vistar, as well as continued strong control of corporate expenses. Net income grew nearly 241% to $78 million in the second quarter of fiscal 2018, compared to the prior year period. The increase was driven by a $59.2 million decrease in income tax expense, due to the recently enacted tax legislation. Diluted earnings per share also increased 241% in the second quarter to $0.75. The federal tax rate reduction enabled us to recognize a $37.4 million or $0.36 per share, one-time non-cash gain in the second quarter as a result of the revaluation of our net deferred income tax liability. Adjusted diluted EPS increased nearly 38% over the prior year period to $0.40 per share. I will now take you briefly through the results of each of our segments. Performance foodservice net sales for the second quarter increased more than 7%, driven by the addition of new customers and further penetrating existing customers. Independent sales as a percentage of total segment sales were up 100 basis points to 44.5%. EBITDA for PFS improved nearly 10% to $83 million. The increase was driven by solid growth in gross profit through a favorable shift in the mix of cases sold to independent customers and sales of performance brands, as well as strong operating expense control, offset slightly by higher fuel cost and continued additions to our sales force. Our performance brand case mix as a percent of independent cases was up 110 basis points to 45.6%. Vistar’s net sales grew almost 14% to $838.9 million, compared to the prior year period. This increase was driven by strong case sales growth in the segment's theater, hospitality, retail and vending channels, along with the recent acquisitions. Vistar's second quarter EBITDA was up 3% versus the prior year to $34 million. Strong gross profit dollar growth for the second quarter was offset by higher variable operating expenses associated with higher case volume, integration cost related to recent acquisitions, and an increase in warehouse personnel costs and fuel expense. The company expects these higher costs within Vistar to abate, and as a result deliver sequential improvement in EBITDA growth throughout the remainder of the fiscal year. Net sales for PFG Customized decreased 4.9% to $888.2 million, driven by the closure of the Austell, Georgia facility in the fourth quarter of fiscal 2017, and a continued soft casual dining environment. Excluding the impact of the Georgia facility, net sales would have slightly increased in the second quarter as a result of favorable shifting customer mix. Segment EBITDA for PFG Customized decreased 11.9% to $5.9 million. The decrease in EBITDA was driven by higher operating expenses, including higher warehouse personnel costs, investment in segment support staff, and increased fuel expense, partially offset by improved gross profit. Now, let me turn to cash flow. In the first six months of fiscal 2018, PFG generated nearly $33 million in cash flow from operating activities, an increase of more than $58 million versus the prior year period. The improvement in cash flow from operating activities was largely driven by higher operating income and strong working capital management, primarily through reduced inventory levels. For the first six months of fiscal 2018, the company invested just over $38 million in capital expenditures, and we now expect capital expenditures for fiscal 2018 to be between $140 million and $160 million. The fiscal 2018 capital expenditures estimate is lower than previously communicated, due to the timing of projects. Now let me finish with a few words on the impact of tax reform. The federal income tax rate for PFG will decrease from the previous 35% rate to a blended 28% rate for fiscal 2018 based on PFG's fiscal year calendar. This federal rate will further decrease in fiscal 2019 and thereafter to 21%. PFG's effective tax rate from operations is expected to decrease from the previous 40% rate to approximately 33% in the third and fourth quarters of fiscal 2018, and further declines to approximately 27% in fiscal 2019. It was a year-to-date true up of tax expense in the second quarter to adjust the federal tax rate booked in the first quarter at 35%, down to the 28% blended tax rate applicable to fiscal 2018. This resulted in a non-cash gain of approximately $2.5 million in the second quarter. For the remainder of fiscal 2018, the company expects cash tax savings of approximately $15 million to $18 million, driven by the lower federal tax rate and the first-year deduction for machinery and equipment, excluding discreet items. Earlier this morning, we reaffirmed expected adjusted EBITDA growth of 8% to 11% for fiscal 2018. We continue to expect second-half adjusted EBITDA growth to be in the high single digits. And as a result, expect to be at the higher end of the full-year adjusted EBITDA range. In addition, due to our strong first-half results and the Act, we increased our adjusted diluted EPS growth outlook to 24% to 34% or $1.54 to $1.61. This compares to the company's prior adjusted diluted EPS growth of 13% to 18%. We will remain on track to deliver our financial goals for fiscal 2018. Our total case growth year-to-date remains healthy at nearly 4%, gross profit margin has expanded 23 basis points, and with a tight focus on our operating and corporate expenses, adjusted EBITDA has grown more than 15%. With that, I’d like to turn the call back over to George.

