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Edited Transcript of USFD earnings conference call or presentation 11-Feb-20 3:00pm GMT

Q4 2019 US Foods Holding Corp Earnings Call

Rosemont Feb 14, 2020 (Thomson StreetEvents) -- Edited Transcript of US Foods Holding Corp earnings conference call or presentation Tuesday, February 11, 2020 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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* Carla Casella

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

* Christopher Mandeville

Jefferies LLC, Research Division - Equity Analyst

* Edward Joseph Kelly

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Jeffrey Andrew Bernstein

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

* John Edward Heinbockel

Guggenheim Securities, LLC, Research Division - Analyst

* John William Ivankoe

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

* Judah C. Frommer

Crédit Suisse AG, Research Division - Senior Analyst

* Kelly Ann Bania

BMO Capital Markets Equity Research - Director & Equity Analyst

* Marisa Sullivan

BofA Merrill Lynch, 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 Food (sic) [Foods] Fourth Quarter Fiscal 2019 Earnings Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

It's now my pleasure to turn the call over to your speaker today, Ms. Melissa Napier. Ma'am, 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. Good morning, everyone. Welcome to our fiscal 2019 fourth quarter and year-end earnings call. I'm here today with Pietro Satriano, our CEO; and Dirk Locascio, our CFO. Pietro and Dirk will provide an update on our results for the fourth quarter and for the full fiscal year. We'll take your questions after our prepared remarks conclude. (Operator Instructions)

During today's call and unless otherwise stated, we're comparing our fourth quarter and full year fiscal 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. As a reminder, organic results exclude contributions from SGA's Food Group of Companies, which we acquired in September of 2019.

In addition to historical information, certain statements made during today's call are considered forward-looking statements. Please review the risk factors in our 2018 Form 10-K filed with the SEC for these potential factors, which could cause our actual results to differ materially from those expressed or implied in those statements. And lastly, I'd like to point out that during today's call, we will refer to certain non-GAAP financial measures. 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. Good morning, everyone, and thank you for joining us. We're going to begin on Slide 2 with an overview of our full year results. In fiscal 2019, we continued to profitably grow our business while expanding our operating leverage. I'll talk first about our organic results for the year, following which, I will cover our total results, which as Melissa said, include the impact of the SGA Food Group acquisition, which closed in September.

Our organic business continued to show growth in all key financial metrics. We grew total cases 1.1% and continued to gain share in the independent restaurant space with 4.4% growth. We delivered 6.2% adjusted EBITDA growth and grew adjusted diluted EPS by 11.1%. Our organic operating leverage increased by $0.08 per case, the fourth consecutive year in which we increased operating leverage, and we expanded our return on invested capital by 130 basis points to 19.6%. I'm happy to report that all of our organic results either met or exceeded our guidance for the 2019 fiscal year.

On a total company basis, which includes the results from the Food Group acquisition, we delivered strong case and EBITDA growth. Total cases grew 4.6% and independent restaurants grew 7.1%. Full year adjusted EBITDA grew 8.3%, while adjusted diluted EPS grew 9.7%. The combination of growth in our organic business and our continued focus on working capital resulted in a 24.8% increase in operating cash flow, which contributed to bring our leverage down to 3.9x. We are very pleased with our full year results and look forward to continued growth in 2020.

Moving to Slide 3. I'd like to highlight some of this year's progress in our Great Food. Made Easy. strategy as well as provide an update on the integration of Food Group. So let's start with the Great Food part of our strategy on the left-hand side. Our innovative products continued to resonate with customers. In 2019, we brought 56 new innovative and exclusive products to market, including a number of sustainable products under our Serve Good program. Scoop continues to drive higher basket and better stickiness with customers as evidenced by our most recent analytics. This coming spring, we are launching our 25th edition of the Scoop, which remains at the heart of our differentiation strategy.

Private brands continued to be a key driver of our gross profit dollar growth. During 2019, private brands as a percentage of our total sales grew by 70 basis points, which is our fourth consecutive year of significant private brand expansion. Private brand sales now comprise more than 35% of total revenue, and we continue to see significant runway on this front.

Sustainable products represent one pillar of our corporate social responsibility or ESG program. During 2019, we expanded our Serve Good product offering, and we now have over 500 sustainably sourced products available. More details on our ESG efforts can be found on our website, and we will be publishing our new corporate social responsibility report later in Q1.

Our Made Easy part of the strategy is all about making it easy for our customers to do business with US Foods and making it easier for them to run their business. Currently, over 70% of sales revenue comes through our e-commerce site, which drives both higher basket and better stickiness. Our more recent focus has been on enhancing the mobile experience, which is where more and more customers live and work.

On our last call, we talked about our omnichannel strategy. US Foods Direct, Pronto and CHEF'STORE provide us with additional ways to reach existing customers and reach new customers. Pronto is active in 8 markets in fiscal 2019, and we plan to add 2 new markets in the first quarter of the year. For our direct -- for our US Foods Direct endless aisle or online marketplace, we are focused on extending the number of products available. We currently have over 30,000 products on US Foods Direct, products that are not stocked in our warehouse, and we expect this number to double by year-end.

