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Good morning, and welcome to Sysco's Fourth Quarter Fiscal 2018 Conference Call. As a reminder, today's call is being recorded. We will begin today's call with opening remarks and introductions.
I would like to turn the call over to Neil Russell, Vice President of Investor Relations, Communications and Treasurer. Please go ahead.
Thanks, Virgil. Good morning, everyone. Thank you for joining us and thank you for your interest in Sysco. With 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 1, 2017, 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.
Thank you, Neil, and good morning, everyone. Earlier this morning, Sysco announced that we concluded fiscal year 2018 with a strong quarter that ultimately translated into a successful year. Fiscal 2018 was also the final year of our three year plan and I'm excited to share that we exceeded the various metrics that we initially outlined during our Investor Day back in September of 2015.
Many of you will recall that when we initially announced this three year plan, we had three targeted objectives we wanted to achieve. The first was to improve the customer experience of doing business with Sysco through enhanced service levels, improve sales retention and higher customer loyalty. The second was to enhance associate engagement through improved workplace safety and associate retention by providing attractive career growth opportunities for our associates. The third was to achieve our financial goals of growing adjusted operating income by at least $400 million, which we raised twice since then, ultimately to the high end of a $650 million to -- $600 million to $650 million range while targeting an adjusted return on invested capital of 15%, all of these excluding the impact of the Brakes acquisition.
Specifically, for our financial goals, we had three key levers that would help achieve those metrics: Grow gross profit through accelerated local case growth and gross margin expansion, leverage supply chain costs and reduce administrative expense. I'm proud to report that our team was able to successfully execute on all of these objectives, which has translated into steadily improving financial results over the past three years.
At the conclusion of the three year plan, local case growth was 3%. Gross profit dollar growth outpaced operating expense growth, creating operating leverage of 2 points, and we delivered $665 million of incremental adjusted operating income, excluding Brakes and based on a comparison of fiscal 2018 to fiscal 2015. Additionally, we grew EPS faster than operating income and we surpassed both our adjusted return on invested capital and working capital targets.
We achieved these goals by staying focused on our customer-centric vision and driving consistent execution at the operating level. Our objective to improve the overall customer experience has been a core element to our success over the past few years and will continue to be a key focus for us as we move forward. As we described at our Investor Day in December of last year, we continue to build on the momentum we've achieved against our strategic objectives, and we'll strive to accelerate our current growth guided by four strategic priorities: First, enriching the customer experience of doing business with Sysco; second, delivering operational excellence in everything we do; third, optimizing the business, what we like to call The Sysco Way; and finally, activating the power of our people.
The overall macroeconomic trends continue to be positive in the United States and the underlying economic picture remains encouraging, including a strong employment market. This has resulted in a healthy consumer that is driving a positive trend in restaurant sales. We also see continued growth at local customers as they increase their reach through flexible menus, innovative concepts, and additional delivery options to reach consumers. Looking at our results for the year, sales grew 6.1% to $58.7 billion driven by strong growth with local customers, the addition of some new customers which helped accelerate our national customer growth, a few key acquisitions, and continued product cost inflation.
We continue to be focused on M&A activity as a part of our strategy and also closed several acquisitions during the year, including HFM in Hawaii, Doerle Food Service in Louisiana, Kent Frozen Foods in the U.K., a small transaction in Sweden as well as acquiring the remaining 50% interest in Mayca, our Costa Rican partner. For the year, local case growth for our U.S. Broadline business was 3.6%. It was the strongest in the fourth quarter at 5%. Overall gross profit grew 5%, driven by a few key factors: First, the acceleration of local cases to improve processes and training of our marketing associates and continued growth in our digital platform; second, the growth of Sysco Brand, which now comprises nearly 46% of U.S. Broadline local cases; third, Cutting Edge Solutions, our product innovation platform, which features our exclusive product offerings has now delivered 1 million cases of new on-trend innovative products to our customers; fourth, the continued success in category management as we continue to introduce new categories to capture value; and finally, effective ongoing management of product cost inflation using our suite of revenue management tools. These positive results were partially offset by continued challenges from inbound freight costs driven by overall industry factors such as driver shortages and adjusting to electronic regulation of hours driven.
From an expense perspective, adjusted operating expense for the year grew 4%, driven by ongoing strategic investments in the business and a few operational challenges that impacted the year. Some of those investments included supply chain transformation work occurring in the U.K., the investment in marketing associates in the U.S. and the continued investment in technology solutions that will translate into a more enriching experience for our customers.
Overall, we delivered adjusted operating income growth of 8.4% to $2.5 billion. With the addition of tax benefits, EPS growth was meaningfully higher than the prior year as adjusted EPS grew 26.6% to $3.14. The operational improvement in our business is a direct result of the hard work and effort of our 67,000-plus associates who executed our business strategy that is predicated on disciplined, profitable, and sustainable growth.
