西斯柯 (SYY) 2016 Q3 法說會逐字稿

Good morning. My name is Lindsay and I will be your conference operator today. At this time, I would like to welcome everyone to the third quarter Sysco 2016 earnings call.

(Operator Instructions)

Thank you. Mr. Neil Russell, Vice President, Investor Relations, you may begin your conference.

Thank you, Lindsay. Good morning, everyone, and welcome to Sysco's third quarter FY16 earnings call.

Joining me in Houston today are Bill DeLaney, Chief Executive Officer; Tom Bene, our President and Chief Operating Officer; and Joel Grade, our Chief Financial Officer.

Before we begin, please note that statements made during this presentation that state the Company's or management's intentions, beliefs, expectations or predictions of the future are forward-looking statements and actual results could differ in a material manner. Additional information about factors that could cause results to differ from those in the forward-looking statements is contained in the Company's SEC filings. This includes, but is not limited to, risk factors contained in our annual report on Form 10-K for the year-ended June 27, 2015, subsequent SEC filings, and in the news release issued earlier this morning. A copy of these materials can be found in the Investor section at Sysco.com, or via Sysco's IR app.

Non-GAAP financial measures are included in our comments today and in our presentation slides. The reconciliation of these non-GAAP measures to the corresponding GAAP measures are included at the end of the presentation slides and can also be found in the Investor section of our website. All comments about earnings per share refer to diluted earnings per share, unless otherwise noted.

To ensure that we have sufficient time to answer all questions, we'd like to ask each participant to limit their time today to one question and one follow-up. At this time, I'd like to turn the call over to our Chief Executive Officer, Bill DeLaney.

Thank you, Neil, and good morning, everyone.

This morning Sysco reported strong third quarter financial results. Our performance reflects both the commitment of our 52,000 associates to supporting the success of our customers and the improving execution of our strategy and three-year plan initiatives.

During the quarter, Sysco delivered sales growth of 2% and gross profit dollar growth of 4%, while limiting adjusted operating expense growth to 1.5%, which resulted in adjusted operating income growth of $60 million, or 16% compared to the prior year. Adjusted earnings per share grew 15%, to $0.46 per share.

These results were achieved with the benefit of favorable weather conditions and an earlier Easter holiday compared to the prior year third quarter. Consumer confidence data points, while still favorable compared to a few years ago, were somewhat uneven and tracked the volatile financial market activity quite closely. Lower fuel prices were likely a net positive, as the impact of consumer spending benefits and reduced delivery costs offset, to some degree, the economic slowdown we are experiencing in energy driven economies in certain parts of Texas and in Montana, North Dakota and Alberta, Canada.

Turning to specific restaurant industry data, the overall sales trends remain mixed. According to the National Restaurant Association, restaurant sales have been uneven during the first three months of 2016 after steadily rising throughout 2015. Both MPD and Knapp-Track have also shown recent traffic and sales declines; however, even with this recent choppy industry performance, the overall trend remains generally favorable for our customers, as illustrated by the US Census Bureau sales data for the quarter rising 1% above the prior quarter, representing the 11th consecutive quarter of restaurant sales growth.

Moving to our results for the first three quarters of FY16, I'm very pleased with the increasing momentum in our business. For the nine-month period ending in March, we delivered the following results. Total broadline cases grew 3.3% and local cases grew 2.9%. Sales were up 1.2%, despite being adversely impacted by both deflation and foreign exchange headwinds. Gross profit dollars grew 3.3% and gross margin increased 35 basis points. Adjusted operating income increased $100 million, or about 8% compared to the prior year, and adjusted earnings per share grew approximately 10%.

These results are in line with our three-year planned financial objectives, to grow adjusted operating income by at least $500 million and to grow earnings per share faster than operating income. Our progress towards the achievement of these financial objectives is being driven by focusing on the following four key levers: accelerating local case growth, improving gross margin, leveraging supply chain costs, and reducing administrative costs.

Regarding the reduction of administrative costs, we recently began to implement a workforce reduction of approximately 1,200 positions. We've taken a very thoughtful approach to this difficult process by focusing on prioritizing all existing work more effectively, reducing layers of management, and expanding spans of control. We believe our approach will allow us to continue supporting our customers with a high level of service, as evidenced by the fact that we are not reducing the number of marketing associates or warehouse and delivery associates who directly support our customers.

During the quarter, we also announced our proposed acquisition of the Brakes Group, a $5 billion European food service distributor with significant presence in the United Kingdom, France and Sweden. We're very excited about this opportunity, as we will inherent an excellent leadership team, a business whose customer centric strategy and culture is very similar to Sysco's, and 15,000 highly capable associates.

We expect this acquisition will provide a solid trajectory of EBITDA growth over time and an excellent platform for further acquisitions in Europe. Equally important, this transaction will not distract us from driving out our three-year plan in our existing business. We continue to target a June or July closing.

As we enter the final quarter of our fiscal year, we are executing our strategy at a high level. We have delivered consistent local case growth for the past two years, expanded gross margins for four consecutive quarters, reduced adjusted cost per case in the field, and put plans into place that will reduce administrative expenses. These actions and related results reinforce our confidence in our ability to achieve our business and financial objectives as we move forward.

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

Thank you, Bill. Good morning.