[George Holm:]

Thank you, Tom. I’d like to get to your questions, but I thought I would briefly highlight two topics. The state of the independent restaurant industry and our MarketWatch innovative technology. From our perspective, total independence stores continued to grow in the low single digits. This is encouraging, as our goal is to grow independent cases at approximately 6% to 10% with most of our growth coming from new customers. We believe, we’re taking our share and continue to growth in this profitable segment. To support our future growth, we are growing our sales staff in the mid-single digits and we will continue to consistently add experienced sales personnel. As we look at the independent restaurant same-store sales, it’s very difficult to tease out the growth. Certain industry sources suggest a slight increase while others suggest a decrease. I believe same-store sales among independent were down slightly in fiscal 2017 or calendar 2017, although we saw a slight improvement in our business during the month of December. But remember, historically same-store sales is not the primary driver of our revenue growth. And so, we outlined at Investor Day, winning new accounts creates the vast majority of topline growth. That is why we are, and have been so committed to hiring, training, and rewarding our world-class sales force. Turning to MarketWatch, Performance Foodservice continues to invest in technologies to enhance customer experience and sales force effectiveness. We’re developing ways for our sales force to be more effective in the field, while providing them with tools to identify critical insights product voids and opportunities to grow our profits. We have rolled out MarketWatch to nearly all of Performance Foodservice, and the early read on this initiative is very positive. To wrap-up, we feel really good about our first-half results, all of our segments are focused on executing their plans for the year, our newly added specialty companies are ramping up and are adding to our growth. The M&A pipeline remains strong. We are in dialogue with several companies, and we are assessing how the recent Act will inform our decisions and their decisions. I’m very proud of our associates for their unwavering commitment to grow this great company. We have so much runway in front of us. I have never felt better about our future than I do today. With that, let’s get into the question-and-answer session.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Karen Short of Barclays.

[Ryan Gilligan:]

Hi good morning, it’s Ryan Gilligan on for Karen. Can you just talk about what drove gross margins higher year-over-year in the quarter, especially in light of accelerating inflation and higher freight cost?

[Tom Ondrof:]

Well part of it was just the change in customer mix as our independent has outgrown our national business. And then within Vistar, it’s been our higher margin channels where we’ve been growing the fastest, and our brand growth has continued to help us as that’s much higher margins then selling national brands.

[Ryan Gilligan:]

Got it. So, obviously freight wasn't as big of a deal for you as everyone feared. What was the impact on gross margins from freight and can you talk about why you're more inflated than maybe everyone thought?

[Tom Ondrof:]

Well, it wasn’t real material for us, but definitely an issue. I mean freight rates are up, and drivers are harder to come by, but it’s just something that we feel like we're managing through fine and just not overly concerned. It’s just not a huge part of our profit.

[Ryan Gilligan:]

Understood, thanks.

[Operator:]

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

[Vincent Sinisi:]

Hi, good morning guys nice quarter. Thanks for taking my question. Just wanted to ask about the investments in the sales desk, I know George you set up kind of mid-single-digit range, can you just give us a little bit more color in terms of kind of how you foresee the role of developing and if those investments are just kind of across the border in any particular area specifically?

[George Holm:]

Well, really, they are all in Performance Foodservice, that’s where we are investing in salespeople, our other businesses, the way they are structured, we don't really need to do that right now. And we are back up to running mid-single digit increases in salespeople. We got behind there for a couple of quarters. And our biggest challenge there is just making sure that we get them trained real well, that we will retain them, and that we send them out there equipped to get their job done.

[Vincent Sinisi:]

Okay. And just to clarify, so within PFS, that’s just kind of across the board no particular geographies or anything right?

[George Holm:]

No, it’s very widespread. Very similar markets.

