US Foods Holding Corp. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis is intended to help the reader understand the Company, our financial condition and results of operations and our present business environment. It should be read together with our consolidated financial statements and related notes contained elsewhere in this Annual Report. The following discussion and analysis contain certain financial measures that are not required by, or presented in accordance with, GAAP. We believe these non-GAAP financial measures provide meaningful supplemental information about our operating performance and liquidity. Information regarding reconciliations of and the rationale for these measures is discussed in “Non-GAAP Reconciliations” below. The following includes a comparison of our consolidated results of operations for fiscal years 2020 and 2019. For a comparison of our consolidated results of operations for fiscal years 2019 and 2018, see Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, of our Annual Report on Form 10-K for the fiscal year ended December 28, 2019, filed with the SEC on February 13, 2020. COVID-19 In March 2020, the World Health Organization characterized a novel strain of coronavirus (“COVID-19”) as a pandemic amidst a rising number of confirmed cases and thousands of deaths worldwide. Since mid-March 2020, our business has been significantly impacted. In March 2020, many countries, including the United States, took steps to restrict travel, temporarily close or enforce capacity restrictions in businesses, schools and other public gathering spaces. Restrictions on public gatherings and attendance at retail or other establishments, including restaurants and recreational, sporting and other similar venues, continue to evolve and are expected to continue to remain in effect in some capacity until the COVID-19 pandemic has fully abated. These government mandates have forced many of our customers to seek government support in order to continue operating, to drastically curtail their dining options, to temporarily suspend operations or to cease operations entirely. In December 2020, two vaccines for COVID-19 were approved by the FDA and, as of the date hereof, a limited number of doses have been made available in the United States to certain frontline workers and at-risk individuals. However, it remains unclear when either of these vaccines or others will be widely available to the general American public. As a result, it remains unclear when and to what extent the COVID-19 pandemic will fully abate. Impact of COVID-19 on Our Business The COVID-19 pandemic has and continues to adversely impact our sales and liquidity position due to the slowdown in total case volume (and, in particular, restaurant, hospitality and education case volume). In mid-March 2020, the operations of our restaurant, hospitality and education customers were suddenly and significantly disrupted by the spread of COVID-19 and the corresponding decline in consumer demand for food prepared away from home. Since that time, many of our customers were required by governmental authorities to temporarily close locations or only offer limited dining options such as carryout and delivery in an effort to reduce the spread of COVID-19, while others temporarily closed locations voluntarily or ceased operations entirely due to decreased consumer demand. Many of these government mandates started to loosen in the summer of 2020 to varying degrees and our case volume decline improved accordingly. Restrictions remain in place in many parts of the United States and, in some jurisdictions, governmental authorities have reinstituted heightened restrictions in response to recent increases in COVID-19 cases. As a result of the COVID-19 pandemic and measures implemented to mitigate its spread, we have experienced decreased demand for our products, resulting in lower than anticipated Net sales and total case volumes beginning in mid-March 2020 through the second quarter of 2020. We saw some improvement in Net sales and total case volumes during the third quarter of 2020, as a result of loosened restrictions and shifts to outdoor dining; however, demand remained lower than 2019 levels for the corresponding periods. In the fourth quarter of 2020, increases in COVID-19 cases and the implementation of heightened restrictions on in-person dining in many markets, as well as other factors, resulted in a slowdown in the total case volume recovery trend that we saw in the third quarter of 2020. Total case volume decreased 11.0% for the 53 weeks ended January 2, 2021 compared to the 52 weeks ended December 28, 2019. Recent Activity and Sector Perspectives We are optimistic about the long-term prospects for our business. US Foods operates in a large and essential industry with a highly diversified set of end consumers. While some of our core customer groups (such as restaurants, hospitality and education) have been more significantly affected by the impacts of the COVID-19 pandemic, other customer groups (such as healthcare, government, retail and cash and carry) have been less significantly affected. Although the timetable for returning to normalcy is unknown, we believe that our case volumes will increase over time as vaccine distribution increases and the effects of the COVID-19 pandemic dissipate, consumer demand for food prepared away from home increases, educational institutions resume in-person learning, and the hospitality industry recovers. As one of the largest companies in our industry, we believe we are well positioned for long-term success as the fragmented nature of our industry and the current environment create new opportunities for companies with the size and resources of US Foods. We believe we are differentiated from many of our competitors on a number of fronts including our national footprint, diversified multi-channel 25 platform, strong technology capabilities and value-added service offerings, all of which have allowed us to continue to serve our customers during these unprecedented conditions. During these difficult times, we are proactively supporting our customers by helping our restaurant and hospitality customers adapt to social distancing restrictions with tools and resources to build and manage carryout and delivery capabilities. In light of the COVID-19 pandemic, we have developed additional innovative services, such as customer education webinars on the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”), assistance with recovery plans for location re-openings, and the creation of unique pantry kits to allow restaurants to continue servicing consumers. Our product development efforts remain in full force and we continue to deliver product innovations that resonate with our customers. In response to the COVID-19 pandemic and ensuing decrease in total case volume, we have evolved our business focus and cost structure. We have taken a number of steps to secure new customer relationships and expand our market share, reduce fixed and variable operating costs on a temporary and permanent basis, and strengthen our liquidity position. We also have the ability to take further cost reduction actions on a temporary basis depending upon the duration of the COVID-19 pandemic and its impact on our business, results of operations