Transitioning now to our annual results by business segment, beginning with U.S. Foodservice operations. Sales grew 5.4% for the year, gross profit grew 4.6%, adjusted operating expenses grew 4.7%, and adjusted operating income grew 4.3%. Top line results were strong as local case growth in our U.S. Broadline business was 3.6%, including the acquisition of HFM and Doerle Food Service. Organic local case growth was 2.8% and has now grown for 17 consecutive quarters. Total case growth was 2.9%, of which 2.1% was organic. The solid case growth performance translated into healthy gross profit dollar growth of 4.6%, driven by a combination of customer mix, product mix, and inflation. Additionally, the previously mentioned growth in Sysco Brand also contributed positively to the gross profit dollar growth.
Turning our attention to cost. Our adjusted operating expense growth for the year was 4.7%, driven by rising fuel costs and increased supply chain costs in both the warehouse and transportation. These costs were largely due to a combination of a tight labor market, weather impacts throughout the year, and ramp-up costs for new business. Additionally, we had ongoing investments in our selling organization to better penetrate underdeveloped markets.
Moving on to International Foodservice Operations. Sales grew 8.5%, gross profit grew 7.1%, adjusted operating expenses grew 9.7%, and adjusted operating income declined 7.7%. Top line growth was strong for the year across all our international businesses. Our business in Mexico added a new national customer, and Canada performed well as we implemented strategic investments from our -- initiatives from our U.S. business, which led to accelerated local case growth for the year. However, in the U.K., we continue to experience acute product inflation in the mid-to-high single digits.
From a cost perspective, we continue to make investments across Europe. The supply chain transformation work in the U.K. to transition from a single temperature warehousing fleet into a multi-temperature network is progressing well and we feel good about the progress that has been achieved. We are also making good progress on the integration of Brake France and Davigel to create Sysco France and are excited about the new capabilities and the unique multi-temperature service that will better adapt to our customers' growing needs. Additionally, the integration of Pallas Foods and Brakes in Ireland is nearly complete and we've achieved good cost synergies throughout the year. We are also making technology investments to improve the infrastructure and to enhance our suite of customer-facing tools. And finally, in Mexico, we absorbed the cost of adding a new large customer during the year.
The overall decline in adjusted operating income is a direct result of the strategic investments we are making in the International segment along with the impact of foreign exchange currency translation. We continue to focus on executing against our long-term plans by investing in necessary capabilities across the International business and by leveraging our position as a platform for future growth.
And finally, SYGMA showed continued top line growth during the year with sales up 6.1%, driven by inflation, along with fees growth of nearly 3%. However, the business continues to struggle with operating expenses related to increased transportation costs and a reduction in backhaul revenue due to driver availability.
I'd now like to briefly discuss the announcement that will be coming out later today. Today, we're announcing our 2025 corporate social responsibility goals. These newly defined goals set a clear path for the future and demonstrate Sysco's continued commitment to care for people, supply products responsibly and protect the planet. We believe it is our responsibility to operate in a manner that meets the needs of our customers today while producing positive lasting change. We are leading our industry with our CSR initiatives and by including specific long-term goals that align with our strategic business priorities, we're living our vision of becoming our customers' most valued and trusted business partner.
In summary, we are excited about the results achieved in fiscal 2018 towards our three year plan and are encouraged by the solid fundamentals across our business, specifically the top line growth trajectory we're on, while continuing to be able to invest in our future. Our success is a direct result of the dedication and hard work of our associates executing on our strategic priorities.
As a reminder, fiscal 2018 is an overlap year in that it was the final year of our initial three year plan and the first year of our new three year plan. We are pleased with the results for the year and remain confident in our ability to deliver the financial objectives associated with our new three year plan that we described in our December Investor Day.
With that, I'll now turn the call over to Joel Grade, our Chief Financial Officer.
Thank you, Tom. Good morning, everyone. As Tom mentioned earlier, we are excited about our performance in achieving our initial three year plan and pleased with the results for both the fourth quarter and the full year. This morning, I'll start with our quarterly results. Sales and gross profit growth were strong at 6.2% and 5.7%, respectively, as we saw positive impacts from overall and local case growth, continued Sysco Brand growth and a benefit from inflation and foreign exchange. Adjusted operating expense growth was 2.5%, resulting in adjusted operating income growth of 15.7% and adjusted earnings per share of $0.94. In addition, we continue to generate meaningful free cash flow as we achieved $1.5 billion for fiscal year 2018.
