西斯柯 (SYY) 2019 Q1 法說會逐字稿

Good morning, and welcome to Sysco's First Quarter Fiscal 2019 Conference Call. As a reminder, today's call is being recorded. We will begin today's call with opening remarks and introductions. I would like to turn the call over to Neil Russell, Vice President of Investor Relations and Communications. Please go ahead.

Thanks, Christina. Good morning, everyone, and welcome to Sysco's First Quarter Fiscal 2019 Earnings Call. Joining me in Houston today are Tom Bené, our President and Chief Executive 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 within the meaning of the Private Securities Litigation Reform Act 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 30, 2018, subsequent SEC filings and in the news release issued earlier this morning. A copy of these materials can be found in the Investors 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 Investors section of our website. (Operator Instructions)

At this time, I'd like to turn the call over to our President and Chief Executive Officer, Tom Bené.

Good morning, everyone, and thank you, as always, for joining us. This morning, I will provide an overview of Sysco's first quarter results, discuss the macro environment that we are currently operating in and walk through our operating performance, including key drivers impacting our performance across each of our business segments. I will then turn the call over to Joel Grade, our Chief Financial Officer, who will discuss our financial results in more detail.

Sysco's overall financial results announced this morning reflect improved year-over-year operating performance, driven by a variety of initiatives across each of our 4 strategic priorities. Due to some temporary headwinds, including decreased inflation across some categories and the impact of Hurricane Florence that hit the Southeast late in the quarter as well as some additional and more persistent operating expense pressures, we had mixed business results across the business.

From a top line perspective, we generated sales of $15.2 billion, a 3.9% increase compared to the same period last year, driven by very strong U.S. Broadline case growth of 5.7% but offset by slower growth in our International businesses. Additionally, we saw our gross profit increase by 3.9%, adjusted operating expense growth of 3.6%, adjusted operating income increased 5.1% and adjusted EPS increase $0.17 to $0.91. Overall, our fundamentals for the quarter were solid. And as an organization, we remain focused on working closely with our suppliers and customers to deliver disciplined profitable growth to enable the achievement of our long-term objectives.

Looking at broader economic and industry trends in the U.S. Overall consumer confidence remains high, which has driven healthy consumer spending. During the quarter, according to Black Box Intelligence, the restaurant industry saw improved performance, particularly in same-store sales growth despite lower same-store traffic. In addition, other data points reflect positive implications for longer-term consumer demand, such as faster-than-anticipated growth in U.S. GDP of 3.5% and the strength in the labor markets, all factors that historically have been positive signs for the foodservice industry.

The economic outlook in our national geographies remains somewhat mixed. Canada's economy is performing well and foodservice sales are projected to continue growing. In the U.K., GDP and household consumption are both forecasted to grow over the next year, but consumer sentiment remains negative in the market with further closures of restaurants and concerns about the food supply chain being driven by continued Brexit negotiations. The remainder of the European market continues to experience healthy foodservice growth and positive economic conditions due to improving consumer confidence.

As it relates to the current operating environment at Sysco and some of the impacts affecting our business, we are seeing cost challenges, specifically driven by the tightening labor market in the U.S., and a slowdown in growth in some of our International businesses, which I will address in the various segment results.

Given some of these ongoing challenges, we are accelerating our focus on managing our overall cost and have in place multiple initiatives across the business that will drive cost improvement and enhance customer service over the next several quarters. A few of these initiatives include: the Finance Transformation Roadmap, which we originally discussed at our Investor Day in December. This initiative increased -- increases centralization and standardization of our end-to-end global finance processes and workflow and utilizes digital automation on a more modern finance platform to improve efficiency. This also allows for increased globalization of certain roles, helping to lower our administrative costs. Job changes have recently begun. And we expect to see financial benefit from this initiative to ramp up as planned over the next few quarters.

Smart spending, which is focused on reducing our overall G&A spend by taking a detailed and accelerated look at indirect spend categories to drive productivity and savings. This effort is providing unprecedented visibility, ownership and performance management in all areas of our business. And third, the Canadian regionalization, which is focused on streamlining our back-office administrative support for our Canadian operations while maintaining an acute focus on our customers. This effort has already commenced and will contribute to increased cost savings as we move forward.

I would like to transition now to our first quarter results by business segment, beginning with U.S. Foodservice Operations. We are pleased with our top line result and local case growth. But as mentioned, we continue to see significant cost challenges. The results are as follows: sales for the first quarter were $10.4 billion, an increase of 5.6%; gross profit grew 5.2%; operating expenses grew 5.8%; and operating income increased 4.3%. As previously mentioned, local case volume was strong within U.S. Broadline operations growing 5.2% and has now grown for 18 consecutive quarters. Total case volume within U.S. Broadline operations grew 5.7%, reflecting a mix of both local and national customer growth.

As it relates to volume, going forward, we expect to see some softening in the year-over-year growth numbers due to the annualization of both the HFM and Doerle acquisitions, the annualization of 2 large national customers added in the prior year and the impact of Hurricane Michael.

Gross profit grew by 5.2% despite moderating inflation as we continue to see growth in Sysco Brand, which is up to 47.2% of local cases. We also continue to see accelerating growth with local, emerging concepts, also known as micro-chains, as these unique locations continue to resonate with today's consumers. In fact, the larger portion of our local growth is currently coming from this type of customer.

From an expense perspective, operating expense for the quarter grew 5.8%, driven by supply chain cost in both the warehouse and transportation, including significant overtime expense and cost associated with hiring due to the tight labor market. Additionally, rising fuel prices also contributed to our higher operating expenses for the quarter. We are addressing these challenges by working on the initiatives I mentioned earlier and by continuing to drive productivity, putting tighter controls in place on how we manage costs and working with our teams to improve our hiring and training practices to better retain talent in our supply chain operations.