and financial condition. Even so, there is no certainty that such measures, or any additional actions that we may take in the future, will be successful in mitigating the impact of the pandemic on our business, results of operations or financial condition. On March 27, 2020, President Trump signed into law the CARES Act. The CARES Act, among other things, includes provisions relating to deferment of employer-side social security payments, net operating loss carryback periods, modifications to the net interest deduction limitations, technical corrections to tax depreciation methods for qualified improvement property and federally backed loans to qualifying small-businesses. US Foods has benefited from certain provisions under the CARES Act and many of our customers are benefiting from the federally backed small business loan program. In addition, on December 27, 2020, President Trump signed into law the Consolidated Appropriations Act, 2021 (the “December 2020 Relief Bill”). The December 2020 Relief Bill, among other things, expands the federally backed small business loan program that was introduced as part of the CARES Act, which we expect will further benefit many of our customers. It is currently unclear if or how US Foods may indirectly benefit from the December 2020 Relief Bill, but we continue to examine the impact of the December 2020 Relief Bill on our business, results of operations and financial condition. The impact of the COVID-19 pandemic is fluid and continues to evolve, and therefore, we cannot currently predict the extent to which our business, results of operations or financial condition will ultimately be impacted. In particular, we cannot predict the extent to which the COVID-19 pandemic will affect our business, results of operation or financial condition in the long term because the duration and severity of the pandemic and its negative impact on the economy (including our customers) is unclear. The impact of the COVID-19 pandemic on us will also be dependent on: the resiliency of the restaurant and hospitality industry and consumer spending more broadly; actions taken by national, state and local governments to contain the disease or treat its impact, including travel restrictions and bans, social distancing requirements, required closures of non-essential businesses and aid and economic stimulus efforts; widespread vaccination of the American public resulting in increased willingness by consumers to consume food away from home, travel and attend sporting and other events; and any prolonged economic recession resulting from the pandemic. Certain of our customers, particularly independent restaurants, have temporarily and, in some cases, permanently shut down their operations due to the adverse business consequences of the COVID-19 pandemic. In addition, although during the course of the pandemic many of our restaurant customers have pivoted their offerings to focus on carryout and delivery, in many markets the combination of colder weather during the winter season and restrictions on in-person dining will likely pose additional challenges to our restaurant customers in those markets. If our customers continue to face business challenges, more of them may permanently shut down, which would impact the demand for our services and have a material adverse effect on our business and results of operations. While economic and operating conditions for our business improved in the third quarter compared to the second quarter, we do not expect to see pre-COVID-19 levels of operation until all government restrictions are lifted and consumers are once again willing and able to resume consumption of food away from home, travel and attend sporting and other events on a regular basis. This recovery may not occur until well after the pandemic abates and the broader economy begins to improve. Operating Metrics Case growth —Case growth, by customer type (e.g., independent restaurants) is reported as of a point in time. Customers periodically are reclassified, based on changes in size or other characteristics, and when those changes occur, the respective customer’s historical volume follows its new classification. Organic growth —Organic growth includes growth from operating business that has been reflected in our results of operations for at least 12 months. Fiscal Year 2020 Highlights Financial Highlights —Total case volume decreased 11.0% in fiscal year 2020, and independent restaurant case volume decreased 11.2% in fiscal year 2020. Excluding the impact of the extra week in fiscal year 2020, total case volume decreased 12.5% in fiscal year 2020, and independent restaurant case volume decreased 12.7% in fiscal year 2020. Net sales decreased $3,054 million, or 11.8%, in fiscal year 2020 primarily due to the negative impact of COVID-19 on total case volumes, which was partially offset by contributions from the Food Group (which is included in our results for the full fiscal year 2020, and for fiscal year 2019, but only 26 from and after September 13, 2019) and Smart Foodservice (which is included in our results for fiscal year 2020, but only from and after April 24, 2020, and is not included in our results for fiscal year 2019). The Food Group and Smart Foodservice contributed aggregate Net sales of $3,112 million for fiscal year 2020. Net sales for the Food Group and Smart Foodservice were also impacted by the COVID-19 pandemic, albeit to different degrees. Gross profit decreased $868 million, or 18.9%, to $3,719 million in fiscal year 2020, primarily as a result of the negative impact of COVID-19 on Net sales, higher logistics costs, and COVID-19 related product donations and inventory adjustments, partially offset by contributions from the Food Group and Smart Foodservice. As a percentage of net sales, gross profit was 16.3% in fiscal year 2020, compared to 17.7% in fiscal year 2019. Total operating expenses decreased $92 million, or 2.4%, to $3,796 million in fiscal year 2020. The decrease was primarily due to the negative impact of COVID-19 on total case volume, the related impact of cost actions taken during fiscal year 2020, and a $17 million gain on the sale of excess land. These decreases were partially offset by a higher provision for doubtful accounts of $47 million due to the impact of COVID-19, operating expenses from the Food Group and Smart Foodservice, $30 million of restructuring costs associated with work force reductions, and $9 million of asset impairment charges on certain trade names acquired as part of the Food Group acquisition. Smart Foodservice Acquisition —On April 24, 2020, USF completed the acquisition of Smart Foodservice. Total consideration paid at the closing of the acquisition was $972 million (net of cash acquired). The acquisition of Smart Foodservice expands the Company’s cash and carry business in the West and Northwest parts of the U.S. The assets, liabilities and results of operations of Smart Foodservice have been included in our consolidated financial statements since the date the acquisition was completed. 