For the fourth quarter, we saw a foreign exchange benefit to sales of approximately 1%. Sysco also experienced inflation in our U.S. Broadline business of 1.1%, driven by a few categories, including dairy, frozen potatoes and vegetables and paper disposables, partly offset by deflation in poultry. Within our International business, inflation was driven by a combination of both product costs increasing and currency translation in the U.K. During the quarter, we had gross profit growth of 5.7% driven by overall and local volume growth and improved Sysco Brand penetration. Adjusted operating expenses grew 2.5% for the quarter. The increase in expense was largely driven by supply chain costs in both warehouse and transportation, which were mostly related to increased fuel costs and a tighter labor market and the previously announced investment in our selling organization in our U.S. operations.
Additionally, we continue to make investments in transformation and integration in our International business. These costs were partly offset by favorable comparison in corporate expense versus the prior year that we previously mentioned. As a result, we saw a gap between gross profit dollar growth and adjusted operating expense growth of 320 basis points this quarter. And while we don't expect to see that trend to continue, we do expect our three year plan gap to be approximately 150 basis points.
As it relates to taxes, our net earnings for the fiscal year were impacted by lower tax rates from U.S. Tax Reform where our U.S. federal rates went from 35% to 28%. Other favorable impacts include additional credits and tax benefits from stock option exercises. Cash flow from operations was $2.2 billion for fiscal year 2018. Net CapEx for fiscal year 2018 was $666 million or about 1.1% of sales, which was $3 million higher than last year. Free cash flow for fiscal year 2018 was $1.5 billion, which was $83.6 million lower compared to last year, primarily due to a pension plan contribution we discussed last quarter.
As Tom mentioned earlier, we also achieved results that exceeded our original three year plan targets, excluding any impact of Brakes. This includes an adjusted return on invested capital, excluding Brakes, of 20.2% and our working capital improvement was 5 days or 1 day better than the original target.
Now, I'd like to close with some commentary on the outlook for fiscal 2019. As Tom mentioned, fiscal 2018 was the first year of our current three year plan concluding in fiscal 2020. For this current plan, we continue to feel confident in our ability to achieve our goal of $650 million to $700 million of operating income improvement. The inflationary environment has abated throughout the year and while we can't predict the impact that macroeconomic factors will play in the cost of our products, we believe modest levels of inflation will likely continue for at least the next few quarters. Capital expenditures are expected to be approximately 1.2% to 1.3% of sales. And from a cash perspective, as we previously stated, our U.S. federal tax rate will drop to 21%. With the addition of state and local jurisdictions, we expect our overall effective tax rate to be approximately 25%, similar to the rate for this year due to some tax benefits that occurred in fiscal 2018 that we anticipate will not fully repeat in fiscal 2019.
In summary, we've had a very strong performance over the past three years and the fundamentals of our business remained solid. We are excited about the future as we kick off fiscal 2019. We expect to deliver continued strong top line fundamentals and improved cost management, building on the momentum from the prior three years. Our strategic priorities of enriching the customer experience, delivering operational excellence, optimizing the business and activating the power of our people will accelerate our current growth and position us well for future success.
Operator, we're now ready for Q&A.
[Operator Instructions]. Your first question comes from Edward Kelly from Wells Fargo.
Tom and Joel, I want to start really with gross profit and gross profit per case. The per case result this quarter was a little bit weaker, I guess, than really kind of what we've seen in some time, although there was, it seems like, more M&A benefit this quarter than what we've had. You have a harder comparison there. I was just wondering, is there any real change in the underlying rate of profit per case growth? Or are there -- does this more relate to one-off issues? And I know freight plays a role within all this, so if you could help out with all, that will be great.
Sure, Ed. I'll start. And I think the answer to that is there really is no, what I'd call, fundamental changes in our view of that. I think you've hit on a couple of the points. I mean, certainly our contract growth was again a bit higher this quarter as well as the freight certainly has still continued to have an impact. And again, we certainly anticipate that continuing, but in terms of any other fundamental impact to that, Ed, I -- there's really none I would call out there.
And just as it relates to freight, there's been talk about incremental freight challenges from one of your largest competitors. Can you just maybe talk about what you're seeing in regards to getting product from vendors on a timely basis, filling open driver positions? Any disruption that you are seeing related to any of this or how you're mitigating it? Is it reflected in the top line at all? I mean, it doesn't seem like and maybe you're actually benefiting, but just some help there would be great.
Yes. Good morning. This is Tom. Look, we've been talking about this for a few quarters now. I mean, the freight challenges out there are real. I think that every industry who's moving freight is dealing with them. And so what I'd say is -- and I think we went all the way back to our probably second quarter when we first started feeling the impacts of this. We struggled a little bit early on, making sure we were getting our lanes filled. We were getting our service levels from our suppliers where we needed them. We started a very aggressive approach back then and continued on through our third and fourth quarter, trying to really make sure we get the right relationships in place with carriers. We've got the right plans in place with our suppliers so that we don't have the type of service issues that one could expect or might expect in dealing with this situation.