Our portfolio of value-added services or check business tools are designed to help customers run their businesses more effectively. In 2019, the number of unique customers using our check business tools increased by 24%, the third consecutive year of over 20% growth. Last year, we further strengthened our portfolio when we announced our exclusive partnership with Toast. Toast is a cloud-based, point-of-sale solution that is one of the fastest growing in the U.S. and integrate seamlessly with a myriad of restaurant management solutions, including some tools in our own portfolio.

On the right-hand side of Page 3, I'd like to highlight some of the progress we've made since closing the Food Group acquisition in late Q3. The new leadership organization for the Northwest region is now in place at both the region and at the area level. We completed rebranding of 9 facilities in over 500 tractors and trailers. We trained new sales associates in our programs and initiatives, including rolling out some of our best-selling Scoop products to Food Group markets. This was very well received not only by customers, but also by associates.

In the first quarter of the coming year, we will begin the process of converting Food Group's systems to the US Foods operating platform, and we expect to have the first location completed in Q2. Beyond system conversions, our key priorities in 2020 include implementing our team-based selling model and continuing to integrate the processes of the 2 organizations. We are on pace to achieve the $65 million of run rate synergies that we've previously outlined, and we expect to generate $10 million of these synergies in 2020. As a reminder, we expect synergy -- synergies to accelerate in '21 and 2022, coincident with this -- with the completion of our systems conversions.

Let's now turn to Page 4 for a look at our volume growth for the fourth quarter. We experienced slower case volume growth during the month of December across all customer types. Industry data such as Black Box also showed a fairly significant slowdown in restaurant traffic during this time, which we largely attribute to the shorter holiday season between Thanksgiving and Christmas.

As to our own results, in the fourth quarter, organic case growth was up 40 basis points, and total case growth was up 12.3% due to the addition of Food Group. Organic case growth with independent restaurants was 2.9%, in large part due to the December holiday season I just discussed. Total case growth with independents was 11.9%, reflecting the addition of Food Group for the full quarter. Organic health care and hospitality grew -- growth was down 20 basis points in the fourth quarter, generally in line with expectations discussed on our last call, plus the impact of the December slowdown. And lastly, with the all other customer type, organic case growth was down 60 basis points as our existing chain business mirrored -- mirror the industry data that I just referred to. Gains from new customer wins generally came in as expected.

Looking ahead to 2020, we are assuming full year organic independent case growth of 5%, which includes the addition of the 53rd week in 2020, and organic case growth across all segments of 2% to 3%, which also includes the 53rd week. The 53rd week is worth about 1% of organic case growth.

I would now like to turn the call over to Dirk, who will walk through our financial results and discuss our 2020 outlook in more detail.

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

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Thank you, Pietro, and good morning. In fiscal 2019, we profitably grew with our target customers and produced strong earnings growth. As Pietro noted, organic independent case growth for the year was 4.4%, and total organic case growth was 1.1%. Organic adjusted EBITDA grew by over 6%, in line with our guidance for the year, and organic adjusted diluted EPS increased 11%. We continue to operate in a higher cost environment but have continued to expand our operating leverage through our disciplined approach to growing gross profit. We also further increased our organic return on invested capital, or ROIC, approximately 130 basis points for the year.

Starting on Slide 5, fourth quarter net sales were $6.9 billion, an increase of 14.8% from the prior year. We experienced 2.5% year-over-year inflation and grew cases 12.3%. The addition of the Food Group contributed 11.8% to net sales for the quarter. We saw inflation across multiple commodity categories, including cheese, poultry and beef. Inflation in the fourth quarter took a modest step-down from the 2019 peak that we saw in the third quarter and remains very manageable while providing a modest tailwind to gross profit dollars. We continue to see moderate inflation in pork. Our commodity team does continue to monitor ASF closely, and we are prepared if we do see higher pork inflation. Looking ahead to 2020, we expect inflation to remain manageable and similar to what we saw in fiscal 2019.

On Slide 6, we continued to deliver strong gross profit results in the fourth quarter. Gross profit was $1.2 billion, a 13.3% increase over the prior year period on a GAAP basis and 14% increase on an adjusted basis. As a percent of sales, gross profit was 17.8% on a GAAP basis and 18% on an adjusted basis. This is 30 basis points lower than the prior year on a GAAP basis due to unfavorable year-over-year change in our LIFO reserve. The 10-basis-point decrease in adjusted gross margin is due to the mix impact of adding Food group results to our organic results and is in line with what we expected.

While the independent mix is similar between US Foods' organic business and the Food Group business, the Food Group's remaining customer mix is weighted more toward national chain business and has less health care and hospitality volume than US Foods' organic business. This change in customer mix as well as Food Group's lower gross profit rate was an approximately 30 basis point negative impact to our adjusted gross margin rate in the fourth quarter, meaning gross margins improved 20 basis points versus fourth quarter 2018 on an organic basis. The change also impacts our total company operating leverage per case, which I'll discuss in more detail in a few minutes. Our strong organic gross profit performance continues to be driven by private brand growth and inbound freight optimization as we've previously discussed. For the full year, our private brand growth was 70 basis points.