[Vincent Sinisi:]

Okay. And then just a quick follow-up if I can. I know you say kind of continued softness in the casual dining anything kind of quarter to date that you can speak toward I know that kind of for the fiscal 2Q, but are you seeing any change? We've just been kind of hearing rumblings that maybe things are slightly better?

[George Holm:]

Unfortunately, we have not seen that. I think a lot of it is weather-related. If you look at where our customized facilities were and where our big broad alignments are for that matter they are pretty much up and down the East Coast and there has been a lot of bad weather. So, we’ve actually seen more softness in the fiscal third quarter than we did in second, but I do suspect that’s probably weather-related?

[Vincent Sinisi:]

Okay, that’s helpful. Thanks very much guys. Good luck.

[Operator:]

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

[Edward Kelly:]

Hi guys, good morning. Hey George, just a quick follow-up on freight, so the inbound side this quarter certainly sounds like it was manageable, you expect that to continue, I guess question one? And then just bigger picture question about freight does any of this work its way into what you need to pay your own drivers going forward and overall level of inflation on the cost side there?

[George Holm:]

Well we feel like we’ve made those moves with our drivers to get them to where, we make sure that our pay rates are competitive for each one of the marketplaces that we’re in. As far as the freight situation getting better, I think it will. We’ve moved some loads back to the suppliers, to manage it instead of us, and they really don’t like that. So, they're working on finding ways to alleviate the problem. We continue to control as much of it as we can through backhauls. I just think as one of those things it’s definitely a problem, but it’s getting better and should continue to get better.

[Edward Kelly:]

Okay, and then just a question on the competitive front and what you are seeing there. So, your largest competitor seems a bit more interested in top line growth. They’ve mentioned hiring salespeople that’s obviously something that you’ve been doing very successful as well. Have you noticed any real change in the landscape there, obviously the large players are all taking share and can everyone continue to win profitably against that backdrop?

[George Holm:]

I believe so. Obviously, there is some tremendous amount of focus on the independent operator, but it’s always been very competitive. I wouldn't say that I see it really any competitive - more competitive right now than it has been, but very competitive.

[Edward Kelly:]

All right. And just the last question for you is just on Vistar, can you talk a bit more about the cost headwinds that surfaced within the business this quarter. I mean you had a really strong quarter from a gross profit dollar growth standpoint, you know EBITDA was way down a little bit by the cost side and just want to better understand what we saw this quarter from a cost perspective that was a bit more non-recurring, how quickly it abates and how we should just think about all that going forward?

[George Holm:]

Yes, it’s a good question. We made an acquisition early in the fiscal year, and typically we do these integrations over about 12 to 18-month period of time. And we made the decision to step that up and to do it quicker, and we still have a lot to do, but we got a lot of it done late in the - or early in the fiscal second quarter, and late in the fiscal second quarter. We can tell that it was going to be a great month for theater, and we just moved a good bit of that theater business into our existing facilities. So, when you do that, I mean it’s changed and change is always an expense. And you’ve got the employees that you’re training to handle that business within the Vistar company’s and you got that expense, but you still had the employees that where at the company that we acquired that are continuing to handle the business. And then once we got it converted over, then you had severance and you had all that to deal with. You also took some leverage out of those smaller facilities that the acquisition had. So, it’s just a myriad of things, it was a good decision. We’re very glad we did it. We see the next two quarters things abating quite a bit and then by the beginning of the fiscal year we will be pretty much clean with that integration and that’s when we’ll get the benefits from that acquisition because it was a very synergistic acquisition.

[Edward Kelly:]

Great. Thanks guys and good luck in the second half year.

[George Holm:]

Thanks.

[Operator:]

Our next question comes from the line of John Heinbockel of Guggenheim Securities.

[John Heinbockel:]

So, George, first thing on or a couple of things on the hiring of the salespeople, are we up to kind of that 5% level yet, is that kind of where you want the run rate to be?

[George Holm:]

Yes. We really stepped it up in this last quarter and we are back up to that 5% level.

[John Heinbockel:]

And that, in theory right, when you think about the leverage, the historical leverage with those hires, you should be able to get back to 9% to 10% with the high end of your independent case growth goal when? Middle of next fiscal year or sooner?