So I think we've done a lot of work as a team to mitigate that as much as we can. That doesn't mean we don't have some of the cost impacts because we got to get the freight there. In some cases, we're still having to go to spot market. We're still having to pay higher rates than we were a year ago, but from a service level perspective, I don't think we're having nearly the challenges that maybe some others have talked about.
What I'd say as it relates to our own drivers and more on the outbound side, we do have challenges filling driver roles in certain markets where the labor market's just very tight. We see regularly drivers being offered significant upfront incentives to join a company. We're having to do some of that same type of thing. So there -- it is very real that there's a tight market out there for drivers and we're experiencing some of that just like everyone else is.
Your next question comes from the line of Chris Mandeville from Jefferies.
Tom, on the case growth acceleration, trends improved really quite nicely on both the one and three year. What would you attribute that to? In terms of influence, how would you rank things? Was it similar to what you outlined on gross profit dollar growth? And have you seen some momentum that was observed in Q4 in 2019 thus far?
Chris, yes. So regarding case growth, I'd say really a continuation of a lot of things we’ve talked about, but certainly, e-commerce, as it does grow, we're now at about 50%. We have seen some improved penetration with customers who are buying on the e-commerce site, so that's certainly helping. But I would say the additional MAs that we added in the year and we've talked a bit about that as well as the training programs we now have and the way we can get our MAs up to a rate of productivity a little faster maybe then we've historically been able to would be maybe another driver.
We talked a lot about our focus in this area. And I think it really is about, one, applying the resources in the places where the biggest opportunities exist. That's some work we've been doing now for a while. And then additionally, making sure that they've got access to the right resources, whether that's specialists to help them grow the parts of their business where maybe we're underdeveloped or even accelerating our business review process we've talked to you all a fair amount about. So it really is a lot of the same fundamental things, but I think as we -- all those things start to come together, we see that acceleration there.
I also mentioned and I think this is true that, that independent customer continues to be kind of well-positioned. And we're seeing that work out for us, too.
Okay. That's helpful. And then, Joel, just for the three year plan into 2020. This past year that you just completed, you were just shy about 8.5% EBIT growth. Can you just provide some color on how we should think about progression for fiscal '19 that need to show a little element of acceleration in the growth rate? And then what may be the primary drivers are that we should be thinking about for the coming year?
Sure. So I think one of the things that we've spent a fair bit of time talking about is the idea that, to some extent, FY '18 was certainly a strong finish to the last, but it was also an investment year. We talked about the fact that if you kind of rewound about 1.5 years ago, given the trajectory we're moving on, in the last three year plan, we got a lot of questions on, "Hey, do we -- are we actually extrapolating that out to an even stronger end of the three year plan than we even ended up?" And part of the reason we continued to emphasize that the high end of the range that we were -- had talked about was just the fact that we continue to -- we do have some investments in our business we're planning to make that we anticipate will continue to benefit here over the next three year plan and then certainly beyond. So I would just look at '18 somewhat -- and again, it was something that we had a view of and then talked about of some investments that we've made that we called out in our sales force, in our International business in terms of some of the transformation work from technology, from the integration of the merger from the supply chain in the U.K. And so I think I would look at it that way.
And so -- and as we move forward, obviously, the main impact this year that I would say we anticipate accelerating over the course of the three year plan is really somewhere around this gap between gross profit and operating expenses. This year came in at a gap about 1% and, again, much of that was related to some of the investment that we talked about. And so I would anticipate, as we move forward a -- as we called out earlier in the call today, a 1.5% gap as we go through that three year plan and certainly that means, from an expense perspective, probably some improvement there as we move into that three year plan.
Chris, the only thing I'll add is, I mean, I think what you should take away is we're committed to that three year plan number that we talked about last December. And so as Joel just said, there's some things we need to accelerate and improve on in '19 and '20 and we feel comfortable we can do that.
Your next question comes from the line of Judah Frommer from Crédit Suisse.
Maybe just to follow-up on some of the questions so far. So for the three year plan going forward with that 1.5% gap between gross profit dollars and OpEx dollars, how should we think about the flattish gross profit per case in the U.S. in Q4 and extrapolating that forward versus the control you have on operating expense and your ability to leverage that line?
So Judah, I think, let me just start and I'll let Joel jump in. I mean, when you say flattish gross profit, we are on our kind of gross profit or actually above our gross profit target for the three year plan. So I think we feel good about our ability to deliver the gross profit growth. And obviously, if we can get some help from what's happening with products and inflation, we might -- we feel comfortable we can get there. I think you're raising the point that Joel was just referring to, which is the cost side. We need to continue to focus on the cost to make sure that we can, in fact, keep that 1.5-point gap that we have alluded to over this three year plan. And we've got some work to do there, but I think we feel good about our ability to get there.