27 Results of Operations The following table presents selected consolidated results of operations of our business for fiscal years 2020, 2019 and 2018: Fiscal Year 2020 2019 2018 (in millions) Consolidated Statements of Operations: Net sales $ 22,885 $ 25,939 $ 24,175 Cost of goods sold 19,166 21,352 19,869 Gross profit 3,719 4,587 4,306 Operating expenses: Distribution, selling and administrative costs 3,757 3,888 3,647 Restructuring costs and asset impairment charges 39 — 1 Total operating expenses 3,796 3,888 3,648 Operating (loss) income (77) 699 658 Other (income) expense—net (21) 4 (13) Interest expense—net 238 184 175 (Loss) income before income taxes (294) 511 496 Income tax (benefit) provision (68) 126 89 Net (loss) income (226) 385 407 Series A convertible preferred stock dividends 28 — — Net (loss) income available to common shareholders $ (254) $ 385 $ 407 Net (loss) income per share: Basic $ (1.15) $ 1.77 $ 1.88 Diluted $ (1.15) $ 1.75 $ 1.87 Weighted-average number of shares used in per share amounts: Basic 220 218 216 Diluted 220 220 218 Percentage of Net Sales: Gross profit 16.3 % 17.7 % 17.8 % Operating expenses 16.6 % 15.0 % 15.1 % Operating (loss) income (0.3) % 2.7 % 2.7 % Net (loss) income (1.0) % 1.5 % 1.7 % Adjusted EBITDA (1) 2.8 % 4.6 % 4.6 % Other Data: Cash flows—operating activities $ 413 $ 760 $ 609 Cash flows—investing activities (1,110) (1,987) (232) Cash flows—financing activities 1,427 1,220 (391) Capital expenditures 189 258 235 EBITDA (1) 366 1,057 1,011 Adjusted EBITDA (1) 648 1,194 1,103 Adjusted net income available to common shareholders (1) 20 523 472 Free cash flow (2) 224 502 374 (1) EBITDA is defined as net (loss) income, plus interest expense—net, income tax (benefit) provision, and depreciation and amortization. Adjusted EBITDA is defined as EBITDA adjusted for (1) restructuring costs and asset impairment charges; (2) share-based compensation expense; (3) the non-cash impact of last-in first-out (“LIFO”) reserve adjustments; (4) pension settlements; (5) business transformation costs; and (6) other gains, losses, or costs as specified in the agreements governing our indebtedness. Adjusted net income available to common shareholders is defined as net income excluding the items used to calculate Adjusted EBITDA listed above and further adjusted for the tax effect of the exclusions and discrete tax items and Series A convertible preferred stock dividends. EBITDA, Adjusted EBITDA, and Adjusted net income available to common shareholders as presented in this Annual Report are supplemental measures of our performance that are not required by, or presented in accordance with, accounting principles generally accepted in the U.S. (“GAAP”). They are not measurements of our performance under GAAP and should not be considered as alternatives to net income (loss) or any other performance measures derived in accordance with GAAP. For additional information, see the discussion under the caption “Non-GAAP Reconciliations” below. (2) Free cash flow is defined as cash flows provided by operating activities less cash capital expenditures. Free cash flow as presented in this Annual Report is a supplemental measure of our liquidity that is not required by, or presented in accordance with, GAAP. It is not a measure of our liquidity 28 under GAAP and should not be considered as an alternative to cash flows provided by operating activities, or any other liquidity measures derived in accordance with GAAP. For additional information, see the discussion under the caption “Non-GAAP Reconciliations” below. Non-GAAP Reconciliations We provide EBITDA, Adjusted EBITDA, Adjusted net income available to common shareholders and Free cash flow as supplemental measures to GAAP financial measures regarding our operating performance and liquidity. These non-GAAP financial measures, as defined above, exclude the impact of certain items and, therefore, have not been calculated in accordance with GAAP. We believe EBITDA and Adjusted EBITDA provide meaningful supplemental information about our operating performance because they exclude amounts that we do not consider part of our core operating results when assessing our performance. We believe that Adjusted net income available to common shareholders is a useful measure of operating performance for both management and investors because it excludes items that are not reflective of our core operating performance and provides an additional view of our operating performance including depreciation, interest expense, income taxes and Series A convertible preferred stock dividends on a consistent basis from period to period. We believe that Adjusted net income available to common shareholders may be used by investors, analysts and other interested parties to facilitate period-over-period comparisons and provides additional clarity as to how factors and trends impact our operating performance. Management uses these non-GAAP financial measures (1) to evaluate our historical and prospective financial performance as well as our performance relative to our competitors as they assist in highlighting trends, (2) to set internal sales targets and spending budgets, (3) to measure operational profitability and the accuracy of forecasting, (4) to assess financial discipline over operational expenditures, and (5) as an important factor in determining variable compensation for management and employees. EBITDA and Adjusted EBITDA are also used in connection with certain covenants and activity restrictions under the agreements governing our indebtedness. We also believe these and similar non-GAAP financial measures are frequently used by securities analysts, investors, and other interested parties to evaluate companies in our industry. EBITDA, Adjusted EBITDA and Adjusted net income available to common shareholders are not measurements of our performance under GAAP and should not be considered as alternatives to net income or any other performance measures derived in accordance with GAAP. We use Free cash flow as a supplemental measure to GAAP financial measures regarding the liquidity of our operations. We measure Free cash flow as cash flows provided by operating activities less cash capital expenditures. We believe that Free cash flow is a useful financial metric to assess our ability to pursue business opportunities and investments. Free cash flow is not a measure of our liquidity under GAAP and should not be considered as an alternative to cash flows provided by operating activities or any other liquidity measures derived in accordance with GAAP. We caution readers that amounts presented in accordance with our definitions of EBITDA, Adjusted EBITDA, Adjusted net income available to common shareholders, and Free cash flow may not be the same as similar measures used by other companies. Not all companies and analysts calculate EBITDA, Adjusted EBITDA, Adjusted net income available to common shareholders or Free cash flow in the same manner. We compensate for these limitations by using these non-GAAP financial measures as supplements to GAAP financial measures and by presenting the reconciliations of the non-GAAP financial measures to their most comparable GAAP financial measures. 