I'll begin my remarks regarding the third quarter by providing an update on some of the initiatives related to our three-year plan and how they've continued to positively impact our business results. As we have mentioned a few times before, our insights-based approach to understanding and meeting our customers' needs continues to guide our efforts and is clearly driving improved performance. For example, during the third quarter, our US broadline operations delivered case growth of 3.6%, including local case growth of 3.4%, gross profit dollar growth of 4.8%, including an improvement in margin of 39 basis points, and for operating expense, we reduced our adjusted cost per case by $0.08, or $0.03 on a neutral fuel price basis, and we had operating income growth of 11.5%.

We are driving increased case growth through a variety of sales and marketing initiatives that are designed to deliver value to our customers while providing a more consistent experience of doing business with Sysco. I'm pleased to report that the third quarter represents the eighth straight quarter of local case growth.

As you know, improving gross margin is another key driver of Sysco achieving our three-year targets, and our strong performance this quarter indicates that we are making progress towards delivering our long-term objectives. During the quarter, we delivered solid growth in key center-of-plate categories, such as beef, pork and poultry, and we continued our growth in produce, reinforcing the benefits driven from a focus on fresh. We also saw a solid increase of more than 50 basis points in Sysco brand sales with our local customers.

These efforts, combined with other initiatives, such as our ongoing work in category and revenue management, as well as the impact of deflation, contributed to an increase in US broadline gross margin of approximately 40 basis points, the fourth quarter in a row with gross margin expansion. These improvements are especially noteworthy, as we've been able to manage through the current deflationary environment fairly well, due in part to our ongoing efforts to improve local case growth as a percentage of our mix, as well as our continued focus on our category management process.

Separately, the operating expense performance during the quarter was particularly strong. We limited total adjusted expense growth to only 1.5%, despite case growth of more than 3%; and as mentioned, we reduced our overall cost per case in the US broadline by $0.03, excluding the impact of fuel prices.

From a supply chain perspective, we continue to make good progress towards our goals to improve overall service to our customers while driving higher productivity in our operations through our continuous improvement process. We've also seen good progress through a series of indirect spend initiatives. And while there's still a lot more work to be done, we are seeing improved operating expense trends and we are targeting a continuation of this performance throughout the balance of the fiscal year.

In conjunction with the series of initiatives to support our long-term strategy, we are implementing a new market structure that reduces the number of US broadline geographic markets from eight to six, effective at the beginning of our FY17 year. Each market team will continue to be led by a Market President and include key functional leaders across Finance, Merchandising, Supply Chain, and Human Resources to provide support to our operating companies and help to drive solid execution of the various corporate initiatives.

We believe that the work we've done in building the capability of the organization through the functional structure over the past two years makes this the right time for us to evolve our structure. This change will reduce overall administrative cost in the field, drive efficiency through a more standardized approach, and improve execution to our customers.

In conjunction with this restructuring, I'm pleased to announce the promotion of three strong Sysco leaders. Greg Bertrand has been appointed Senior Vice President, US Food Service Operations, with responsibility for all US broadline operating companies. We also announced that Scott Sonnemaker has been named Senior Vice President, International Food Service Operations Americas; and Bill Goetz has been named Senior Vice President, Sales and Marketing.

These are just a few of the key priorities and changes that are positively impacting our operational and financial results. And while we need to continue to execute at a high level, I'm confident we are on the right path to achieve our long-term objectives.

In summary, our customer and operational strategies are being executed well in the field and our headquarters teams are doing a terrific job of providing our organization with field-ready tools and processes that are enabling our success.

Now I'd like to turn the call over to Joel Grade, our Chief Financial Officer.

Thank you, Tom, and good morning, everyone.

We had a strong quarter, led by continued momentum from improved underlying business performance, strong local case growth, particularly solid gross profit dollar growth, and good cost management, achieved in an environment with continued deflation and currency headwinds. We continue to make solid progress towards our FY16 plan and our three-year goals.

We grew sales in the third quarter by approximately 2% year-over-year, despite deflation of 0.4%. We saw continued deflation in center-of-the-plate protein categories, such as meat, seafood and poultry, as supply recovers from various events in 2015. This deflationary trend has been persistent over the past few quarters

Acquisitions increased sales by 0.9%, while foreign exchange negatively impacted sales by 1% in the third quarter. The US dollar's strength against the Canadian dollar was responsible for the vast majority of the foreign exchange impact. The negative impacts we have been experiencing on a comparative basis is lessening as we began to wrap the initial decline in relative value of the Canadian dollar. On a constant currency basis, sales would have been up 3.1%.

Turning to case growth, consistent with our three-year plan to achieve disciplined case growth, we had another quarter of strong performance. Total broadline case growth for the third quarter was 3.3% and local was also 3.3%. This is the eighth consecutive quarter of year-over-year local case growth for the total broadline.

Looking at gross profit and gross margins, we grew our gross profit at a solid 4.1%, while also continuing to see expansion of gross margins, which grew by 34 basis points. The key drivers of gross margin improvement included category management, a more beneficial mix of local business, higher Sysco brand penetration in our local business, and deflation. On a constant currency basis, gross profit growth was 5%.

During the third quarter, we had a few certain items that impacted our results. These include restructuring costs, such as charges related to technology changes, severance and professional fees of $60 million, and about $10 million of acquisition financing costs.