Moving to operating expenses on Slide 7. OpEx increased 14% from the prior year quarter to $1.1 billion, driven primarily by higher case volume from the addition of Food Group, higher supply chain wages and higher acquisition-related costs. Adjusted operating expenses increased $113 million or 14.1% over the prior year fourth quarter and as a percent of sales was 13.2% flat to the prior year fourth quarter. As I mentioned last quarter, we continued to work toward embedding continuous improvement culture in our daily operations, which will help mitigate the higher wage increases we've seen, and also believe our strategy to improve supply chain is the right one.

On Slide 8, our operating leverage gain for the quarter was $0.01 per case, and our organic operating leverage gain for the quarter was $0.10 per case. On a full year basis, our operating leverage increased by $0.04 per case in total and $0.08 per case on an organic basis, completing our fourth straight year of significantly expanding our operating leverage. As I discussed earlier, the Food Group business operates at a lower gross profit profile, primarily due to the different customer mix and a lower rate per case, part of which we plan to address over time through cost of good synergies, expansion of private brand sales and growth with our target customer types.

I'm now on Slide 9. Fourth quarter adjusted organic EBITDA was $317 million, an increase of 6.7% over the prior year period, and total adjusted EBITDA was $335 million, up 12.8% over the prior year period. Food Group's adjusted EBITDA was modestly below our initial expectations due primarily to deferral of some promotional income, combined with some nonrecurring costs, largely to move business around related to the divestitures. We expect these costs to remain until we complete system conversions and optimize the customer base but don't expect these costs to impact the business over the longer term. As a percent of sales, total adjusted EBITDA was 4.8%, a decrease of 10 basis points from the fourth quarter 2018. That 10 basis point decline is due to the addition of Food Group, with the organic business increasing 20 basis points for the quarter. Over time, we also expect to expand Food Group's EBITDA margins to the $65 million of synergies that Pietro discussed.

Our adjusted diluted EPS for the fourth quarter increased $0.06 or 10% to $0.66 per share as we continue to grow our adjusted diluted EPS faster than adjusted EBITDA. On a full year basis, adjusted diluted EPS was $2.38, an increase of 9.7% over the prior year. And finally, on the far right, fourth quarter GAAP net income decreased $8 million, while adjusted net income increased $14 million. The decline in GAAP net income was primarily due to an $8 million higher LIFO charge in the addition of Food Group integration-related costs.

Turning to Slide 10. Operating cash flow for the year was $760 million compared to $609 million in the prior year. The increase is related to not repeating a $70 million prior year pension contribution that I've previously discussed, combined with earnings growth and improved working capital results. Our business continues to produce strong operating cash flow that supports our ability to delever.

Net debt at the end of the year was $4.6 million, an increase of approximately $1.3 billion from the prior year-end due to the acquisition of Food Group. Net debt declined $188 million in the end of the third quarter as we continue to focus on reducing outstanding debt, and our net debt-to-adjusted EBITDA leverage ratio at the end of the year was 3.9x, which is down from 4.2x at the end of the third quarter. If you did the same calculation with the full year trailing 12 months of adjusted EBITDA of Food Group, our pro forma leverage would have been closer to 3.6x. As a reminder, we expect to return to a 3x leverage ratio in 2021, and we'll continue to demonstrate a disciplined approach to delevering based on our solid operating cash flow.

On an organic basis, our ROIC, as I mentioned earlier, increased 130 basis points in 2019 and over 250 basis points over the last 2 years. This disciplined and efficient use of capital has resulted in consistent expansion of ROIC over the last 4 years.

Moving now to Slide 12. We're providing our initial view of 2020 guidance, which includes the expected impact of a 53rd week in 2020. The 53rd week is expected to add approximately 1% to both case growth and adjusted EBITDA growth. For fiscal 2020, total case growth is expected to be between 9% and 11%, with organic total case growth expected to be between 2% and 3%. Specific to independent restaurants, we expect case growth of approximately 5% for the year, also inclusive of the 53rd week.

Total adjusted EBITDA is expected to be between 12% and 15%, and organic adjusted EBITDA growth is expected to be between 6% and 8%. We do expect Q1 EBITDA growth to be modestly lower than our full year guidance due to the lower expected case volumes we've discussed. Cash CapEx is expected to be $325 million to $335 million; interest expense between $210 million and $220 million; and depreciation expense of between $330 million and $340 million; and our adjusted effective tax rate to be between 25% and 26%. And finally, we expected adjusted diluted EPS growth of approximately 13% to 18% or $2.70 to $2.80 for fiscal 2020.

In summary, we're pleased with our results for 2019 and excited about the future growth opportunities the Food Group acquisition provides and confident in achieving our 2020 guidance. Now I'd like to open up the call for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Chris Mandeville from Jefferies.

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Christopher Mandeville, Jefferies LLC, Research Division - Equity Analyst [2]

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In terms of the 2 -- in terms of the guidance of the 2% to 3% for total organic cases, Dirk, I think I just heard you reference something with respect to expecting lower case volume in Q1. Can you just walk us through the cadence for the year? And maybe give us some color on quarter-to-date trends. And then I believe I also heard Pietro say something along the lines of all other segments should be growing 2% to 3% for the full year. So if that's the case, maybe you can give us just some additional commentary with respect to mix and how that plays out for the full year.

