US Foods Holding Corp (USFD) 2017 Q4 法說會逐字稿

Hello. My name is Dan, and I will be your conference operator today. At this time, I would like to welcome everyone to the US Foods Fourth Quarter and Fiscal 2017 Earnings Call. (Operator Instructions)

I'd now like to turn the call over to Ms. Melissa Napier, Senior Vice President, Treasurer and Investor Relations. Please go ahead.

Thanks, Dan. Good morning, everyone. Joining me for today's earnings call are Pietro Satriano, our Chairman and CEO; and Dirk Locascio, our CFO. Pietro and Dirk will provide a business update and speak about our performance in the quarter and for our fiscal year. We'll take your questions after management's prepared remarks conclude. Please provide your name, your firm, and limit yourself to one question.

During today's call, and unless otherwise stated, we're comparing our fourth quarter and full year results to the same periods in fiscal year 2016. Our earnings release issued earlier this morning and today's presentation slides can be accessed on the Investor Relations page of our website.

In addition to historical information, certain statements made during today's call are considered forward-looking statements. Please review the risk factors in our latest Form 10-K filed with the SEC for potential factors which could cause our actual results to differ materially from those expressed or implied in those statements.

And lastly, I'd like to point out that during today's call, we will refer to certain non-GAAP financial measures. Reconciliations to the most comparable GAAP financial measures are included in the schedules on our press release.

I'll now turn the call over to Pietro.

Thanks, Melissa, and good morning, everyone. I hope everyone is well, and welcome to our fourth quarter and year-end earnings call. So let's begin on Page 2 with an overview of our results.

Q4 was a very good quarter, 9.4% growth in adjusted EBITDA and 8.8% for the year, which brings adjusted EBITDA as a percent of sales to 4.8%, a 20 basis point increase compared to prior year.

The quarter's results were driven by growth with independent restaurants of 7.1%; growth in private label of 100 basis points; and strong gross profit performance, which grew $0.12 per case more than operating cost per case, and this despite significant headwinds in the freight industry, which were a drag on gross profit.

Moving to the balance sheet. In the fourth quarter, as you know, our sponsors, KKR and CD&R, sold their remaining US Foods stock, meaning that we are now 100% publicly owned. And as part of that transaction, we repurchased 10 million shares, ending the year with a 3.4 leverage ratio, down from 3.8 a year ago.

So let's turn to Page 3 for a more detailed analysis of our volume performance. We were very pleased with our growth with independent restaurants, which has continued to get stronger. For the quarter, absolute growth was 7.1% while organic growth was 5.2%. Holiday timing did shift about 50 basis points or so of growth from Q1 2018 to Q4 2017 for a normalized run rate in the fourth quarter closer to 4.7%. This is still our best performance in almost 2 years and in line with what we expect to see going forward.

Growth in health care and hospitality turned down slightly as we began to wrap the addition of Brookdale in the last year -- in last year's fourth quarter. Our pipeline is healthy, and we expect to grow at a rate closer to market in the back half of the year. The all other group of customers also benefited from the shift in holiday timing, which means that the normalized run rate for this group of customers in the fourth quarter was closer to what we saw in the third quarter.

We continue to optimize the portfolio of chain customers with some wins and some planned exits coming in the first half. The bulk of these exits is coming in Q1, which will add to the decline we saw in Q4, after which we will begin to ramp up to growth to a level nearly approaching flat in the back half of the year. As we discussed in the last call, customers we are choosing to exit are those with no or negative contribution margin, which means the impact to EBITDA of these moves is accretive. It does take about 90 days for us to pull out the costs associated with these exits, which means a modest drag on operating expense in the first half.

On Page 4, let's delve a little deeper into the outlook for restaurants. On the left-hand side, we are showing Technomic's updated outlook for the industry, which continues to be strong, in particular for independent restaurants, as shown by the green bars. In part, this reflects the positive impact of the recently passed tax reform. The right-hand chart isolates the impact of tax reform but on the entire restaurant sector, as per some analysis done by IHS, a different industry analyst.

While our growth with target customers has benefited from the continued strength in our industry, our market share gains with independent restaurants are fueled by our differentiation strategy. So now let's turn to Page 5 for an update on those programs that differentiate US Foods and thereby supporting the market share gains that I just discussed.

Let's start on the left with our innovative products featured in our 3-times-per-year Scoop program. These are products that help operators stay on trend or remove labor from the kitchen. Trial of our new products continues to increase from approximately 20% earlier in the year to close to 40% in the most recent Scoop. On the middle, you can see e-commerce penetration continues to climb, as does the placements of value-added services on the far left.

Let's drill down for a couple of pages. First, Page 6 gives a preview of our next edition of the Scoop, which launches next week. This is our seventh year and our 20th edition of the Scoop, and it is entirely dedicated to sustainable products.