Yes. And again, Judah, just I think the question that you made actually was on the gross profit per case and, again, that's -- as I mentioned earlier, I mean, I don't know that any -- there's a bit of a flattening out at this particular this quarter. Again, I'm not overly concerned about that on a long-term basis. And as Tom said earlier, we certainly feel very good about the -- about our outlook for our three year plan moving forward.
Okay. Great. If I could sneak one more in on that national competitor Ed mentioned. So beyond the freight implications, clearly they struggled in this calendar second quarter. Is there anything you'd call out in terms of a benefit from their struggles on cases or kind of business as usual?
No. I'd say, look, you guys know, we talk about this pretty often. It's very competitive out there. It remains very competitive. I wouldn't say that -- anything that they talked about was necessarily a similar impact for us. And I'm not necessarily sure we, in any way, benefited by the challenges they were facing. So I think it's pretty much we see the same competitive environment we've always operated in.
Your next question comes from the line of Karen Short from Barclays.
Just a couple of questions. And in terms of -- I'm going to ask the case growth a little bit differently or the gross profit growth question a little differently. So your case growth was up 5.3% and gross profit was up kind of 5.2%, which is definitely the narrowest gap we've seen in a long time so -- I mean, looking back 8 quarters kind of thing. So is it really just a function of freight or is there anything else you could point to?
We talked about there are a couple of things driving that. So if you think about the freight impact for sure on the inbound side; the customer mix, which as Joel talked about earlier, the fact that we had more growth in our national customers or our contract business; and then product mix also comes into play there some so which products are inflating versus not. So I'd say those 3 things and combined probably affect that, but we still feel really good about those numbers. And we're able to basically hold our margin flat given everything else that's going on. We feel actually really good about that.
Your next question comes from the line of Bill Kirk from RBC.
So in the quarter, your expense control in that final period of the first three year plan, it was very strong. So can you help us better understand those year-over-year improvements? And how do you make sure you aren't cutting resources that may be needed somewhere in the future?
Sure, this is Joel. So I think a couple of points on that. I mean, number one, as we've headed into this quarter, one of the things that we've given a heads-up to people on is the fact that we anticipated this quarter being in -- this sort of this gap being very strong as it relates to last year due to some things that were in last year's expenses, particularly on the corporate side, that were not in this year. And so -- and we also, I think, made a point today of making sure to point out that, look, this -- obviously, the 3 points -- the 320 basis point gap is extremely strong. That's not something I would look at as a long-term trend, but really settling in around over time, again, this long-term view of 1.5 points between GP and OpEx.
And so I -- this is not a matter of somehow doing something that is a onetime expense cut that hit that. It's simply something we anticipated coming. We've continued to improve, again, our management of our expenses. We had a strong year in general in our corporate expenses and so that was something that, over the course of the year, certainly helped us manage the gap that we had and, again, make some of those savings and investing them in our operations as we've talked about throughout the year. But in no way, shape or form should you interpret the strength of what happened in this fourth quarter as somehow anything that was a management or resource that's going to impact us negatively moving forward.
Got it. And on the inflation commentary, I think you said you expect a little or a modest inflation for the next few quarters. Do you expect something different after those next few quarters or that's just the time frame you're comfortable commenting on?
Yes. I would say that's typically how we comment on these things. Obviously, much beyond that is not really any basis on anything and wouldn't be responsible in our part so that's just our typical comfort of how we look forward.
Your next question comes from the line of Vincent Sinisi from Morgan Stanley.
Wanted to just go back to the sales force investments. Could you just kind of give us an update? I know you said kind of part of the solid case growth this quarter was due to that, but kind of where are we, what inning in terms of the low investment? And then just any color you can give us in terms of productivity, what may be the newer class of folks versus years past are looking like? And I know you said kind of e-commerce around 50%. I'm guessing that's the local restaurant cases. I feel like not too long ago it was 40%. So kind of where are some of the better productivity tests going toward, that would be helpful.
Sure, Vinnie. I'd say you actually hit on a few of the things yourself, which is e-commerce has continued to grow. As you said, we're at 50% now and which has been kind of an ongoing move. As we talked a lot about how we think about e-commerce, it's really been this customer choice platform. And so we -- the good news is we're seeing more and more customers wanting to migrate to e-commerce.
And so the other big thing with our sales force, and so we go back to the MAs. We talked through the last couple of quarters that we've added marketing associates. And we're kind of at that point now. I wouldn't say we're necessarily adding more, but we still have some of the expenses associated with those new marketing associates in our numbers. When I think about getting those more -- those marketing associates more productive, what we're really talking about is how do we get them into a territory where they're actually delivering results. And I think the training programs we now have, the way we bring them on board and the type of more focused effort we got around that is really helping us get them into a territory starting to produce, if you will, on a much quicker basis. We used to talk about that would take 18 months to two years to get someone up to speed and we're -- we've cut that in about half now. We believe that, that is certainly something that we're going to continue to get better at.
