Sysco Corp (SYY) — Q1 2019 Earnings Call Transcript

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 July 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'll 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'll 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 four 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 a very strong US 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 increased $0.17 to $0.91. Overall, our fundamentals for the quarter were solid and as an organization we remain focused and 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 US, overall consumer confidence remains high, driven by 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 US GDP of 3.5% and the strength in the labor markets, all factors that historically have been positive signs for the foodservice industry. Economic outlook in our international geographies remains somewhat mixed. Canada's economy is performing well and foodservice sales are projected to continue growing. In the UK, 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, 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 US 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 costs and having placed 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 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 US 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 US Broadline Operations, growing 5.2% and has now grown for 18 consecutive quarters. Total case volume within US 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 through the annualization of both the HFM and Doerle acquisitions, the annualization of two 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 brands, 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, a larger portion of our local growth is currently coming from this type of customer. From an expense perspective, operating expenses for the quarter grew 5.8% driven by supply chain costs in both the warehouse and transportation, including significant overtime expenses and costs 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 control 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; 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 UK 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 combining Brake France and Davigel which will enable us to leverage the size and scale of these businesses to deliver accelerated performance as we create Sysco France. And in 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 for our US 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 UK 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 area 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 businesses, 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 the other business segment, guests apply 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 expenses 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 three-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, 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 24%. Gross profit in the first quarter increased 3.9% and gross margin increased two 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, increased fuel costs, as well as increased bad debt expense in our US operations related to larger recoveries in the prior year and a couple of 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 increase costs in our US 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'll 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, states, and other jurisdictions. With regard to share repurchases, we repurchased 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 is $188 million higher compared to the same period last year. Free cash flow was $171 million, which is $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 was a good opportunity to take advantage of investor demand in Canada and further balance our assets and liabilities in different geographies. As we looked to term out internal debt that was created to repatriate earnings from Canada as a result of US Tax Reform. We're very pleased with the transaction and the interest on the notes will be paid semi-annually in April and October beginning in April of 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 US business we expect to have continued volume growth as a result of both a healthy macro environment and our initiatives differentiating 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 will begin to annualize in the second half of the fiscal year. And the annualization of two large national customers which will impact our overall volume growth. Due to this annualization, along with a 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 three-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 three-year plan. We are committed to servicing our customers and executing at 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're now ready for Q&A.

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

Yes, Chris, just this is Joe. I think just to clarify your question, I mean I think 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 a difference in having M&A this year and not last year. And I note that if that is your question.

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

Yes. Well, I think, look, I think, one of the things I would certainly reference you back to is the three-year plan that we talked about with an overall volume growth. Again that made some assumptions of some M&A about of some M&A about 1%, 0.5% or 1% in there. We talked about overall volume growth over 3% local about 3.5%. Again every quarter is going to look a little different and there's going to be some impact of some things that we've talked about here, but I think we broadly still feel good about the volume numbers we talked about as part of our three-year plan. Those things are just going to move around some, but I think our 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 a 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 trying offset that to see some improved trends overall even 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 we'll improve from here on out.

Yes, hey, Chris. This is Tom. So I think, I don't think we said we are 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 they would be. And so 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.

Hey, good morning. Just to leverage off that a little, I mean I think about the gap between case volume growth and gross profit dollar growth wind out in an 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 Joe. So I think the couple things on that. I'll start with the deflation point is obviously there was an anticipated level of inflation and some of the projections we had as part of this three-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 you are a less inflationary environment you typically have some mathematical improvement in the margin percentage that you actually have less gross profit dollars. And so when the impact of lower inflation does tend to have 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 and 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 will even I would call some of the pure independence that's part we are also referencing is something we're seeing as a somewhat leveling off of our gross profits that's I think part of what we're calling out here. So those are couple of.

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've talked about both of them is one of them impacted quarter one, the other one Michael will actually more impact quarter two. But typically what we find is we lose the top-line right. We don't get the cases because outlets are shut down, the markets 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 are 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 some where the impact of the, let's say Florence itself is pretty somewhere a little less than a penny I would call.

Yes, hi, guys. Good morning. 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 impacting the P&L, right? Because there's a part of the cogs that there's impact and there's part of OpEx as we think about and Bob started to ask sort of along these lines, 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 mix issue and lack of inflation issue?

I'll start and then Joe can jump in. I think it's probably more of you suggest. I think it's more of a mixed issue and somewhat of, look, it's a slowing down of the inflation that we had planned, but it is also seeing deflation in a couple of key categories which is impacting us. I think in addition, look, I think the inbound freight is gotten better. It's still not great but it's more I think more consistent and maybe 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-- we'd say everything around drivers because it's 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 but that will continue throughout the year but as we get to this holiday season, we do worry that we see more pressure there as there are just more freight on the road.

Yes, and I think this, just one thing I'd add to that, yes, it is just I think Tom's comment earlier about these the categories themselves that are actually in deflationary are important. We've always -- and we 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. And in this case some of them, we've had in our FreshPoint business for example, we had a fairly significant deflation in the produce area and again on the center of the plate in the meats area. Those are large dollar cases you start experiencing some of the deflation and that has some more impact on 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, 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 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 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 the focus is how do we keep our top-line growing very strong and then make sure we are managing the cost side of the business tighter.

Yes, and again just as part of that three-year plan if you remember that that gap was targeted at for that three-year time period. So certainly there's a plan that has some acceleration.

So Tom and Joe, 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 these shared services are part of that but maybe talk about the way you're attacking that here specifically in the next couple of quarters? And then is it fair for us to think that line item can grow? You can hold the growth to 1% or 2% on a go-forward basis or is that too low?

Well, let me start and then Tom can chime in if he wants. I mean-- I --first of all, no, the answer your original question is we did not actually that was not part of the 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 that, 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 in the operations side. These are areas that we need to continue to accelerate even at a faster rate than we have today. And so I think as we always think about those type of costs, there are pay increases and there's things and so each --there are going to be a couple points of the 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 smart spending categories.

Yes, are you pulling forward the timetable on some of that in light of the warehouse cost pressures 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're either stay on track or where we can't accelerate we're doing so.

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

Yes. As you know, John, that we've 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 and kind of leading with pricing downward to drive market share. We need to earn that based on all the things we've talked about. We're very focused on all those I would call differentiators in the business to create a better experience for our customers.

Hi, thanks. So my question is I guess in early September you kind of indicated that you probably you loosely achieved a third of your three-year goals and operating income in 2018 and you'd indicated that the remaining two-thirds would be pretty evenly distributed between fiscal 2019 and 2020. And obviously with what you have 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 2020. 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 am still trying to understand really what changed from early September to today?

So, Karen, a couple is, I would say not just a year 2020. I think we're telling you is back half of 2019 and 2020 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 you're going to have some big balloon when you need to stall for. So as far as what's changed, I mean I think what we are --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 over time 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 of 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 this supply chain cost and all we're saying is we're going to accelerate some things in some other areas knowing we've got to offset that.

Okay so then just to clarify also you were kind of asked this earlier but in terms of the components of achieving that 650 to 700 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 cycle not leveraging supply chain but reducing admin costs to be a more of a contributing factor? And then if you could give us just some color in terms of the dollar buckets in the three areas that you called out the finance transformation, smart spending, and Canadian regionalization that would be helpful?

Karen, so I'll start I mean I think the bucket is 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 - every - we --again express confidence in our goals and if it looks a little different than we'd originally anticipated, but I wouldn't necessarily come to conclusion right now that all those things are going to just dramatically shift in terms of the buckets. I think that's, again, we're 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 costs out of our system. So I think that's really the main message here. And I think - [Multiple Speakers] yes and on those specifics, Karen, again we haven't-- we're not going out and actually I guess assigning specific cost to those items just suffice it to say, and we talked about this in Investor Day. Those were certainly a sizeable portion when we talked about of their G&A savings, and yes we can accelerate some of that we're looking to do so.

Hey, great, good morning, guys. Thanks very much for taking my questions. Also of course just wanted to follow up with what the cost focus. So I guess Tom you said it's 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 breaks 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 may there --may be just be more efficiencies that you should be realizing overall?

So, Vincent, there are a couple of things. So the cost challenges are, if you think about the various segments, the business we talked about. Our biggest cost challenges are in North America. So the US business in 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 are not a big driver of our cost issue. So it's the supply chain 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 US or whether they're an 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? Some are and some aren't. And so finance roadmap we talked about that Investor Day, we plan 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 are in the numbers; some of them are going to be accelerating, but I think the key message for you guys is, look, we understand that we were 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're shifting; 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 anticipated. And we are aggressively going after those so 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 again somehow jamming all that into the final year, the three-year plan.

Good morning, thanks for taking my question. 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 three-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 year and a half?

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 cost. They are higher than we are comfortable with and I think we've got some initiative 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.

Yes, and I guess to your point also, I mean, look the expectation is that we're in a world of pretty stable utilization in our facilities themselves that should continue to help us manage there. And then really how do we get better and better productivity around cost per case as we manage that volume and all to stay in a flat kind of run rate.

Okay and I guess Joel just on the comment on gross margin and the impact of deflation and the mathematical impact that has. I guess can you quantify what that did have on the gross margin rate? I guess it would have thought gross margin would have been up a little bit more last time we 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 takes underlying gross margin?

Yes and so again just to be 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 are actually experiencing some level 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 earlier 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 which when we were talking about this couple years ago we're a couple points of deflation. And that obviously has certainly a much more significant margin percentage impact than what we are talking today.

Okay and can you 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've talked about them being kind of less than 100 units, but generally covering multiple from our view-- multiple operating company. 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 there are concepts that usually have done well for a while as a local or independent customer and now we're 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, etc. and so that's why we say that that segment is a little more margin pressure than an independent restaurant operator, and but that they vary in size and scope. They're not --they're certainly not changed like you typically think of a chain but they are starting to emerge and shift beyond kind of their traditional market.

Yes, hi, good morning. I was wondering if you could maybe expand a little bit on the general operating environment for independence. 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. And 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 this competition by itself driving some of that increased cost pressure. So just wondering if you are 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 these nine months to or so ago by adding some marketing associates. We believed that we had now had the 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 Q --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, I'm 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 higher case growth drives higher operating expense in general. If you're growing 5% plus in the cases and you should expect your operating expenses are going to grow. Our problem is our operating expenses, we're not getting leverage on them or they're growing faster than what obviously we're just getting on the case grow. 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 US for restaurant spending, but then based on the recent performance at breaks 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're 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 for anything. I think just to be clear when you talk about breaks or Europe that's a very different situation. And as I said in the remarks, I think in the UK there's certainly some uncertainty in that market continues because of this Brexit question that's out there. And quite honestly what we see in here as it gets closer to the date where they need to make some decisions 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 sort --we are managing through what is a little bit of a bumpy environment in some of our international markets.

Yes, Ajay, I just, this is Joel. I think just to clarify I think what we're saying is that the Q2 we are 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 some moderation a bit due to some of the lapping 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 is more similar is the answer to your questions is we really we're calling out there in a second quarter.

Hi, thank you. 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 in particularly this quarter we're 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 it might just be a function of some of these contracts kind of rolling over or for you to set up a new whether cost-plus percent or cost plus your dollar per case basis whatever it is for you to capture the true cost to deliver to these customers?

Hey, 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 that'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 swing because of it.

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

That's right, John.

Yes, that's right.

Hi, good morning. I just want to drill down on some of this 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. I just want to confirm that and change in terms of where more pressure came. And then I want to --one of you guys referenced started over talking your answer but maybe can do two 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 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 those are 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 central to that. If you could perfectly match up the supply of labor with demand, would you --these cost pressures mitigate? In other words it's just-- is there just a lot of turnover and it'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?

Yes. 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.

Yes, and you can imagine, Andrew, I mean it's --the more your --the issues you are 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 of the retention. So that's just really - and 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 say about $0.03 a case in terms of our fuel impact this quarter. So it's pretty significant, and you can certainly anticipate that coming continuing fuel surcharges I think the way ours-- 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 and on the contract side most of those are negotiated in. We have 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 and the other income. It was pretty big swing this quarter especially without any other income this quarter and a year ago going up. Is that a pattern or are you guys going to go back to having sort of a decent other income line going forward? Otherwise it's like -- if we annualized this quarter so 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 to play 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.