On a GAAP basis, without excluding these certain item, and the comparable certain items from the prior year, our operating income grew 15% and our diluted earnings per share grew about 27%. The rest of my discussion will focus on the non-GAAP, or adjusted for certain items results.

Adjusted operating expense grew 1.5% during the quarter and by 2.4% on a constant currency basis. This increase was mainly driven by the previously mentioned higher case volumes and incentive accruals, and is partially offset by various decreases, including reducing indirect spending, reduced fuel costs, and foreign exchange translation. This progress is reflected in our reduced cost per case. As a result, adjusted operating income for the third quarter was $438 million, up 16% compared to the prior year and 17% on a constant currency basis.

As it relates to taxes, our effective tax rate in the third quarter was 33.6%, compared to 33.9% in the prior year period. Both quarters' tax rates were positively impacted by the favorable resolution of state tax matters.

Compared to the prior year, adjusted net earnings grew 10% and adjusted earnings per share grew 15%. Cash flow from operations was $1 billion for the first 39 weeks of FY16, up approximately 15% from last year. Net working capital improved by about a half a day during the third quarter, compared to the same period last year. This was largely driven by improvements in both receivables and inventory.

Net CapEx for the first 39 weeks was $348 million and free cash flow was $641 million. Both cash flow from operations and free cash flow include the cash impact of certain items of $272 million in FY16 and $128 million in FY15. As a reminder, the certain items for 2016 are mostly related to the termination of the proposed merger with US Foods, and for 2015 include items related to the planning of the merger integration. Excluding the cash impact of certain items from both years, cash flow from operations grew $273 million and free cash flow grew $346 million.

Now I'd like to close with some commentary on the remainder of the fiscal year. First, we are currently on track to hit our FY16 financial objectives. Second, we expect deflation to persist for at least another quarter. Third, we had a relatively strong fourth quarter last year, which will make fourth quarter comparisons this year more challenging. And finally, we now expect CapEx for the fiscal year to approximately $500 million, or approximately 1% of sales.

During the quarter, we also completed a successful debt offering, the proceeds of which are to be used for the acquisition of Brakes that Bill mentioned earlier. The very attractive coupons associated with this financing, approximately 3% on a weighted average basis, represents both the strength of our balance sheet, as well as impressive work by our team throughout the process. In addition, Sysco put in place hedges during the quarter that protect approximately half of the purchase price of the Brakes transaction against unfavorable movements in foreign exchange rates.

In summary, we had a strong quarter, led by continued momentum from improved underlying business performance, strong local case growth, solid gross profit dollar growth, and good cost management.

That said, we have more work to do in order to achieve the financial objectives of our three-year plan. We are committed to serving our customers and delivering a high level of execution in all the areas of our business that will improve our financial performance in both the near and long term. I feel confident in our ability to achieve the financial objectives of our three-year plan and we will aggressively continue to look for incremental opportunities to exceed our goals.

Operator, we are now ready for Q&A.

(Operator Instructions)

Your first question comes from the line of Kelly Bania from BMO Capital.

Hello. Good morning. Thanks for taking my question and congrats on a nice quarter here. Just curious if you could talk about the local case growth continues to accelerate, maybe just if you can provide some historical perspective on when the last time it was this strong. Are you seeing it in both comp restaurant growth or new independent local customers coming into the mix? And then in terms of the private label penetration with that local segment, where do you think you can take that longer term?

Hello, Kelly. It's Bill. I'll start and I'll let Tom give you a little more color. I think in terms of historical context, this is by far the strongest quarter we've had over the last four or five years, and that's very encouraging and certainly something that is bringing the momentum to the business that both Tom and Joel talked about.

So in terms of where it's coming from, I think it's the same answer as I would give you if you'd asked about margin or even expenses, at this point. It's coming from a lot of good work over the last few years on the commercial side of the business that Tom can give you a little more color on, and really good alignment, I think, with our leadership team throughout Sysco.

And I would say this particular quarter, we acknowledge it, there were some tail winds. And I don't like to talk about weather a lot. I think that the last two third quarters we've talked about weather. Two years ago, we had a brutal winter at the beginning of the winter, and last year I think it was at the end of winter. And this year was a pretty mild winter, so I think that helped a little bit.

With that said, I think I was also trying to get out there that the data out there right now is a little bit mixed in terms of overall industry growth. So I think we had some tail winds that we took advantage of, but more than anything, I think that it's more and more good execution of key initiatives that we put in place on the commercial side over the last three, four years.

On the brand -- and then I'll kick it to Tom real quick -- these things tend to go together. When you're growing your business, you're creating differentiation at the customer level, and that's what the brand allows us to do. And so we've brought renewed focus on the brand over the last few years in conjunction with our category management work, and I think we're doing it the right way. And I don't know, we're not really chasing a number here, Kelly. I think what we're saying is the key to all of this is really growing those local cases and as we do that, we should be able to grow the brand. I don't know that there's a particular percentage that we're trying to get to, other than to utilize the brand as a way to differentiate ourselves more effectively. But let me kick it to Tom here and give you a little more color on that.

Thank you, Bill. And I won't repeat a lot of what Bill said, because I think he hit pretty clearly on what the key drivers are. Let me just add on the local case growth, you'd asked about current customers and new customers. We spend a fair amount of time looking at what we call new sales, lost sales, and then penetration. And think about that as new customers, any customers that we may have lost some business at, or where we've done a better job of selling more to those customers.