You may recall that our summer 2016 Scoop was also dedicated to sustainable products, the first such effort in our industry. And since then, we have launched 280 sustainable products under our Serve Good brand, products that either reduce waste or are responsibly sourced. And the uptake by customers has been very encouraging. On a monthly basis, almost 25% of our independent customers purchased at least 1 of the products under the Serve Good brand.

Page 7 provides an update on technology. In January, we relaunched our website. Given our high penetration of sales on e-commerce, our e-commerce platform is where existing customers tend to lay. Prospects, on the other hand, primarily interact with us on our website, which is why we have configured the website to be much more friendly for prospects. One example is we dramatically enriched the content on our products and value-added services. Another example is we have given prospects and sellers the opportunity to collaborate so that they can explore and share relevant ideas together. As a result of these changes and these enhancements, average time by visitors to our website is already up 27%, which is definitely indicative of greater engagement.

I'm going to finish on Page 8 with an update on our gross profit and operating expense initiatives. By way of a quick reminder, several of these initiatives have been in flight for 2-plus years and are nearing maturity, while others which were initiated more recently, will be discussed in more detail at our upcoming Investor Day. Let's start on the left-hand side with a quick rundown of our gross profit initiatives.

Our CookBook pricing optimization has been fully deployed to our sellers, and we are very pleased with the impact on gross profit, which you can continue to see. We are continuing with our second touch, targeting those markets or those sellers lower on the adoption scale. Strategic vendor management is an ongoing opportunity, with more upside expected in the future from COP and produce as a result of the move to centralized replenishment, which will enable us to better coordinate inbound freight and have more looks at opportunity buys.

Speaking of centralized replenishment, completion is expected to be closer to Q2. This is slightly longer than originally anticipated but is prompted by our desire to ensure that the handoff from the local markets is done in a seamless fashion. And lastly, we see continued benefit from the increasing importance of independent customers in our mix as well as the continued growth in our penetration of private brands, which, as I mentioned, finished the year 100 basis points above where we started.

We're also pleased with our progress on our operating expense initiatives. We've made good progress on the first 3: the cost resets, the centralization of indirect procurement and sales force productivity. With respect to the last 2 initiatives, expanding our shared services and optimizing our supply chain, we are in the early innings. And given the size of these 2 areas and the opportunity we've identified, we see tremendous upside for years to come, another topic that we will explore in greater depth at our upcoming Investor Day.

Lastly, on the M&A front, our pipeline does remain healthy, and we are at different stages with a number of potential targets, and we would expect to have more news in the next quarter or 2.

I will now turn it over to Dirk, who will walk down our P&L and balance sheet. Thank you.

Thanks, Pietro, and good morning, everyone. As Pietro commented, we had a strong fourth quarter. Our operating income increased $66 million to $182 million, and our adjusted EBITDA increased 9.4% in spite of a significant continuing inbound freight cost headwind. We also experienced strong independent restaurant growth, solid growth with other customer types and strong cash flow.

Let's walk through our results now in a little more detail. On Slide 9, fourth quarter net sales were $6 billion, an increase of 5.6% over the prior year. This increase was a result of our 1.9% case growth combined with approximately 3.7% from year-over-year inflation and product mix. Our case growth for the quarter was strong with independent restaurants at 7% or 5.2% organic, and health care and hospitality volume growth at about 2.5%.

Case growth was stronger than we originally anticipated for the fourth quarter, as Pietro mentioned, in part due to the impact of holiday timing, which resulted in approximately 50 basis points of incremental case growth in the quarter. We expect to have an opposite impact in Q1 2018 due to lost ship days from the New Year's timing and schools returning later in January compared to the prior year.

We saw modestly less year-over-year inflation in the fourth quarter than we did in the third quarter, and the inflation was primarily in commodities such as produce, beef, dairy and pork, as well as modest inflation in several grocery categories.

Now to gross profit performance, which you see on Slide 10. We continued to deliver strong gross profit results. For the fourth quarter, gross profit was $1.1 billion, which is a $47 million or 4.6% increase over the prior year on a GAAP basis and up $40 million or 3.9% on an adjusted basis. This is on a 1.9% case volume increase, meaning we continued to increase gross profit per case.

The elements of our strategy Pietro talked about that are focused on gross profit rate expansion continue to make progress, with gross profit per case up double-digits cents per case again this quarter in spite of the continuing freight headwind. As a percentage of sales, gross profit on both a GAAP and adjusted basis was 17.9%. This is 20 basis points lower than the prior year period on a GAAP basis and 30 basis points lower on an adjusted basis, with the decrease primarily driven by higher freight costs.

Gross profit as a percent of sales was negatively impacted by year-over-year inflation and higher inbound freight costs, as I just mentioned, due to the continued tight inbound freight capacity. The trucking industry capacity has continued to tighten since mid-2017, which has been widely reported on in the press. A recent Wall Street Journal article cited there were 10 loads waiting for every available truck 1 week this January compared to just 3 loads a year ago for the same week, meaning demand is far outpacing supply. As a result, we've seen spot market freight costs increase significantly over the prior year. We're taking steps to re-optimize our freight lanes and are working with our vendors to mitigate the impact from higher third-party freight costs. Industry capacity is expected to continue to be a headwind at least through the first half of 2018.

