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Edited Transcript of USFD earnings conference call or presentation 5-Nov-19 3:00pm GMT

Q3 2019 US Foods Holding Corp Earnings Call

Rosemont Nov 10, 2019 (Thomson StreetEvents) -- Edited Transcript of US Foods Holding Corp earnings conference call or presentation Tuesday, November 5, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Dirk J. Locascio

US Foods Holding Corp. - CFO

* Melissa Napier

US Foods Holding Corp. - Senior VP of IR & Treasurer

* Pietro Satriano

US Foods Holding Corp. - Chairman & CEO

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Conference Call Participants

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* Blake Anderson

Jefferies LLC, Research Division - Equity Associate

* Jeffrey Andrew Bernstein

Barclays Bank PLC, Research Division - Director & Senior Equity Research Analyst

* John William Ivankoe

JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst

* Marisa Sullivan

BofA Merrill Lynch, Research Division - Research Analyst

* Rebecca Scheuneman

Morningstar Inc., Research Division - Equity Analyst

* Sooyeon Chang

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* Stephen Charles Kovalsky

Guggenheim Securities, LLC, Research Division - Associate

* Stephen Robert Caputo

BMO Capital Markets Equity Research - Associate

* Yunhee Park

Crédit Suisse AG, Research Division - Research Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by and welcome to the US Foods Third Quarter Business Performance Update.

(Operator Instructions)

Please be advised that today's conference is being recorded. Thank you.

I would now like to hand the call over to your speaker today, Ms. Melissa Napier. Please go ahead.

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Melissa Napier, US Foods Holding Corp. - Senior VP of IR & Treasurer [2]

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Thank you, Grace. Good morning, everyone. Welcome to our Third Quarter Fiscal Year 2019 Conference Call. Joining me for today's call are Pietro Satriano, our CEO; and Dirk Locascio, our CFO. Pietro and Dirk will provide an update on our results for the third quarter and the first 9 months of fiscal 2019. We'll take your questions after our prepared remarks conclude.

(Operator Instructions)

During today's call and unless otherwise stated, we're comparing our third quarter results to the same period in fiscal year 2018. Our earnings release issued earlier this morning and today's presentation slides can be accessed on the Investor Relations page of our website. Also, during today's call, we will refer to certain organic financial results. Organic results exclude contributions from SGA's Food Group of Companies, which we will refer to as the Food Group. Food Group acquisition was closed on September 13, 2019, and is included in our financial results from this date through the end of the third quarter.

In addition to historical information, certain statements made during today's call are considered forward-looking statements. Please review the risk factors in our latest Form 10-K filed with the SEC for these potential factors, which could cause actual results to differ materially from those expressed or implied in these statements. And lastly, I'd like to remind you that during today's call, we will refer to certain non-GAAP financial measures. All reconciliations to the most comparable GAAP financial measures are included in the schedules on our earnings press release.

And now I'll turn the call over to Pietro.

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Pietro Satriano, US Foods Holding Corp. - Chairman & CEO [3]

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Thanks, Melissa, and good morning to everyone. We'll begin our third quarter earnings call on Slide 2 with an overview of this quarter's results.

First, as Melissa mentioned, we completed the acquisition of the Food Group, and with the divestitures behind us, our integration efforts are off to a good start. I'd also like to take this opportunity to welcome the 3,000 Food Group associates to US Foods.

Our core business continued to deliver both volume and profit growth. Case growth for the quarter was 3%, while organic case growth was 0.9%, led by organic independent restaurant growth of 4.2%. We expanded our operating leverage for the 15th consecutive quarter. In this quarter, gross profit per case exceeded operating expense per case by $0.09. Growth in private brands and strong freight performance were the main contributors to the gross profit per case expansion, while distribution costs remained in line with our full year expectations.

Our focus on profitable growth helped deliver organic adjusted EBITDA growth of 6.7% or 8.5% when we include the 2 weeks of the Food Group into our results. Lastly, we are raising our adjusted EBITDA guidance and now expect to deliver 6% organic adjusted EBITDA growth for fiscal 2019.

Moving to Slide 3. Let's now take a closer look at our volume growth for the quarter. As I mentioned, total organic case growth was 90 basis points up for the quarter, driven by organic independent restaurant growth of 4.2%. The growth with independent restaurants was solid, albeit down slightly from the first half. We attribute this to a combination of a slight slowdown in the industry and selected markets slowing down. We expect fourth quarter volume growth with independent restaurants to be in line with our Q3 results and for full year results to be at the midpoint of the 4% to 5% guidance we gave earlier this year.

Our outlook for independents remained strong, and we expect to continue to profitably gain share while growing at roughly twice the market using Technomic's most recent market forecast of roughly 2%.