[George Holm:]

That’s a great question. I’m not sure it’s one that we can answer, but I am going to do my best job at it. We went through a long period of time where we have grown our cases out about twice the rate that we growing our number of people. And like any business when you get pretty mature, and your average sales person is doing significantly more business than they were doing a few years ago, our thinking today is it’s going to be more like 50% better, so with 5% more people we should be able to grow our case to 7.5%. Obviously, these people are new, some are dealing with non-competes. So, it’s going to take some time. I think that middle of our range we should be able to get to some time to our next fiscal year, but that takes a crystal ball to really know that, and obviously we’re counting on when the marketplace continuing to show growth.

[John Heinbockel:]

And then two things related to tax reform tangentially, back to the hiring, how does that, the fact that you are hiring as much as you are and more than your peers, how does that help you on the M&A front getting maybe a private company wanting to sell to you versus the others, is that a big deal? And when you also talked about CapEx, what’s the state of the physical plan today, right across, I guess particularly Foodservice and Vistar, where do you need to make investments? I don't think it’s new facilities, is it more expansions?

[George Holm:]

It is more expansions. In the case of Vistar, probably one new facility. I would say that we have some capacity constraints in both of those businesses, probably a little bit more in Vistar. We also have places where we have excess capacity. So, we are just trying to balance that. I would suspect that you will see us with a higher CapEx numbers. We thought that we would already be spending a bit more, it just isn't as easy as it sounds to do. Some of these facilities have taken much longer than we have thought to get the additions done, but the CapEx is a very important part of our future growth.

[John Heinbockel:]

Okay, thank you.

[Operator:]

Our next question comes from the line of Bryan Hunt of Wells Fargo Securities.

[Bryan Hunt:]

Tom and George thanks for taking my questions. I was wondering when you were talking about new facilities, can you talk about the efficiency gains that you’ve experienced over the last couple of quarters on your automated distribution center and is it, you know to the efficiency point that you originally targeted at this date or given the CapEx spending in ROI implications that you had rolled into your plan?

[Tom Ondrof:]

Yes, we’ve had continuous improvements. We’re very pleased with it, it’s not at the level of profitability that we would like, but it’s quite profitable. We want to move on with a couple more facilities. We understand that we need to go back and do some retrofitting and make some changes to the initial one. But at this point, we have a level of confidence where we feel we should be moving on because there is business that we can garner by having the better coverage out of an automated facility that we have today.

[Bryan Hunt:]

Great. My next question is, when you look at mix, which was discussed slightly earlier and the Performance Brands mix, where does that pipeline stand in terms of rollout and where do you think the mix of Performance Brands can go?

[George Holm:]

Well it’s another great question. We’ve been able to get ourselves into the high 40s. We do have a couple of our distribution centers that are 60. So, we all will be like those two, I don't know, but we certainly feel that we can get closer and closer to 50. And we’re not against selling national brands by any means either. So, we feel like that part of our business is going to continue to grow. If we can stay in that 1% to 4% better growth in our brands than we do kind of in our total independent cases. I think that’s a sweet spot for us and we can support our national brand partners and still grow our brand.

[Bryan Hunt:]

And then my last question is, you talked about the rebound in December, after Hurricanes, do you believe that rebound is a trend or do you think that it was a restocking. I mean based on what you’re seeing in the current quarter?

[Tom Ondrof:]

Well the restocking would have happened long before December and December was the month, the better month. It’s hard to tell if that was a trend because the weather has impacted January to such a degree. I do feel in December that the calendar fell better where the holidays fell, so I think we got some benefit from that. So, I think that’s probably a better question for, you know when these weather events are behind us, but I think it’s kind of partial, partial calendar and partial just a little help to your business.

[Bryan Hunt:]

Very good. I’ll hand it off to somebody else. Best of luck in the back half.

[Operator:]

Our next question comes from the line of Andrew Wolf from Loop Capital Markets.