29 The following table reconciles EBITDA, Adjusted EBITDA, Adjusted net income available to common shareholders and Free cash flow to the most directly comparable GAAP financial performance and liquidity measures for the periods indicated: Fiscal Year 2020 2019 2018 (in millions) Net (loss) income available to common shareholders $ (254) $ 385 $ 407 Series A convertible preferred stock dividends (see Note 16) 28 — — Net (loss) income (226) 385 407 Interest expense—net 238 184 175 Income tax (benefit) provision (68) 126 89 Depreciation expense 343 311 300 Amortization expense 79 51 40 EBITDA 366 1,057 1011 Adjustments: Restructuring costs and asset impairment charges (1) 39 — 1 Share-based compensation expense (2) 40 32 28 LIFO reserve adjustment (3) 25 22 — Pension settlements (4) — 12 — Business transformation costs (5) 22 9 22 COVID-19 bad debt expense (6) 47 — — COVID-19 product donations and inventory adjustments (7) 50 — — COVID-19 other related expenses (8) 13 — — Business acquisition and integrated related costs and other (9) 46 62 41 Adjusted EBITDA 648 1,194 1,103 Depreciation expense (343) (311) (300) Interest expense—net (238) (184) (175) Income tax provision, as adjusted (10) (19) (176) (156) Series A convertible preferred stock dividends 28 — — Adjusted net income available to common shareholders $ 20 $ 523 $ 472 Cash flow Cash flows from operating activities $ 413 $ 760 $ 609 Capital expenditures (189) (258) (235) Free cash flow $ 224 $ 502 $ 374 (1) Consists primarily of severance and related costs, organizational realignment costs and asset impairment charges. (2) Share-based compensation expense for expected vesting of stock awards and employee stock purchase plan. (3) Represents the non-cash impact of LIFO reserve adjustments. (4) Consists of settlement costs resulting from payments to settle benefit obligations with participants in our defined benefit pension plan. See Note 20, Retirement Plans, in our consolidated financial statements for a further description of the pension settlement costs for fiscal year 2019. (5) Consists primarily of costs related to significant process and systems redesign across multiple functions. (6) Includes the increase in reserve for doubtful accounts expense reflecting the collection risk associated with our customer base as a result of the COVID-19 pandemic. For the 53 weeks ended January 2, 2021 we had a total of $67 million of reserve for doubtful accounts expense. Management estimates that approximately $47 million of this reserve for doubtful accounts expense was attributable to the negative impact the COVID-19 pandemic had on many of our customers’operations during the 53 weeks ended January 2, 2021. This amount was derived by subtracting what management believes to be a reasonable estimate of what reserve for doubtful accounts expense would have been for the 53 week period ended January 2, 2021 had there been no COVID-19 outbreak from actual reserve for doubtful accounts expense for the relevant period. (7) Includes COVID-19 related expenses related to inventory adjustments and product donations. (8) Includes COVID-19 related costs that we are permitted to addback under certain agreements governing our indebtedness. (9) Includes: (i) Food Group acquisition and integration related costs of $24 million, $52 million and $29 million for fiscal years 2020, 2019 and 2018, respectively; (ii) Smart Foodservice acquisition and integration related costs of $21 million for fiscal year 2020; and (iii) other gains, losses or costs that we are permitted to addback for purposes of calculating Adjusted EBITDA under certain agreements governing our indebtedness. (10) Represents our income tax provision adjusted for the tax effect of pre-tax items excluded from Adjusted net income available to common shareholders and the removal of applicable discrete tax items. Applicable discrete tax items include changes in tax laws or rates, changes related to prior year unrecognized tax benefits, discrete changes in valuation allowances, excess tax benefits associated with share-based compensation, and the tax benefits recognized in continuing operations due to the existence of a gain in other comprehensive income and loss in continuing operations. The tax effect of pre-tax items excluded from Adjusted net income available to common shareholders is computed using a statutory tax rate after taking into account the impact of permanent differences and valuation allowances. 30 A reconciliation between the GAAP income tax (benefit) provision and the income tax provision, as adjusted, is as follows: Fiscal Year 2020 2019 2018 (in millions) GAAP income tax (benefit) provision $ (68) $ 126 $ 89 Tax impact of pre-tax income adjustments 92 47 32 Discrete tax items (5) 3 35 Income tax provision, as adjusted $ 19 $ 176 $ 156 Comparison of Results Fiscal Years Ended January 2, 2021 and December 28, 2019 Highlights • Total case volume decreased 11.0% in fiscal year 2020, and independent restaurant case volume decreased 11.2% in fiscal year 2020. Excluding the impact of the extra week in fiscal year 2020, total case volume decreased 12.5% in fiscal year 2020, and independent restaurant case volume decreased 12.7% in fiscal year 2020. • Net sales decreased $3,054 million, or 11.8% to $22,885 million in fiscal year 2020. • Operating loss was $77 million in fiscal year 2020, compared to operating income of $699 million in fiscal year 2019. As a percentage of net sales, operating loss was 0.3% in fiscal year 2020, and operating income was 2.7% in fiscal year 2019. • Net loss was $226 million in fiscal year 2020, compared to net income of $385 million in fiscal year 2019. • Adjusted EBITDA decreased $546 million, or 45.7%, to $648 million in fiscal year 2020. As a percentage of net sales, Adjusted EBITDA was 2.8% in fiscal year 2020, as compared to 4.6% in fiscal year 2019. Net Sales Total case volume decreased 11.0% in fiscal year 2020. Excluding the impact of the extra week in fiscal year 2020, total case volume decreased 12.5% in fiscal year 2020. The decrease was due to the negative impact of COVID-19 on total case volume which was partially offset by contributions from the Food Group and Smart Foodservice. Organic case volume decreased 21.3% in fiscal year 2020, and organic independent restaurant case volume decreased 20.8% in fiscal year 2020. Excluding the impact of the extra week in fiscal year 2020, organic case volume decreased 22.6% in fiscal year 2020, and organic independent restaurant case volume decreased 22.2% in fiscal year 2020. Net sales decreased $3,054 million, or 11.8%, to $22,885 million in fiscal year 2020, comprised of a $2,866 million, or 11.0%, decrease in total case volume and a $188 million, or 0.8%, decrease in the overall Net sales rate per case. The decrease in the Net sales rate per case primarily reflects changes in our product mix, partially offset by an year-over-year inflation increase of 1.9% in multiple product categories including beef, cheese and disposables. The year-over-year increase in inflation benefited Net sales since a significant portion of our Net sales is based on a pre-established markup over product cost. Sales of our private brands represented approximately 34% and 35% of Net sales in fiscal years 2020 and 2019, respectively. The Food Group and Smart Foodservice contributed aggregate Net sales of $3,112 million for fiscal year 2020. Gross Profit Gross profit decreased $868 million, or 18.9%, to $3,719 million in fiscal year 2020, primarily as a result of the negative impact of COVID-19 on total case volume, higher logistics costs, $50 million of COVID-19 related product donations and inventory adjustments, and unfavorable year-over-year LIFO adjustments, which were partially offset by contributions from the Food Group and Smart Foodservice. Our LIFO method of inventory costing resulted in expense of $25 million in fiscal year 2020, compared to expense of $22 million in fiscal year 2019. Gross profit as a percentage of net sales was 16.3% in fiscal year 2020, compared to 17.7% in fiscal year 2019. 