Continuing on Slide 3. Organic health care and hospitality volume was up 60 basis points for the quarter. Our growth was impacted by the loss of a large hospitality customer during the quarter, which means that growth for the fourth quarter will be slightly above flat and around 1% for the year. Having said that, we continue to feel good about our position with these group of customers and the strengthening pipeline leave us confident that we will improve growth in health care and hospitality customers in the new year.

Last in our discussion is volume for Q3. Organic growth with the all other group of customers was down 90 basis points, consistent with the decline in same-store sales that we saw Black Box report for this quarter. We also experienced some minor delays in onboarding some new chain business, business that is now shipping. And so as a result, we do expect positive case growth for the fourth quarter and roughly flat case growth for the full year. Overall, in terms of the macro environment, we see no change on the horizon, and the competitive environment remains stable.

Let's now turn to Slide 4. Our profitable growth with independent restaurants does demonstrate that our Great Food. Made Easy. strategy continues to resonate with customers, so I'd like to take a minute or so to update you on our continued innovation on that front.

Let's start on the left-hand side of the page with an update on the long-standing pillars of our strategy, product innovation and e-commerce. We now have 61% of independent restaurant sales and more than 70% of total sales coming through our e-commerce site. Recently completed research that we commissioned indicates that US Foods' online ordering tools continue to be rated the easiest to use in the industry, and that same research indicates that online ordering continues to grow in importance for customers. We believe that our technology remains a key differentiator and a competitive advantage for us.

Scoop serves as a high-profile platform for us to launch new, innovative products under our private brands. If you'll recall, our Summer Scoop focused on products that help operators meet the growing demand for on-the-go dining, such as compostable takeout containers, and it delivered a trial rate of 42%. This was our third consecutive launch where the trial rate of our exclusive and innovative products was over 40%. Our Fall Scoop, which launched in September, highlights global flavors and foods, and many of the products were developed in collaboration with chefs renowned for pioneering work in their respective cuisine. And finally, we continued to expand private brands as a percentage of net sales at a rate of approximately 100 basis points per year. In this quarter, 36% of net sales dollars came from our private brands products.

Let's move to the right-hand side of this page where I'd like to give an update on our more recent efforts to create an omnichannel approach that complements our Great Food. Made Easy. strategy.

Pronto. Pronto allows us to reach customers in dense urban areas that are not easily serviced with larger trucks. Pronto uses vans and smaller straight trucks, which are able to more easily maneuver around crowded areas like Miami Beach and allow us to meet the requirements for smaller job sizes in these dense areas. Pronto is helping us attract new independent restaurant customers in these markets. If you remember, we piloted Pronto in 2018. We've now expanded service from 3 to 8 markets in 2019. We're pleased with the results, and we plan to continue to expand Pronto to new markets in 2020.

Second is US Foods Direct, which we rolled out nationally to independent customers in August. This provides our customers with access to an endless aisle of products not stocked in our local warehouses. Customers can access 25,000 items in addition to the 10,000 that a typical DC might provide, and our goal is to continue to add categories and vendors to this platform. Customers like the ease-of-use, they can order the product while placing their regular orders and it's drop-shipped directly to their locations. And we like the model because it is a no-touch model, which allows us to compete more effectively with specialty distributors.

The third leg of our omnichannel strategy is CHEF'STORE, our cash-and-carry channel. These retail locations allow us to increase our share of wallet with existing customers while also reaching new customers. Our original 4 stores, all of which have been open several years, continue to show same-store sales increases in the high single digits, while our newest stores continue to prove the merits of this omnichannel approach. Existing customers not only buy from this channel but increase their purchases that are delivered from us. With this success, we're planning to add to our footprint in the coming years.

I'm now on Slide 5. We completed the acquisition of the Food Group in September and completed the mandated divestitures of the 3 facilities in Kent, Boise and Fargo in mid-October. This means that within 30 days, we were able to successfully move over 1,000 customers from the Kent facility to our network with no notable service disruptions. The seamless execution of these divestitures harbors well for the integration work that lies ahead.

We are in the early stages of our integration efforts, and we are off to a good start. Our new Northwest region leadership team is in place, and we have converted the Food Group financial systems to the US Foods fiscal calendar. We've also completed the setup of Food Group products and customers in our systems, which is a key first step in the systems conversion process.

Our efforts in the next few months will be focused on building excitement with customers and associates alike, including launching some of our best-selling Scoop products to Food Group customers and completing the rebranding of the facilities and fleet in that region. We'll continue to update you as the integration progresses.