Moving on to International Foodservice Operations. We had mixed results for the quarter. Sales increased 0.6%, gross profit grew 0.1%, adjusted operating expenses were flat and adjusted operating income increased 0.2%. Top line results were softer than expected in Canada. After a good second half of fiscal 2018, first quarter sales in Canada lost momentum as year-over-year growth began to moderate.

In Europe, performance for the quarter met our expectations, and we have a combination of activities impacting our overall performance that includes the rationalization of some customers in the U.K. as we restructure our operations, along with saturation of restaurants in the market, partially driven by the uncertainty surrounding Brexit. In France, we have made significant progress towards the combining of Brake France and Davigel, which will enable us to ultimately leverage the size and scale of these businesses to deliver accelerated performance as we create Sysco France. In our Latin American businesses, we saw solid performance, particularly in our Costa Rica operations, which were partially offset by a challenging operating environment in Mexico.

From a cost perspective, Canada is experiencing similar cost challenges to our U.S. business in both warehouse and transportation. Additionally, our strategic transformation efforts in Europe continue with the integration of Sysco France progressing well, along with the final phase of cost synergies occurring in Ireland as we combine Brakes and Pallas Foods there. Finally, our ongoing investment in multi-temperature distribution in the U.K. is moving forward and will eventually enable us to improve our overall cost structure and customer experience as we reconfigure the supply chain network across the country.

Moving on to SYGMA. The underlying macro cost challenges with both the transportation and warehouse areas in the supply chain are also impacting this segment of our business. We continue to take a disciplined approach to growth with our customers. And as we have transitioned some business, sales modestly decreased during the first quarter. We continue to look for opportunities to improve our value proposition in this important chain restaurant segment while also looking for synergistic opportunities for growth.

Lastly, in our other business segment, Guest Supply also experienced cost challenges due to a combination of tariffs, which began to put pressure on certain product categories in the business, along with increased cost of shipping products to our customers. Overall, we continue to see top line growth in the hospitality segment and are working on a variety of activities and initiatives to mitigate some of the increased operating expense associated with this business.

In summary, despite some of the challenges we are experiencing related to our operating environment, we delivered improved year-over-year results in our largest segment of the business. Our overall fundamentals are solid, and we remain confident in our ability to achieve our 3-year plan financial objectives. Furthermore, we remain focused on delivering against our strategic priorities, which we believe will serve as our roadmap for additional growth and long-term value creation.

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

Thank you, Tom. Good morning, everyone. I would like to provide you with additional financial details surrounding our performance for the quarter.

As Tom noted, for the first quarter for total Sysco, sales were $15.2 billion, an increase of 3.9% compared to the same period last year. Changes in foreign exchange rates decreased sales by 0.4%. Gross profit in the first quarter increased 3.9%. And gross margin increased 2 basis points, in part due to a year-over-year decline in inflation, primarily driven by deflation in the meat, poultry and produce categories.

Adjusted operating expenses for total Sysco grew 3.6% for the quarter. The increase in expense, as previously discussed, was largely driven by supply chain costs in both warehouse and transportation and increased fuel costs as well as increased bad debt expense in our U.S. operations related to larger recoveries in the prior year and a couple large local customers going out of business. Additionally, we continue to make investments in transformation and integration in our International business.

Regarding the gap between gross profit dollar growth and adjusted operating expense growth, we were disappointed in that performance for the first quarter. The compression in the gap during the quarter can be attributed to continued increased costs in our U.S. and Canadian supply chain operations, customer mix and Hurricane Florence. But as Tom indicated, we are taking an aggressive approach to accelerate our cost initiatives to improve this performance going forward. Total adjusted operating income was $692 million in the quarter, an increase of 5.1% compared to the same period last year. Changes in foreign exchange rates decreased operating income by 36 basis points.

In terms of earnings per share, our results this quarter were primarily impacted by a lower tax rate, which I will discuss more in a moment, driving an adjusted earnings per share growth of more than 22% to $0.91 per share. However, this was partially offset by increased interest expense, which was higher than the same period last year due to variable rate changes and slightly less stock option exercises than in the prior year.

Returning to taxes. Our effective tax rates for the first quarters of fiscal 2019 and 2018 were 20.3% and 32.6%, respectively. The lower effective tax rate for the first quarter of fiscal 2019 is primarily due to lower tax rates resulting from the enactment of the Tax Cuts and Jobs Act and the favorable impact of excess tax benefits of equity-based compensation, partially offset by higher rates in local, state and other jurisdictions. With regard to share repurchases, we repurchase shares based on a dollar-based amount program. With the increase in share price, this means fewer shares are being repurchased than during the same period last year.

Cash flow from operations was $271 million for the quarter, which was $188 million higher compared to the same period last year. Free cash flow was $171 million, which was $222 million higher compared to the same period last year. It's important to note that the first quarter is often a weaker quarter for cash flow seasonally than the remainder of the year. The improvement in cash flow is mostly due to improved working capital. And I'm pleased with our net working capital performance for the quarter. We had good improvement versus the same period last year, driven primarily by changes in our receivables and payables.

In September, Sysco issued senior notes in Canada, where we previously had no fixed income exposure. This is a good opportunity to take advantage of the investor demand in Canada and further balance our assets and liabilities in different geographies as we look to term out internal debt that was created to repatriate earnings from Canada as a result of U.S. tax reform. We're very pleased with the transaction and the interest on the notes will be paid semiannually in April and October, beginning in April 2019.

Before closing, I would like to reinforce some of the messages we have shared with you as we look ahead to the next couple of quarters. As Tom mentioned, in our U.S. business, we expect to have a continued volume growth as a result of both a healthy macro environment and our initiatives differentiate our capabilities from the competition.

However, we will begin to annualize a couple of large acquisitions: one we are beginning to annualize now; and the other, we'll begin to annualize in the second half of the fiscal year; and the annualization of 2 large national customers, which will impact our overall volume growth. Due to these annualizations, along with the customer mix shift towards more growth of emerging concepts or micro-chains, we expect our gross profit dollar growth to moderate.