31 Operating Expenses Operating expenses, comprised of distribution, selling and administrative costs and restructuring costs and asset impairment charges, decreased $92 million, or 2.4%, to $3,796 million in fiscal year 2020. Operating expenses as a percentage of net sales were 16.6% in fiscal year 2020, compared to 15.0% in fiscal year 2019. The decrease in operating expenses is primarily due to the negative impact of COVID-19 on total case volume, the related impact of cost actions put into place, and a $17 million gain on the sale of excess land. These decreases were partially offset by operating expenses for the Food Group and Smart Foodservice of $514 million, a $47 million increase in the provision for doubtful accounts reflecting the collection risk associated with our customer base as a result of COVID-19, $30 million of restructuring costs associated with work force reductions, and $9 million of asset impairment charges. The $9 million of asset impairment charges relate to the decline in fair value of certain trade names acquired as part of the Food Group acquisition primarily due to the adverse impact of COVID-19 on forecasted earnings and the discount rate utilized in our valuation models. Operating (Loss) Income Our operating loss was $77 million in fiscal year 2020, compared to operating income of $699 million in fiscal year 2019. Operating loss as a percentage of Net sales was 0.3% in fiscal year 2020, while operating income as a percentage of Net sales was 2.7% in fiscal year 2019. The decrease in operating income was due to the factors discussed in the relevant sections above. Other (Income) Expense—Net Other (income) expense—net includes components of net periodic benefit costs (credits), exclusive of the service cost component associated with our defined benefit and other postretirement plans. We recognized other income—net of $21 million in fiscal year 2020, primarily due to the improved funded status of our defined benefit pension plan as of December 28, 2019. We recognized other expense—net of $4 million in fiscal year 2019, including $12 million of non-cash settlement costs resulting from payments to settle benefit obligations with participants in our defined benefit pension plan. Interest Expense—Net Interest expense—net increased $54 million in fiscal year 2020, primarily due to an increase in our indebtedness to finance the Food Group and Smart Foodservice acquisitions and to strengthen our liquidity position at the onset of the COVID-19 pandemic, which were partially offset by a decrease in benchmark interest rates in fiscal year 2020 as compared to fiscal year 2019. Income Taxes Our effective income tax rate for fiscal year 2020 of 23% varied from the 21% federal corporate income tax rate, primarily as a result of state income taxes and the recognition of various discrete tax items. These discrete tax items included a tax expense of $2 million primarily related to an increase in an unrecognized tax benefit and a tax expense of $1 million, primarily related to a tax benefit shortfall associated with share-based compensation. Our effective income tax rate for fiscal year 2019 of 25% varied from the 21% federal corporate income tax rate, primarily as a result of state income taxes and the recognition of various discrete tax items. These discrete tax items included a tax benefit of $4 million primarily related to excess tax benefits associated with share-based compensation. Net (Loss) Income Our net loss was $226 million in fiscal year 2020, compared to net income of $385 million in fiscal year 2019. The decrease in net income was due to the relevant factors discussed above. Liquidity and Capital Resources Our ongoing operations and strategic objectives require working capital and continuing capital investment. Our primary sources of liquidity include cash provided by operations, as well as access to capital from bank borrowings and other types of debt and financing arrangements. In response to the impact of the COVID-19 pandemic, in fiscal year 2020 and early 2021, we took actions aimed at strengthening our liquidity by increasing cash on hand and preserving financial flexibility in light of the economic and business uncertainty resulting from the pandemic. In particular: • in March 2020, we borrowed an aggregate of $300 million under the former accounts receivable financing facility (the “ABS Facility”) and $700 million under the ABL Facility; • on April 24, 2020, we borrowed an aggregate principal amount of $700 million under the 2020 Incremental Term Loan Facility, the proceeds of which were used to finance, in part, the Smart Foodservice acquisition; 32 • on April 28, 2020, we issued $1.0 billion aggregate principal amount of 6.25% Senior Secured Notes due 2025 (the “Secured Notes”), the proceeds of which were used to repay $400 million in principal amount of the 2020 Incremental Term Loan Facility and the balance of the net proceeds were used for general corporate purposes; • on May 1, 2020, we used $542 million of cash on hand to repay all of our outstanding borrowings under the ABS Facility in full and terminated the ABS Facility; in connection with the repayment and termination of the ABS Facility, we transitioned the accounts receivable that secured the ABS Facility to the collateral pool that secures the ABL Facility; • on May 4, 2020, we entered into an amendment to the credit agreement governing the ABL Facility pursuant to which certain of our lenders agreed to increase their aggregate commitments by $390 million to a total commitment of $1,990 million; • on May 6, 2020, we completed the issuance and sale of 500,000 shares of our Series A Preferred Stock to KKR for an aggregate price of $500 million, the proceeds of which were used for working capital and general corporate purposes; and • on February 4, 2021, we issued $900 million aggregate principal amount of 4.75% Senior Notes due 2029 (the “Unsecured Notes due 2029”), the proceeds of which were used, together with cash on hand, to (i) redeem all of the then outstanding Unsecured Notes due 2024, (ii) repay all of the then outstanding borrowings under the 2020 Incremental Term Facility and (iii) pay related fees and expenses. After giving effect to the transactions described above, we believe that we will have sufficient liquidity to fund our operations and meet ordinary course obligations through 2022 even if total case volumes remain unchanged from current levels. We cannot, however, assure you that this will be the case. We may pursue additional capital raise transactions at some point in the future if we determine that it would be advisable to further strengthen our liquidity position. We make no assurance, however, that we will be able to raise any additional capital in the future on satisfactory terms or at all. Our continued access to sources of liquidity depends on multiple factors, including