Before I turn the call over to Dirk, I'd like to talk about supply chain for a moment. We did communicate a few weeks ago, that our supply chain officer had left the company, and we have begun a search for his replacement. On an interim basis, Jay Kvasnicka, one of my direct reports, will assume responsibility for supply chain. Jay is the EVP of Local Sales and Field Operations and the [P&L] reports to him, and he brings 25 years of experience with US Foods including prior roles as a division president and then as a region president. We remain committed to the supply chain roadmap that we presented 18 months ago, and Jay's familiarity with the operations, the team and that roadmap will ensure that we continue to make progress. Service levels to customers continue to perform above last year, as evidenced by our continued growth.

I will now turn the call over to our CFO, Dirk Locascio, for a walk-down of our financial results

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Dirk J. Locascio, US Foods Holding Corp. - CFO [4]

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Thank you, Pietro, and good morning. In the third quarter, we continued to grow with our target customers, and we produced strong earnings growth. As Pietro noted, total case growth for the quarter was up 3% with organic total case growth up 90 basis points. We grew organic independent restaurants 4.2%, which is approximately twice the market rate. We continue to operate in a higher-cost environment, but have been able to offset a portion of the higher distribution wages with our expense control initiatives and have continued to expand our operating leverage, this resulting in organic adjusted EBITDA growth of 6.7% and strong adjusted diluted EPS growth of 12.1% for the quarter.

The Food Group contributed $0.01 or approximately 2% to our adjusted diluted EPS growth for the quarter. As a result of our business performance, we're raising our full year organic adjusted EBITDA growth guidance to 6% and raising the lower end of our full year adjusted diluted EPS guidance range by $0.05, resulting in a new range of $2.35 to $2.40.

On Slide 6, third quarter net sales were $6.5 billion, an increase of 6.1% from the prior year. We experienced 3.1% year-over-year inflation in product mix and 3% case growth. The addition of the Food Group contributed 2.1% to case growth for the quarter. Inflation was broad-based across multiple product categories and remains manageable while providing a modest tailwind to gross profit dollars.

On Slide 7, we delivered strong gross profit results again this quarter. Gross profit was $1.2 billion, a 4.3% increase over the prior year period on a GAAP basis and 5.3% increase on an adjusted basis.

As a percent of sales, gross profit was 17.7% on both a GAAP and adjusted basis. This is 30 basis points lower than the prior year period on a GAAP basis and 20 basis points lower on an adjusted basis with a larger decrease in GAAP results due to an unfavorable year-over-year change in our LIFO reserve.

The 20 basis point decline in adjusted gross margin is due to inflation on items that we saw with a fixed gross profit dollar amount per case. If inflation occurs on these items, we make the same amount of gross profit dollars, but the margin rate can compress. The impact of inflation on gross margin for the quarter was approximately 25 basis points, meaning our adjusted gross margin for the quarter would have been up slightly if not for inflation.

Our gross profit performance continues to be driven by private brand growth and inbound freight optimization, as we previously discussed. And also, as Pietro mentioned, in the third quarter, our private brand growth reached 36% of net sales, continuing our growth of approximately 100 basis points per year.

Moving now to operating expenses on Slide 8. OpEx increased 4.2% from the prior year quarter to $968 million, driven primarily by higher distribution and acquisition-related costs. Adjusted operating expense increased $30 million or 3.7% over the prior year quarter and as a percent of sales was 13%, a decrease of 30 basis points. Adjusted operating expense as a percent of sales would have increased approximately 30 basis points without the impact of private -- product inflation on net sales.

While we continue to manage through a tougher supply chain operating environment, we're starting to see a modest reduction in fuel costs and expect to continue to see a modest favorability in fuel on a year-over-year basis in the fourth quarter.

Our supply chain roadmap, which consists of several warehouse and delivery productivity initiatives, continues to progress. We believe our strategy to improve supply chain is the right one, and we continue to execute against this roadmap with the goal of further improving operational efficiencies and continuing to vet continuous improvement in our operations.

On Slide 9, our operating leverage gain for the quarter was $0.09 per case, which is an improvement over the first 2 quarters of the year. The work we're doing around gross profit and OpEx continues to consistently drive meaningful expansion in our operating leverage. We're on pace for our fourth straight year of high single-digit per case expansion in our operating leverage. As we begin incorporating the Food Group into our results, we do expect to show a moderate decline in gross profit per case and a small improvement in OpEx per case for the next 4 quarters. If you recall, the Food Group's adjusted EBITDA margin is lower than ours. We expect to improve this margin over time as we implement the synergies we've previously discussed.