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

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Sure. So for the full year, we do expect total case growth to grow at 2% to 3%, inclusive of the roughly 1% for the 53rd week, so meaning, roughly, 1% to 2% overall. He didn't make any comment on the overall all other guide for 2020 as opposed to total and independents.

I think the lower Q1 was really, as we've talked about -- with the exit of the larger health care hospitality customer and then as we onboard new customers throughout the year, we expect that Q1 growth rate to be a little bit lower but then accelerating as we go through the year. We're not going to provide specific commentary on a quarter-by-quarter basis, but do expect the year to grow in line with the outlook that we provided.

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Operator [4]

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Your next question comes from Kelly Bania from BMO Capital.

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Kelly Ann Bania, BMO Capital Markets Equity Research - Director & Equity Analyst [5]

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I guess just kind of furthering -- just think about the case growth, the 1% to 2%. I think what would maybe be helpful is just a little bit more in terms of puts and takes and what you're thinking on an organic basis across the 3 segments. And independents in particular and with -- with health care and hospitality, you mentioned the exit. Just -- can you help us understand why and what impact that has? And any new customer wins you're planning for in 2020? Are those kind of cemented? Are those things that you're planning to secure over the next course of the several months?

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Dirk J. Locascio, US Foods Holding Corp. - CFO [6]

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Sure. I think -- so if you come back to -- with the independents, the 4% for the year, again, you could have some quarters a little higher, a little lower, but we expect that to be relatively consistent as you go throughout the year. The health care and hospitality and all others, there's always a pipeline that you're working in, so at different -- there's different customers that are at different stages of that pipeline as far as -- some are onboarding now, some you're continuing to work with and you expect to onboard at different points.

I think the health care and hospitality was the large customer we talked about a few times in the fourth quarter, so that shouldn't be a big surprise. And so really, as you lap that through the kind of earlier part of 2020, it's obviously going to be a lower growth rate as a result of that. But we feel good about the pipeline and our ability to continue to grow and grow with our target customer types throughout 2020.

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Kelly Ann Bania, BMO Capital Markets Equity Research - Director & Equity Analyst [7]

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Okay. And then in terms of some of the metrics you were giving with, I think, Scoop and e-commerce, particularly on the basket size, it seems to be creeping up a little bit, just looking at my notes from the past. So maybe you can just help us understand how you see that going forward. What's driving that? And some of the other retention rates that you're seeing, if that's -- it seems like that's still very steady. Just maybe talk about that a little further.

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

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Yes. So this is Pietro, Kelly. I think that the main reason for the kind of continued, to use the words, creeping up of the impact on baskets and retention is just a cumulative impact on our customers of Scoop, right? So I think we've said of all the, I think, over 400 products we've launched over time, and we're now on our 25th edition, close to 80% are still in market somewhere, not necessarily market, but somewhere. So those items become an important part of customers' menu. And as we continue to add and as they -- as customers continue to add items from Scoop to their menu, it just creates greater stickiness over time.

And I think there was a second part to your question that you'll have to remind me of.

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Kelly Ann Bania, BMO Capital Markets Equity Research - Director & Equity Analyst [9]

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Just wanted to touch on the retention rates.

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Pietro Satriano, US Foods Holding Corp. - Chairman & CEO [10]

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So similar impact in terms of both basket and retention coming from the cumulative impact of all those products.

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Kelly Ann Bania, BMO Capital Markets Equity Research - Director & Equity Analyst [11]

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Okay. And then can you also just let us know what you're planning in terms of debt paydown for 2020? Your interest expense seemed a little bit lower than we were thinking.

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Dirk J. Locascio, US Foods Holding Corp. - CFO [12]

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So we would expect -- not a particular number that we'll guide, but we would expect cash flow to continue to grow relatively commensurate with earnings growth after taxes. And I think the other thing, if you remember, is -- so over the course of 2019, there were some rate cuts. We also did some refinancing that helped reduce some rates on our existing debt. So Scott and Melissa can probably help you out a little bit more afterward, but we feel good about our outlook on that and in our ability to continue to delever toward the 3x in 2021 that we've talked about.

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Operator [13]

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Your next question comes from Edward Kelly from Wells Fargo.

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Edward Joseph Kelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [14]

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Congratulations on what looks to be continued solid execution. I did want to ask you about Food Group picture on -- Dirk, maybe -- can you just provide a bit more color on the shortfall in EBITDA in Q4 and then 2020? And then absent that, any changes in the underlying assumptions as to how you're thinking about the performance of that business ex synergies?

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Pietro Satriano, US Foods Holding Corp. - Chairman & CEO [15]

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Yes. So I want to talk about the fourth quarter. Maybe Dirk can talk about the full year. But start with the last part of your question, so no changes in the underlying strength of the business, and as we've said before and continue to believe, feel really good about the assets we acquired and the people. And I think the progress we've had in the first few months has been really exemplary.