economic conditions, the condition of financial markets, the availability of sufficient amounts of financing, our operating performance and our credit ratings. Two rating agencies downgraded our credit ratings in May and September 2020, respectively. Our access to additional capital and the cost of any future financing transactions could be negatively impacted by these downgrades or any future downgrade or if financing sources were to ascribe higher credit risk to us or our industry. In addition, the COVID-19 pandemic has previously adversely affected, and in the future may again adversely affect, the availability of liquidity generally in the capital markets. If in the future the COVID-19 pandemic has an adverse effect on the availability of liquidity generally in the capital markets that could significantly impact our future cost of borrowing and the availability of additional capital to us. Indebtedness The aggregate carrying value of our indebtedness was $5,748 million, net of $60 million of unamortized deferred financing costs, as of January 2, 2021. As discussed above, on May 1, 2020 we terminated the ABS Facility and transitioned the accounts receivable that secured the ABS Facility to the collateral pool that secures the ABL Facility and, on May 4, 2020, we entered into an amendment to our ABL Facility which increased the aggregate commitments by $390 million to a total commitment of $1,990 million. This transition increases the size of the borrowing base under the ABL Facility. We had no outstanding borrowings and had issued letters of credit totaling $281 million under the ABL Facility as of January 2, 2021. There was remaining capacity of $1,584 million under the ABL Facility based on our borrowing base as of January 2, 2021. The Initial Term Loan Facility had a carrying value of $2,098 million, net of $3 million of unamortized deferred financing costs, as of January 2, 2021. The 2019 Incremental Term Loan Facility had a carrying value of $1,451 million, net of $30 million of unamortized deferred financing costs, as of January 2, 2021. The 2020 Incremental Term Loan Facility had a carrying value of $284 million, net of $11 million of unamortized deferred financing costs, as of January 2, 2021. The Secured Notes had a carrying value of $987 million, net of $13 million of unamortized deferred financing costs, as of January 2, 2021. USF’s 5.875% Senior Notes due 2024 (the “Unsecured Senior Notes due 2024”) had a carrying value of $597 million, net of $3 million of unamortized deferred financing costs, as of January 2, 2021. We also had $323 million of obligations under financing leases for transportation equipment and building leases as of January 2, 2021. The ABL Facility will mature in 2024 . The Initial Term Loan Facility and the 2019 Incremental Term Loan Facility will mature in 2023 and 2026, respectively. The Secured Notes will mature in 2025. We used the proceeds from the Unsecured Senior Notes due 2029, together with cash on hand, to redeem all of the then outstanding Unsecured Senior Notes due 2024 and repay all of the then outstanding borrowings under the 2020 Incremental Term Loan Facility, as further discussed in Note 27, Subsequent Events. As economic conditions permit, we will consider opportunities to repurchase, refinance or otherwise reduce our debt obligations on favorable terms. Any potential debt reduction or refinancing could require significant use of our other available liquidity and capital resources. We believe that the combination of cash generated from operations, together with borrowing capacity under the agreements governing our indebtedness and other financing arrangements, will be adequate to permit us to meet our debt service obligations, ongoing costs of operations, working capital needs, and capital expenditure requirements for the next 12 months. 33 The agreements governing our indebtedness contain customary covenants. These include, among other things, covenants that restrict our ability to incur certain additional indebtedness, create or permit liens on our assets, pay dividends, or engage in mergers or consolidations. For additional information, see Item 1A of Part I, “Risk Factors-Risks Relating to Our Indebtedness.” USF had approximately $1.3 billion of restricted payment capacity under these covenants and approximately $2.8 billion of its net assets were restricted after taking into consideration the net deferred tax assets and intercompany balances that eliminate in consolidation as of January 2, 2021. Every quarter, we review rating agency changes for all of the lenders that have a continuing obligation to provide us with funding. We are not aware of any facts that indicate our lenders will not be able to comply with the contractual terms of their agreements with us. We continue to monitor the credit markets generally and the strength of our lender counterparties. From time to time, we repurchase or otherwise retire our debt and take other steps to reduce our debt or otherwise improve our leverage. These actions may include open market repurchases, negotiated repurchases, and other retirements of outstanding debt. The amount of debt that may be repurchased or otherwise retired, if any, will depend on market conditions, our debt trading levels, our cash position, and other considerations. See Note 13, Debt, in our consolidated financial statements for a further description of our indebtedness. Cash Flows The following table presents condensed highlights from our Consolidated Statements of Cash Flows for fiscal years 2020 and 2019: Fiscal Year 2020 2019 (in millions) Net (loss) income $ (226) $ 385 Changes in operating assets and liabilities 154 (54) Other adjustments 485 429 Net cash provided by operating activities 413 760 Net cash used in investing activities (1,110) (1,987) Net cash provided by financing activities 1,427 1,220 Net increase (decrease) in cash, cash equivalents and restricted cash 730 (7) Cash, cash equivalents and restricted cash—beginning of year 98 105 Cash, cash equivalents and restricted cash—end of year $ 828 $ 98 Operating Activities Cash flows provided by operating activities decreased $347 million to $413 million in fiscal year 2020. The year-over-year decrease was primarily attributable to the decline in operating results driven by the impact of COVID-19 on our results, and the associated impact on the Company’s working capital requirements resulting from lower total case volume and lower inventories. Investing Activities Cash flows used in investing activities in fiscal year 2020 included the $972 million cash purchase price for the acquisition of Smart Foodservice and cash expenditures of $189 million for fleet replacement and investments in information technology, as well as new construction and/or expansion of distribution facilities. Cash flows used in investing activities in fiscal year 2019 included the $1.8 billion cash purchase price for the acquisition of the Food Group and cash expenditures of $258 million for fleet replacement and investments in information technology, as well as new construction and expansion of distribution facilities. During fiscal year 2019, we sold three Food Group distribution facilities for aggregate proceeds of $94 million and sold certain excess properties for aggregate proceeds of $6 