[Andrew Wolf:]

Thanks. Good morning. George between what you said today, and I think ICR, it sounds like the independent channel is kind of shifting from same-store sales growth more to new unit expansion, but still generating sales growth, for distributors, so I want to check that I’m understanding that right. I also wanted to get your sense, is that kind of typical for a maturing economic cycle. And lastly, do you think it’s sustainable? For example, is it like new units being added, by existing restaurant stores, which probably I would say carry less risk than sort of someone just planting a restaurant out there and hoping they can make a go in the business. You can certainly give us a sense of that, it would be helpful.

[George Holm:]

Yes, I do believe that we’re continuing to see these new units open. I was just with a group of customers and asked them about their same-store sales and actually it was only one that was running same-store sales growth, but what I got them was them was, you know there used to be four restaurants in my street, now there are six type of thing. And I think though that for the most part as far as getting financing to do a restaurant seems to be easier to do then it certainly was a few years ago, but they seem to be good operators, a lot of it are people that are putting up a second or a third unit. Maybe not the same name, but I still feel very good with the independent operator, and you know there’s going to be casualties any time once you get over built, but I think for the most part there is good operators out there and I just really like the independent part of the restaurant business right now.

[Andrew Wolf:]

Okay. And just back to your sales force build, was this coming off flat or just a lower than normal growth? Number one.

[George Holm:]

No, we had actually got to where we were flat in the group. So, it was a pretty significant ramp up.

[Andrew Wolf:]

And how is the profit build versus the expense build, you know, how should we think about it giving it pretty much you're going from 0% to 5% right around now? So, does it take the full year or so of their non-competes or I assume it’s less time than that, but if you could get a sense of that it would be helpful in remodeling?

[Tom Ondrof:]

Yes, it’s all over the board. We have some people that come in and they kept calling existing accounts and they do really well in their year-ends and they don't even want to go to old territory, they are just fine. All the way to others that are good sales people and they have a great book of business that follows them, but that first year is pretty close to debt cost for us. So, it really varies, but it is definitely an investment. I think it was a good time for us to do that. We’re doing pretty well. We’ve got the Tax Act that will help us as far as cash flow goes. It was just a good time, and I would expect that before it has a real material impact it’s probably going to be here, but we’ll get some benefit before that.

[Andrew Wolf:]

And just lastly, is there a vulnerability in certain markets like, I think Cisco said, they were doing it more surgically then across the board, is your just more a go to market strategy and it’s more of a generalized approach?

[Tom Ondrof:]

Yes. I mean, I would say we’re probably more generalized. You know, we don't have the kind of share in maturity that they have. So, it’s probably different for us where we can get good people, we need them. And we don’t pass on the opportunity to get someone that’s talented.

[Andrew Wolf:]

Okay. Thank you.

[Operator:]

[Operator Instructions] Our next question comes from the line of Karen Holthouse of Goldman Sachs.

[Karen Holthouse:]

Hi. Thanks for taking the question. A couple for you, to do things of, when you brought on CapEx guidance for this year, I noted, I think there was a timing issue or that was largely due to the timing of spending, should we think of fiscal 2019 then of, as having a little bit higher than usual CapEx as you sort of catch up on that?

[George Holm:]

I think that’s right. I mean a couple of them, not a couple, a majority of the major projects this year fortunately or unfortunately are in California and New York, and so those bring their own set of challenges. So, I think it is timing and I think you’ll see a bit more in 2019 to sort of make up for that timing difference?

[Karen Holthouse:]

And then you confirmed a couple of parts of guidance, but not necessarily all of the underlying drivers, and sort of focusing in on organic case growth, which year-to-date is running right around 2% versus guidance of 3% to 5%, should we think about some of the composition of getting to guidance as maybe changing a little bit versus the original plan?

[George Holm:]

No, I don't think so. The guidance always contemplated a bit of M&A and certainly we’re in that range in the 3 to 5 with the M&A. So, the components are pretty, I think pretty consistent between organic M&A, price mix changes and inflation.

[Karen Holthouse:]

And then thinking about the acquisition side and say that it was from a case growth perspective it looks like a little bit higher this quarter than what we’ve seen, is that something you can hold going forward or was there, when do you sort of start to roll-off things that are benefiting this quarter?