Part of what helps drive that is the support resources we give them as we try to move them from being order takers to more consultative sellers. And I think we've made really good progress there as well. And our people -- so our people's capability is growing. Therefore, how they're investing their time is getting better. And that's translating into not only larger territories, but more importantly, more effective and productive selling resources.
Okay. Super helpful. And if I could just slide one other one in here. Just turning to International for a second. Granted, I kind of knew the currency translation and inflation, all that was continuing to be a part. Just more on the kind of what's more under your guys' control with the temperature zones and more of the fundamental changes, where would you say we kind of are with some of those investments from an inning perspective?
Sure. I think we're still early days on a lot of those investments. Now, we kind of break up some of the countries in Europe. We talked about the Irish business where we had owned Pallas Foods for quite a few years now. That integration between Brakes and the Pallas business in Ireland has actually gone very well and I'd say in that place where we're close to the end of our full investment as well as benefits that are coming out of there. In the U.K. and France in particular, both those geographies, we still are kind of early days and are investing there to get these distribution businesses and the operating environment, we talked about our multi-temp, up to where we'd like it to be. The good news is, in both places, we think once we get there, that will be a competitive advantage for us, but we do have a few years ahead of us of investments and really bring that organization along to some of those changes.
Your next question comes from the line of Karen Short from Barclays.
My follow-up quick question would be on International, when we look at obviously the improvement throughout the year, as we look to '19, how should we think about the kind of run rate? Should we think about it as more related to the back half of this year or do you think you'll actually start getting to see a little bit more profitability?
Yes. And so, again, I think you remember the -- some of the calendar challenges that we outlined in the beginning that actually had certainly a more positive second half than the first half of the year, but I would anticipate and think about that business more along the lines of what you saw in the second half. The first half was clearly impacted by a fairly negative calendar impact. And I think there's certainly an expectation that we continue to grow profits there. I think that's a more reasonable run rate to think about within second half of the year.
Okay. And then just to follow-up on inflation. I know you've talked about modest inflation. So is it -- is there a chance though, do you think, that we end up going back into deflation, I guess, in your fiscal '19? And then also thoughts on inflation, both from an FX perspective and just product cost in International?
So in the U.S. Broadline, just to your first question, again, our current view is that we anticipate a modest level of inflation. So at this point, we're not seeing what you're suggesting in terms of deflation, but I would say a modest level of inflation. In the European, primarily in the U.K., again, depending on the variability of the sterling, we certainly still anticipate some challenges there given the fact that, I think as we talked about, probably half their product is procured from outside of the U.K. Obviously, they're working hard to do things to manage that more effectively, but that still continues to be an issue and we anticipate that to carry forward a bit.
Karen, just on that inflation in the U.S., it has gotten less throughout the year. So the beginning of the year, we talked it was a couple, 2 to 3 points. It has slowed to kind of 1 to 1.5. So it is slowing. We don't necessarily believe that's going to go deflationary, but you're right in assuming that it's mitigating some.
Well, I think just one other comment on that. I mean, the categories, Tom mentioned earlier in his comments, it does matter in terms of the categories. And we have seen some deflation in some of the center of the plate categories, poultry are less inflation, I would say. And meat has been another one of those, as of late, we've seen some of that. So I think there's -- that gets back a little bit of the GP per case as well and -- but there's been some level of that, that we experienced.
Your next question comes from the line of Andrew Wolf from Loop Capital Markets.
I wanted to focus on the U.S. Foodservice and the big step-up in the organic case growth for the local customers. Could you kind of help allocate that? I know you hired -- you're hiring sales folks. How would you allocate that between the existing customers doing a little better because it looked like the restaurant sector picked up in the second quarter, account penetration and maybe your sales folks bringing in some new customers?
Andrew, I think it's a combination of all those things. We have seen -- which is good news -- we have seen our penetration, which is that same-store turn going up, which is good. That's some of the hardest growth to get, but we have seen penetration improve, which does speak, I think, positively around some of the trends we're seeing in the industry. And then obviously, we continue to focus on new customer growth and that's always an opportunity and certainly something that's the lifeblood of this business. So it's really a combination of both.
And I don't know if I missed this, but could you give us a quantitative -- like, how much -- what is your growth rate in the sales force?
We don't necessarily comment on the number of salespeople we've added, but again, we're much more targeted today than we were in the past and we feel good about how we approach the focused kind of resourcing that we do out in the market.
And just one follow-up. Can you give us a sense of the cadence of the acceleration in the organic case growth and sort of sustainability and how's it going quarter towards to-date?
Yes. So I'll take that. We're actually -- I think we've got also a decent start here in the first part of this year. So in other words, this wasn't some type of a onetime shot at the end of the year. We continue to see some good progress here in the first part of this year.