million during fiscal year 2019. We expect total cash capital expenditures in fiscal year 2021 to be between $290 million and $305 million, exclusive of approximately $35 million to $45 million of capital expenditures under our fleet financing leases. We expect to fund our capital expenditures with available cash or cash generated from operations and through fleet financing. Financing Activities Cash flows provided by financing activities in fiscal year 2020 included aggregate borrowings of $700 million under the 2020 Incremental Term Loan Facility, the proceeds of which were used to finance, in part, the Smart Foodservice acquisition; $1.0 billion of gross proceeds from the issuance of the Secured Notes; and $500 million of proceeds, net of $9 million of related fees, from the issuance and sale of 500,000 shares of our Series A Preferred Stock. Cash flows used by financing activities in fiscal year 2020 included $158 million of scheduled payments under our Term Loan Facilities and financing leases. We borrowed an aggregate of $1.0 34 billion under the ABL Facility and ABS Facility in March 2020 for the purposes of increasing cash on hand and to preserve financial flexibility in light of the current economic and business uncertainty resulting from the onset of the COVID-19 pandemic. With the improvement in total case volume as well as cash generated in the second half of fiscal 2020, we were able to repay the entire outstanding balance of the ABL Facility by January 2, 2021. We used part of the proceeds from the issuance of the Secured Notes to repay $400 million of borrowings under the 2020 Incremental Term Loan Facility, and we used $542 million of cash on hand to repay all of our outstanding borrowings under the ABS Facility, which we then subsequently terminated. We incurred approximately $33 million of lender fees and third-party costs in connection with the aforementioned financing transactions. Cash flows from financing activities in fiscal year 2020 also included $18 million of proceeds received from stock purchases under our employee stock purchase plan and $3 million of proceeds from the exercise of employee stock options, which were partially offset by $5 million of employee tax withholdings paid in connection with the vesting of stock awards. Cash flows provided by financing activities in fiscal year 2019 included aggregate borrowings of $1.5 billion under the 2019 Incremental Term Loan Facility and approximately $330 million in borrowings under the ABL Facility and ABS Facility, which were used to finance the acquisition of the Food Group. Cash flows used in financing activities in fiscal year 2019 included net payments of $166 million under the ABL Facility and ABS Facility and $116 million of scheduled payments under our Term Loan Facilities and financing leases. We incurred approximately $44 million of lender fees and third-party costs in connection with the 2019 Incremental Term Loan Facility and the ABL Facility refinancing transaction. Financing activities in fiscal year 2019 also included $19 million of proceeds received from stock purchases under our employee stock purchase plan and $19 million of proceeds from the exercise of employee stock options, which were partially offset by $5 million of employee tax withholdings paid in connection with the vesting of stock awards. Retirement Plans We sponsor a defined benefit plan that pays benefits to eligible employees at retirement. In addition, we provide certain postretirement health and welfare benefits to eligible retirees and their dependents. We did not make significant contributions to the Company-sponsored defined benefit and other postretirement plans in fiscal years 2020 and 2019, and we do not expect to make significant contributions in fiscal year 2021. As described in Note 20, Retirement Plans, in our consolidated financial statements, in the fourth quarter of fiscal year 2019, we completed a voluntary lump sum settlement offer to certain terminated defined benefit plan participants. In addition, in the fourth quarter of fiscal year 2019, we also completed a spin-off of certain active participants with small accrued benefits and retirees into a separate defined benefit plan and immediately terminated that plan. Those participants were able to elect to receive immediate lump sum payouts, with any remaining liabilities transferred to an insurance company through the purchase of an annuity contract. Pension obligation settlement payments of $66 million related to these transactions, consisting of lump sum payments and purchased annuities, were paid from plan assets. Certain employees are eligible to participate in our 401(k) savings plan. We made employer matching contributions to the 401(k) plan of $47 million and $51 million in fiscal years 2020 and 2019, respectively. We also are required to contribute to various multiemployer pension plans under the terms of certain of our CBAs. Our contributions to these plans were $44 million and $38 million in fiscal years 2020 and 2019, respectively. Contractual Obligations The following table includes information about our significant contractual obligations as of January 2, 2021 that affect our liquidity and capital needs. The table includes information about payments due under specified contractual obligations and the maturity profile of our consolidated debt, operating leases and other long-term liabilities. Payments Due by Period Less Than More Than Total 1 Year 1-3 Years 3-5 Years 5 Years Recorded Contractual Obligations: Debt, including financing lease obligations $ 5,808 $ 131 $ 2,267 $ 1,969 $ 1,441 Operating lease obligations 427 57 118 77 175 Self-insured liabilities (1) 176 43 51 23 59 Pension plans and other postretirement benefits contributions (2) 7 1 2 2 2 Unrecorded Contractual Obligations: Interest payments on debt (3) 828 211 384 206 27 Multiemployer contractual minimum pension contributions (4) 12 4 8 — — Purchase obligations (5) 1,667 1,643 24 — — Total contractual cash obligations $ 8,925 $ 2,090 $ 2,854 $ 2,277 $ 1,704 35 (1) Represents the estimated undiscounted payments on our self-insurance programs for general, fleet and workers compensation liabilities. Actual payments may differ from these estimates. (2) Represents estimated contributions for Company-sponsored defined benefit plan and benefit payments under other Company-sponsored postretirement benefit plans. Estimated contributions beyond fiscal year 2021 are not available for the Company ’ s defined benefit plan. (3) Represents future interest payments on fixed rate debt, financing leases and $3.3 billion of variable rate debt at interest rates as of January 2, 2021. The amounts shown in the table include interest payments under interest rate swap agreements. (4) Represents minimum contributions to the Central States Teamsters Southeast and Southwest Area Pension Fund through fiscal year 2023. (5) Represents purchase obligations for purchases of product in the normal course of business, for which all significant terms have been confirmed, information technology commitments and forward fuel and electricity purchase obligations. The balance does not include fiscal year 2021 capital expenditures expected to be between $290 million to $305 million, exclusive of approximately $35 million to $45 million of capital