So what happened in the fourth quarter? If you walk down the P&L, volume was where we expected, probably in fact, maybe a little bit better. If you'll remember from the pro formas that we presented when we made the acquisition, we assumed a little bit of erosion in volume that you often get with -- post an acquisition. Did not see that in this case despite the -- the prolonged uncertainty, so feel good about the volume side of things.

The negative impact is really 2 temporary things. One was a deferral of promotional income, which moves as a result of just not wanting to take on too much of that -- comes back to us in 2020. And the other temporary thing is -- I'll just take a minute to explain this. So as a result of the divestitures, the 3 divestitures, you remember we kept about half the business that came with Kent, but we have to move that business out of Kent to other facilities. And in some cases, that business that we had to move is in -- not necessarily the facility, it's going to be long term, again, because we need to be on one system to have the optimal network. And so we are incurring some incremental distribution costs, which go away when we optimize the network as a result of being on one platform. And so when we go on one platform, not only do we realize the anticipated synergies, some of these kind of temporary additional distribution costs also go away. And that really is the story of the fourth quarter.

Dirk, you want to talk about 2020?

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Dirk J. Locascio, US Foods Holding Corp. - CFO [16]

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Sure. So I think when we think about 2020, Food Group, as Pietro said, we feel just really good still about the outlook for the business and the progress we're making, both on the core business and on synergies. I think the contribution that's inferred in our guidance is about 6% to 7% of the growth or about $95 million to roughly $110 million in total Food Group EBITDA for the year.

I think the -- one of the things that may contribute to the little lower-than-some-of-you-expected is post transaction closing, when we're able to do some more work on the divestitures, the impact of divestitures was a little bit bigger than we had contemplated upfront. There was some impact on some of the specialty businesses and their sales, which took that impact from $25 million to about $30 million from those divestitures. And in that case, it does impact 2020, but over time, as we've talked about, we do expect to get more gains from the meat and produce business as we integrate it across our broader US Foods. So we still don't feel like that impacts us over the longer term.

Outside of that, again, feel good about the $10 million and then the range, similar to an organic range, contemplates a range of outcomes, for example, around macroeconomic factors and impacts from business losses as one may expect in an acquisition we've talked about and the increased competition. So feel good about the outlook.

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Edward Joseph Kelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [17]

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Okay. And then I wanted to ask you about gross profit per case. First off, I don't know, but can you provide the impact that Food Group had on gross profit per case in the quarter? And then -- excluding that, performance looks really good. And I'm just kind of curious if you could just provide a little bit more color on that, maybe as part of it, talk about inflation and what you're seeing from a pass-through perspective.

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Dirk J. Locascio, US Foods Holding Corp. - CFO [18]

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Sure, Ed. So it's about $0.09 or $0.10 lower on adjusted gross profit per case. I think the overall rate is around $1 sort of lower, again, because of the things that we've talked about. We feel, again, over time, that through the focus on mix and then the synergies and all the things we've talked about, that, that will continue to improve. We knew going in it was a lower EBITDA margin business. So not -- again, not a lot of surprise there.

I think the -- otherwise, as we talked about, the core business, pretty stable. And yes, on the organic side, really all throughout 2019, we had strong gross profit performance. And really, as we've talked about, it's been about profitable sales growth for us. So it's managing sort of that rate and that volume growth, and we're very pleased with the outcomes for the year.

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Edward Joseph Kelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [19]

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Okay. And if I can just squeeze one more in. From a leverage standpoint, Dirk, I mean, if I do the numbers on sort of like guidance, cash flow and all that, I mean, it looks like you get to 3x by the end of '20, maybe not '21. Just -- I guess, thoughts on capital allocation maybe once you get to 3x and potential for return of cash to shareholders? Any thoughts there?

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

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Sure. I think it's -- we get pretty close 2 or 3x because it's pretty close. It's -- whether it's later this year, into 2021, we feel good about our ability to significantly delever over the course of this year to your point. And I think what we've said is as we get closer, we'll reconsider, as we've talked about before at our Investor Day, just -- whether it's buybacks, dividends, et cetera, but nothing really more to share other than as we get closer, it definitely remains on our radar.

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Operator [21]

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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 [22]

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A couple of questions as well. The first one, just on the organic case growth in the fourth quarter going into '20, I think you mentioned that the fourth quarter might have been a little bit below expectation due to the shortened time frame between Thanksgiving and Christmas. I'm just wondering -- the fact that you are guiding to a higher level for 2020, is that at least safe to imply that trends have bounced back in January and February quarter-to-date? Or are you assuming an acceleration as we move through 2020 based on any specific factors?

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Dirk J. Locascio, US Foods Holding Corp. - CFO [23]

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So I think that -- as you think -- so the calendar impact, you do see that piece rebound in January, and we have seen that. I think what you think throughout the year though, from the guide, there's a lot of moving parts. So there's the combination of, again, that exit that we talked about in the fourth quarter, that sort of fully comes to fruition here in early 2020. And then you also -- as I said, with the pipeline, you have new customers that onboard as well. So really, it's -- our outlook is a combined version of those. And again, it's less about quarter-to-quarter guidance as opposed to just because of the exit, calling out the -- a little bit lower Q1 and then feel good about our ability to grow the core business 1% to 2% overall this year, excluding the impact of the 53rd week.