As for expenses, as Tom mentioned, we have a plan to aggressively manage and accelerate our cost initiatives and expect the benefit of these initiatives to ramp up over the next few quarters. As a result, we expect to have modest operating income growth during our second fiscal quarter. However, we expect improved performance in the second half of fiscal 2019 and are still committed to and confident in our ability to ultimately achieve the financial objectives associated with our 3-year plan.

In summary, our results for the quarter reflect continued momentum from our underlying business, including solid local case growth and strong gross profit dollar growth. That said, we have more work to do in order to mitigate the macro environment headwinds, manage our overall costs and achieve the full financial objectives of our 3-year plan. We are committed to servicing our customers and executing on a high level in all areas of our business to continue to improve our financial performance in both the near and long term.

Operator, we are now ready for Q&A.

(Operator Instructions) Our first question comes from Christopher Mandeville from Jefferies.

You guys saw some nice sequential improvement in your organic cases of close to 70 to 80 basis points. But I don't think you had provided prior year first half numbers. So I was just hoping maybe you had those offhand on organic cases for Q1, Q2, first off.

Yes, Chris, this is Joel. I think just to clarify your question to me, and I think in the first half of last year, there was very little M&A. And so we hadn't -- I think that's probably part of what you're looking at here is just the difference in having M&A in this year and M&A not in last year. I don't know if that answers your question or...

Yes, the only question I suppose would be thinking about trends on a 2-year basis. You referenced that you're looking for or expecting some moderation in Q2 on the top line or cases for that matter. How do you feel about maybe keeping things somewhat stable on a 2-year stack basis?

Yes, well, I think, look, I think that the -- one of the things I will certainly reference you back to is the 3-year plan that we talked about with an overall volume growth. Again, that made some assumptions of some M&A, about 1 -- 0.5% to 1% in there. We talked about overall volume growth of 3%, local, about 3.5%. Again, every quarter is going to look a little bit different and there's going to be some impact of some of the things that we've talked about here. But I think we broadly still feel good about the volume numbers we've talked about as part of our 3-year plan. Those things are just going to move around some. But I think what we're really trying to get at here is just to give some line of sight to the fact that as we head into this next quarter and over the next little bit of near future here, that some of the things that we have been benefiting from, including the HFM acquisition, the Doerle acquisition, some large, as we referenced, national accounts coming on, that we're simply suggesting that we're seeing some of that moderation happening as we move forward.

Okay. And my follow-up would be, so you referenced that you weren't happy with your gross profit dollar growth in the quarter and you'll be accelerating your cost savings programs going forward to help try and offset that and see some improved trends on overall EBIT in the back half of the year. You also mentioned that you were still confident in your 2020 outlook. But if I recall, over half of the growth was going to be predicated on gross profit dollar growth. So has the algorithm changed to some degree? Or should we be just thinking that there's some near-term softness in gross profit dollars and will improve from here on out?

Yes. Chris, this is Tom. So I think -- I don't think we said we were disappointed in our gross profit dollar growth. What we said was that the gap between gross profit dollar and expenses was not where we had hoped it would be. And so the -- we still expect to see, I think, good gross profit dollar growth. What we've got to get is better focus and management of the cost because the current cost increases are not -- we're not comfortable with where they are at. And so I think the headline here is that we still expect to see decent gross profit growth as similar to what we've talked about externally. But we just got to figure out how to mitigate some of these rising costs that are challenging us right now.

Our next question comes from Bob Summers from Buckingham.

Just to leverage off that a little, I mean, when I think about the gap between case line growth and gross profit dollar growth wind out in a not favorable way, like any more texture to that? And if I think about deflation impacting that number, what's the right way to view it?

Yes. So Bob, it's Joel. And so I think the -- there are a couple things on that. I'll start with the deflation point is obviously there was an anticipated level of inflation in some of the projections we had as part of this 3-year plan and where we're at today is less than that. So I think part of what we're calling out is the fact that again in a deflationary environment, which -- or a less inflationary environment, you typically have some mathematical improvement in the margin percentage, but you actually have less gross profit dollars. And so when the impact of lower inflation does tend to be having lower gross profit, and so I think that's part of what we're seeing there. I think some of the other things we talked about a little bit here was a bit of the mix. Again, we called out some of this mix between some of the -- even within our local cases of some of the micro-chains, some of the things that are actually growing at an accelerated rate versus some of what even -- what I call some of the pure independents. That's part of what we're also referencing is something we're seeing as a somewhat a leveling off of our gross profit that's, I think, part of what we're calling out here. So those are a couple of...

Okay. And then you referenced the hurricanes, but you didn't size it up in any way. On the cost side, on the case volume side, how should I try and normalize?

Yes, I think typically, Bob, the way we try to look at those hurricanes -- and the reason we talk about both of them is one of them impacted quarter 1. The other one, Michael, will actually more impact quarter 2. But typically, what we find is we lose the top line, right? We don't get the cases because outlets are shut down, the market is basically shut down. But we still have some of the costs. We still pay our people. We still -- and sometimes, we try to recover. We're paying overtime because we are having to struggle to get as many people where we need them, when we need them there. And so what we tend to get is less top line and more cost in those situations. And that's what we experienced in both of those situations. Obviously, in the first quarter, we had a little bit of that a year ago with a couple of hurricanes. So the real impact probably here is somewhat smaller in the first quarter and will be a little maybe larger in the second quarter.

Yes. And you're right, Bob, we didn't size it out. I mean, somewhere -- the impact of the, let's say, Florence itself, it's pretty -- somewhere a little less than $0.01, I would call it.

Our next question comes from Edward Kelly from Wells Fargo.

I just wanted to dig a little bit further into the cost pressures that you're talking about in here and just, I guess, how they're expecting the P&L, right, because there's a part of the COGS that is impacted and there's part of OpEx. As we think about -- and Bob sort of asked sort of along this line. As we think about gross profit dollar growth this quarter relative to case growth, there clearly was a shortfall within that relative to, I think, what has been going on historically. What is going on with inbound freight? Has that gotten worse to some extent? Or is this truly just a -- more of a mixed issue and lack of inflation issue?

Ed, I'll just start and then Joel could jump in. I think it's probably more of what you suggest, I think it's more of a mix issue and somewhat of a -- look, it's a slowing down of the inflation that we had planned but are also seeing deflation in a couple of key categories, which is impacting us. I think in addition, look, I think the inbound freight has gotten better. It's still not great, but it's more, I think, more consistent than maybe what we were experiencing last year. So I think that consistency enables us to manage through that a little bit better. It's still up obviously. It still continues to be a challenge as all of the -- what I would say everything around drivers we get is a challenge, whether it's our ability to hire and retain and make sure we're doing everything we can to get our products out the door or the impact of products coming in. I think what we're just seeing within inbound is we're a little more stable than we were a year ago. We're cautiously optimistic that, that will continue for the rest of the year. But as we get to this holiday season, we do worry that we see more pressure there as there's just more freight on the road.

Yes. And I think the one thing I'd add to that, Ed, is just I think Tom's comment earlier about the categories themselves that are actually in deflationary are important to believe. I think we've always talked about this pretty consistently. It matters what inflation or deflation is, but it also in some ways matters what the categories that are inflating or deflating are. In this case, some of that -- again, in our FreshPoint business, for example, we had fairly significant deflation in the produce area. And again, on the Center of the Plate and the meats area, again, those are large dollar cases. If you start experiencing some of the deflation in that, that has some more impact on the per case number that you're referring to.

All right. And just a follow-up on the cost side and the potential offsets. How are you thinking about pricing at this point in the industry, given the rising cost pressures? I mean, your top line is obviously very strong. And it doesn't take a lot of pricing to offset issues like driver pay and what's going on with the warehouses. Are you actively looking to try to offset some of this with price? And if not, then why?

Yes. So Ed, of course, we are and we always try to look at what is reasonable to pass along from a pricing perspective. I think the only challenge I'd say we've seen is the -- as we talk between the inbound freight, which is adding to our COGS and some of the inflation in some categories that we've seen, we are trying to pass along as much of it as we can. Having said that, we did see a little bit of a gap between the COGS rising and our pricing in this quarter. And that is obviously creating some of this pressure we're talking about. So we continue to leverage our revenue management tools and all the work we've done over the last couple of years. We're just -- we're doing everything we can to move it along without creating issues obviously for our customers or for our overall top line growth.

And just last question, when you think about the back half of the year, obviously you're expecting an improvement there. When you say that, do you mean back to that 1% gap in GP versus SG&A growth?

Yes, that's -- very much of the focus is how do we get -- keep our top line growing very strong and then make sure we are managing the cost side of the business tighter.

Yes. And again, this part of that 3-year plan, if you remember that, that gap was targeted at 1.5% for that 3-year time period. So certainly, there is a plan that has some acceleration.

Our next question comes from John Heinbockel from Guggenheim.

So Tom and Joel, let me start with corporate overhead, right, or your corporate EBIT. Did that grow a little faster in the period than you would have liked or have planned? How do you attack that -- I know that a lot of the shared services are part of that. But maybe talk about the way you're attacking that here, specifically on the next couple of quarters. And is it fair for us to think that, that line item could grow, you can hold the growth to 1% or 2% on a go-forward basis? Or is that too low?

Let me start and then Tom can chime in if he wants. I mean, I -- first of all, no, the answer to the original question is we did not actually -- that was not part of a cost acceleration that happened this quarter, so -- but having said that, one of the things that Tom had referenced in his comments were around some of the areas in terms of the Finance Technology Roadmap, some of the smart spending. So that is not to suggest we don't still have areas of opportunity that we're continuing to address. And again, in a world where we have some of the challenges we talked about in some of the macro, in particular on the operation side, these are areas that we need to consider accelerating even in a faster rate than we have today. And so I think as we always think about those type of costs, I mean, there are pay increases and there's things and so each -- there are going to be a couple of points of increase in any given year. But what we're talking about now is actually doing some things that are going to further accelerate decreases in that area. And again, it starts with these things that Tom referenced in terms of Finance Technology Roadmap and the smart spending categories.

Yes. And are you pulling forward the timetable on some of that in light of the warehouse cost pressure or it's on the same timetable?

In some cases, yes. But obviously, there's some puts and takes in all that. But we're certainly making sure we either stay on track or, where we can, accelerate we're doing so.

All right. Then maybe just for Tom, when you think about this question of pricing, the flip side being, I mean, obviously you've got a lot of data when you think about the position you're in versus a lot of your peers, right, which is a far better competitive position. If you don't take pricing and they do, is there an idea -- would you look at elasticity that, that can lead to a step-up in share? Or not -- and I know it's account-by-account and item-by-item, but that's really not the path you want to go down.

Yes, as you know, John, we talked a lot about this in our past, we are not looking to buy share, if you will. We need to be obviously competitive in the marketplace. But you should not expect and we would not be out there kind of leading with pricing downward to drive market share. We need to earn that based on all the things we've talked about, and we're very focused on all those, what I would call, differentiators in the business to create a better experience for our customers.

Our next question comes from Karen Short from Barclays.

So my question is, I guess, in early September, you kind of indicated that you'd loosely achieved 1/3 of your 3-year goals in operating income in '18. And you'd indicated that the remaining 2/3 would be pretty evenly distributed between fiscal '19 and '20. And obviously, with what you've given us today, that doesn't appear to be the case. Achieving your remainder of the $400 million or $450 million to $500 million in operating profit is pretty heavily weighted to fiscal '20. So I guess, the first question is that, I mean, that is an accurate statement, right? And I guess, the second question would be, I guess I'm still trying to understand really what changed from early September to today.

Karen, a couple. I would say not just fiscal year '20. I think what we were telling you is back half of '19 and '20. But we are still confident we can achieve those numbers that we've shared with you all. So I think from that standpoint, I wouldn't assume by any means that this is a -- we're pushing everything off to the last year and going to have some big balloon we need to stall for. So as far as what's changed, I mean, I think what we -- or one big thing that we are feeling maybe more right now than we had anticipated or had been prior to that is this cost pressure on the supply chain side. And look, we knew it was out there. We were managing it pretty well. But I think we've gotten to a point now where we are, like probably everyone, starting to feel the impacts of that kind of day in and day out. And if we think about what that really looks like, it literally is if you don't have enough drivers in the building, then we need to pay what we have overtime to get those products out. We need to invest more in recruiting people faster because we're not getting the folks in the door. And so whether it's incentives we have to pay to get people in, it's all of these things that we all know are out there. But I think maybe we were feeling less of that than others in the last couple quarters. And now it's hit us kind of squarely like everyone else. So I think that's the single biggest thing that's changed here. Obviously, we talked about going forward more of these just lapping issues that we have, where we had some acquisitions a year ago that we'll start to lap and we had some new -- some bigger customer acquisitions. But it's really about the supply chain cost. And all we're seeing is we're going to accelerate some things in some other areas, knowing we've got to offset that.

And so then just to clarify also, you were kind of asked this earlier, but in terms of the components of achieving that $650 million to $700 million, as I think you were asked, gross profit was 55% to 65% of that. So is that still the case? Or should we expect the leveraging -- well, not leveraging supply chain, but reducing admin costs to be more of a contributing factor? And then if you could give us just some color in terms of the dollar buckets in the 3 areas that you called out, the finance transformation, smart spending and Canadian regionalization, that would be helpful.

Karen, it's Joel, I'll start. I mean, I think the buckets, broadly speaking, I wouldn't call it materially different. There's probably some shifting around a little bit there that skews towards some more of the cost side again out of necessity. Again, we -- again, every -- we again expressed confidence in our goals. And if it looks a little different than we'd originally anticipated, but I wouldn't necessarily come to the conclusion right now that all those things are going to just dramatically shift in terms of the buckets. I think that's -- again, all we're really saying is that where we have some experiences of some of these issues, particularly in our supply chain area, we're just going to continue to focus on accelerating those areas that we can continue to take cost out of our system. So I think that's really the main message here. And I think -- yes. And I'll be specific, Karen, again we're not going out and actually assigning specific costs to those items. Just suffice it to say that, and we talked about this at Investor Day, those are certainly a sizable portion of what we talked about at our G&A savings. And again, where we can accelerate some of that, we're looking to do so.

Our next question comes from Vincent Sinisi from Morgan Stanley.

Also of course, just wanted to follow up with the cost focus. So I guess, Tom, you said certainly supply chain seems to kind of be the biggest difference versus last quarter. But then in your prepared commentary, it felt at least like you talked quite a bit around kind of opportunities for cost cuts across really all your geographies and not maybe just with Brakes and whatnot. So I guess, first, is that a fair statement? And then just more holistically, are some of these cost initiatives strictly to combat the headwinds that you ran through or by different geographies maybe just be more efficiencies that you should be realizing overall?

So there are a couple of things. So the cost challenges are -- if you think about the various segments of the business we talked about, our biggest cost challenges are in North America, so the U.S. business and Canada from a supply chain perspective. That's where we're feeling the majority of the impact. Our European business, while there's a few things, that's not a big driver of our cost issue. So it's the supply chain in North America, big focus, so that's number one. Second, what I would say is, while I referred to other opportunities, those are the ones we've been talking about, finance roadmap, smart spending, some regional, I talked about Canadian regionalization. Some of those are kind of normal course of business opportunities. And we'll continue to look for those as well. Whether they're in the U.S. or whether they're in International, we'll continue to look for and we will drive out cost opportunities that exist beyond big strategic focus areas. And so the last thing I think you asked is, are they in the plan or not? Some are and some aren't. And so finance roadmap, we talked about that at Investor Day, we planned for some of that. We're accelerating some of the work there. But we had planned for some of these things. So I think some of them were in the number, some of them are going to be accelerating. But I think the key message for you guys is, look, we understand that we're seeing some cost headwinds today that we had not anticipated. And you should expect and we are focused on mitigating those by taking out other -- by taking out cost in other areas. That's why we're not really saying we should be shifting the model a lot. There might be slight adjustments, as Joel suggested. But this is basically saying, look, we got some more cost headwinds than we had anticipated and we are aggressively going after those that we feel comfortable we can deliver the numbers we've committed.

Yes. And I think just again, that benefit again, we certainly anticipated seeing some of that starting in the second half of this year as opposed to again somehow jamming all that into the final year of the 3-year plan.

Okay, all right. That's helpful, guys. And maybe just as a quick follow-up, Joel, I guess, this is more for you. Just in terms of the rest of this year, how are you thinking about inflation, which was just very slight? And then also how should we think of tax rate going forward?

Yes. So from an inflation perspective, I mean, I think we're certainly kind of around this flattish area. And I would just say that our anticipation for the next couple of quarters is I'd say somewhat modest inflation/kind of -- just kind of right around this flattish area over the next couple of quarters, I think, is probably the best view we'd have right now. Tax rate certainly at this point continue -- we talked about expecting a 25% tax rate that we've called out in our earnings call for our fourth quarter as some guidance there. And while obviously we certainly continue to drive for additional opportunities there, at this point, that's certainly -- we're still looking at that 25% tax rate at this point.

Our next question comes from Judah Frommer from Crédit Suisse.

Maybe just to break out the expense pressure from the top line strength, I mean, it does sound like the expense pressure is expected to continue. But that's tied to wage growth. And you're talking about a pretty supportive macro in the U.S. That said, it sounds like there is some channel shifting going on that's kind of pressuring margins. You talked about the micro-chains versus independents. So how much confidence do you have in continued top line strength potentially offsetting elevated costs in the near term?

Judah, I'd say, look, I think we feel like the top line should continue to see solid growth, where all of the -- as you said, the macro environment there is pretty positive. And a lot of the things we're seeing across the foodservice segment continue to give us confidence there. I think the other thing you were raising, and we've talked about this a little bit already this morning in the call, is there is some potential pressure on margin based on the mix of the customers and where some of that growth is coming. So I think the growth will continue. But this kind of emerging segments, micro-chains growing at a faster rate maybe than we had seen earlier, is creating some pressure there. And we're going to have to figure out how to manage through that as well. And I think your point on expenses was these aren't short term, these are -- we see these continuing at this point. And so yes, that's why we have to get aggressive in some of these other areas because we don't see those cost increases mitigating any time in the short term.

Okay. And then kind of beyond the broader expense pressures in the industry. I mean, there's clearly different things going on at each of the public players. Is there anything you'd call out in the first quarter or going into second, where you've seen material share shifts amongst the top players in the industry? Or is this kind of you guys executing on your plan and that's where the top line is coming from?

Yes, I would say in our case, I can't really speak for the other guys, but we're -- this is more just continued execution of our plan. We continue to be very focused. We talk about this disciplined profitable growth. And while we have some of these challenges we're talking about, we're still very focused on each customer and making sure there's value we can create for the relationship but also being thoughtful about not every customer is a good fit for what we're trying to accomplish. And we'll continue to focus on managing our business that way.

Yes. And just remember the size or the sheer size of the industry in terms of competitors. Again we often -- the conversation was often around the 3 of us. But really again, those -- the 3 of us maybe had a 30% share at the top. And so I think there's just a lot of competition in there just, for sure, moves around.

Our next question comes from Marisa Sullivan from Bank of America.

I just wanted to follow up on the top line focus. Can you just give us a little bit more detail on the drivers of the healthy case growth you saw in the U.S.? Was it more new business that you're bringing in? Was it increased penetration? Are you seeing accelerated share gains? And then any commentary on the quarter-to-date, whether that's continued?

So from a top line standpoint, I think it's really all of the above. We continue to see obviously some new business gains. Obviously, that's important for all of us in this segment of the industry. I think in addition, we are seeing improved penetration in certain geographies and with certain customers, which is a good sign; again, the kind of some of the robustness in the industry, in certain segments of the industry, I should probably say. And then the last, I guess, I'd say is we have -- like everybody, we have markets that are performing better than others. And when I say markets, I'm talking about geographic markets, say, in the U.S. And so we are constantly kind of managing through that. Whether it's competitive situations or weather-related situations or whatever, we've got to manage through those on a regular basis. So I'd say the top line is nothing changed dramatically from what we've seen historically. Again, some of that growth, as we've talked about, was still acquisitions and some nonorganic. But we feel really good about organic growth. And we're kind of right where we thought we would be from that top line perspective. As it relates to -- what was the second part of your question?

So just quarter-to-date if you've seen the momentum continue.

Yes, I think in general, as we go into the second quarter, we talked about some of these things, some of the lapping issues. So I would say in general, yes, understanding that we have some of these lapping things that we shared occurring as we speak.

Got it. And if I could just quickly follow up on the cost side, given that a lot of this is coming from wage pressures both in the warehouse and transportation, can you give us a little bit more detail on some of the productivity initiatives you have underway in both the warehouse and supply chain? Are there opportunities for automation that you see that could help offset some of these pressures over the mid-term? Just any more color there.

Sure. And just on the pressure, so it's -- wage, to some extent, I think the important thing for everybody to remember, and I know we've talked about this, is we aren't -- folks who are out there may be increasing the minimum wage or coming out with higher wages for their associates. We generally aren't as impacted by that because we're already at or above those rates. But what we're finding is with the reduced availability of workforce with the current levels of employment, we are just having a harder time attracting and retaining a certain associate. And I think that's what we get into this little bit of a churn situation where again, when we don't have enough, we're paying overtime and that's driving our cost or we're having to spend money at a higher rate to get people in the door. And it's not necessarily the pay rate or the wage rate, it's more of that churn that we're experiencing there and everything around that. That's when we talk about trying to retain folks longer. We know, just like customers, that if we can retain our associates, it helps our overall cost. As far as other things we're doing, we've talked about things like small delivery vehicles. So let's talk about that for a second. That's a great example of where you may -- instead of having to find a CDL driver, where we know there's huge pressure right now for that commercial driver’s license person, we can use folks who don't necessarily need a CDL. Ability to accelerate initiatives like that can be -- can do a couple of things, help us dramatically in our service for our customers but also impact that overall cost or wage rate and expense of that driver issue we've been dealing with. That's an example. Automation, we have a fair amount of automation in our facilities, not like what you might think of as high-tech automation, but automation around some of the slower-moving items, so we're able to put more items into our facilities. We have piloted and tested some various types of warehouse automation and we will continue to look at that. We've not seen necessarily that being a big driver for us in the short term. But that doesn't mean we don't continue to look for ways to do that. I'd say the other areas where we might use, think about automation, is around analytics. As you think about the AI, you hear a lot about how do we take the information we have, enable us to make quicker decisions, enable us to do some things in a way that maybe in the past, it took us a little more manual approach to. And then maybe the last thing around our delivery is the way we route our trucks and the way we -- the more we can be efficient in our routing, it also enables us kind of to manage through this driver challenge but also improve our cost, meaning we can get more cases on the truck and we can obviously if we can have bigger drops with our customers, all those things really do help and improve that pressure on the supply chain cost.

Our next question comes from Kelly Bania from BMO Capital.

I guess, just another way to ask the cost question, do you think that your planned initiatives on the cost side just need to be bigger than maybe previously expected over the 3-year period in order to offset some of these supply chain costs, which sounds like it's more drivers and warehouse labor versus maybe freight? But I guess, the question, what are you assuming for those kind of supply chain costs over the next 1 year, 1.5 years?

So Kelly, I think it's a combination of things. I think as we were just talking with Marisa's question, we need to improve the current run rate of our supply chain costs. They are higher than we are comfortable with. And I think we've got some initiatives underway to continue to manage that. But to make sure we cover this increase that we're seeing, we are going to -- I'd say probably not necessarily bigger but accelerate some of the cost initiatives that we've had out there. We have a pretty good line of sight to the areas of opportunity. And I think it's really about accelerating those faster versus making them bigger, if you will.

Okay. And I guess, Joel, just on the comment on gross margin and the impact of deflation and the mathematical impact that, that has, I guess, can you quantify what that did have on the gross margin rate? I guess, I would have thought gross margin would have been up a little bit more. Last time you went through this deflationary cycle, it was also up a little bit more. So can you help us understand maybe kind of some of the puts and take underlying gross margin?

Yes. And so again, just to be kind of clear on that, again we haven't quantified that. But I mean, the point here really is we're not in deflation yet. What I was really referring to is that we were actually having, you want to call it less inflation. And in certain categories, we're actually experiencing some level of deflation. But we're not in an overall deflationary place. Now the point I was also making was that if you look at last year in the same quarter, we actually had more inflation. And so I guess that was really the point of the kind of the year-over-year comparison that there's some mathematical, if you want to call it, contribution to the gross margin percentages. That happens when you look at that year-over-year. But that's really the point I was trying to make. But we're not in a deflationary environment right now in total. So again, when we were talking about this a couple of years ago, we were in a couple points of deflation. And that obviously has certainly a much more significant margin percentage impact than what we're talking about today.

Okay. And can you also just help us understand how you're defining these micro-chains? How big are they? And how close is the margin profile to more of a local independent restaurant versus a chain and how we should think about that?

I think typically we talk about them kind of less than 100 units but generally covering multiple, from our view, multiple operating companies. So instead of being like within a local geography with a few locations, these are emerging concepts that are starting to grow beyond their traditional borders. And think about it as they're concepts that usually have done well for a while as a local or an independent customer and now are at the stage where they feel like they're ready to expand. And so we're just seeing that segment of the market starting to grow a little bit faster. As they do that, they require things that are probably more similar to a national account, both from how we manage their business but also the kind of programs they're getting from suppliers, et cetera. And so that's why we say that, that segment is a little more margin-pressured than an independent restaurant operator. But they vary in size and scope. There's not a -- they're not -- they're certainly not chains like you typically think of a chain. But they are starting to emerge and shift beyond kind of their traditional market.

And our next question is from Ajay Jain from Pivotal Research Group.

I was wondering if you could maybe expand a little bit on general operating environment for independents. Obviously, your competitors have had some recent challenges with independent case growth. And they've also been adding marketing associates to address that challenge. And on the last earnings call, I think you mentioned at the time that you were also hiring some marketing associates. So even though your top line for independent case growth has been really strong, I'm wondering if there's a more competitive backdrop to get that incremental case growth. Is competition by itself driving some of that increased cost pressure? So just wondering if you're seeing any combination of increased industry pricing and headcount expenses for drivers and for more salespeople.

Yes, Ajay, maybe the way I'd answer that is if you recall, we actually probably led this 9 months or so ago by adding some marketing associates. We believe that we had now had kind of the data analytics and tools to allow us to focus where we were going to add resources. So we started that kind of our Q2 of last year. And that carried on kind of through now. So we have seen some additional expense associated with our adding some marketing associates. But we also believe that, that's helping us drive our local customer and case growth. And so I'd separate that as far as what we see is the strategy we put in place is working. Is the competitive environment changing as others now look to add marketing associates out there? Sure, on certain markets, we're seeing some of that. And as it gets more competitive, obviously we need to be there to compete. But I would separate those from the operating expense, other than to say that obviously long -- higher case growth drives higher operating expense in general. If you're growing 5%-plus on the cases, then you should expect your operating expenses are going to grow. Our problem is our operating expenses, we're not getting leverage on them, where they're growing faster than what obviously we're just getting on the case growth. So that's our issue. And we've got to get that back in check, which is what we've really been talking about here this morning.

Okay. And Tom, in your prepared comments, you -- I think you cited improved economic data points and improved environment in the U.S. for restaurant spending. But then based on the recent performance at Brakes and SYGMA, you mentioned a more moderate rate of earnings growth in Q2. But can you mention or can you confirm whether that operating income growth in Q2, is that supposed to be similar to this quarter? Or could it be potentially worse than Q1?

Yes, I think we were suggesting that where we sit today, we feel like we just want to make you all aware of a couple of the lapping issues we've talked about. So we're not sitting here calling down anything. I think just to be clear, when you talk about Brakes or Europe, that's very different situation. And as I said in the remarks, I think in the U.K., there's certainly some uncertainty in that market that continues because of this Brexit question that's out there. And it's quite honestly what we see in here is it gets closer to the day where they need to make some decisions that, that's probably creating more dynamics in the market right now. But the rest of our International markets, we feel pretty good about, France and Sweden, Ireland all doing well. And so we just are -- we are managing through what is a little bit of a bumpy environment in some of our International markets.

Yes, Ajay, this is Joel. I think just to clarify, I think what I think we're saying is that the Q2, we're anticipating looking somewhat more similar to what we have this quarter as opposed to something a lot worse than that. So I think what we're calling out is just a moderation a bit due to some of the lapping on some of the volume. And then again, we talked about some of these expense acceleration kicking in, but we're anticipating some of that more in the second half of the year. So I think just to clarify, more similar is the answer to your question is really what we're calling out there in the second quarter.

Okay. And just lastly for you, do you expect higher interest expense? Is that going to remain a headwind for the rest of the year? Or does that moderate at all?

No, that expense is remaining a bit of a headwind.

Our next question comes from Karen Holthouse from Goldman Sachs.

Just another way to ask the question on the cost side of things. It sounds like you're pulling forward some cost savings. But is there a level of inflation? Or are we at the point? Or how much worse would wage inflation have to get before that sort of 150 basis point gap between gross profit and operating expenses in the 3-year plan would be addressed?