I'm now on Slide 10. Third quarter adjusted EBITDA was $307 million, up 8.5% over the prior year, and organic adjusted EBITDA was $302 million, up 6.7% over the prior year period. As a percent of sales, adjusted EBITDA was 4.7%, an increase of 10 basis points over the prior year. Adjusted diluted EPS increased $0.07 or a strong 12.1% to $0.65 per share for the quarter as we continue to grow adjusted diluted EPS faster than adjusted EBITDA. Inclusion of the Food Group had approximately $0.01 positive impact on adjusted diluted EPS for the quarter, as I mentioned earlier.

As we highlighted in September, we're also now excluding intangible amortization from our adjusted diluted EPS number and have revised our historical numbers to reflect this change and ensure all prior years are on a comparable basis. For full year 2019, existing US Foods intangible amortization, so excluding the amortization from the Food group acquisition, is roughly $39 million.

And finally, on the far right, third quarter GAAP net income decreased 7%, while adjusted net income increased 13%. The decline in GAAP net income was primarily due to a $10 million higher LIFO charge, higher year current tax expense and the addition of Food Group integration-related expenses. Prior year tax expense was lower as a result of onetime deductions allowed under the Tax Cuts and Jobs Act.

Turning now to cash flow and net debt on Slide 11. Operating cash flow for the first 9 months of 2019 was $559 million compared to $444 million in the prior year. The increase is related to a prior year pension contribution of $70 million that we discussed last quarter that did not repeat, combined with improved operating results.

Our business continues to produce strong operating cash flow that supports our ability to delever from the $1.8 billion of debt incurred to finance the Food Group acquisition. Net debt at the end of the quarter was $4.8 billion, an increase of approximately $1.5 billion from the year-end 2018 due to the acquisition of the Food Group. Our net debt-to-adjusted EBITDA leverage ratio at the end of the third quarter was 4.2x.

The calculation of our leverage presented on Slide 11 includes 2 weeks of adjusted EBITDA for the Food Group, which coincides with the amount of time we owned the Food Group in the quarter. If you were to do the same calculation with the trailing 12 months of adjusted EBITDA for the Food Group, our leverage ratio would have been approximately 3.8x.

As a reminder, we expect to return to 3x leverage ratio prior to the end of 2021, and we'll continue to demonstrate a disciplined approach to delevering based on our solid operating cash flow.

Now moving to Slide 12. As I mentioned before, we're updating our full year fiscal 2019 guidance. Total case growth is expected to be between 4% and 5% with organic case growth now expected to be between 1% and 1.5%. Adjusted EBITDA growth, inclusive of Food Group, is expected to be 8.5%. And as I mentioned, we are raising our organic adjusted EBITDA guidance to 6%. We're also raising the lower end of our adjusted diluted EPS range by $0.05, resulting in a new range of $2.35 to $2.40.

Our updated interest expense guidance of $185 million now includes the additional debt related to the Food Group acquisition. And changes to our guidance numbers related to CapEx and depreciation and amortization are also shown on the slide and are inclusive of the Food Group impact.

In summary, we're pleased with our results for the quarter. Solid organic EBITDA growth of 6.7% and double-digit adjusted diluted EPS growth highlight our commitment to profitably growing the business. We continue to grow independent restaurant volume faster than the market rate while focusing on executing our supply chain roadmap in a challenging operating environment. And at the same time, working on successfully integrating the Food Group.

I would like to now open the call for question and answers.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Your first question comes from John Ivankoe from JPMorgan.

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John William Ivankoe, JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst [2]

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The question is on just overall consumer credit quality at this point in terms of your restaurants in particular. With some of, I think, some unevenness in terms of independent restaurants that may have happened this past quarter, especially may have regionally happened this past quarter, are you beginning to see any signs of stress? In terms of independent restaurants, are you beginning to see any signs of stress at all in terms of credit quality? Are you asking your salespeople and your account representatives to be more careful with credit going forward? Just trying to look for some signs of kind of late-cycle change that you may be noticing from a credit worthiness perspective in terms of your customers. And I have a follow-up.

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Dirk J. Locascio, US Foods Holding Corp. - CFO [3]

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John, this is Dirk. I'll take that. So overall, we're not seeing a significant change in the credit environment. You do have restaurants that are opening and closing at any point in time, and we do continue to see that. And from a process perspective, what -- our credit process is quite robust, so there's really not a lot of change that we have to do in that space. We're always trying to manage through effective process while, at the same time, serving our customers by having timely reactions to them as far as approvals. So overall, not a big change.

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John William Ivankoe, JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst [4]

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Okay. And then secondly, in terms of US Foods Direct, which was an interesting announcement, it does look like those products are going to be shipped via UPS and FedEx. Are you going to be more or less a marketplace where the products are going to be drop shipped directly from the manufacturer? That's kind of the first point. And secondly, would it make sense at some point to broaden that to overall consumers outside of your larger registered restaurant customers?