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Jeffrey Andrew Bernstein, Barclays Bank PLC, Research Division - Director & Senior Equity Research Analyst [24]

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Understood. And then as you think about the -- at least your restaurant industry clients, some of your foodservice peers have spoken actually favorably about the fundamentals of the restaurant industry despite what we see in terms of traffic growth challenges, at least from the chains, and commodity and labor inflation. So I'm just wondering how do you characterize the underlying health of the restaurant industry, maybe distinguishing between chains versus independents or QSR versus casual dining or however you might slice it.

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Pietro Satriano, US Foods Holding Corp. - Chairman & CEO [25]

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Right. So I think that's a good way to slice it, as you said, which is a distinction between chains and independents. Our outlook for independents remains positive and consistent with what we've talked about in the past and what we see from either outlooks from Technomic or other sources, continues to be very consistent. And the story of the fourth quarter, as you said, is really the timing of the holidays, and early part of Q1 looks in line with full year guidance.

The chains is a different story. Black Box continues to report, I think, minus 2% traffic with the chain, which is our kind of best proxy for chain. So -- and again, what you saw in December was the minus 2% go down to minus 6%, but I think it's back to around minus 2% in January. So it's just -- the chains really depends on the nature of the concepts you're associated with. Some do well, some do not. The good news with that is that is, from a margin profile perspective, much less accretive than the independents. And so while there's a little bit more volatility to it, the impact on the bottom line is much more muted.

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Jeffrey Andrew Bernstein, Barclays Bank PLC, Research Division - Director & Senior Equity Research Analyst [26]

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Got it. And then my last question is just as you think about the longer term, is it fair to assume the -- I mean, at least, guidance for 2020 was for organic case volume growth of 2% to 3% and -- well, I guess, that's 1% to 2%, ex the 53rd week, and organic adjusted EBITDA growth of 6% to 8%. Are those appropriate metrics if we were to think about long-term guidance? Are there other perhaps unusuals in 2020 other than that 53rd week that would maybe make those growth estimates meaningfully differ from a reasonable long-term view?

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Dirk J. Locascio, US Foods Holding Corp. - CFO [27]

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So we're -- in the future, we'll come out with long-term -- updated long-term guidance. But what I would say though, to answer your questions on 2020, there aren't, other than the 53rd week, a lot of anomalies in the year. And I think if you actually tie this back to our Investor Day when we talked about more of a 7% to 9% organic growth, the 2 things -- just as a reminder, we've talked about that really. So [GP] and independent restaurant growth, really largely on track with that outlook. It's, overall volume, about 100 basis points lower, mostly health care and hospitality, which we still feel good about our long-term ability to accelerate growth there as well as the 100 basis points roughly in OpEx from the tougher supply chain operating environment. So many areas of the business still continuing to grow healthy.

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Operator [28]

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Your next question comes from John Heinbockel from Guggenheim Securities.

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John Edward Heinbockel, Guggenheim Securities, LLC, Research Division - Analyst [29]

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So let me start with -- maybe you can give us a sense of the spread, right, between US Foods independent case growth and the Food Group. I don't know if it's a couple of hundred basis points, something like that. But roughly speaking, that spread.

And then where do you think -- or when do you think that's right, you can get Food Group up to your level of growth? And what would be the 1 or 2 things that drive that most notably?

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

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Sure. So I think the -- it's probably not a fair compare right now to compare our case growth with theirs, given the -- if I think back to our uncertainty from 7 or 8 years ago, what they went through. So the fact that they were kind of flattish to some modest growth here in the fourth quarter on independents, I think, is a positive, we think, overall. But from there, we think it continues to accelerate through 2020 and 2021, and there's really various things that contribute to that. One is -- Pietro talked about our selling model, getting our selling model in place there, which we believe is a differentiation. As markets continue to cut over to our systems, then some of our -- more of our tools and technology become available.

And then finally, on the product side. So as he mentioned, we did sort of a best of Scoop and they will now be -- when we do our spring Scoop for example, they'll be part of that broader -- and that product innovation will continue to come to life there.

So we think it's really the same 3 things that we've talked about in our core business, that is: they'll continue to get more ingrained in their business over the course of the next year or 2; that we continue to see acceleration there; and then feel good about, based on that marketplace, our ability to grow their independents over time at or faster than our core business.

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John Edward Heinbockel, Guggenheim Securities, LLC, Research Division - Analyst [31]

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And then what's your -- what is the -- your current outlook, when you think about -- so warehouse labor cost pressure and freight, if you think about 2020 versus '19, where would both of those sit?

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Dirk J. Locascio, US Foods Holding Corp. - CFO [32]

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Probably pretty similar. I think when we think through warehouse, pretty similar. So we remain not quite where it was a couple of years ago, but still elevated above where it was historically as far as year-over-year wage increases and the like and then the overall difficulty in retaining warehouse associates, especially. So that continues to be a focus for us into 2020.

I think the -- on the second part, freight, we expect the freight to be fairly stable. So as we've talked about, it was a meaningful headwind for us in 2019. I think in 2020, it's more of a kind of stable for us. There's some things. Rates get a little more challenging, we think, with some of the activities we're doing internally, but again, it largely mitigates it. So not a big impact.