[George Holm:]

Well, in terms of, kind of overlapping the prior year acquisitions? Four of the deals were done in the first, four of the seven last year were done in the first half. So, we pretty much lapsed all those, two more in the middle of the third quarter, and then one right at the tail in the last year. So, we’ve lapsed well over half of what we did last year.

[Karen Holthouse:]

Great. Thank you.

[Operator:]

Our next question comes from the line of Bill Kirk of RBC Capital Markets.

[Bill Kirk:]

Good morning. In your prepared comments on the uses of tax benefits, there was no mention of price. So, I guess how did you get comfortable that the other uses whether it’s CapEx or labor are better than price investment?

[George Holm:]

Well, we think that’s the key to our growth, is people and making sure that we have the capacity to grow and we don't see price as something that we need to grow. Certainly, in the national account area, but that’s just not the emphasis, it just doesn’t make sense for us to do brick and mortar for that type of business.

[Tom Ondrof:]

I think, I’d add that, given the fragmentation of the market I mean again 31% market share from the big three and you see all of them growing this quarter as I think should be the case. The pressure to price is not particularly there because of that fragmentation.

[Bill Kirk:]

Okay, that’s helpful. And then more housekeeping on the tax rate. Why doesn't it step down to 27% beginning January 1? Well, I guess, I ask the different way, why is it 33% for the next two quarters?

[George Holm:]

Because of our fiscal year. Yes, if you look at the chart, we are at June year-end, so we have a 28% blended for this year than it steps down the following year.

[Bill Kirk:]

So, 33% in the press release, I think it says 33% for 3Q and 4Q, does that mean blended - the full year is blended to 33%?

[George Holm:]

It is. And then you’ve got the state rate on top of it. So, that is our full effective rate. So, 40 is a full effective rate, state and federal for last year this year it will be 33, state and the federal.

[Bill Kirk:]

Okay, great. Thank you for that clarification. That’s it from me.

[Operator:]

Our next question comes from the line of David Lantz of BMO Capital Markets.

[David Lantz:]

Hi good morning thanks for taking the question. When was the last time you felt like you saw negative comps and independents and why do you think it was negative in 2017? Was it possibly because of too much new capacity being built and then just a little further on that, does it make you rethink investing in growing the sales force in-light of these comments on independents at all?

[Tom Ondrof:]

Well, I’m going to once again stress that there’s people that put different numbers out there, okay with independents. So, I am giving you - a company as Performance Food and how we look at it. And we have seen when you look at our account base that the same-store sales growth has not been there in 2017, but we’ve also had a robust independent business, and we’ve been able to do that growth more through new accounts than through penetration, and we see it. I mean we just see the number of new units that are opening. And I think, as far as growing our sales force, I think that’s more important when there is more units. You have more people to call on and you got to have your people out there doing that.

[David Lantz:]

Okay great, thanks. And just one other follow-up, was the comment about softness into 3Q just on casual dining and is there any weather weighing on independents?

[Tom Ondrof:]

You know, weather doesn't differentiate, I mean when it’s bad weather it affects everybody, but yes, the Q2 it was more of the casual dining that was slow. We had a bankruptcy of one-off or accounts and we saw a lot of store closings, and some same-store issues. So, it was pretty wide spread issues when it comes to casual dining. We did not see that in the independent at all?

[David Lantz:]

Okay thanks.

[Operator:]

Our next question comes from the line of Ajay Jain of Pivotal Research Group.

[Ajay Jain:]

Yes, hi good morning. First, I had a housekeeping question, I wanted to ask if you could confirm the customized revenue figure without the impact of the closure of the Georgia facility. I know George you mentioned that it was slightly positive, but can you confirm the actual figure?

[George Holm:]

No. I mean it would have been slightly positive, but yes, we’re not, we didn’t want to strip out that specific opco and identify it. But it would have been slightly positive.

[Ajay Jain:]

All right. Fair enough. As a follow-up, I thought expense comparisons were supposed to be very favorable in the first half especially as it relates to customized, so I'm just wondering was there any aspect of the latest results that you think fell short of what you were expecting a few months ago based on the mid-teen EBITDA guidance for the first half and that question is specific to customized, I’m just trying to figure out if the recent softness there was expected or where you are not contemplating all of those expense pressures with customized in Q2?