And I would tell you all of those metrics continue to head in the right direction as it relates to our local customers, meaning our new sales continue to be very strong. Our lost sales have declined a little bit over the past couple of quarters. And our penetration sales, which is what is delivering more to those current customers, has also been increasing. And that's a key metric for us, because that tells us if we're improving in all those areas with our customers, our current customers, and making sure that we're continuing to satisfy their needs. So we feel good about all those metrics and where the business is heading.

And then lastly, on the Sysco brand, the only thing I'd add to what Bill said is our focus, a lot of the category management focus is in fact driven towards that local customer. And based on that, the more we bring them differentiated solutions, we've talked about innovation in the last couple of quarters is when we bring them new news and innovation, that actually helps us grow our Sysco brand, because generally those products are in the Sysco brand line up. So it's just, I think that, as Bill said, they go hand in hand, and I think this continued focus by us in bringing new and differentiated products to our customers is helping us grow that.

And I would agree with Bill. We don't have a number per se that we're targeting. We know that it's important and we continue to focus on it quarter in and quarter out.

Thank you.

Our next question comes from the line of Andrew Wolf from BB&T.

Great. Thanks and congratulations on the quarter. Bill, just wanted to ask you on the sales count, the MAs up and down the street. Is that up sequentially or year-over-year a little bit, or is the organization driving the good local penetration and general growth with the same headcount in the sales side?

It's roughly the same. I think the mix is a little different. We put a lot of trainees in over the last year and that's began to level out. Tom, you got anything?

No, I think that's the big change is from our base MAs were very much flat versus the past year in this quarter. We actually, because we've got good retention with our marketing associates, we're down a little bit on the number of trainees that we have out there because we just aren't needing as many in the pipeline. But overall, we're driving these sales with our existing sales force.

The reason it can be flat, Andy, is because of some of the work that we've done over the last two, three years with the CRM tool, with some things we're doing in terms of territory management to be more rifle-like in terms of going after the business. And that will continue to be a point of emphasis in our sales strategy.

Okay. That's an encouraging change, I think, from the way the business has historically operated. Do you think going forward, if you want to continue to keep this momentum going forward, you can at least leverage sales, get local case growth at a multiple of -- sounds like you can, I just want to confirm how you think about that. Used to be a one-to-one relationship between sales headcount and internal sales growth. It sounds like you've actually gotten to a point where maybe it's a lot better than that.

I think it's a little better than that. I think you will continue to see that.

And the other question is for Joel. On the $59 million total restructuring costs, can you just tell us how much of that was accelerated depreciation related to SAP or anything else?

Yes, I would say maybe about 25% of that was, a little less than that. There's a part of that that was, it was that stuff and then what I'll call a one-time write-off of projects that were in process that were associated with the SAP conversion at the time when that decision was made. We took a one-time charge on some of those. So again, it was split up, for the most part, between again, the one-time write-off, which was quite a bit higher than the accelerated depreciation, and then again, a couple other, severance-related costs were part of the certain item.

Okay. So the project cost didn't go through accelerated depreciation, just the one quarter of the--

That's right. That's something you'll see in the third quarter, not part of the accelerated depreciation, that was a one-time write-off of the project costs that were, again, associated with the SAP.

Okay. So we should take about $15 million or so off of the D&A just to get to a normalized D&A for the quarter? That's what I'm really trying to get to.

You know, that's probably a reasonable ballpark, Andy.

Great. Thank you.

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

So really looking at the change in the org structure, the eight to six markets, what changes does that necessitate for the levels below them, right down into really out to the op companies, what are they going to have to do differently? Where do you think you pick up execution benefits? And do you think this is the structure we're going to have going forward, or do you think you'll play around with it a little bit more and look for some more efficiency?

I think, John -- good morning -- again, the structure hasn't changed. All we've done really is consolidated from eight to six. When we went to the structure, the structure's really evolved over the last few years, but when we went to the functional structure a couple years ago, we felt eight was important. There's a lot of ramp up work and change management work to do when you put this type of structure in place and you've never had it before.

We just feel today that, in conjunction with everything else, that it's a good metaphor, if you will, for what I talked about in the expenses, where we can spread our people, our top people, a little bit further. We're further along in a lot of our transformative work, and we just felt that we can run the business very well with six. And it impacts not just the market presence, but all of the functional needs, as well, in the four areas, but really doesn't change that much at all, if anything, at the operating company level. Tom, do you want to?

Yes, the only thing that it adds is a little more geography for each of the markets, which means a couple more operating companies that report into that market level. As Bill said, the reason we're confident now is we've had enough time with this structure and the functional leadership that we feel like we're driving out consistency across the business, and a few more operating companies for each market is not going to be a challenge for them.

I think that's the only other thing I'd add is we're very focused on a consistent design. And what I mean by that is both at the market, but also at the operating company and trying to drive a little more consistency, which we believe will improve execution, and we've seen that so far. And we also believe it will create better customer experience, because there will be more consistent market to market and operating company to operating company.

John, I think we'll continue to tweak things, to Tom's point, but this structure, we really believe is vital, and I think that it's been a key part of the beginning of the momentum that you're seeing here over the last several quarters. So I wouldn't expect a structural change. These are $5 billion and $6 billion markets, so when you think about that, it requires a fair amount of focus between the corporate center and that op co. And so we think we've got it about right here at six.

And then maybe for Tom, where are we now with the revenue management organization? How much of the benefit are we now starting to see flow through? And where do you think the biggest opportunity is, if you think about the next 12 to 18 months, and both margin and case growth do impact either one?

So great question. So we no, literally last week, had our training for our last dozen operating companies. So basically by the end of the fiscal, as we've said, we'll be fully up and running, meaning a revenue manager in every operating company, and the market structure that's been in place now for a quarter will be fully operational.

So what we continue to believe is that by leveraging that organization and creating a more standardized set of what I'd call routines, and they partner nicely with our business technology team in creating some tools for these folks to really focus on ensuring that the product cost in a market is competitive and consistent, and we believe that by leveraging those routines and some of those tools out there that we're going to continue to see some benefit on the margin side. It's really there as a support or enabler for cases, it's not a driver of case growth, per se, other than ensuring that we've got the right market pricing in place.

So we feel good about where we're at. I'm not at a point where I'm looking to peg a number for you, but I think we feel good about the work that's been done and we're continuing to scale it across the organization.

Okay. Thank you.

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

Great. Thanks very much for taking my question. Good morning, guys. So I just wanted to ask also for an update on the ERP rollout. I know a couple months back, you folks had mentioned a bit of a different approach to that. Just wondering if you could give us all an update there?

Yes, there's not a lot to report there. Its just been a couple months, as you point out. So we're putting together the plans. There's 12 op cos that we're going to bring back to this enhanced SUS platform, and we're going to start with one company here in the next couple months. But we're on target from a planning standpoint. We've put the teams in place and got great coordination between the operating side of the business and the BT side, as well as shared services. So early days, but still very committed and on track.

Okay. Great. Thank you. And then just as a follow-up, maybe just going back to your private brand sales that had a nice increase this quarter. I know you mentioned obviously about the independent customer growth volumes coming through, but just in terms of categories that you are seeing, where do you think some of the most opportunity is there, any expansion plans from the private brands in general, maybe where you see the bigger changes by a product standpoint?

This is Tom. I'm not sure there's necessarily any big changes by product category. It's a fairly developed side of our business. And so what I think it allows us to do is as we introduce new products through the innovation pipeline, most of those are Sysco brands. So that is maybe one new focus area, and I wouldn't say that's necessarily in any specific category.

I think the only other thing I'd say is that a lot of what we do in the produce space, and you heard me talk about the produce growth and this focus on fresh, is in Sysco brand, as well. And that certainly, that continued focus there, that growth that we're seeing in some of those areas are also driving some of the Sysco brand momentum.

Great. Thanks very much, Tom.

Our next question comes from the line of Stephen Grambling with Goldman Sachs.

Hello. Good morning. Thanks for taking the questions. Just the first, on the trajectory of margins. You had the single best EBIT growth, I think, in over about a decade. As we think about deflation moderating and inflation potentially coming back next year, how should we be thinking about the recent level of top line flow through, particularly if you see case growth momentum hold?

Hello, Stephen. Well, first of all, I wish I could tell you when we were going to cross over between deflation and inflation, as we were pretty cautious in our comments. I think we said that we expect it to last at least another quarter. It could be longer than that, based on what we're seeing. So I'm not really sure when to make that call.

As far as your question goes, it's one of those great questions that's hard to answer, whether I'm looking back or looking forward. But I think if you go back and look at some of the things that we've said over the last several months in putting the three-year plan together, our hope here would be when we can return to a more moderate inflation environment that we would grow the cases and at least hold margin flat, maybe grow it a little bit. And that's the plan and that's going to take a lot of cohesive execution, which we're quite confident in right now, between cat man, Tom's spoken of rev man here a little bit ago, and continue to grow those local cases.

So the key is the local cases and the mix. We need to both grow both our local and corporate managed cases, so have that in the right ratio. That will help us on the brand penetration. And if we do that, I think we'll be able to manage our margins well.

Great. Thanks. And then as a quick follow-up for Joel, when you say that you're going to be lapping this tougher fourth quarter, is that primarily focused on just the margin or is there something else that we should be aware of as it relates to top line comparisons? Thanks.

No, I think you've hit it. And again, we had a pretty decent operating income quarter, as well, in Q4 of last year. So I think we're just calling out that the comparison for this quarter, in particular, is a little bit tougher than we've had over the last three.

Got you. Thanks so much. I'll jump back in the queue.

Your next question comes from the line of Edward Kelly from Credit Suisse.

Hello, guys. Congratulations on a great quarter.

Thank you, Ed.

Question for you, just from a top line perspective. Obviously, a lot of good strong momentum here in broadline's case growth. Can you maybe just talk about where you are within the runway here, whether it's penetration with existing customers, private brand in general, and even new channels? There hasn't been that much talk about areas like retail, for instance, which I know is something that's newer for you and maybe the opportunity that you see there. So I'm just trying to figure out the sustainability of the momentum that you're seeing today.

Well, let me start. I think, again, on the momentum part of it, it was a really, really nice quarter and we did a lot of good things and benefited from that. I think from an external standpoint, there were some tail winds that I don't think you can plan on every quarter, in terms of some of the favorable weather comparisons and that kind of thing. And we may be seeing a little bit of a softening out there right now in terms of what we're seeing in our business and the industry. So I think there's the external aspect of that. We can't do much to manage that. But I think obviously, we're managing within that environment very well right now and we expect to continue to do that.

I'll get to your question here in a second. The key, I really think, is what Tom spoke to earlier, in the earlier question, in terms of sustainability, it has to come from the book of business that we have today, in terms of our ability to do that. So certainly, our ability to continue to fill a pipeline with quality new account business, and that may come from different segments, to your point. We are doing some things on the retail side. We have talked a fair amount about some good work we've done over the last couple of years on the ethnic side, in particular Hispanic. We have some more opportunity there, beyond Hispanic and within Hispanic.

The whole area of fresh and organic is an area that provides a lot of opportunity. So whether it's customer segments, product segments, trends in the industry, those are all opportunities for us that we are exploring and beginning to get some traction in.

With that said, for us to sustain what we put up here over the last several quarters, and in particular this quarter, we need to continue to penetrate with our existing accounts -- that's the most profitable business for us -- bring in some new accounts from that quality pipeline, and do a little bit better, and we're starting to, in terms of our customer retention.

So we need to do all those things. And the good news is, we are doing those things right now. So I wouldn't overreact to one quarter or another, but when you look at the year-to-date numbers, those are well within the range of what we've targeted for the three years and we remain quite confident that we can deliver that.

And just one follow-up for you on something that's quietly becoming a bigger part of your story, is if you look at your free cash flow year-to-date, reported wise, it's up 50%, I think, based upon what Joel was talking about it, maybe it's up more. But you've obviously had good EBITDA growth, CapEx now trending below your forecast. Can you maybe talk about where the free cash flow and the CapEx sits within what you're focusing on in terms of improvement within that three-year forecast and what we should be expecting going forward?

Well, with great trepidation here, let me start and Joel will give you his color on it. One of the things we're very careful about and meticulous about in terms of the three-year plan was to lock in two or three key objectives that we have financially that we thought would resonate with our investors and potential investors, based upon feedback that we got. So we locked in an operating income growth, and we also acknowledged that we would expect to grow our EPS somewhat faster over that three-year period than the operating income growth. And we locked in on return on invested capital, and we set a goal out there for 15%. Now obviously, that was before the Brakes deal, but we're on track today within the business as it sits today, Ed, to hit or slightly surpass the 15%. Once we close on the Brakes deal, we'll be able to bring that in and give you some color on the impact of that.

But we are very, very focused on the return on invested capital. And obviously, they come together, to your point, in terms of free cash flow and EBITDA growth. So we don't have a particular delta target, if you will, for EBITDA growth or free cash flow right now. But it's been strong here for some time and I would expect it to continue to be strong. And in terms of how we're going to invest it, I think you'll continue to see us invest in the business.

You're right. We're a little under where we thought we would be on CapEx this year. I think Joel commented that we expect to be around $500 million for the year, which is about 1%. In any given year, that could go up or down a little bit, based on timing. But I think that 1%, maybe slightly more every now and then, is what you should expect there. And we're going to continue to, obviously we're going to be very focused on assimilating Brakes in the right way and even more focused on continuing to run the business here as we've laid out.

So bottom line is I think you'll continue to see us invest in the business about 1% CapEx, increase the dividend modestly, probably not quite as fast as the earnings go up, continue to look for good acquisitions and opportunistically look at buying back shares. Joel?

Our next question comes from the line of Zach Fadem from Wells Fargo.

Good morning, guys. You called out some of the fresh categories in your prepared remarks, specifically produce and proteins. Seems these categories tend to have more specialty competition, particularly for local customers. First of all, would you agree that fresh is an area that you're taking share? And I'm curious how you think about this as a longer term opportunity, just given your scale versus the specialty mom and pops?

Yes, why don't I jump in? And first of all, it's hard to tell whether we're taking share, but we're certainly seeing good growth in these areas. So as you know, we have our own specialty companies in these areas, Fresh Point on the produce side, and also a variety of specialty meat companies across the enterprise. But we're very focused on these categories. And I don't think it's necessarily a new thing for Sysco. But what we know is if we can perform well for our customers in these maybe more challenging categories at times, of delivering fresh meat and produce, then that allows us to do the other things also and also do them well.

And so we've had a focus on quality and making sure that we've always got the right products out there. We've got a great program in place, through our Sysco brand, around traceability, which is also very important. So we definitely believe that even as large as we are, we're able to compete in this space, and we're continuing to focus on how we can be better every day for our customers. And so I think we feel good about our performance to date and feel like we can continue to grow in this area, but it's an ongoing day-to-day management of that business to be successful.

Got you. And just with the volatile inflationary environment right now, can you talk a little bit about pricing guard rails for your MAs? How much autonomy do they have on pricing? And can you talk a little bit about your approach, to the extent you can, to ensure that you aren't leaving money on the table yet still being competitive on price?

Well, what I'd say is that we still believe in pricing is local in this business for local customers. And so while they have some autonomy through our revenue management work, we're continuing to do a much better job of giving them tools and process to ensure that we're competitive locally, but that we're also managing the business. So I would say we continue to believe it's important for them to have that flexibility for our customers. We want to make sure we're competitive on the street each and every day. And we're trying to create the environment where we're doing that together, meaning the sales person and the Company, with both customers' and our objectives in mind.

Got it. Thanks for the color.

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

Yes. Hello. Thanks for the question. I mainly wanted to get some clarification on your outlook for the operating expenses in the fourth quarter and for FY17. So is $70 million still the right number, based on your guidance for this year for total charges? And if that is the right number, am I right in assuming that you're looking at $10 million or $11 million in fourth quarter charges? And then the same question for FY17, are you still looking at, I think it was $130 million in charges for next year?

Yes, this is Joel. We've talked about, when we talked about the couple of recent announcements that we've had that we anticipated around $70 million for this year and around $130 million for next year. Those estimates still hold. So I don't know if that answers your question, but the numbers that we talked about earlier, we still feel good about in terms of as we look forward.

Okay. And the severance is on top of those numbers, is that correct?

There's an element of severance actually built into those numbers, Ajay. So we made some estimates in terms of severance. The $70 million and the $130 million basically were comprised of, the way I think about it, really four different things. It was this one-time write-off this year in this quarter, which we talked about in terms of the construction and progress write-off. It's accelerated depreciation. It's severance and what we call conversion costs, things that essentially are due to moving from the SAP system to our enhanced version of SUS. So I was thinking about that as really is grouped into those four different areas. And so severance, again, we have severance estimate that was actually part of that number for those two years.

Okay. And I had one follow-up question. I think it's a follow-up to one of the questions that was asked earlier on the transition from deflation to inflation. So assuming that there is some inflation that reappears next year in FY17, so I understand the gross margin percentage increases when you have deflation, but would you say there's also some underlying benefit when you're seeing your cost of goods going down, as they've been going down over the past two or three quarters, both from fuel and deflation. So would you say it's possible that your input costs are going down at a faster rate than you're passing along to some of your broadline customers, and does any of that benefit start to get offset as you start to deal with inflation again, whenever that happens?

Yes, there's an element of that, Ajay. There's the math aspect of it and then there's an element of that. Obviously in our business, where you turn your inventory every 20 days, you can't hold the prices for too long, given the competitive environment that we're in. So to Tom's earlier point, we're always trying to strike the right balance there with what the customers' needs are. So that's certainly part of it. But I would also say to you that I'm not a big fan of deflation, so I think the longer it goes, the more challenging it becomes. People start to expect prices continue to go down, so it's not a good place to be, but it's explainable.

A lot of the way we got here is these center-of-the-plate, these protein categories are flat to now down, whereas a year, 18 months ago, they were up double digit. And the rest of the categories are roughly flat, maybe up a little bit or down a little bit. So it's primarily being driven in the protein area. And that's the area that we'll have to watch closely in terms of when we come out of it.

But I would just echo what I've said for years, and I think what Sysco's said for even longer than that, the best environment for us and for our customers is when you have a moderate level of inflation, ideally across multiple categories, 2%, 3%, whatever. And I would say it gets more challenging if you go to where you have 5% or 6% inflation, and we've seen that. And it's certainly challenging over the medium term when you have deflation.

So bottom line, I feel really good about how we're managing it. I think a lot of these commercial initiatives I spoke to earlier, and that Tom has spoken to, have come at just the right time in terms of managing through this process. And yes, there's some short-term benefits with deflation, to your point, but medium to long term, not where we want to be.

And I would just add one thing, if I could. It's Joel. Just as a reminder, the way it impacts our financials, yes, there is some margin benefit to that; however, they ultimately lead to dollars on the gross profit side we roll through are less when we have deflation, typically. So that certainly is a headwind for us, just as a reminder of that.

Okay. And one final question, if I could, since you called out the Easter calendar shift in your prepared remarks, can you quantify that at all in terms of the sales impact?

No. I don't think the Easter thing -- we called it out just because it was real. But Easter, my experience, is not quite as big a deal as it used to be years ago, certainly not as big a factor as Mother's Day. But it was a factor. I think the weather was a bigger factor, Ajay. When you look at the delta in the case growth, it would be great to think it was all us, but I think part of it was driven by a pretty mild winter in most of the markets that we serve. So to me, that was a bigger deal than the holiday.

Great. Thanks.

Sure.

Our next question comes from the line of Mark Wiltamuth from Jefferies.

Hello. Good morning. Wanted to get a gauge for how big the pressure was from those oil-related states, how big is that for your overall mix of sales and when do you think you'll start lapping out of that?

I have no idea when we're going to lap out of it, just like I can't predict when we're going to move from deflation to inflation. We haven't talked about that publicly. I think again, we're making an effort here to give you our perspective of what's going on as fuel impacts us. So I think on the good news, on the tail wind side of it, there's some flow through, we believe, with the consumer level. It's hard to quantify that from what we see, but it certainly is enhancing discretionary income. Prices started to tick up here a little bit of late. It has certainly helped us on our cost structure, although we've managed costs extremely well outside of that impact.

And we're just pointing out that the downside of it is in a good portion of the Southwest, as well as you get up into Montana, North Dakota and into Alberta, Canada, it goes the other way. So it's meaningful in those markets. And I think if it persists and becomes a more meaningful number, we probably will give you some color on that. But right now, we haven't.