Okay. So would that -- so the cadence was kind of moderately up and it's maintained or something along those lines?
Correct.
Your next question comes from the line of Marisa Sullivan from Bank of America.
I just wanted to touch on gross margin outlook for fiscal 2019 and just kind of talk through some of the puts and takes. For freight, how should we think about your assumptions for freight if you start to lap the step-up post-hurricanes last year? Are you kind of assuming steady state? Are you assuming that it could potentially get better or worse? And then on customer mix, how should we think about the headwinds and tailwinds? You've brought on some new chain customers that I assume are lower gross margin. How much of a headwind would that be and what are some of the offsets?
Sure, Marisa. So I think the -- as you think about the freight, look, I think we do know we're going to start lapping some of that here in our second quarter. I think that based on that, we kind of think about that maybe flat to maybe up slightly. Again, hard to predict what's going to continue to happen in this space. And then as you think about customer mix, that obviously will continue to play a role until we cycle some of that new national customer business. But we look to -- continue to look at obviously category management as a way to offset some of that as well as our Sysco Brand, which we continue to be very focused on. So if you think about the combination of inflation, the work we're doing around category management in our Sysco Brand, our revenue management tools we talked about to help us manage through that inflation and even deflation, if it flips on us, we feel like -- we feel pretty good about our gross margin focus. We are not looking to see a step-up necessarily in gross margin on a percentage basis, but we aren't necessarily looking to see it go the other way either. We're just looking to manage it as best as possible in the new year.
Got it. Just as a follow-up on private label, you've obviously seen some nice growth in the penetration. How much more runway do you think there is for increasing private label penetration? Will it come more from the local customers or do you actually see some opportunities on the contract customer side?
I think we see it actually on both. And there probably maybe even more opportunity on the contract side. I think there's work we still have to do there to create the environment that's easy for all those customers to participate more in Sysco Brand, but we still see an opportunity in the local customers as well. It's really a balance of making sure we're bringing out the right type of products. You heard me talk about the Cutting Edge Solutions and we're now at 1 million cases. A majority of those items are Sysco Brand items and we can continue to bring innovative solution-type products to the marketplace. We are seeing good traction there and we think that creates even more runway for us on the Sysco Brand.
Yes. And Marisa, again, just as a reminder, that's -- we don't necessarily -- we don't set a target per se in terms of it, but we certainly do expect -- anticipate some continued runway there. And again, it's all driven by our ability to continue to drive value-added products in the marketplace. That creates a pull on our demand for those products and ultimately grows our percentages.
Your next question comes from the line of Karen Holthouse from Goldman Sachs.
A couple of follow-ups to things that you've talked about already. First, on the International business, should we think of next year's year-over total investment dollars could still be going up or still high but maybe a step-down from this year?
Karen, this is Joel. I would think about that as still having some level of increase next year.
Great. And then just maybe remind us as we're looking into the third -- or the fiscal first quarter, any sort of things we should be keeping in mind in terms of laps related to hurricane disruptions last year, either on the case growth or the cost side?
I don't know that I'd sort of overemphasize that. I mean, there may be a little bit of it, but I mean, the reality of it is, I mean, we managed our way through that pretty well. Again, over the last question, Marisa, on the freight, there's probably going to be a little bit of overlap when we saw some of that big impact in the second quarter, but in general, I -- we're not anticipating anything real significant there in terms of the overlap.
Your next question comes from the line of Kelly Bania from BMO Capital.
Curious in terms of both freight and fuel prices. I guess, in the context of your performance this quarter and as you look out over the next few years and part of your three year plan, can you just help us understand the magnitude of the pressures from those factors? Are there items that are coming in better than you expected to offset those pressures? Or are you just maybe conservatively forecasting those areas with some cushion in order to still kind of beat or meet your targets?
Well, I guess, I'll start. And I think the main way I'd think about that from a freight perspective, I mean, obviously the three year plan and there's a lot of puts and takes on a lot of these numbers. We certainly have committed to a level of growth in gross profit and OpEx in a relative basis and certainly feel good about the fact that we have -- again, feel strongly about achieving those numbers. In other words, some of the takes that we may have on fuel in terms of the freight from the gross profit area, we certainly anticipate strong results in growing our local cases and our brand, our category management, our revenue management. There's certainly all these things that we've factored into this whole thing, realizing not everything goes exactly how you think it's going to all the time, but feeling very good about that number.
On the fuel side, again, from a magnitude perspective, I mean, there's a couple of cents per case in fuel that have been impacting us here. But certainly, and as we've talked about, we've done a lot of work around some derivative hedges to make sure that we're giving ourselves some consistency, some stability around those numbers and that's certainly, if it's kind of on a rolling basis, a year ahead. And so I think that's certainly good -- at least 2/3 of our fuel purchases are covered by some of that and so there's certainly some level of consistency we achieved through that.