Well, a couple things, I'd just like to just make one slight comment that Tom made. I would not characterize this as wage inflation per se. It is demand for labor, particularly on the transportation side. And again, with pretty low unemployment obviously, that impacts our ability to try and retain on the warehouse side as well. So it's really that as opposed to just wage inflation itself that's causing that impact. And I guess, what I'd say to that, Karen, to your other question, how much of that is going to happen before it just blows out the course of the 3-year plan? I mean, the reality of it is, is again we've been in an environment for a while now where we've had some of these driver challenges. We've navigated through that for a while now. It's starting to pinch us a bit more, which is what we've talked about here. I'm certainly not ready to make the call, though, that -- again unemployment is pretty low, driver shortages have been there. And so I don't -- I certainly don't know whether we're contemplating it's near or where that somehow gets just exponentially worse and it just blows this plan out yet. We're certainly -- we've talked about a couple of times today. It's a headwind, we've got to deal with it, both from how we become more productive on our supply chain as well as some of the other costs that we need to accelerate to deal with that. We will do so. And we certainly, again at this point, we certainly have -- continue to express our confidence in achieving our 3-year plan numbers.

Yes, I think that's the important thing, Karen, is where we sit today, we still feel like we will deliver the 3-year plan we committed. Will we have to make some continued adjustments? No doubt. And that's what we've been talking about mostly this morning.

Our next question is from John Ivankoe from JPMorgan.

The question is on pricing, but pricing not to your local accounts but to your contract accounts. And I was just wondering whether some of the cost pressures that you're seeing internally, and particularly this quarter, were allowed to be passed on in general to your current contract accounts? In other words, are you selling them products at one delivered price that's different than what your own backdoor price is? And might this just be a function of some of these contracts kind of rolling over for you to set up a new whether cost plus percent or cost plus dollar per case basis, whatever it is, for you to capture the true cost to deliver to these customers?

John, it's a good question. There are certainly some contracts that have longer periods of time for adjustments of cost increases for us to pass them along. But I wouldn't say it's a big driver here. But there's some of that for sure. But I wouldn't characterize that as something that's a major impact or you should see some big switch -- swing because of it.

And at least from what I remember historically, was it 50% contract and 50% locally managed? I mean, is that still the breakout within your Broadline? Or has that not that much changed?

Yes, that's roughly the same.

And our last question comes from Andrew Wolf from Loop Capital Markets.

Just want to drill down on some of the -- maybe into some of the line items on the cost pressure. So it sounds like you're saying it's still -- the change was still more on the driver side than in the warehouse side. Just want to confirm that, change in terms of where more pressure came. And then I wanted to -- one of you guys referenced -- sorry to overtalk your answer, but maybe you can do 2 at once. One of you guys referenced increasing overtime. And that sounds more like a warehouse issue. Or is it also a driver issue?

So let's start there, Andrew. So I think it's both. And so we obviously have hours of service types of things that we have to manage on the driver side. But it's both. And I would say that costs are both as well. If you think about though the relative expense, the driver and the transportation costs associated in our business are significantly higher than the warehouse. So both are being impacted. But if you have heavy impact on transportation and the drivers, that plays a disproportionate role in the overall expense load. And that's really the point.

And in terms of the labor shortage, and I think the turnover that's very essential to that, if you could perfectly match up the supply of labor with demand, would these cost pressures mitigate? In other words, is there just a lot of turnover that's sort of unpredictable and that's when you're caught short? Or is it generally just more of a general process, and you're just short labor most of the time?

We historically have not been short labor most of the time. So this is clearly a new phenomenon. And I think it's driven by all of the factors we've talked about. Certainly, just the unemployment levels are a lot lower. There is a shortage of what we would call skilled drivers, these drivers that have the CDL licenses. And there's just a high demand for them in lots of industries right now. And as long as they remain short, we're going to have to do everything we can to retain the ones we have and attract the ones we need. And so that's where a lot of this is happening.

And you can imagine, Andrew, I mean, it's -- the more your -- the issues we're having with retention, there's more training costs, there's more churn, there's more -- people take some time to ramp up productivity and accuracy and all those things. I mean, all that stuff just exacerbates when you're having some of the issues with retention. So that's just really a -- I mean, that's both on the warehouse and the transportation side.

Okay. And if I could just ask kind of housekeeping. I think you called out fuel for the first time in a while. I don't know if you'd be willing to give us a swing in fuel and just sort of comment on whether this -- future surcharges, what degree that mitigates things.

Sure. Well, so yes, so fuel has continued to increase. Obviously, we continue to use some forward derivatives to hedge some of that. But nonetheless, those are on a rolling 12, that as fuel costs continue to go up, those also go up. And so we certainly had sort of about $0.03 a case in terms of our fuel impact this quarter. So it was pretty significant. And again, certainly anticipate that coming -- continuing -- fuel surcharges, I think the way those work, I mean, again that's not a dollar-for-dollar offset, to be clear. We have had some increase in our surcharges, those -- on the contract side, most of those are negotiated in with the contract customers. And those do move up and down based on some type of grid. On the street side, yes, that's something we're certainly continuing to evaluate. And again, as the markets move, those do tend to move some as well but aren't nearly as big an impact.

Okay. And Joel, just on the reclassification on the other income, it was a pretty big swing this quarter, especially without any other income this quarter and the year-ago going up. Is that a pattern? Or are we going to -- or are you guys going to go back to having sort of a decent other income line going forward? Otherwise, if we annualize this quarter's adverse swing, it's like a $0.05 a share.

Well, so again, that was related to an accounting change related to the way the pension accounting works. That used to be up above the line. And so that is a reclassification from up above to down below. That is something you're going to see because again that's just simply a classification issue. That's really the main impact on the other income this quarter and that you'll see for this year and beyond.

Thank you, everyone, for joining us today. This concludes today's conference call, and you may now disconnect. Have a great day.