expenditures under our fleet financing leases. See “Investing Activities” above. Other long-term liabilities as of January 2, 2021, as disclosed in Note 14, Accrued Expenses and Other Long-Term Liabilities, in our consolidated financial statements, consist primarily of an uncertain tax position liability of $33 million, inclusive of interest and penalties, for which the timing of payment is uncertain. Off-Balance Sheet Arrangements We had entered into $281 million of letters of credit, primarily in favor of certain commercial insurers to secure obligations with respect to our insurance programs, under the ABL Facility as of January 2, 2021. Except as disclosed above, we have no off-balance sheet arrangements that currently have or are reasonably likely to have a material effect on our consolidated financial condition, changes in financial condition, results of operations, liquidity, capital expenditures or capital resources. Critical Accounting Policies and Estimates Except as otherwise set forth, we have prepared the financial information in this Annual Report in accordance with GAAP. Preparing these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during these reporting periods. We base our estimates and judgments on historical experience and other factors we believe are reasonable under the circumstances. These assumptions form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Our most critical accounting policies and estimates pertain to the valuation of goodwill and other intangible assets, vendor consideration and income taxes. Valuation of Goodwill and Other Intangible Assets Goodwill and other intangible assets include the cost of the acquired business in excess of the fair value of the tangible net assets recorded in connection with each acquisition. Other intangible assets include customer relationships, amortizable trade names, non-compete agreements, the brand names comprising our portfolio of private brands, and trademarks. We assess goodwill and other intangible assets with indefinite lives for impairment each year, or more frequently if events or changes in circumstances indicate an asset may be impaired. For goodwill and indefinite-lived intangible assets, our policy is to assess for impairment as of the beginning of each fiscal third quarter. For other intangible assets with definite lives, we assess for impairment only if events occur that indicate that the carrying amount of an asset may not be recoverable. For goodwill, the reporting unit used in assessing impairment is the Company’s one business segment as described in Note 26, Business Information, in our consolidated financial statements. Our assessment for impairment of goodwill utilized a discounted cash flow analysis to determine the fair value of the reporting unit for comparison to the corresponding carrying value. Based on our fiscal year 2020 annual impairment analysis for goodwill, we concluded that it is more likely than not that the fair value of goodwill exceeded its carrying value. Our fair value estimates of the brand name and trademark indefinite-lived intangible assets are based on a relief from royalty method. The fair value of each intangible asset is determined for comparison to the corresponding carrying value. If the carrying value of the asset exceeds its fair value, an impairment loss is recognized in an amount equal to the excess. Due to the adverse impacts of the COVID-19 pandemic on forecasted earnings and the discount rate utilized in our valuation models, in fiscal year 2020, the Company recognized impairment charges of $ 9 million related to two trade names acquired as part of the Food Group acquisition, which was included in restructuring costs and asset impairment charges in the Company’s Consolidated Statement of Comprehensive Income. Key assumptions used in the relief from royalty method included the long-term growth rates of future revenues, the royalty rate for such revenue, and a discount rate. No other impairments were noted as part of our fiscal year 2020 annual impairment assessment. 36 Due to the many variables inherent in estimating fair value and the relative size of the goodwill and indefinite-lived intangible assets, differences in assumptions could have a material effect on the results of the Company’s impairment analysis in future periods. Vendor Consideration We participate in various rebate and promotional incentives with our suppliers, primarily through purchase-based programs. The amount and timing of recognition of consideration under these incentives requires management judgment and estimates. Consideration under these incentives is estimated during the year based on historical and forecasted purchasing activity, as our obligations under the programs are fulfilled primarily when products are purchased. Consideration is typically received in the form of invoice deductions, or less often in the form of cash payments. Changes in the estimated amount of incentives earned are treated as changes in estimates and are recognized in the period of change. Historically, adjustments to our estimates for vendor consideration or related allowances have not been significant, and we do not expect adjustments to our estimates for vendor consideration or related allowances to be significant in the next 12 months. Income Taxes We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the consolidated financial statements. Under this method, deferred tax assets and liabilities are determined based on the differences between the consolidated financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. We record net deferred tax assets to the extent we believe these assets will more likely than not be realized. An uncertain tax position is recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Uncertain tax positions are recorded at the largest amount that is more likely than not to be sustained. We adjust the amounts recorded for uncertain tax positions when our judgment changes as a result of the evaluation of new information not previously available. These differences are reflected as increases or decreases to income tax expense in the period in which they are determined. The Company does not expect the liability for unrecognized tax benefits to change significantly in the next 12 months. Our uncertain tax positions contain uncertainties because management is required to make assumptions and to apply judgment in estimating the exposures associated with our various filing positions. We believe that the judgments and estimates discussed herein are reasonable; however, actual results could differ, and we may be exposed to losses or gains that could be material. To the extent we prevail in matters for which an uncertain tax position has been established, or pay amounts in excess of recorded positions, our effective income tax rate could be materially affected. An unfavorable tax settlement would generally require use of our cash and may result in an increase in our effective tax rate in the period of resolution. A favorable tax settlement may be recognized as a reduction in our effective income tax rate in the period of resolution. Recent Accounting Pronouncements For a discussion of recent accounting pronouncements, see Note 3, Recent Accounting Pronouncements, in our consolidated financial statements.