For the full year, gross profit increased 4.1% in dollars over the prior year from volume growth and the benefits of our margin expansion initiatives, partly offset by an increase in our LIFO charge. And on an adjusted basis, gross profit increased $199 million or 4.9%, and adjusted gross profit as a percentage of sales decreased 10 basis points from the prior year to 17.5%.

Moving now to operating expenses on Slide 11. Operating expenses decreased 2.1% or $19 million for the quarter from the prior year to $892 million, primarily resulting from a reduction in our depreciation and amortization expense due to the full amortization of a customer intangible asset at the end of the second quarter, lower restructuring and productivity gains. These gains more than offset the additional expenses related to higher case volume. Adjusted operating expenses increased $16 million or 2.1% for the quarter, and adjusted operating expense as a percent of sales was 13.1%, which is a decrease of 40 basis points from the prior year. The increase in adjusted OpEx dollars was primarily due to higher case volume.

For the full year, operating expense dollars were essentially flat to the prior year period. As a percent of sales, operating expenses decreased 80 basis points to 15.1%. Adjusted operating expenses increased 3.7% year-to-date -- or for the year or 30 basis points ahead of the prior year as a percent of sales. From an adjusted OpEx perspective, our focus has been and continues to be on controlling OpEx growth so that it increases significantly less on a rate per case than gross profit in order to continue to drive our operating leverage.

As you can see on Slide 12, our adjusted gross profit per case expansion has been significant this year, and we're very pleased with those results since we're making more gross profit dollars per case than a year ago. In fact, the fourth quarter gain in operating leverage per case was our best quarter in 2017, meaning the difference between gross profit rate per case growth and OpEx per case growth was its largest.

We've significantly improved our operating leverage by growing gross profit per case meaningfully faster than we increased OpEx per case in every quarter of both fiscal 2016 and 2017, resulting in 60 basis point higher adjusted EBITDA margins in fiscal year '17 compared to fiscal year '15.

I'm moving now to Slide 13. We made solid improvements in our key profitability metrics. Adjusted EBITDA was $290 million in the quarter, up 9.4% over the prior year, and $1.058 billion for the fiscal year, up 8.8% from the fiscal 2016. As a percent of sales, adjusted EBITDA increased 10 basis points to 4.8% for the fourth quarter and 20 basis points to 4.4% for the fiscal year. As I mentioned earlier, we've increased EBITDA margins 60 basis points from fiscal year 2015 through fiscal year 2017.

Operating income this quarter increased $66 million to $182 million and year-to-date increased $160 million to $574 million. And finally, on the far right, fourth quarter net income increased to $256 million compared to $77 million in the prior year period. Our pretax income increased $62 million year-over-year as a result of strong business results, lower intangible asset amortization and lower restructuring.

Our fourth quarter net income improvement also reflects a $118 million income tax benefit in the current year compared to essentially no impact in the prior year, with the credit resulting from an adjustment to our deferred tax liabilities to reflect the new corporate tax rate. Fourth quarter adjusted net income decreased $22 million from the prior year due to a $66 million adjusted tax increase, partially offset by stronger business results.

For the full year, our net income improved $234 million to $444 million as pretax income increased $273 million, offset by a lesser income tax benefit in the current year period than in the prior year. Adjusted net income also decreased $9 million to $312 million as a result of improved results, offset by a $197 million higher adjusted income tax expense.

Turning now to cash flow and debt. Operating cash flow in fiscal 2017 was strong at $748 million compared to $556 million in the prior year for a $192 million increase or 35%. Net debt at the end of the year was $3.6 billion, a decrease of $13 million from fiscal 2016. As Pietro mentioned, just as another reminder, we completed a $280 million share repurchase during the quarter, and absent that repurchase, our net debt would have decreased nearly $300 million from the prior year-end. Our net debt leverage remained at 3.4x at the end of the year even with the repurchase, which is consistent with the end of the third quarter and down from 3.8x at the end of fiscal 2016.

Moving to Slide 15. Beginning with our midterm outlook, we're updating and raising our midterm outlook from 7% to 10% to 8% to 10%, which we'll discuss further at our upcoming Investor Day in March. We're also providing guidance today for fiscal 2018.

We expect adjusted EBITDA growth for fiscal 2018 to be in the 6% to 8% range, and we expect the first quarter growth to be approximately 100 basis points below the low end of this range primarily as a result of broad-based poor weather conditions across multiple regions so far in Q1, holiday timing, as well as some temporary transition costs related to the planned customer exits that occurred in late Q4 and in Q1. We expect our year-on-year adjusted EBITDA growth rate to accelerate sequentially throughout the year.