[Tom Ondrof:]

Well, first of all the driver issue is a real issue. So, we have addressed driver compensation where we’ve needed to. And then when you have a change in your customer rates and a business like that, and you have a bankruptcy to deal with and a lot of store closings, it changes all of your routing, in many cases it changes your slotting, and it just adds layers in a lot of expense to kind of reworked the business and get it back to the efficiency that it typically runs. It’s a very well-run business, and when the current balls [ph] come it just takes a little bit of time to adjust to it. And that’s what we needed to do.

[Ajay Jain:]

Okay, so would you day the EBITDA decline in customized was isolated event to Q2 or would you expect that trend to continue in the back half?

[Tom Ondrof:]

No, I think we expect it to pick back up in the second half. I think the only thing I would add to George's comments were the fuel increases sort of in the back half of the quarter and there’s a lag effect for that to recover pricing to come back to equilibrium on that, but we expect it to come back in the second half.

[George Holm:]

Yes, the only caveat I would give to that is, weather has a big impact as well. So, January although we haven't seen the numbers it will be a high expense number. Just because of the weather issues in customized, but that aside we expect to see the customized business get better.

[Ajay Jain:]

Okay, I just had one final question, I know George you mentioned that inbound freight costs were not that big of a deal for you as compared to some of your competitors, but I was still surprised by the growth in gross margin, I just want to confirm that inbound freight cost reflected in gross margin and SG&A on the outbound side, am I right, is that how you allocate the inbound outbound freight cost?

[George Holm:]

That's correct.

[Tom Ondrof:]

Yes, that’s correct.

[Ajay Jain:]

All right. Thank you.

[Tom Ondrof:]

Thanks.

[Operator:]

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

[Edward Kelly:]

Hi guys, just a quick follow-up on the inflation front, what’s the expectation here over the next few quarters, I mean it does seem like you're going to start to lap some of those costs, I don't know if sequentially you’re still seeing growth there and then obviously with freight and just kind of like overall labor pressure in the system, just curious as to how we should be thinking about the expectation around inflation going forward?

[George Holm:]

You know, we're thinking that inflation is going to stay in that 2 to 2.5 range that it is now. We just don't see anything that would change that.

[Edward Kelly:]

Okay. Great, thank you.

[George Holm:]

Thanks, Ed.

[Operator:]

Our final question comes from the line of Bob Summers of Macquarie.

[Bob Summers:]

Good morning guys. I wanted to come at the tax issue from a different with two questions. First, are you aware of what the tax structure of some of your private competitors look like and whether you now have an advantage on that basis? And then second, how - now as you look at M&A, does it change your approach acknowledging that, look, the EBITDA numbers of acquired or potentially acquired targets doesn't change, but you have a widening GAAP between that and potential earnings accretion? Does it change how you look at potential transactions now?

[Tom Ondrof:]

Well Bob, we will definitely continue to look at our deals as we’ve sort of the same metrics as we talked about before where they are accretive in initial year and then across the cost of capital over a sort of three-year period. It does raise the bar a bit, obviously with the map. So, that would be the change, but it will be the same metric just a slightly higher bar. In terms of the targets that we look at and their tax structures, the vast majority, I don’t know if George has talked to over the years, he’s in conversations with our family-owned businesses privately held. They minimize tax, they are run it to not [indiscernible] as little taxes as they can. So, I don't know yet, particularly if it’s going to be a big driver, tax has never been a driver in my experience from whether people sell or don't sell, so given that, I’m not sure this will have a big impact.

[Bob Summers:]

Let me ask the second part again, I mean, because you said, raises the bar, but to me it would open up the landscape more, or I'm thinking about it wrong. You can now get to accretion a lot easier than you could before?

[Tom Ondrof:]

No. But we would take this off-line, but I think cost of debt goes up as well because you are on this bigger tax yield. So, your accretion bar goes up.

[Bob Summers:]

Okay, alright fair enough.

[Operator:]

And that was our final question, I would now like to turn the floor back over to management for any additional or closing remarks.

[George Holm:]

Thank you everyone. Have a wonderful day.

[Operator:]

Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect.