Earnings Call Transcript - USFD Q3 2022

Operator, Operator

Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the US Foods Third Quarter 2022 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you. Adam Dabrowski, Investor Relations. You may begin your conference.

Adam Dabrowski, Investor Relations

Thank you, Rob. Good morning, everyone, and welcome to US Foods Third Quarter Earnings Call. Speaking on the call today, we have Andrew Iacobucci, Interim Chief Executive Officer; and Dirk Locascio, our Chief Financial Officer. Additionally, Bob Dutkowsky, our Executive Chair, will join for our Q&A session. We will take your questions after our prepared remarks have concluded. Our earnings release issued earlier this morning and today's presentation slides can be accessed on the Investor Relations page of our website. During today's call and unless otherwise stated, we're comparing our third quarter results to the same period in the fiscal year 2021. In addition to historical information, certain statements made during today's call are considered forward-looking statements. Please review the risk factors in our 2021 Form 10-K for a detailed discussion of these potential factors that could cause our actual results to differ materially from those anticipated in those statements. Lastly, 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 as well as in the appendices to the presentation slides posted on our website, except that we are not providing reconciliations to forward-looking non-GAAP financial measures as indicated therein. Thank you for your interest in US Foods, and I will now turn over the call to Andrew.

Andrew Iacobucci, Interim CEO

Thanks, Adam. Good morning, everyone, and thanks for joining us today. First and foremost, I'm delighted to report that we delivered strong third quarter results, reflecting continued execution of our long-range plan. US Foods' performance to date underscores our confidence in achieving our 2022 outlook. We remain committed to continuing the momentum from the first three quarters and driving our long-range plan. Let's turn to Page 3 for key takeaways from the quarter. First, our results this quarter demonstrate continued solid execution across the three pillars of our long-range plan. Our associates are a critical part of this progress, and I am grateful to them for their focus on execution and on serving our customers. In addition to strong day-to-day execution, US Foods associates have continued their tradition of stepping up when our customers and communities need us most. Most recently, during Hurricane Ian, which severely impacted many of our customers on the East Coast, our teams worked tirelessly to ensure our customers and the relief agencies we support could operate effectively and properly serve their customers. Based on feedback we received, our storm preparation and response are best-in-class in our industry. This intense focus on delivering for our customers is a large part of why we've been able to capture market share with key customer types in all three quarters of 2022. Second, with strong momentum in our plan, US Foods is increasingly well positioned to win in an evolving macro environment, particularly in light of our effective management of inflation and deflation, our scale and customer diversity and continued recovery tailwinds. Our results reinforce our confidence to deliver a strong finish to the year. Finally, we expect to drive meaningful value creation for shareholders through a new share repurchase program announced this morning. We are committed to utilizing US Foods' strong cash flow to deliver long-term shareholder value. Turning to Page 4, I'll start by walking through our third quarter highlights. Starting off, we once again delivered strong financial results. Net sales for the quarter grew 13% year-over-year, and volume growth strengthened as the quarter progressed, which we see as positive for both our business and for our customers. Adjusted EBITDA grew nearly 21% for the quarter, an acceleration from our Q2 growth rate. Our adjusted EBITDA margins also increased 20 basis points from the prior year as we gained operating leverage. Finally, we have updated our 2022 guidance toward the top end of our prior adjusted EBITDA outlook range. Our results show the resiliency in our business and the ability of our team to deliver on the plan we put forth earlier this year. Turning to our customer experience, we launched MOXē, our next-generation industry-leading digital tool and we continue to drive market share gains with key customer types, which we expect to continue as we further embed share data into our operating processes. Finally, we further expanded our omnichannel with two new chef stores, which opened in Q3 and early Q4. This brings us to four stores open to date with an expectation of two more openings before the end of 2022. We also continue to expand our Pronto service, a delivery service focused on smaller customers in concentrated geographies and are active with that program in nearly 30 markets. Next, we are pleased with our continued progress on supply chain. We completed our warehouse selection technology deployment as planned. This system enables a better associate experience, improved selection accuracy, and ultimately, a better customer experience. I talked last quarter about the various actions we are taking to improve employee retention, and I'm happy to report that we are seeing progress. Both driver and warehouse turnover have improved from what we experienced in H1. We are not yet where we want to be, and we remain laser-focused on improving retention by simplifying our core processes, strengthening leadership engagement, and offering greater flexibility with respect to shift schedules. Early returns from our seven-day work week pilot in the Southeast have been promising, and the flexibility it offers proved very helpful before and after Hurricane Ian. Finally, we continue to make progress on inbound logistics, resulting in further improved financial results and third-party partner collaboration. This work is well ahead of plan for the year. Lastly, we've been intentional in managing our capital structure and have reduced our leverage to 3.7x as of the end of Q3 2022. During Q3, we prepaid $100 million on our 2021 term loan, and in October prepaid another $100 million on our 2019 term loan. We were also very pleased to have announced earlier today that our Board of Directors has approved a $500 million share repurchase program, a significant step in further demonstrating the strength of our capital structure, confidence in our future, and focus on shareholder value creation. With that, let's turn to Page 5 and discuss how our performance in the quarter translates into progress on the three pillars of the long-range plan to drive profitable share gains, expand margins, and improve operational efficiencies. Looking at our first pillar, we are tracking to exceed our targeted restaurant growth rate of 1.5x the market. We are also continuing to win in the marketplace, as demonstrated by our share gains in key customer types of independence, healthcare, and hospitality. The MOXē launch I mentioned earlier is a significant milestone. MOXē is a step change to the customer experience from a performance and ease-of-use perspective. We have been focused on ensuring increased customer speed, confidence, and control. Our new one-stop shop app is 30% faster than it was before and is similar to the user experience of leading retail apps. Customer and seller feedback has been very positive, and we expect this to extend our technology lead in the industry. As mentioned earlier, we expect to open six new Chef stores in 2022, which is the high end of the range we previously communicated. As we open stores, we are building our capabilities to accelerate that pace in 2023. Let's move on to the margin optimization pillar. As a reminder, we've been working on a number of internal initiatives to improve gross profit per case that are independent of market conditions. For example, we continue to build on the momentum from inbound logistics as our process management initiatives program continues to drive efficiencies. We effectively managed inflation and deflation by running our proven plays. In the third quarter, we saw less sequential inflation than we experienced in the first half of the year, and yet our gross margins remained strong and in line with the first half of the year. Our cost of goods management program is also performing well and continues ahead of schedule with approximately 40% of our total vendor spend expected to be addressed by year-end. Turning last to operational efficiencies. We are making progress despite the challenging macro environment. Our routing optimization and network planning work continued, and our cases per mile improved further ahead of 2019 in the third quarter to the best results we've seen to date. We are pleased with the progress, yet remain focused on the benefits still to come from this work and from the routing system replacement in a future phase. The work we are doing on employee engagement, flexible schedules, and process standardization, for example, is yielding benefits as we experienced a lower turnover in the third quarter than we saw in the second quarter. We tackled productivity through a combination of network-wide initiatives and targeted optimization efforts in select markets with the greatest productivity opportunities. Turning next to Page 6. We've made significant progress over the last three quarters and expect to build on that progress to achieve our plan. The entire US Foods organization is focused on these initiatives and the actions that drive our long-range plan and we are relentlessly executing against all three pillars. As a result, we are enhancing the customer experience and our operational foundation, leading to share gains and significant year-over-year profitability improvements. We are a resilient business serving many customer types. Given our U.S. focus, our operations are less volatile than others. This positions us well to win even in a challenging macro environment and further strengthens our belief in the rightness and the achievability of our long-range plan. As we continue to build momentum against this plan, we will prudently allocate the strong and growing cash flow against our four priorities to create shareholder value. In summary, I am proud of and energized by our progress this year, and I am confident we will build on this momentum to deliver a strong 2022 and set us up for a strong 2023. With that, I will hand it over to Dirk to do a deeper dive into our financial results. Dirk, over to you.

Dirk Locascio, CFO

Thanks, Andrew, and good morning. I will start on Page 8. We're very pleased with what we accomplished this quarter. We continue to build on our momentum from the last two quarters and demonstrated progress against our long-range plan. Adjusted EBITDA grew 21% from the prior year to $351 million for the quarter, which is an acceleration from our Q2 growth rate. In addition to strong EBITDA dollars, our adjusted EBITDA per case remained strong and was in line with Q3 2019. The Q3 adjusted EBITDA was the best quarter relative to 2019 since prior to the start of the pandemic. Adjusted diluted EPS increased 25% over the prior year third quarter to $0.60. These highlights demonstrate the actions we are taking to grow and further strengthen our business are delivering meaningful results. Net sales were $8.9 billion in Q3, an increase of 13% over the prior year. Total case volume increased 1% from the prior year, and food cost inflation was 12%. Similar to last quarter, our Q3 year-over-year case growth was negatively impacted approximately 200 basis points by the planned mid-2021 exit of the grocery retail business we temporarily added during the pandemic and a small number of strategic exits. Independent case growth increased 3% over the prior year. We continued our trend of strong gross profit dollar growth again this quarter. Our adjusted gross profit dollars increased 15% from the prior year. And as a result, we generated strong adjusted gross profit per case. This is important because we experienced little sequential inflation compared to large amounts in the first half of the year, yet we're able to maintain similar gross profit per case. OpEx remains elevated, however, as the quarter progressed, we saw positive signs with improved operations turnover and productivity rates. Let's look at volume further on Page 9. Independent cases increased 3% on top of nearly 25% growth in the prior year. Hospitality grew 20% and healthcare grew 3%, offset by approximately 7% lower chain volume and the retail exit impact I noted previously. Our chain decline was driven this quarter largely by the strategic exit of a small number of lower profitability and more complex customers, consistent with what we talked about in Q2. Case growth across almost all customer types finished the quarter with stronger growth rates than they started and above the quarter's overall case growth for each type. This was very positive, and we expect volume to improve further in Q4. We delivered share gains in key customer types again this quarter. I will focus briefly on growth relative to 2019, the last full year prior to the onset of the pandemic. Q3 total case growth was about 6.5% below 2019, with independent cases performing the strongest at 3.3% above Q3 2019. We ended the quarter with strong momentum as our exit rates were above Q3 growth rates for most customer types. We still have embedded COVID recovery gains regardless of the macro backdrop. As healthcare cases were about 6% below Q3 2019 and hospitality was approximately 14% below 2019, while showing improvement from Q2 results. We are optimistic about our positive volume trends in September and October as they show continued strength and improvement. Turning to Page 10. We are updating our fiscal 2022 guidance provided previously. We expect to exceed our volume goal relative to the market. Technomic's latest outlook for 2022 calls for restaurants to be negative compared to 2021, while we expect to be positive, even with a small number of strategic exits previously discussed. Within restaurants overall, our independent growth remains positive and is expected to improve further, while the Technomic outlook for the year is negative. We also are on track to exceed their outlook for healthcare and be in line for hospitality. As full-service lodging, an area that has been lagging in recovery accelerates, we expect to further improve hospitality relative to the industry. Moving to earnings, we are tightening our adjusted EBITDA guidance to a range of $1.28 billion to $1.3 billion. This reflects our significantly increased confidence in achieving the high end of our previously provided range, as a result, the three quarters of strong execution against the three pillars of our long-range plan. We're also tightening our adjusted diluted EPS range to $2.10 to $2.20 to align with the updated adjusted EBITDA range. Interest expense is expected to be $250 million to $255 million, and cash CapEx is expected to be $270 million to $280 million. Total CapEx, including cash and financing leases for fleet, are expected to be approximately $400 million. Finally, we continue to expect net leverage to be approximately 3.5x at year-end. Looking at Page 11. We made further progress again this quarter in strengthening our capital structure and reducing leverage. We reduced our net leverage compared to both Q3 2021 and Q2 2022. Our net leverage ratio was 3.7x at the end of the third quarter, which is a 1.1 turn reduction from a year ago and a 0.5 turn reduction from Q2 of this year. We reduced gross debt approximately $450 million compared to Q3 2021 and during Q3 2022 prepaid $100 million of term loan. And finally, to date, in Q4, we have prepaid an additional $100 million of term loan. Leverage reduction is one of the focus areas of our capital allocation strategy. We continue to make strong progress toward our goal of 2.5x to 3x net leverage, and we expect to achieve net leverage range in fiscal 2023. I am quite pleased with the progress we continue to make in further strengthening our capital structure and delivering on our priority to reduce leverage. Turning to Page 12. US Foods has strong cash flow, and we're using to fuel our stated priorities. We will continue to invest in the business for growth with roughly $400 million in capital invested in 2022. And against technologies such as MOXē and warehouse selection, facilities such as our new distribution center in New Orleans and our most environmentally sustainable distribution center in Sacramento, New Chef stores, and fleet. We have made significant progress in reducing our leverage and expect to achieve our target range of 2.5x to 3x in 2023. We are doing this by using our strong cash flow to reduce debt and grow earnings. Finally, we are very pleased to announce the $500 million share repurchase program. This is a significant step as we have demonstrated meaningful leverage reduction and focus on a balance of further leverage reduction and return of capital to shareholders. We expect to begin some opportunistic repurchases in the fourth quarter. It reflects strength in our balance sheet, the resiliency of our business, our strong cash flow generation, and the tremendous value we see in our shares. In 2023, we expect to continue reducing leverage and opportunistically repurchasing shares in parallel. These actions and outcomes demonstrate our commitment to a strong capital structure and activities that create shareholder value. We expect to end the year in our target leverage range, inclusive of any capital we may return to shareholders. Just to sum it up, I am pleased with our progress this year, and I'm confident in our ability to deliver our 2022 outlook.

Andrew Iacobucci, Interim CEO

Thanks, Dirk. In closing, we continue to be laser-focused on driving profitable share gains, expanding gross margins, and building on our strong operational and financial momentum. I'm confident in the growing strength of our business, thanks to the initiatives we have underway and the hard work of our talented team as they continue to focus on serving our customers and executing our long-range plan with excellence. To put it succinctly, we are winning, and I am proud of our progress. With that, operator, please open up the line for questions.

Operator, Operator

Your first question comes from Jake Bartlett from Truist Securities. You may proceed.

Jake Bartlett, Analyst

Great, thank you for the question. My first inquiry is about independent case growth, which is nice to see accelerating. Could you share more details about what is driving this acceleration? How is customer traffic affecting this—has it been a disadvantage or an advantage? And is the acceleration primarily due to increased wallet share or new account generation? I have a follow-up as well.

Andrew Iacobucci, Interim CEO

Hi Jake, it's Andrew. Thank you for the question. We are quite pleased with the balance we are seeing in that growth. It is a combination of both gaining share of wallet and new business. Additionally, we have noticed a reasonable strengthening of our own customer demand, indicating that they are also growing. So it involves a mix of expanding share of wallet, acquiring new customers, and our existing customers experiencing growth in their business.

Jake Bartlett, Analyst

Great. I have a question regarding the case growth compared to 2019. It seems that in most segments, except for hospitality and healthcare, there was a slight slowdown in the third quarter compared to the second. Could you provide insights into what caused that? Were your share gains in the third quarter similar to those in the second? Any thoughts on why there was a slight deceleration?

Dirk Locascio, CFO

Sure. Good morning, Jake, this is Dirk. Good question. Overall, I think we're pleased. The beginning of the third quarter had a slower start due to broader market conditions and weaker demand. However, we've seen continuous improvement as the quarter progressed. This aligns with the confidence Andrew and I discussed regarding how we exited the quarter and entered the fourth. I feel positive about the case growth trajectory. It's important to note that we continue to gain market share among our key customer segments. We believe that healthcare and hospitality are also improving compared to 2019, and we expect this trend to continue, serving as a significant advantage for us. We are well positioned to grow with the right customer types. Our focus remains on profitable growth rather than growth for its own sake. Overall, I feel good about the quarter and our position as we move into the fourth quarter.

Andrew Iacobucci, Interim CEO

Yes. And Jake, just to add to your question, we saw share gains that were quite consistent in trajectory to what we saw in Q2.

Nicole Miller, Analyst

Thank you very much. I have a couple of quick questions. Could you provide some insights on your fill rates for both inbound and outbound, as well as any opportunities for backhaul? I believe there is a significant opportunity for you in that area.

Andrew Iacobucci, Interim CEO

Yes, thank you, Nicole. It’s Andrew. I appreciate the question. Our outbound fill rates to our customers continue to improve. However, inbound fill rates have remained relatively flat compared to Q2, with slight improvements in some key categories. Overall, it's still quite flat, and we are addressing this in two main ways. First, we are diversifying our supplier base to ensure we have alternatives when our primary suppliers are out of stock. Second, we are building up extra safety stock to guarantee we have products available in key categories. Regarding the backhaul opportunity, we have been actively pursuing this for some time, and our freight and logistics income results show that our efforts are yielding positive results. There is still room for further growth in this area, and our team is very focused on it.

Nicole Miller, Analyst

And remind us the inbound, like I've asked this question, I guess, of late, had the opportunity to. It's trying to understand the domino effect there. Is that something on the manufacturer side with their or their own inventory, their own capacity, like what's the problem today?

Andrew Iacobucci, Interim CEO

I think it's all of the above continued challenges. The only thing I'd add to that list is continued challenges as raw material supply in some of our categories. The system has still got some challenges that it's working through. We're definitely starting to see some improvements. And even though our fill rates in absolute terms haven't improved as much as we would like, our de facto fill rates have improved because of the diversification of supplier base. So we are still getting the product, which is not getting it from the usual sources in all cases.

Nicole Miller, Analyst

And then thinking back to prior recessions or really any period of macro consumer weakness that you could speak to. Did US Foods, I guess, sales, right, I guess it would be organic go up or down. And more importantly, in terms of your share when you think back to those types of prior periods. Did you take share from bigger and smaller peers? Or did you see share to smaller or bigger peers?

Dirk Locascio, CFO

Good morning, Nicole. This is Dirk. That's a good question. So overall, our industry and our business has shown itself to be quite resilient. If you look at what was a very tough recession in 2008, 2009, cases were down mid-single digits, earnings were relatively flat. If you look at other though, outside of 2008, 2009, the last three or four inflation-induced recessions, you saw much less volume decline. So it's a very, very small impact. I think that's a demonstration of the resiliency of our business. One of the things that I think if you look back even in '08, '09 and prior, we were a very different company. A lot of the work around differentiation that we've done has been since then. And so we would expect that all the same things that are resonating today for us to take share across these key customer types to continue to resonate. And in fact, I think that positions us even better to weather any kind of a challenge that comes than we were in the past. So I think we're well positioned and even though we can't control the macro, we can't control the execution of our long-range plan and the initiatives to drive that, and that's what we're going to focus on.

Nicole Miller, Analyst

And last question, please. How does less inflation disinflation impact the top and bottom line? And what is the lag until you see that impact versus the market movement in the underlying commodity items? Thank you.

Dirk Locascio, CFO

Overall, the lag is relatively short. Most of our contracts or non-contract prices tend to adjust within a timeframe of about a week to a month. This is quite quick. Notably, in the third quarter, we experienced the least amount of sequential inflation since early 2021, with only small increases compared to the first half of the year, while our gross profit per case remained strong. This reflects the resilience of our business. In Q3, we also observed some deflation in several key protein categories. Our processes and playbooks, as Andrew mentioned earlier, have allowed us to manage this effectively. We believe these areas are more likely to show deflation, and most of them operate on a fixed markup over our costs. Consequently, this does not significantly impact our overall profitability over time. We are satisfied with our progress and our management in response to these inflationary and deflationary trends.

Nicole Miller, Analyst

Thank you very much.

Operator, Operator

Your next question comes from the line of John Heinbockel from Guggenheim. Your line is open.

John Heinbockel, Analyst

On then start independent cases, right? So I think you've said you've seen improvement thus far in the fourth quarter. Any quantification of that, right? I'd imagine it's fairly modest, but maybe that's wrong. And is that coming from a number of accounts were drop size. And then lastly, just on that topic, right? If the market grew slower, do you think you can flex up the 1.5 to maintain the current level of growth or the market would impact your ability to grow?

Andrew Iacobucci, Interim CEO

So John, thanks for the question. Yes, we would say a meaningfully better exit rate than we saw overall in the quarter. And that would be driven by a combination of the factors you mentioned, as I said in the earlier question from Jake, we're pretty happy with the balance that we're seeing in the way we're driving IND growth.

Dirk Locascio, CFO

Yes. I was just going to mention that regarding our ability to grow despite the environment, it's difficult to predict how we will perform if there is a slowdown, but we believe we will continue to grow. A key factor that may allow us to grow even more is our differentiation and the offerings we provide to customers to help them succeed, especially in challenging situations. We've demonstrated this by assisting customers with PPP loans—guiding them on how to acquire and utilize them effectively—as well as helping them navigate inflation in their businesses. Therefore, we feel we are likely better positioned now, and the efforts we are making should enable us to keep gaining market share.

Andrew Iacobucci, Interim CEO

And John, just to add to that, I think one of the things we've learned most through COVID really is the ability to be nimble and agile and redeploy resources where the growth is. And I think that's been a pretty significant contributor to what has really been very steady sequential market share gains period-over-period over the course of the entire first three quarters of the year.

John Heinbockel, Analyst

Could you provide an update on staffing selectors and drivers? Also, on a normalized basis going forward, how much lower can labor hours be compared to case growth due to productivity? Do you anticipate that the hourly wage rate will grow in the mid-single digits, or is there a chance to keep it lower?

Andrew Iacobucci, Interim CEO

Yes. John, why don't I start and then maybe Dirk can talk a little bit about what we're seeing on the rate side. As far as our staffing situation, we feel very good. We're in a very solid position in the vast majority of our markets. As I mentioned in my remarks, we saw turnover take a pretty meaningful reduction over the course of the third quarter. And that was a combination, primarily, I think driven by some of the initiatives we've taken to better engage our workforce and create a culture that they want to be part of. Those are really starting to show some real impacts. But we've also undoubtedly had a little bit of help from the macro environment as well. So I would say, right now, I feel pretty good about the staffing situation. I'll maybe start on the second part of the question.

Dirk Locascio, CFO

John, I think to get back to the point on what we look at costs going forward. So I do think we can get back to an environment where costs grow in line to less than cases. I think that the part that's a little harder to know exactly is at what pace that happens, just knowing that so much of it is driven by the turnover and the retention factor. And as Andrew said, we're pleased with the early signs we're seeing there, and we know we're not where we want to be, but we're going to continue to be focused on improving that. I think from an overall wage inflation perspective, as we see and as we look ahead, that does appear to be coming back, call it, closer to historical levels of inflation. It's hard to know depending on what happens with the macro exactly where it settles. But I think the important takeaway there is it doesn't appear as though last year's level of outsized increases appear to be the new norm. But as you would expect, we're watching and managing that quite closely.

John Heinbockel, Analyst

Okay, thank you.

Operator, Operator

Your next question comes from the line of Edward Kelly from Wells Fargo. Your line is open.

Edward Kelly, Analyst

Hi, good morning guys. I just wanted to zero in on a couple of things that have been sort of asked already. But in terms of gross profit per case, I think, Dirk, you pretty intentionally highlight the fact that inflation is decelerating yet cost or gross profit per case has been very strong and even this quarter, it looks like it's accelerated. I guess I'm trying to figure out, are you implying that the current level is sustainable. And then as we think about going forward into next year with the continued benefit of mix, is that a line item that you could even grow from here? Just kind of curious as to how you're thinking about gross profit per case off of this level.

Dirk Locascio, CFO

Thank you for the question, Ed. You're correct, we intentionally highlighted this aspect. Our goal is to clearly communicate the durability we see in our gross profit per case. We believe that deflation is more likely to impact center-of-the-plate items than grocery items, and we're managing this situation effectively. Looking ahead, we anticipate that we can continue to grow our gross profit. This belief is reinforced by the fact that most of our gross profit gains are stemming from our internal initiatives rather than external deflation or inflation, though we do see some inflation segments that remain consistent, especially in areas where we apply a percentage markup. Overall, we feel well-positioned and are pleased with our progress this quarter, and we look forward to maintaining this momentum into 2023. This is evident when we reflect on 2022 and plan for 2023, as the initiatives we've implemented this year across various pillars will significantly drive our earnings growth going forward.

Edward Kelly, Analyst

Great. And then just a quick follow-up on where you stand in terms of customer exits. I know you know it sort of retail and then some other miscellaneous exits. But are you now at the point where you're really focused on more of sort of the net case growth going forward, meaning a lot of the exits are behind you?

Dirk Locascio, CFO

Certainly. Out of the 200 basis points we discussed this quarter, slightly less than half came from the grocery sector, specifically retail, which will be fully lapped by the end of the third quarter. The other portion that has changed will extend into the first quarter. Our emphasis has been, and continues to be, on growing with the right customers. This means focusing on profitable growth rather than just increasing case volume. In any business, it's important to maintain a healthy mix and replace less favorable customers with better ones. Overall, our aim is to grow the business, particularly with more profitable customers. This quarter's 21% EBITDA growth indicates that we are positioned well as we approach the end of 2022 and look toward 2023.

Edward Kelly, Analyst

Awesome, thank you.

Operator, Operator

Your next question comes from the line of Lauren Silberman from Credit Suisse. Your line is open.

Lauren Silberman, Analyst

Thank you very much. I want to begin by announcing the share repurchase program. Could you discuss how your capital allocation priorities have changed and where buybacks fit in relative to reducing debt? Thank you.

Dirk Locascio, CFO

Sure. Good morning, Lauren. That's a great question. We're excited to be able to discuss this. We've been very deliberate in managing our capital structure. This aligns with one of our four key priorities that we've often mentioned. Regularly, we've stated that we don't need to reach the upper limit of 3x to start this process. However, I want to be clear that we are committed to reducing leverage and moving towards that range. We believe that the share repurchase is a timely opportunity to enhance shareholder value, especially given the current levels of our shares. Additionally, we expect to further reduce debt while also growing earnings and repurchasing shares. We anticipate being in the 2.5x to 3x range by the end of next year, including any capital we return. This reflects our ongoing efforts to strengthen our capital structure as part of our overall strategy, and we're pleased to announce this today.

Lauren Silberman, Analyst

Great. Thanks. And just on the gross profit side, can you talk about what you're seeing with private label? And in more challenging environment, would you expect to see an increase in the level of penetration? And I guess just going forward, the most meaningful initiatives or opportunities you see to get that level even higher.

Andrew Iacobucci, Interim CEO

Yes, hi Lauren, it's Andrew. Thanks for the question. Yes, we absolutely have seen throughout a great opportunity to improve our penetration. One of the challenges, of course, has been supply. Most of our arrangements are with a limited number of suppliers from pre-COVID times, and we've had to significantly change our thinking around that to have alternatives in place. And we've done a really good job of doing that. We're in a very, very good spot now from a fairly stable supply foundation to really aggressively go after those increases. We've seen a natural improvement as customers tend to seek out the value that the control brand represents. And we expect that to accelerate as we get into a much better supply situation. So yes, I definitely expect to see that penetration level go up over the next several quarters.

Lauren Silberman, Analyst

And just the last one. On the gross profit per case, how much of your business is on a percentage markup versus a dollar markup to the extent you're willing to provide that?

Dirk Locascio, CFO

Sure. As a straight percentage, it's about half of the business, and then the other half is a combination of either a fixed markup and/or kind of more spot pricing on noncontract type of business.

Operator, Operator

Your next question comes from the line of Jeffrey Bernstein from Barclays. Your line is open.

Jeffrey Bernstein, Analyst

Great. Thank you very much. A couple of questions. The first one just on the food service chain business. You mentioned the decline in that business relative to independent growth. Just trying to get a sense, you mentioned a big portion of that is intentional exits of certain business. What we've heard from others that maybe there's an actual slowdown in the actual chain business. So just trying to get a sense for the balance between what you consciously exited versus what perhaps is the business slowing down and maybe the outlook you see for that going into '23?

Dirk Locascio, CFO

Sure. If we compare the decline that we're seeing are still the amount below 2019 levels. Almost all of that is the combination of these exits that we've talked about as well as the two concepts that we've talked about that have more meaningful reductions in same-store sales. Absent those two things, our chain business is relatively in line with where it was 2019. I think to your point, Jeff. So we're watching it closely. You do see across the different chains. You see some that continue to perform very well. You see others that don't perform as well. We'll continue to watch to see if you see any kind of a sort of more discernible slowdown. But again, those are typically on the lower end of the margin spectrum. And we think that even chains that we have on board and growing are well positioned in the environment that we're in. So our key is going to continue to be with growing with those key customer types and then being very opportunistic in all other.

Jeffrey Bernstein, Analyst

Understood. You mentioned that you expect continued easing in commodity inflation, and you're comfortable that it could drop to single digits as we approach the end of '22. You've referred to deflation a couple of times, particularly in relation to center of plate. Is there any concern that the overall inflation basket might shift towards deflation, or is that not a worry? Can you give us an idea of where you see that inflation basket heading in the short term, and whether deflation would be a concern if it were to happen?

Andrew Iacobucci, Interim CEO

Yes. It's challenging to predict what inflation will do based on our experiences over the past several quarters. What Dirk is indicating is that we have noticed some easing in a few commodity categories, and we believe we can handle that well. However, as we look ahead, we’ve mentioned before that there will likely be some easing in commodity categories, but we don’t anticipate seeing the same level of relief in non-commodity categories. Typically, prices in that area tend to rise, so we expect there will be significant stickiness in non-commodity categories regarding inflation.

Jeffrey Bernstein, Analyst

Got it. And lastly, just because we're now a month or so away from 2023. Is it still reasonable to assume that the prior guidance is achievable? I mean, it seems like you're coming in, in '22 at the upper end of ranges. I know you've talked about growing that 1.5x the market, but I think you had also thrown out there at least $1.5 billion in EBITDA and margins getting back into that mid-4% range. Is that realistic for 2023? Or has the more recent dynamic made those goals change either for better or for worse?

Dirk Locascio, CFO

Sure. So I think, Jeff, we will update that when we release our Q4. But what I will tell you is just kind of reinforcing what Andrew and I both said is we're very pleased with where we're sort of the progress we're at to date and that we expect to exit '22 with. So I think with that, we feel very good about where the business is. We feel very good about the progress against the plan. And we'll let you take with that which you may, and again, look forward to talking about it more in February.

Operator, Operator

Your next question comes from the line of Mark Carden from UBS. Your line is open.

Mark Carden, Analyst

Good morning. Thanks so much for taking the questions. So to start on MOXē, it sounds like you're hearing good feedback so far. Would you expect for this to be a reasonable tailwind where it's been deployed so far in 4Q. Or is it still too early from a ramp perspective? And then more broadly, how should we think about the pacing of the broader rollout over the next few quarters?

Andrew Iacobucci, Interim CEO

Thank you, Mark. We are very pleased with the early feedback from MOXē. Its primary benefit in the short term is encouraging our customers to join the e-commerce platform, which we've mentioned in the past has various advantages. We believe this platform is comparable to many leading retail platforms in terms of ease of use and functionality. Although we haven't specifically measured its impact on independent case growth, it's clear that the momentum we're experiencing is likely partly driven by MOXē. The rollout is now complete for our local customers, although we still need to adapt the platform for our national customer base to align with their order guide setup. We are actively working on this and expect to see progress in the first half of next year. Overall, we're very satisfied with the local results and while we haven't isolated the exact impact of MOXē, we are confident that we're experiencing many of the benefits historically associated with getting customers onto the e-commerce platform, driven in part by the use of MOXē.

Mark Carden, Analyst

Okay. Great. And then my second one is a follow-up to Lauren's question. After your recent debt paydowns, how does your exposure to fixed and floating rates shake out? And how are you thinking about the mix there going forward?

Dirk Locascio, CFO

Sure. We concluded the quarter with approximately 55% fixed rate. The additional $100 million from variable will slightly increase the fixed percentage. I expect that the extra debt we will pay down in the future will target variable rate debt, which will gradually raise the fixed percentage over time.

Operator, Operator

Your next question comes from the line of Kelly Bania from BMO Capital Markets. Your line is open.

Kelly Bania, Analyst

Hi, good morning. Thanks for taking our questions. Just a couple of follow-ups here on inflation and the impact. I guess, one, do you anticipate that moderating inflationary environment may or may not impact the competitive environment. So that's part one. And then also, do you think there could be some stronger volume growth hard to tell with all the volatility, how inflation has really impacted volume. I guess I'm just trying to ask the elasticity question if we start to see inflation really start to moderate here, could you have some stronger volume growth as the offset to that.

Andrew Iacobucci, Interim CEO

Yes, thank you for the question. I believe what we're observing in the competitive landscape is a persistent level of rationality regarding pricing. We are all seeking ways to lower our costs and price competitively, which is likely to remain a priority for everyone. However, I don't expect any significant changes in the competitive dynamics as a result of this. In terms of volume growth, we are closely monitoring our pricing relative to others, as well as category market share and any softening in those categories. When we identify a pricing issue, we have taken steps to address it. Overall, we haven't seen a significant impact from the continued rise in prices, although that could change in the future. We are focused on maintaining a balance between margin and volume growth and have been successful in growing our margin while also increasing market share.

Operator, Operator

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

John Ivankoe, Analyst

Hi, thank you. I want to take a moment to discuss your most profitable market segments, particularly independent restaurants, along with health care and hospitality. Focusing on independent restaurants, what were the main reasons in 2022 for possibly losing some customers? What factors have prevented you from acquiring new customers? Are you identifying what can be improved to enhance customer loyalty and ultimately grow your customer base? Also, what do you believe are the most crucial actions US Foods can take beyond just pricing to enhance retention, especially considering how this might have evolved in the current dynamic environment compared to a few years ago?

Andrew Iacobucci, Interim CEO

Yes, John, thank you for your question. We are very pleased with how our business has grown across all key segments, as shown by our market share gains from the beginning of the year to now. We expect this trend to continue. There are a couple of reasons for this. As the supply environment improves, it highlights our important differentiators as a company, such as our team-based selling, our innovative product platform, and the technology we provide to customers. The combination of these factors, along with the team's excellent work focusing on growing areas of the business, has contributed to our success this year in terms of our ability to continue to grow and capture market share in those key profitable segments you mentioned.

John Ivankoe, Analyst

Let me ask you this. I remember some years ago there were changes in overall route efficiencies, such as the day or time a day that customers received their orders, which may not have made customers happy and could have affected deliveries. For example, changes like the minimum number of cases a customer was required to order. Were those changes made a few years ago obstacles, or were they not really a factor? I'm just trying to understand how customer demand for flexibility may have changed and how it impacts your ability to provide that flexibility.

Andrew Iacobucci, Interim CEO

Yes, that's the balance. To address your earlier question, customers are generally willing to pay for strong service. However, they often expect their products to be delivered within a tight timeframe, which we strive to achieve, but we cannot be everywhere at once. We need to develop our routes in a way that minimizes distance. We have found that prioritizing our most profitable customers in designing these routes has been effective, allowing us to create efficiencies while ensuring high-value customers receive the service they deserve. We plan to continue this approach moving forward. We are also exploring initiatives like a seven-day work week, which we believe could bring significant benefits in terms of employee retention. Additionally, spreading volume throughout the week may enhance the service experience for our customers, which is why we are optimistic about this potential.

Dirk Locascio, CFO

John, regarding the drop size, we haven't encountered any issues. In fact, having more smaller drops can sometimes lead to a poorer customer experience by delaying competitors' trucks. What emphasizes our commitment to our customers is our focus on the core broad line delivery customers, along with our Pronto service, which Andrew mentioned. Pronto is our small truck service operating in nearly 30 markets, mostly in densely populated urban areas, catering to smaller customers with attractive economics. It offers more flexibility, allowing for later cutoffs for those who have limited storage space. We see significant potential in this area. Our direct service, which we've previously discussed, offers a much wider online assortment with direct shipping. Lastly, there's Cash & Carry, which we continue to expand, enabling our existing customers to make fill-in purchases while also accommodating other smaller customers. Our main goal is to serve the right customers with appropriate options rather than trying to cater to everyone with a broad line.

John Ivankoe, Analyst

Excellent, thank you.

Operator, Operator

Your next question comes from the line of Alex Slagle from Jefferies. Your line is open.

Alexander Slagle, Analyst

Thank you, good morning, and congratulations on the progress. I wanted to ask about the seven-day work week pilot and the program details, including the timing. I covered some of that already, but if there's more to discuss, please share. Additionally, I’d like to follow up on the positive shift in working capital. Is it accurate to say that this is becoming more of a tailwind now? I believe you mentioned towards the end of 2023, Dirk would be within the range of 2.5x to 3x, or maybe just 2.5x if that was the target. I wanted to confirm those details.

Dirk Locascio, CFO

Sure. Overall, there's not much more to add regarding the first part that Andrew mentioned. The seven-day work week is a pilot program, and while there are early positive results, it's still early in the process. We look forward to providing updates as things progress, and it would be a significant win for the associates, customers, and the company if we can move forward successfully. Looking ahead to next year, you're correct about the positive shift in working capital. As the recovery continues for certain customer types, we are getting closer to a more normalized working capital environment. Finally, could you remind me of the last part of your question?

Alexander Slagle, Analyst

Debt leverage target.

Dirk Locascio, CFO

So I wasn't specific. The range is between 2.5x to 3x, and we expect to be within that. If we have anything more specific to add, we will do that when we provide our 2023 guidance early next year. I want to reiterate that we are pleased and on track for our 3.5x target that we discussed for the end of 2022. We are focused on delivering on the commitments we have made.

Operator, Operator

Your next question comes from the line of John Glass from Morgan Stanley. Your line is open.

John Glass, Analyst

Thank you very much. Dirk, I want to revisit the balance sheet discussion, and I appreciate the insights on buybacks and managing that aspect. You still have a significant amount of variable rate debt. What are your plans regarding that? Is it something that can be addressed? Additionally, if you were to either hedge or return to the market to fix the rate, what do you believe the current rates would be? Is that what is currently holding you back? Thank you.

Dirk Locascio, CFO

Sure. Overall, we expect to continue reducing our variable rate. We do consider our capital structure and will provide updates when we have them. We don't believe the current market will prevent us from taking action, which is more likely to involve a financial instrument rather than a new issuance. When we have an update, we will share that information. It's important to note that despite the current rates, our overall borrowing rates are quite solid, and we believe we are well positioned in this environment.

John Glass, Analyst

Thank you. And just on market share growth, your peers down in Houston talk about this holistically, right? They grew at 1.4% or whatever times the market, including all segments. Can you talk about maybe that in your business in that context, what you think you're growing at relative to the market? And I know you've said you're going to exceed your 1.5x target for restaurants. What is that right now? Where are you growing at?

Dirk Locascio, CFO

So overall, we would expect to be largely in line with the market with our goals for the overall business, which would be about 1x or a little over 1x. We do have the retail piece that we would pull out this year again. But other than that, we expect to be in line. I think the important thing to take away and the reason that we separate it and don't talk about it maybe in the same way that they do is because not all growth is the same. So if you had outsized growth in chain or K-12 education, that is not our focus. And we really are targeted at really outgrowing in those key more attractive customer types. And I think what you're seeing is you're seeing this show up in our larger increases in profitability overall. And so we'll continue to grow and grow smartly, and you should expect that of us.

John Glass, Analyst

Okay, thank you.

Operator, Operator

And your final question comes from the line of Peter Saleh from BTIG. Your line is open.

Peter Saleh, Analyst

Thank you for taking my question. I wanted to inquire about seasonality, as we've heard from various restaurant operators that summer tends to be slower, with a recovery into the Fall. Can you provide insights into the seasonality in your business, especially in hospitality, and whether there are similar trends in health care? Are you observing a return of that seasonality? Additionally, any comments on Omicron, which seemed to have some impact in the fourth quarter last year and into the first quarter, would be appreciated.

Dirk Locascio, CFO

Thank you for the good question, Peter. To address your point, Omicron had a limited impact in the fourth quarter, more so in the first quarter. When considering seasonality, the slower summer periods coincide with the significant rise in fuel prices, making it difficult to identify if the slowdown is purely seasonal. It's important to highlight the increased exit rates we mentioned and the strong performance leading into the early part of the fourth quarter. In terms of seasonality, especially in hospitality, we need to keep an eye on holiday events and the return of larger gatherings. Additionally, with fall events related to football and similar activities, we'll monitor those closely as well. Those are the key factors I would focus on as we move forward.

Andrew Iacobucci, Interim CEO

I believe, Peter, that we still have significant potential for recovery in the crucial segments of health care and hospitality. We anticipate a consistent acceleration in these areas that may surpass their usual seasonal trends. We expect to observe this over the next year.

Peter Saleh, Analyst

Thanks and just my last question would be, I think you mentioned several times some deflation in center of the plate. Any way to quantify what you're seeing? And is there any evidence to suggest that that won't continue into 4Q and into '23?

Andrew Iacobucci, Interim CEO

We don't typically quantify at that level, but I would say we saw in some categories, a pretty meaningful pullback. But those categories are, I think returning to sort of more normal volatility, I would describe it, than necessarily systematically reverting back to a deflationary world. In fact, we've already started to see a number of the poultry category start to creep back up again. There just continues to be such volatility in the market from a supply standpoint that, that's, I think, driving as much of sort of the unpredictability of it. I don't foresee, I don't think the team is foreseeing a continued downward trend, but instead, more volatility than perhaps we've seen where the trajectory was typically mostly upwards.

Peter Saleh, Analyst

Great, thank you very much.

Operator, Operator

And this concludes today's conference call. Thank you for your participation. You may now disconnect.