Okay. So what do you think the primary factors are to give you your better performance on a local case volume trends versus these disappointing results we're seeing out of Knapp-Track and some of the other casual dining metrics?

Oh, that's a hard question for me to answer. I can speak to our performance. And I think our performance comes from continuing to differentiate ourselves relative to our competition, in what remains a very competitive marketplace. And so Tom spoke to the penetration and that's big, as well as improved retention. Obviously, as I've said now two or three times and as we've said really since there's been a Sysco, that local case growth, that street case growth is a key focus for us where some of the data that you're citing there is more chain driven. So I think there's a little bit of a customer mix reconciliation there, as well.

Okay. Thank you.

Sure.

Our next question comes from the line of John Ivankoe from JPMorgan.

Hello. Great. Thank you. Firstly, can we talk about digital as a percentage of sales, either in broadline or local case volume, just where that is? And I don't remember, I'm sorry if you have, if you've publicly stated where you think that can go, let's say, by 2018 and the implications that it may have for your business?

So we haven't talked about where we think it can go. What we have talked about is that our approach here is to provide the options to our customers to order in whatever manner they choose. And so we continue to believe that's the right approach. We feel great about our marketing associates and the work they've been doing. We know that we need a good, viable online system, and that's what we've been rolling out through our mobility platform. And obviously, we still have orders that are placed in other means, called in or faxed in.

Having said that, we continue to feel good about the work we're doing. The mobility piece, think about mobility as more of the hand held or the iPad, iPhone type of, or Android device. We obviously have desktop. And so our, as I think we've said before, our online purchases are still relatively small on the Street, just slightly under 10%, but growing, and we feel really good about the progress we're making there. But we haven't pegged a number by a certain date, because we really believe it's going to find its level place, based on what the customers' needs and expectations are.

Thank you. And secondly, is there any implication at all if the UK leaves the EU in terms of your Brakes acquisition? In other words, Brakes, which has operations in the UK and the EU, are they completely separate and would that have any impact on your business at all?

Well, hard to assess at this point. There will be an impact, John, in Europe, obviously, and the UK, in particular. It's hard for me to tell at this point where we are with Brakes to really give you any specific color on that. So we're watching it. And we were certainly well aware of Brexit when we entered into those discussions.

So there's no point in me conjecturing on that. I think we're just going to have to watch and wait for the vote and see where it goes. But again, just like in this country, people are going to go out to eat and we are very, very fortunate to be getting ready to close the transaction with a very well respected, strong company with a great leadership team that's got a lot of good things going on. So we'll deal with whatever comes there. But right now, I think we're very excited about the team that we're going to inherent.

And I would just add, just as a reminder, we're in this thing for the long haul. We look at that deal as very much a part of our long-term value creation. And so again, as Bill said, we certainly knew that was out there when this was in here, but we're certainly in this for the long term.

Thank you.

Our last question comes from the line of Erin Lash from Morningstar.

Thank you for taking the question. I just wanted to follow-up on an earlier discussion regarding CapEx. I got the impression that the reduction for this year was related to more timing issues and that would potentially flow into next year. So if you could confirm that. And also then as it relates to the Brakes deal, and I realize that the deal has not closed yet, but the extent to which you can provide some of your initial expectations in terms of whether there's going to need to be a step up in CapEx as you bring that business online, that would be very helpful.

Sure. This is Joel. I'll take that. The CapEx commentary, there's some element of timing in that, but I wouldn't say a lot. So I wouldn't think about this that there's going to be some big spike next year as a result. As Bill talked about, we certainly see this area around 1% of sales from CapEx being a very normal and reasonable number for us. Again, we've got a very disciplined process for the way we manage that, based on the needs of our business. And so again, there's some element of timing in that, but again, I wouldn't expect something significant changing going forward on that.

And then from a Brakes perspective, the one thing I think we've talked about is that in general, this company has been well invested in, and so certainly, as part of the modeling we did for this deal, we factored in some level of CapEx, as you'd expect. But again, I think the level they are anticipating and the level we are, are relatively in line. So I would certainly, again, anticipate we'll give some more clear guidance on that once the deal is done. But just at a high level, I think, again, they're in a pretty well invested place and look at CapEx in a relatively similar way that we do.

Thank you. That's very helpful. And then just following up, at the CAGNY conference earlier this year, you discussed the fact that the challenges facing the oil industry were actually benefiting you in terms of your facing some of the truck driver shortage issues that had added to your costs over the last few years. And I wondered if you could discuss that, whether you're still seeing a benefit in terms of an enhanced pool from which to attract truck drivers or whether maybe some of that benefit has been moderating?

Erin, I think we are. I think the markets that we struggled in a year ago, 18 months ago, we certainly have closed the gap there. Now some of those challenges were self-inflicted and we've gotten better on the talent acquisition side, as well, over that period of time. So if we were in the business of hiring truck drivers, we'd be in a better place right now. I would rather have the trade-off, though. I'll take the business and struggle with hiring truck drivers. But to your specific question, that certainly has mitigated or muted over the last several months, and it's not a real big issue for us right now.

Thank you very much. I appreciate it.

Sure.

And there are no further questions at this time. I'll turn the call back over to the presenters.

Okay. Thank you very much, everyone. We appreciate your time today.

This concludes today's conference call. You may now disconnect.