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Pietro Satriano, US Foods Holding Corp. - Chairman & CEO [5]

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So I think marketplace is a good analogy or a good word to describe it. We chose direct because I think that -- given that we're in the delivery business, direct kind of conveys what this value proposition is. But it's got the attributes that I think you're implying in terms of a broad assortment.

In terms of expanding it, we always want to make sure that we can meet the promise -- our brand promise, and we've started with independent restaurants. We prototyped this last year in 4 markets. We've now extended this to independent restaurants. Before, we would go out to the consumer, and I'll be honest, we haven't contemplated that. We still have other customer types within our own environment that we would roll out to first.

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Operator [6]

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And your next question comes from the line of Christopher Mandeville from Jefferies.

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Blake Anderson, Jefferies LLC, Research Division - Equity Associate [7]

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This is Blake on for Chris. Can you talk a little bit more about why you lowered your organic case growth expectations? How much is due to that? How much of that is due to the hospitality customer loss you mentioned? And then you mentioned some delays with the chain account. Just wondering how much that factored into it.

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Pietro Satriano, US Foods Holding Corp. - Chairman & CEO [8]

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Sure. So I think there's, as I mentioned, Blake, the loss of this 1 customer in the hospitality segment, which is significant to us, I'll categorize it as unusual, obviously had a part to play. If you look back at Q2, we were I think 1.6%. We were trending very close to the lower end of guidance that we've talked about and unfortunately this step back has set us back. But we still feel good about the pipeline we have in health care and hospitality and the value proposition.

On the all other side, which you referred to, we feel that we're really on track there. There's always some timing differences in terms of when customers come on board. Onboarding is a complex process but we feel like, based on the customers that are shipping now, we should be in positive territory in Q4. And the only factor that really could impact that up or down is the environment for change, which as you saw, was a little bit worse in the last few months than it's been for the year. But we feel that we're right on track. And the thing worth reminding folks is the customers we are bringing on board in the all other segment are considerably more attractive to us not only than those that we've exited over time but the average of the customers within that pool of customers. So the customer optimization strategy that we've talked about for a couple of years now is really yielding kind of benefits that we were looking to achieve.

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Operator [9]

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Your next question comes from the line of Marisa Sullivan from Bank of America.

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Marisa Sullivan, BofA Merrill Lynch, Research Division - Research Analyst [10]

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I wanted to touch on independent case growth and just see if you could comment on the exit rate for the quarter and quarter-to-date trends. And I think it may sound like the -- your outlook for kind of continuation of 3Q trends could imply maybe a little bit of a choppiness expected in the fourth quarter. So I wonder if you can just give a little bit more color on that.

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Pietro Satriano, US Foods Holding Corp. - Chairman & CEO [11]

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Yes. So I think we expect the fourth quarter to be in line with third quarter based on where we sit now. I think in terms of the trends that might be informing that maybe I'll add a couple of words on that. So from an external perspective, I think the thing to remember is it's still a very positive outlook for independent restaurants. If you look at the demographic factors that underlie that, you look at food that's consumed away from home, continues to gain share of stomach, as I like to say it, from the food consumed at home. We expect those 2 lines to cross next year or the year after. And the macro environment in terms of unemployment, disposable income and fuel prices is very positive.

I don't know if you remember, Marisa, on the last call, I had talked about Technomic lowering its outlook by about 30 basis points. Shipment data first half versus second half for the industry seems in line with that order of magnitude. So there's a little bit from an environment perspective, it's still very, very positive. But from our end, we always look at the, as I talked about, the value proposition we bring to customers continues to resonate. We always have a portfolio of better-performing geographies and less-performing geographies and we had a few kind of step back, and typically we have a few step-up, and that's kind of normal course of business, and we take all that into consideration. That's why we're calling for the fourth quarter to be in line with the third quarter.

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Marisa Sullivan, BofA Merrill Lynch, Research Division - Research Analyst [12]

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Got you. That's helpful. And then if I could just pivot to the organic EBITDA growth guidance. I think it implies a bit of an acceleration in the fourth quarter. Can you just give a little bit more detail on what the main drivers of that would be?

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Dirk J. Locascio, US Foods Holding Corp. - CFO [13]

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Sure. This is Dirk. So when you look at where we are year-to-date in talking about the organic, it actually implies more in line for the fourth quarter with where we've been running this year, the [6%].

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Marisa Sullivan, BofA Merrill Lynch, Research Division - Research Analyst [14]

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Got it. And then can you just talk about what the puts and takes would be that could drive it higher or lower than what you're guiding?