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Operator [33]

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Your next question comes from Judah Frommer from Credit Suisse.

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Judah C. Frommer, Crédit Suisse AG, Research Division - Senior Analyst [34]

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Sorry, can you hear me all right?

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Melissa Napier, US Foods Holding Corp. - Senior VP of IR & Treasurer [35]

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Yes.

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Judah C. Frommer, Crédit Suisse AG, Research Division - Senior Analyst [36]

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So first, maybe just to start, obviously, some big changes at your 2 largest competitors on the management, on the M&A side. Have you seen anything in your local markets changing in terms of competition or go-to-market strategy yet?

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Pietro Satriano, US Foods Holding Corp. - Chairman & CEO [37]

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We have not. We always characterize our industry as being competitive and hotspots to flare up, and those tend to happen more as a result of changes in local leadership. So we have not seen any changes.

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Judah C. Frommer, Crédit Suisse AG, Research Division - Senior Analyst [38]

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Okay. Makes sense. And then we've gotten kind of a mixed read on inflation pass-through in Q4 and kind of expectations heading into 2020. Would you say that you've had the ability to kind of fully pass on inflation in those commodity-heavy categories? And I think Dirk mentioned that the expectation for 2020 is that the level would be similar to 2019. That seems like a good thing, kind of coming down from that 3% level. Maybe there's something more in the 2s.

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Dirk J. Locascio, US Foods Holding Corp. - CFO [39]

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Sure. So we don't see anything in the current environment that would really indicate a significant change in inflation. And as I mentioned, we would expect it to be consistent with where we've been, and to your point, somewhere in the 2s. But I think grocery, we expect to be steady as it's been. Commodities are a little harder to tell as they can be more volatile. But just a reminder, these categories for us tend to be more fixed markups, so less impact on EBITDA with inflation or deflation in those cases. Also as our -- a good portion of our business is contract related, any cost increases or decreases get reset on kind of weekly to monthly basis. So overall, not a big change, and we didn't see anything different in the quarter that really impacted our ability to pass it through.

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Melissa Napier, US Foods Holding Corp. - Senior VP of IR & Treasurer [40]

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And we don't expect to.

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Dirk J. Locascio, US Foods Holding Corp. - CFO [41]

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We don't expect to, going forward at this point.

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Operator [42]

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Your next question comes from John Ivankoe from JPMorgan.

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John William Ivankoe, JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst [43]

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A couple of follow-ups, I think a couple of new ones as well. You did make the comment that the divestiture of the health care hospitality customer happened in the fourth quarter. And I think that impact is going to trough in the first quarter. Can I ask -- I mean, what that specific sequential change is for the health care hospitality segment is between the fourth quarter and the first quarter because of that customer losses, to make sure that we have it right.

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Dirk J. Locascio, US Foods Holding Corp. - CFO [44]

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So I think what we've talked about is it happened in the quarter. So the first quarter is sort of the first full quarter that it's out. So we expect Q1 to be a little bit softer than where it was, but overall, continue to accelerate as we bring on new customers from there, and again, our ability to really bring new customers on to grow that at a faster pace and achieve our 1% to 2% overall case growth that we talked about for the year.

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John William Ivankoe, JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst [45]

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Okay. And I'm sorry to push, and I understand if you don't want to answer, but it's a little bit softer? Is that 50 basis points? 100 basis points? 200 basis points? I mean that's -- obviously, you can interpret a qualitative comment like that in a number of ways.

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Dirk J. Locascio, US Foods Holding Corp. - CFO [46]

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I think at this point, John, we've shared what we're going to share. And I think the thing I would hope you'd take away is just our confidence in our ability to really accelerate that case growth to achieve the 1% to 2% overall that we've talked about.

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John William Ivankoe, JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst [47]

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Okay. Understood. I thought it was worth at least trying. A little bit of a comment on a specific customer, which is a public company. Obviously, talked about -- you're kind of -- you're pursuing some supply chain efficiencies, some distribution efficiencies. But do you kind of view, as Aramark and Avendra has kind of like talked about their business -- I mean, is this an opportunity for you guys to kind of increase your business? I mean is there anything in the near term that we should be sensitive to? Is there an opportunity to kind of take that contract longer term and actually grow your business? If there's anything that we can talk about in terms of that customer just because it is public and has made some public comments would be interesting to hear.

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Pietro Satriano, US Foods Holding Corp. - Chairman & CEO [48]

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John, so this is Pietro. So I think when we talked about -- or when we were asked about the acquisition of Avendra by Aramark, as we said -- 2 things. We have a very strong relationship with Avendra. We have served them very well over the course of time, and we believe that could parlay into opportunities and to broad opportunities. But we're not in a position, and it's premature to really talk about what that could be.

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John William Ivankoe, JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst [49]

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Okay. But even those comments were helpful. And the final question, as you've guided, and thank you for that, the CapEx plus capital leases in fiscal '20, does that include facility modernization for SGA? Or do -- should we anticipate some potential step-ups in '21 and '22 as you start to improve some of the physical plant within the acquired facilities after you've integrated some of the systems in fiscal '20?

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Dirk J. Locascio, US Foods Holding Corp. - CFO [50]

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Sure. So overall, for 2020, our guidance does contemplate the increased CapEx we would expect for Food Group being part of US Food. So at this point, we wouldn't expect a significant step-up from there. And just overall, as part of our overall CapEx number, each year, there typically is a large portion of that, that comes with, whether it's new facilities, facilities expansion, et cetera, to allow us to continue to grow.

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Operator [51]

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(Operator Instructions) Your next question comes from Melissa (sic) [Marisa] Sullivan from Bank of America.

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Marisa Sullivan, BofA Merrill Lynch, Research Division - Research Analyst [52]

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Just a follow-up on commentary around expenses. And I think you referenced some expense control initiatives in your prepared remarks. Can you just give us a little bit more color on that, where you're seeing the greatest impact. And then what do you see are the biggest opportunities to get more expense leverage in 2020?

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Dirk J. Locascio, US Foods Holding Corp. - CFO [53]

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Sure. This is Dirk. I think the -- overall, the cost initiatives are really balanced in a number of areas across the business. So supply chain, which we talked a fair bit about, that although it's not at the level we're striving for, still identifying opportunities for improvement across there through -- whether it's routing, systems implementation, process enhancements, et cetera and other areas around our shared services and continuing to optimize the work around there that balances quality and cost. And then others are just smaller pieces throughout the business in different admin functions. So it's really, I'll call it, a constant stream of improving those opportunities as we go forward.

I think that the biggest opportunity to step up, and it's maybe until beyond 2020, to a lesser extent, to 2020, is as we talked a lot about the supply chain, as we get continuous improvement really embedded in our environment and really get more of these improvements embedded, we believe there's an opportunity to step up our level of productivity that we drive on an ongoing basis to mitigate more of our annual cost increases we incur. And then of course, there's also continued opportunities, whether it's across shared services or others. But I think supply chain would be the biggest step-up opportunity as we think ahead.

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Marisa Sullivan, BofA Merrill Lynch, Research Division - Research Analyst [54]

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Got you. And then if I could just follow up quickly. On fuel, how should we think about fuel as a tailwind or headwind as you move throughout the year?

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Dirk J. Locascio, US Foods Holding Corp. - CFO [55]

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I would think of it really as neither. It's pretty flat compared to 2019. So we have a large portion of our fuel locked in already, and the fuel cost will be similar to what it was last year. Of course, there are other -- the smaller pieces, market level, and that would be tied to the market.

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Operator [56]

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(Operator Instructions) Your next question comes from Carla Casella from JPMorgan.

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Carla Casella, JP Morgan Chase & Co, Research Division - MD & Senior Analyst [57]

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Just one clarification on your prior question about -- you talked about the percentage of your business that was contract related, where there's some pass-through cost mechanism. I missed that percentage. And I'm just curious if that's a broad cost base or is that based on -- are there specific mechanisms for fuel versus other input costs?

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Dirk J. Locascio, US Foods Holding Corp. - CFO [58]

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Sure. So this is -- we've talked about in the past, roughly 2/3 of our business is some form of a contract. This is with our customers, and so that predominantly relates to pass-through of product cost. And so other things, if there is something around fuel, et cetera, those are in a number of our contracts, but they're -- it's a different structure versus -- product cost is very direct with the pass-through on that.

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Carla Casella, JP Morgan Chase & Co, Research Division - MD & Senior Analyst [59]

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And would the pass-through be similar on the fuel and others in terms of like how much of your business? Or is it in more of the contracts?

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Dirk J. Locascio, US Foods Holding Corp. - CFO [60]

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A few will be in more of the contracts, and it is -- so if you think about directionally, it works the same, but it's not as direct or as necessarily quite as quick a timing as some contracts.

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Carla Casella, JP Morgan Chase & Co, Research Division - MD & Senior Analyst [61]

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Okay. Great. And then just one -- you got a bunch of questions on your capital structure. But I'm just -- any thoughts about refinancing the bonds out there callable and -- or your balance between secured and unsecured debt?

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Dirk J. Locascio, US Foods Holding Corp. - CFO [62]

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Sure. So we continue to look at the capital structure. And Melissa's other hat, other than being our Head of IR, is also our Treasurer. So we're always looking at those. And just as we took advantage of some market conditions in 2019 to refi, we will continue to look for those opportunities for that and/or fixed variable opportunities in 2020. So it's definitely on our radar.

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Operator [63]

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There is no further question at this time. I would now like to turn the call over to Pietro.

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Pietro Satriano, US Foods Holding Corp. - Chairman & CEO [64]

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Okay. Well, thank you for all the questions, and thanks for your participation today. Just to summarize quickly, we're very pleased with 2019 independent case growth, adjusted EBITDA growth, improvement in ROIC and the very successful beginnings to the integration of the Food Group. We're very confident in our outlook for 2020, which includes growth in EBITDA and EPS. And finally, I'd like to thank all our associates across all the company, whose hard work and commitment makes these results possible. Thank you for joining us today, and have a great day.

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Operator [65]

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