I'll now walk through our case volume and net sales guidance. Weather and holiday timing will impact our Q1 growth rates across almost all of our customer types. For full year 2018, we remain bullish, as Pietro noted, on our outlook for independent restaurant volume growth and expect to be at or above the growth levels we achieved in 2017. We expect full year 2018 total case volume to increase 1% to 2% from the prior year period, and we also expect net sales to increase 3% to 4% in fiscal 2018.

In 2018, we expect gross profit per case to continue to increase significantly faster than OpEx per case even as we make some necessary investments in supply chain. Interest expense is expected to be $175 million to $180 million, and depreciation and amortization between $340 million and $350 million. We expect cash CapEx of between $250 million and $260 million. And finally, we expect a significant increase in our adjusted diluted EPS to $2 to $2.10 per share and expect our 2018 adjusted effective tax rate to be 25% to 26%.

Our business performed well in Q4 and fiscal 2017, and we're pleased with the results. And with that, thanks for joining us today, and now we can go to Q&A.

(Operator Instructions) Your first question comes from the line of Karen Short with Barclays.

Just a clarification and then I guess a bigger-picture question. There's an extra week in fiscal '20, isn't there? So I just want to clarify that, that 8% to 10% EBITDA growth includes or does not include an extra week, if there is one.

You -- this is Dirk. You kind of -- from a -- what year were you referring to?

In fiscal '20, isn't there an extra week? And so I guess I'm just wondering on your 8% to 10%, 3-year new target, does that -- if there is an extra week, does that include or exclude the extra week?

This will be on a normalized basis. So comparing 52-week to 52-week periods.

Okay. So just wondering if you could dive into that a little bit in terms of what will drive that increase. Is it kind of better top line, better margins? And if it's kind of margins, I'm assuming it's more gross margin than OpEx. So maybe you could just give a little color on what the drivers of that would be.

Yes. So this is Pietro. I mean, the drivers really come across the whole P&L. You saw how our growth with independent restaurants is accelerating. We expect that to continue to continue. We're -- as you -- as we'll talk about at our Investor Day, you'll see how gross profit per case has continued to increase, and we expect to continue to do that. And as for my -- the last part of my comments to you, the opportunity in shared services and, in particular, in supply chain is -- given that those are our 2 biggest cost lines in the operating expense part of the P&L and that's where we see the biggest opportunity, that's also a big contributor to the guidance that -- and our outlook for the midterm.

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

So a couple of things. Let me start off. Is there -- or was there a tangible tax benefit reinvestment contemplated in the '18 guidance of 6% to 8% growth? If there was, how much roughly? And in what areas might you be reinvesting?

It's Dirk. So it's -- there's not an explicit investment. We believe we've been making and continue to make the investments that we need in the business in order to drive the results that we have and expect to continue to. Where we are seeing some reinvestments of a portion of those savings is, as you can see, we have a little bit higher CapEx spend as we increase some of our facility CapEx as well as modest increases in IT costs. I think in those areas, it's -- we're going to continue to be disciplined to make sure we do the right projects, but that's where you're going to see a little more of the reinvestment coming back through.

Okay. And then secondly, I know it's only 1% at the low end of the range, but when you think about the new medium-term guidance, what is that specifically coming from sort of in your thought process? Is that share gains accelerating, primarily?

Is your question, John, with respect to -- when you say where is that coming from, are you talking about the Q1 guidance Dirk gave or the midterm guidance?

No. When I think about the 8% to 10% versus the 7% to 10%, right, so the low end is up 1%. The high end always had some M&A, right. So the low end, I assume that's organic. Is that more organic share gains accelerating from the prior plan as opposed margin improvement?

I see. Okay, thanks for clarifying. The -- my answer is very similar to what I gave to Karen. The -- we've always said we think we can perform better with independent restaurants. That's at the high end of the spectrum from a margin perspective. We're starting to see that as a result of the work Jay is doing, and you'll hear from Jay at Investor Day on talent and routines to drive better performance. And the outlook -- the other piece that is a little bit new is the outlook continues to be very favorable for independents. Gross profit, I would say, is just a continuation of the trend we've been on. And lastly, just the opportunity that we see in supply chain. Supply chain is, as we've often said, 55% of our costs. That's where we're in very early innings. And again, at Investor Day, you'll hear Ty Gent paint a picture of the road map by which we can reap the benefits of some of those initiatives. Now as Dirk said, we are having to invest a little bit this year to make sure that we drive the productivity agenda that we expect to drive in the midterm guidance.

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

Yes. Can we just start on the EBITDA growth target of 8% to 10%? You did 9% in 2017, 11% in 2016. So these are numbers that you've been hitting. As we think about 2018, 6% to 8%, if we were to adjust for freight, the transition drag, are you essentially in that range in 2018 as well?

This is Dirk. Yes, we're relatively close to that range. It's really -- it's the industry headwinds around freight, weather, et cetera, as you called out, so -- especially as you think about Q1, just the meaningful impact those things have on a quarter. Otherwise, the core part of the business continues to perform strong with all the levers that Pietro talked about.

Okay. And then just as we think about freight, could you provide a little bit more color on how this impacts the business? Is it only the noncontract business? Does it -- how does it impact the contract side? What's the lag like in passing this through? Just some color there I think would be helpful.

Okay. This is Pietro, Ed, and I'll take it just because my merchandising days, obviously this is something that we touched. So I'll do a little bit of a freight primer, if I can. So when we talk about inbound freight, either -- that happens in 1 of 2 ways: The vendor delivers or we pick up. When the vendor delivers, freight is built into the cost of goods, and that gets -- so any risk is absorbed by the vendor, and that gets passed on to us to the degree that they choose to increase cost of goods. And as you just, I think, were intimating, if it's a contract, then it's being passed on relatively quickly. If it's noncontract, there's potentially a lag. But when we look at our margins, noncontract margins, excluding freight, they've been continuing to rise so that has gone well. The issue is when we pick up, and there, too, there's 2 flavors. When we pick up and when we do it on our own trucks, minimal impact. The primary cost, which is drivers, is governed primarily by collective bargaining agreements. And so there's lots of visibility into how those costs might change.

Where the compression has happened is when we pick up and we outsource to a third-party. And that's where the stats that Dirk gave really come into play, right. When capacity shrinks, as we've seen it, partly as a result of some new regulations with electronic logs, when demand is up, spot prices go up. I think the article that Dirk referred to has spot rates going up 20% year-on-year. And so that's where the compression happens, because our costs from those third parties go up immediately. But the revenue, I guess, or the spread between the costs and the allowance we negotiate with the vendor when we're picking up, that has to be renegotiated. And so that's where we're focused on. And so when Dirk in his comments says, our self-help plan is around re-optimizing the freight lanes and renegotiating those rates, those allowances with the vendors, regardless of what happens with respect to those headwinds, we will have mitigated them by the back half of the year through those 2 initiatives. Does that help?

Yes, perfect. And if I could just squeeze one more in. As we think about the growth strategies of the companies here, there does seem to be a little bit of divergence. I mean, you are clearly intensely focused on driving the right growth, the higher-margin growth. Some of your peers seem to have a little bit of a broader strategy now. I think the market is a little concerned that maybe within all this, there's an acceleration in price competition for some of these [counts]. Is that the case? Or is this just simply differences in strategies between these companies at this point?

I think it's difference -- it's the latter. It's differences in strategies and focus. And some of it is due to we bring a different set of assets, right? We are singularly focused on broadline. And so what we're always looking to do is optimize the mix of customers across those 3 customer types that I talked about. And we have not seen -- again, the 3 largest players account for about 1/3 of the industry. And so even though we all are talking more about pursuing independents, we have not seen the impact on pricing or margins. It's a pretty competitive industry to start with, as you know. And when we look at gross profit per case, one of the -- I think it's been going up, and I think that's an -- that's as good an indication as any that the price competition has been steady. No change there.

Your next question comes from the line of Karen Holthouse with Goldman Sachs.

There's been some commentary from some of your competitors about the health of the independent restaurant industry recently. So just curious what your thoughts there are in terms of sort of share shifts between chain businesses and independents, health of same -- how healthy same-store sales are at independents. And do you have any concerns that price competition among some of the largest chains is going to be driving market share towards what are, in a lot of ways, self-owned distribution models?

Right. So as per my answer to Ed, Karen, we haven't seen it. When we look at the industry data that we all have access to, and I referred to Technomic's most recent update, which is more positive on independents than their previous update; when we look at IHS, which, granted, is the entire sector, does attribute some benefit of tax reform, the outlook continues to be positive, if not more positive. In terms of some of the comments you referred to, the other thing we look at internally is where the growth is coming from. We call it new, existing and churn. And I can tell you, as we look at that data for the last 6 months, we've seen no change in the pattern of growth as it comes from new customers, existing customers or lost customers. So we haven't seen a change in outlook. In fact, it's gotten better. Our conversations with our leaders in the field are very bullish, and our own internal metrics are fairly consistent.

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

Just another one on gross margins, and it's helpful to hear you walk through the freight. But just curious, would gross margin have been up year-over- year if it weren't for the elevated freight costs? I guess I would have thought that the mix between your customers would have been more supportive of gross margin. So just any more color on that. And if you can also, just what percent of your inbound freight is coming in via third party? And what's the exposure there and the steps that you can use to mitigate that as you go into the back half?

Great. So our gross margin on a basis points would have been closer to flat year-over-year, excluding the freight headwinds, and I think that's still because of a lot of the commodity inflation year-over-year that we've talked about in a number of our prior calls. So I think, though, if you look back in our rate per case improvement on gross profit, you see it continued to be significant even with the freight headwinds. So we -- one of the thing -- the levers really that we're working on, the 2 things that Pietro talked about, is really making sure we're re-optimizing our internal freight lane management as well as working with our vendors in order to be able to pass that through as we proceed through the year. So we haven't talked about the individual percentages, but the piece that we use third party for is pretty meaningful. And really for the quarter, just to give you a rough estimate, our EBITDA growth was negatively impacted about 300 basis points as a result of the freight compression year-over-year. So you can see it's pretty meaningful. And even in spite of that, we were able to grow the business 9.4%. I hope that helps.

That's very helpful. And just with the independents, I think I heard the word market share gains a couple of times. I know it's hard to pinpoint down to an exact number, but do you feel the acceleration and the confidence you have with that channel in the future is because of the strength of the independents themselves or the market share gains that you're also getting with them? Or maybe a little bit of both? Just any thoughts on how you're thinking about that and the analysis you do to get to that point.

Yes, and it's a little bit of both, Karen -- Kelly. And it comes from when we look at the data, external data on the growth of independents, which is -- continues to be around 2%. We're growing, you can call it in the last year, 4% to 5%. So we've often said our target is 2x, and that's what we seem to be achieving, which equates to market share gains. And the things we are working on, as I think I mentioned, are in terms of building -- we still see variability across markets that is not related to the particular economic circumstances of those markets. That relates to just continuing to strengthen the routines and extend the best practices and driving the talent agenda to make sure we have the right leadership and also the right sellers. I think I had mentioned in the past how, when you look at the performance of our top-quartile salespeople compared to our bottom-quartile salespeople, the top-quartile salespeople tend to grow better and churn less, which, in the end, has been a big part of the motivation to continue to optimize the number of sellers we have in place.

Your next question comes from the line of Ajay Jain with Pivotal Research Group.

Yes. I first just wanted to get some clarification on the independent case growth figure of 7% in Q4. Can you confirm how much of that was organic? And then I also wanted to ask if you have any color on what you're assuming for independent case growth in your fiscal '18 guidance.

So organic for the quarter, we have it in the materials, it's 5.2%. And as Pietro commented, that was helped a little bit by some of the holiday timing. So as we normalize, it's about 4.7%, which is still the strongest growth we've had in roughly 2 years. So very, very strong independent restaurant growth quarter. And we haven't put a specific number out there for 2018, but -- so we do expect 2018 organic growth to perform at or better than what we saw in 2017. So remain very bullish on our ability to grow that at 2x the market or faster as we continue throughout 2018.

Okay. And as a follow-up on the fiscal '18 guidance, I know you've already gotten some question along these lines, but what's the main driver for the slower growth rate of 6% to 8% EBITDA? It looks like, based on the data that you cited from Technomic, growth from independents is supposed to moderate a little bit this year. And then you mentioned in your prepared comments that expense leverage between gross profit dollars and expenses should be solid. So I was just wondering, is the expected slowdown in earnings growth partly a customer mix issue based on the outlook for independents? Or would you say it's much more expense driven from some of the recent industry headwinds for the freight costs?

It really is more on the 3 or 4 factors that I've talked about before: the freight headwind that we expect at this point to continue through at least of the first half of the year; as well as the early-in-the-year weather and holiday timing, which are a fairly meaningful drag on Q1; combined with some impacts from transition costs as we exit some of these unprofitable national accounts or chain accounts. And then as we talked about with the -- that the core elements of the business continue to be performing well, and things around independent restaurant growth, margin levers, private label, et cetera, we expect those to continue to perform as well or better than they have in the past. So that's why we remain so bullish on the outlook for the midterm.

Okay. And I just had one final question. Maybe I'll address it to you, Dirk. So I know you can't necessarily forecast all of the non-GAAP adjustments on the P&L. There is a lot of variability there. But for business transformation specifically, I assume a lot of those costs are contemplated ahead of time. So do you have any sense for when those costs eventually roll off? Or is that something we should expect to see for the foreseeable future?

Sure. So yes, you're right, we haven't quantified it specifically. But I what I can tell you is we do expect transformation costs to meaningfully decline over the course for 2018, and we would expect them to be minimal as we get to 2019. Really the only thing -- there's a couple of things around supply chain transformation and the like that may span a little bit into '19, but 2018 ramps down, '19 largely goes away. So we're really in the last elements of the big transformation parts of our business. And as you see, our add-backs have declined and continue to decline as we are driving GAAP results even faster than we're driving our adjusted results.

Your next question comes from the line of John Ivankoe with JPMorgan.

First, a clarification and then a question. On the clarification, do you know what drove the increase in overall restaurant sales in '19 over '18? That's kind of interesting to see that your external people are expecting an acceleration in '19 for growth over the growth that we'll see in '18.

There were a number of factors when I looked at it, John. And one of the contributing factors was the impact of tax reform, but there were several factors which we're happy to share.

Okay. Can you share them?

I actually don't have it right in front of me, and what I don't want to do is misquote the latest report.

Okay. But that is interesting that they expect the impact of taxes to be more of a positive in '19 than the positive seen in '18. So that lag, I guess, surprised me a little bit. But yes, I certainly look forward to some clarification there. And then secondly, in terms of your sales staff, I mean, some of your competition is talking about actually adding to their marketing associates or territory managers, whatever the vernacular is, in terms of pursuing new accounts and new business. So can you talk about what you've been doing with your territory managers year-over-year and what that number is, if you're still quoting that? And if you think that's the right type of strategy for you to consider in '18 and '19 specifically to get some of that new independent business?

Right. So just to go back to a couple of statistics I quoted earlier, and you'll hear more from Jay at our Investor Day, who's really been driving this. The learning for us a few years ago when we started down this path is the better sellers actually grow the business more, and they grow it more through all 3 levers. They grow it by finding new -- being better at finding new accounts, being better at servicing existing accounts and churning their accounts less. So there's some, I guess, what we call mix benefit from moving accounts from TMs that are underperforming to TMs that are overperforming.

And that really is what's driving the slow reduction in the sales force. Having said that, we do continue to hire new salespeople because we do want to grow. And we're hiring salespeople who better fit the profile of what we offer, salespeople who aren't necessarily interested in being order takers, who represent the brand well, who are consultative in their approach and who can leverage all the assets and tools we have to help our customers. So the profile of the seller of the future is also changing in conjunction with how our customers are changing.

I certainly understood that. And yes, thank you for repeating some of that language. But as we get to the end of '18 and end of '19, do you anticipate having same, more or less territory managers in the company?

Yes. I don't know that we are at a -- we want to disclose that for obvious reasons, John. I think hopefully, what you take away from the conversation is the thoughtfulness of the approach. The data-based approach gives you the confidence that we're being very smart about this. And the way the industry works today is very different than it's going to work in 5 years from now, and we're going to be ahead of the game, perhaps, compared to others.

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

I just wanted to quickly follow up on the 6% to 8% EBITDA growth. Does that include acquisitions? And if so, how much of an impact would those have?

That would be our all-in expected growth, as Pietro said, since we haven't had any new acquisitions at this point and would provide some later in the year. The new acquisitions would be as we go further. So that is our all-in expectation for the year. And the -- so the M&A impact would be relatively small at this point based on transactions completed in the last year. We would update it to the extent we have new information, as Pietro said, in the next quarter or 2.

So to confirm it, it includes existing M&A but not any new M&A in the pipeline?

That's right.

Okay. And then just on the case growth, 1% to 2% being a little bit below the 2% to 4% midterm target. You talked a little bit about the outlook for independents in 2018, but can you just comment a little bit more about the chain customer types? I think you mentioned that you had some wins. And then also, in the health care and hospitality, how should we think about the cadence of case growth in those channels as well as -- in 2018?

Sure. So I think within the all other, as Pietro mentioned, so we had some of the exits that continued in Q4. We have some additional ones in Q1. So really, we would expect the Q1 negative to be more significant than we had in even Q3, which I use Q3 because it doesn't have the holiday noise that Q4 did. And then from Q1, we would expect us to continue to improve the balance of the year, getting closer to flattish all other by the end of the year as the exits begin to cycle and as well as we bring some new expected wins onboard as well. As for health care and hospitality, so health care and hospitality will be a little bit softer in Q1 as weather, holiday and the full ramp of the large Brookdale customer that Pietro mentioned. And we would really expect health care and hospitality to return more to market-level growth in the back half of the year as the -- our customer pipeline remains solid there.

The next question comes from the line of Shane Higgins with Deutsche Bank.

You guys finished the year with leverage around 3.4x, and I know you guys have a midterm target of around 3. Free cash flow remains pretty strong. And by my math, I think you guys are going to get another incremental $70 million or so from the lower cash taxes this year. Can you just talk about priorities for free cash flow and whether or not share buybacks are factored into your EPS guidance for the year?

Shane, so we'll talk more about this at the Investor Day. We'll actually share just more broadly our updated thoughts on capital allocation. At this point, historically, the information we've put out there is -- obviously, we remain focused on reinvesting in the business, and it's been to reduce debt. And we'll share at that point further thoughts on how we may use some of that incremental cash flow going forward on net debt versus other options.

Okay. And then I just had a bigger -- kind of a bigger-picture question. You guys talked about optimizing the portfolio of your business. Now how much more opportunity do you guys have ahead in terms of just overall portfolio optimization? As you look out over the next, say, 2 to 3 years, do you think the portfolio looks a lot different than it does today? And I guess I'm just trying to understand where your national chain business might be. And does it really start to stabilize maybe in 2019 as a percent of your total book? And then how should we think about the margin implications of that mix?

Right. And I presume you're talking about the portfolio of chain customers, what is -- which is what the all other largely consists of. So as I said, in -- by the back half of '18, and as Dirk reiterated, we expect that to approach flat. As we look out 2 or 3 years beyond that, obviously as a result of the good work we have done, there's fewer and fewer customers -- or maybe I should say deals -- there's fewer and fewer deals that are low or negative profit. And the reason I say deals is because exit, as we've said, is always the last resort. What we prefer to do is to find something that's a win-win proposition that works for the customer and works for us. And the reason we don't have more visibility for '19 and '20 is, if you take the back half of this year as the baseline, which, as Dirk said, approaches flat, there's potentially upside on top of that as we are able to change deals as opposed to exit customers. So I would say the -- what we're calling for in the back half of this year is a good starting point to work up from.

Your next question comes from the line of Vinnie Sinisi with Morgan Stanley.

Just wanted to ask. So if we think of just kind of the sequential cadence of this year, right, 2 of the larger factors are going to be, of course, kind of normalizing trends in freight in the second half, and then also, as you get kind of past some of the first half customer exits and associated expenses kind of working themselves through, right? So I guess on those 2 lines, kind of what are you thinking, first, from a freight perspective? Like how much of that is -- do costs kind of get worse before they get better? Or how much is it your ability to kind of maybe switch from third parties? How much maneuverability is there? And then just more of, I guess, kind of a big-picture question on the chain exits. Kind of when you exit some of those businesses, where do those customers typically go? And then if you look kind of at the rest of the landscape there, obviously you're having nice independent growth. But is there more opportunity that would be worth it for you to look at on some of those higher-volume customers or just not? Any color would be great.

Sure. Vinnie, this is Dirk. I'll start on the freight outlook. As you said, we expect to see sequential improvement in our EBITDA growth as the year goes on. And a lot of that, as you noted, is because in the second half, we get past some of these kind of "temporary" first half headwinds. So for -- that the freight is a big component that is -- helps in the second half. And really, it's 3 things. One is you are lapping sort of a higher-cost period a year ago. But then within the improvement or the self-help type of thing, this -- that's the combination that Pietro made reference to earlier of it really is a mix of re-optimizing our lanes, where it's managing the mix of what we haul, making sure we have the -- can we expand our carrier base that are a better deal for us, et cetera, as well as working with the vendors to get them to increase it. So not specific quantification, but it really is a blend of those things as we go to the back half of the year.

And on the chain customers, Vinnie, as I said, we definitely do look for opportunities to strike an agreement or a deal that's better for both of us, whether they're large or small. And of course, if they're larger, we -- they're more important to us. And there's a number of levers, from assortment to routing. Those can really drive the contribution margin one way or the other, and that's always where we start the conversation. That's always where we start the conversation with existing customers.

(Operator Instructions) Your next question comes from the line of Andrew Wolf with Loop Capital Markets.

Pietro, you were talking about the enhancements to your sites and how that's driving increased usage and time spent. I thought I heard you say that's also the sellers and prospective customers are engaging there. I just want to make sure I heard that right. And if so, can you elaborate a little bit about that process and maybe even provide an example of the flow of how that would occur?

Sure. And again, we'll talk more about this at our Investor Day. But if you think about it, existing customers view less of a need to navigate a website. Where they mostly interact is on our e-commerce platform when they're placing orders. And so we've done a lot of work over the years to provide opportunities to cross-sell when they are on our e-commerce platform, but to do so in a way which doesn't remove the utility of that site or slow them down because they want to get stuff done. Prospects obviously don't have access to the e-commerce platform. The way they interact with us is through our website. And so what we have done is to configure it in a way that is more prospect-friendly. There's information there now and content there now that's probably of less interest to existing customers and more to prospects. What I was referring to is by the opportunity to exchange favorites. The -- that can now go 2 ways. The -- if there's a business manager attached to a prospect, they can together create some -- identify some opportunities that they can talk about when they're continuing the courtship process. And that's going to continue to evolve over time.

Okay, I'll look forward to your conference as well. And just to follow up, Dirk, on the drag, the 50 basis points, not the help in the quarter but now the drag in this quarter to case growth from the holiday swing, was that mostly to do with independents? And if so, could we bump up the independents' benefits and drag to about 75 basis points based on your mix?

It's actually -- it impacted a lot of different customer types. And what happens is the way Christmas goes from a weekend to the middle of the week. And then the timing, it shifts Christmas breaks. So it had a pretty meaningful impact across a lot of our different customer types. So I think the 50 is as good a proxy for independent restaurants as it is for the overall number.

Okay. So we're at the hour. Thanks, everyone, for joining us. I want to, as I always like to do, thank -- use this opportunity to thank all our employees for their commitment to our customers and the great results they continue to generate from an -- despite some of the headwinds we've seen. And we look forward to seeing many of you at our upcoming Investor Day in about a month. Thanks again.

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