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Dirk J. Locascio, US Foods Holding Corp. - CFO [15]

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Sure. I think the -- probably the main thing that I would call out because I think we found, as Pietro made mention, the operating environment, although it remained a tougher environment, has been fairly stable. Our turnover has stabilized, albeit at a higher level than historical level. So we think that stays pretty consistent through the fourth quarter. And really, it would be more probably macro factors as far as the environment or things of that nature that would impact it more than some of our internal initiatives or focus areas.

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Operator [16]

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And your next question comes from Jeffrey Bernstein from Barclays.

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Jeffrey Andrew Bernstein, Barclays Bank PLC, Research Division - Director & Senior Equity Research Analyst [17]

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Two questions. First one just on the independents. I know you talked about gaining share with this target customer group and maybe growing twice the rate of the broader market. But seemingly, your peers are pursuing similar accounts. I'm just wondering if you were to prioritize the factors leading to your success in this outsized growth, is it just leading with lower pricing? Or is it more kind of pushing the better service or technology? Why do you think you're having the success you're having gaining these independent accounts when everyone's pursuing similar?

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Pietro Satriano, US Foods Holding Corp. - Chairman & CEO [18]

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Yes. So first it's a very fragmented industry, right? So I think the fact that we're having gains, that we're having a lot of -- because of the fragmentation, I don't know that you get folks feeling the impact of that, which I think is sometimes some of the concern that underlies that question. In terms of what's leading to the growth, it really gets down to our value proposition, product innovation and technology. That's why I did spend a few minutes talking about it. We embarked down this path many years ago, but we're not standing still. We continue to evolve how that value proposition shows up to customers in terms of products or technology or how we cover those customers. And that better mousetrap, a term that I've used in the past, I think is primarily responsible for the outsized growth and then our focus on sales excellence is what we focus on to ensure that we can achieve returns even higher than we're seeing. We always strive for higher than what we're seeing today.

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Jeffrey Andrew Bernstein, Barclays Bank PLC, Research Division - Director & Senior Equity Research Analyst [19]

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Got it. And then the other question was just on the M&A environment. After, let's say, the Foods Group acquisition complete, but seemingly with the regulatory challenges or maybe not challenges, maybe delays completing that acquisition, I'm just wondering your outlook for future sizable acquisitions, maybe the pipeline for that, whether or not your leverage level currently temper your enthusiasm for it or whether you're aggressively looking for other similar-sized or large-sized acquisition.

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Dirk J. Locascio, US Foods Holding Corp. - CFO [20]

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So on the larger broadline acquisition, so SGA, as we said before, was our top choice. And that also filled the main white space we had in the Northwest, and to an extent in the West. So we're very pleased, and as you said, we're very happy to have that close now and be able to work on the integration. I think the -- as far as other large broadliners, I'm not sure there would be any other that would be that attractive but -- at least for the near term. Our focus is about really successfully integrating the Food Group into our business and then being very selective on the tuck-in M&A where it would be more around some of the things around our meats, our produce, where it's about filling in white space in certain areas of that part of the business. So not that we'd be fully out of the game, but that would be where it would be targeted alongside the successful integration.

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Operator [21]

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And your next question comes from the line of Kelly Bania from BMO Capital Markets.

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Stephen Robert Caputo, BMO Capital Markets Equity Research - Associate [22]

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This is Steve on for Kelly. I just had a question about your view on the labor market and where you see that going -- heading forward. And also, any impact that the investments that you guys have made in technology and other areas of efficiency over the last several quarters, how might that play if we start to see some improvement in labor?

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Pietro Satriano, US Foods Holding Corp. - Chairman & CEO [23]

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Okay. Thanks. And I presume by later you're talking about the back of the house side of labor, the warehouse and distribution. Look, I think Dirk alluded to this in his comments, the labor -- the operating environment from a back of the house labor perspective is still very much challenging compared to what we've experienced in prior years. If we look at wage rate increases that we've experienced, wage rates have gone up at a higher rate this year than last year and last year a higher rate than the prior year as a result of the labor tightness that we've experienced. Having said that, our strategy that we've got in place is still the right strategy to continue to make gains in terms of operating expenses and to mitigate that environment. When we look at turnover, turnover has stabilized, and adjusting our wages has probably had an impact on that. We also are in a better position as a result of that as well in terms of staffing, and staffing really matters because if you fall behind on staffing, that impacts you in 2 ways, that drives overtime up, that drives turnover up. So from a staffing perspective, we're probably in the best position we've been in, in a while.

From a technology perspective that you asked about, so the one technology that we presented at our Investor Day is making good progress. We had talked about new technology by which we are -- that our selectors pick from the products that goes to the customer. We've got that deployed in about 1/4 of our DCs right now. So we're on track, and we'd like to find ways to accelerate that because we're very pleased with the impact it had, both on reducing the time to onboard a new selector, which again matters if you have turnover and in terms of the level of service for customers in terms of reducing the [specs].

And the third thing I would talk about, the first was -- the second was the technology and the first was the environment, is our focus on continuous improvement. We've now rolled that out fully across the company. And I think that over the long term can have the biggest impact on driving local efficiencies and effectiveness and creating the kind of engagement that leads to a really high retention rate with your workforce.

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Stephen Robert Caputo, BMO Capital Markets Equity Research - Associate [24]

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That's very helpful. And then just a quick follow-up. I know it's early days, but could you talk about any competitive responses that you've seen in some of the markets where you made the SGA acquisition? If there's been any change in the last month or so since you completed the deal?

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Dirk J. Locascio, US Foods Holding Corp. - CFO [25]

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So far, and since we've closed it, we really haven't seen any meaningful change in the competitive environment. What I'd say is more so we're focusing on is -- there is the uncertainty that always comes from an extended period of getting a transaction like this approved. And so we're pleased with how well the Food Group's case growth and business held up during that extended period. And now we're very excited to move forward and helping accelerate the growth in that business and also bring some of the tools and product innovation that we have to those marketplaces and successfully bringing them further and further into the US Foods business.

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Operator [26]

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And your next question comes from Edward Kelly from Wells Fargo.

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Sooyeon Chang, Wells Fargo Securities, LLC, Research Division - Associate Analyst [27]

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This is actually Stephanie on for Ed. I wanted to ask you first about your Head of Supply Chain. Is there any additional color you could give on his departure? How long you expect it will take to find his replacement? And is there anything that's changed, either from like an operational or strategic standpoint that we should know about?

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Pietro Satriano, US Foods Holding Corp. - Chairman & CEO [28]

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So his departure was disappointing. There's really no additional color we can provide. The good news, Stephanie, is we continue to make good progress against the roadmap that we presented 18 months ago, both in terms of some of the fundamentals that we talked about then, in terms of improving our processes, like routing or selecting. Also in terms of the -- what we call, small fee technology. I gave an update on that just to a prior question in terms of that. And then lastly, long term, in terms of automation, we've actually now got a small dedicated team to exploring automation, something we didn't have in the past. So from the strategy or the roadmap presented, still very much the roadmap that we are continuing to work. And in terms of the team to execute that roadmap, as I talked about, Jay is very familiar with the roadmap, the people because of his role, how supply chain works. So that, combined with the existing team below him that we've actually beefed up, we feel pretty good for however long it's going to take to find a suitable replacement. And these things typically take 6 to 9 months in our experience.

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Sooyeon Chang, Wells Fargo Securities, LLC, Research Division - Associate Analyst [29]

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Okay. And just following up. A question on gross profit dollar growth. First off, is there anything you can share on how much SGA contributed? I know you mentioned their lower margin from an EBITDA standpoint, but just curious about the impact from a gross profit standpoint. And also any impact from ASF or any color on your outlook for inflation.

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Dirk J. Locascio, US Foods Holding Corp. - CFO [30]

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Sure. So for the quarter, it impacted our gross profit and OpEx per case each by about $0.03, so offset. So overall, no impact on our leverage. The thing that I would caution against though is with 2 weeks like that where you end up is, I wouldn't take and extrapolate that impact over the longer term. As I mentioned that -- because of the lower EBITDA margin, we would expect it to have more of a negative impact on our gross profit per case than OpEx. And as we guide in 2020, we'll reflect properly that impact as we go forward into there. And then over time would expect to improve their EBITDA margins, as I talked about, as we integrate them and bring to fruition the synergies that we've talked about.

From an ASF perspective, we continue, as you would expect us to, to monitor that quite closely. And at this point, haven't seen any broad-based inflation. I know there is some expectation of some more potential inflation over the next 6 months or so. And as we watch that, and if that does occur, we'll work closely with our customers and suppliers to effectively manage through that.

I think the -- another important thing is that we learned a number of things as we've worked our way through the avian flu impacts in past years and as a result have positioned us to better deal with anything that may happen from an ASF perspective, things like working with vendors on guaranteed supply agreements, a robust communication process with customers and sales. And then also, in this case, working with our customers to reformulate their recipes and switch to different protein sources should we see that level of increase in inflation. Because as we've talked about in the past, one positive is when it's a particular protein like that, customers do have more flexibility as far as menu and portion sizes.

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Operator [31]

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Your next question comes from John Heinbockel of Guggenheim Securities.

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Stephen Charles Kovalsky, Guggenheim Securities, LLC, Research Division - Associate [32]

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This is Steve Kovalsky on for John. I wanted to touch on the cadence of synergies you expect from the Food Group acquisition. When we'll start to see those flow through the model and whether the timing of recognition will be different between the COGS and SG&A components?

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Dirk J. Locascio, US Foods Holding Corp. - CFO [33]

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Sure. So we'll -- this is Dirk. So you will begin to see synergies show up in 2020. And we'll include that in our outlook when we provide guidance in February for the 2020. So I think that kind of more to come on that.

I think from the cadence -- yes, so cadence, again, and we'll talk about this more as time goes on. But a number of the COGS pieces will come a little sooner than some of the headcount because again, that's more tied to some of the IT conversions in that, that we've talked about in the past. I think the other thing is it'll happen over multiple years, again, as we've talked about in the past. So more to come on that as we give our 2020 guidance.

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Stephen Charles Kovalsky, Guggenheim Securities, LLC, Research Division - Associate [34]

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Great. And then maybe as a follow-up with the health care account. Is there any readthrough from that account where you see some other accounts at risk? Or is that just a one-off situation?

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Dirk J. Locascio, US Foods Holding Corp. - CFO [35]

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So with that one, there's -- you're always going to have some wins and losses. We haven't had a loss of this size in a number of years, and I think it's -- there's not anything to readthrough on that. We feel still very well positioned with our health care and hospitality customer base, with the value that we bring, both economical to them from the tools in that. So still feel very well positioned about our ability to grow with this customer type. And you do have from time to time something like this.

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Operator [36]

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And your next question comes from the line of Rebecca Scheuneman from Morningstar.

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Rebecca Scheuneman, Morningstar Inc., Research Division - Equity Analyst [37]

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So you did mention that during the approval process that you were pleased with client retention from the SGA side. I'm just wondering like now that the acquisition has closed and we're getting into integration, are you seeing clients maybe shift a portion of purchases away to avoid disruption? Or are they kind of holding steady with previous purchase patterns?

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Dirk J. Locascio, US Foods Holding Corp. - CFO [38]

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Sure. So I think actually, it'd be more of the opposite. I think what we see is -- just even using our own experience back during a few years back. Its customers not knowing what's going to happen will tend to either diversify prior to a transaction. And so now it's too early to really talk about case growth trends post close, but we feel that the team is very well positioned to really accelerate growth in that part of the business. And Food Group had a strong base, to begin with and can continue to accelerate now from that, especially as we bring more of our technology and innovative products into the Food Group markets, which will happen here coming up.

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Operator [39]

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And we have Judah Frommer from Credit Suisse.

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Yunhee Park, Crédit Suisse AG, Research Division - Research Analyst [40]

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This is Yunhee on for Judah. I know it's early, but if you could update us on the initial customer reaction, especially as it relates to having access to your foods private label brand and technology. And also, how are your conversations with vendors going?

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Pietro Satriano, US Foods Holding Corp. - Chairman & CEO [41]

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I would say that it is, like you (inaudible), it's very early on. So in many cases -- I'll use technology as an example, other than some of the preparations of carving off the divested locations and some things like bringing them onto our e-mail and converting their financial calendar to ours. So we've had some strong success in those things. So we're very pleased we're there. But from a customer perspective, they haven't seen a whole lot yet. So I think that'll be more appropriate for us to comment on as we go forward. But early on, those things that are more behind the scenes from an integration perspective, we're very pleased about how well it's going.

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Operator [42]

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And we do have a follow-up question from Marisa Sullivan from Bank of America.

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Marisa Sullivan, BofA Merrill Lynch, Research Division - Research Analyst [43]

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I just wanted to touch on Pronto. Do you think there's anything that you could share with us in terms of like what kinds of sales growth lifts you're seeing in the markets where you pulled it out? And just how did the margins compare versus the overall business?

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Pietro Satriano, US Foods Holding Corp. - Chairman & CEO [44]

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So we're -- I mean, the best I can do, Marisa, is to say we're pleased with the incremental sales and the margin associated with the first markets, and that's why we're continuing to expand the number of markets that are served from Pronto. But we're pleased from both a sales and margin perspective.

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Operator [45]

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And no further questions at this time. I'll be turning the call over back to Mr. Pietro for closing comments.

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Pietro Satriano, US Foods Holding Corp. - Chairman & CEO [46]

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Thank you. So I'd like to thank everyone for the questions. In summary, we had a good quarter. We closed on the acquisition of Food Group. We're pleased with -- we're off to a good start. And I'd like to close by thanking all of our associates across the company whose hard work and commitment makes these results possible. Thank you for joining us this morning, and have a great day.

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Operator [47]

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Ladies and gentlemen, this concludes today's conference call. Thank you all for joining. You may now all disconnect.