So I guess, what I would say to you is, I mean, the -- we are -- one of our roles in running this company is there's a lot of puts and takes that go into some of this stuff and we certainly believe there's enough levers to pull in different places to -- that neither of those two things are going to have any dramatic impact to us as we look at our three year plan, but challenges nonetheless.
Kelly, the only thing I'd add on the operating expense side is with that fuel pressure that Joel talked about and this more our side now, the delivery driver, retention and hiring along with some just challenges we're seeing starting to see in that same way in the warehouse, we just have to be really good at driving productivity in our supply chain. And so those are real headwinds that we'll be dealing with. And what we're very focused on is how do we cover those through productivity improvements, whether that's in the way we -- our cases that we deliver per truck and per route and all the metrics that we really focus on to improve the overall productivity of our operation. So that's -- to Joel's point, we have a lot of that, that we try to build in. We've got a lot of work to do. And we probably have more headwinds than we've had in a few years, mostly driven by the tight labor market and some of the recent fuel increases.
Okay. That's helpful. And then maybe, Joel, just one other one for you just in terms of the quarter, the operating income growth. If my math is correct, it seems to imply that the Brakes operating income was kind of flat year-over-year. Is that the right way to think about it for the quarter?
I think it's roughly that. I think it's not the -- if you kind of back out all the FX impacts and on an adjusted basis, our whole International operation was up a little bit. And so I think Brakes was probably off a bit. I would not -- I'd call more down slightly than flat.
Your next question comes from the line of John Heinbockel from Guggenheim.
Two things. On the selective, very surgical MA hiring that you did over the last year, were those predominantly experienced distribution foodservice salespeople? And, I guess, those investments have worked. Were those markets kind of one-off or is there opportunity to do the same thing very strategically in other markets and get a similar return?
John, so I think there -- the approach we now have, I would tell you that there's opportunities in many markets. And some markets are bigger than others where we've got -- where our -- maybe our market position is a little stronger, but many markets have those opportunities. And as far as the type of individual we're hiring, I'd say it's a combination. We certainly are still finding folks who are looking to join Sysco who got experience either in the industry on our side kind of the industry or even on the operator side of the industry. And then we also, with our new program, have brought in some folks more earlier in their career and we now have a program, a development training program and onboarding program that allows us to do that. And so it's really a balance of -- we're looking for the best people in general, who we feel like would be successful working for Sysco.
Is the greatest impact of that -- of this hiring cycle, say the last, I don't know, 6, 9, 12 months, is that still ahead of us or we're at that run rate now?
If you're talking about from a total number, we did a majority of that this last year or the year that we're in, right, that we're talking about. So there's little bit of an overhang as we go into '19. We continue to hire obviously. We have -- we turn up a bit of the sales force every year. So we're always in the market hiring and we're always going to look at putting those people where the biggest opportunities exist. And so you should think about it more as we're going to continue to use the tools we have now to deploy a selling organization in the right places. As we talked earlier, hopefully, continue to drive more productivity because of things like e-commerce and focusing them more on consultative selling versus order taking. But generally speaking, I wouldn't think about a further ramp-up of more MAs in fiscal year '19.
And then just lastly, the outbound driver shortage. Do you think -- has that had any adverse impact on top line over the past, whatever, six months, one year? Or is it really more throwing more cost and more dollars at the situation? And then what can you do as you think about giving drivers sort of an ability to do more? Is there any way to restructure how you load trucks, how you lay out the processes so that the existing drivers can actually do more out on the road?
John, it's a really good question and an important point. I think -- if you think about one of the things we've talked about recently is we even got an initiative out there. We talked about small vehicle initiative. And part of the reason for that is there are really couple of drivers of it, not the least which is the fact that it enables us to get around with smaller drops to customers to increase our -- and improve our service level. But one of the things we're also learning is that because those trucks don't require a certain class driver, that we -- the pool of potential candidates to fill those routes is larger. And that's something that we're going to be accelerating in fiscal year '19 because we've gotten the learnings now and seen some of the benefits. So that's certainly one way that we're going to try to deal with this ongoing challenge.
And then additionally, you talked about -- look, anything we can do to move more effort into the warehouse and make it easier for that delivery driver to do his job not only creates satisfaction for them, but also helps us deliver and meet the service requirements of our customers. Ultimately, as you articulated, I think it had probably maybe a small impact in certain markets when we can't get the drivers that we need from a top line perspective, but more importantly, I think it's affecting our cost and it's why we've got to continue to look for new and different ways to manage that.
Your next question comes from the line of Ajay Jain from Pivotal.
My question is more industry-specific. So even if it's not evident in your results, I'm just wondering if there's any industry-specific softness that might be impacting your competitors more than Sysco. So in terms of overall spending in independents, traffic and based on net unit growth for independents, are you seeing any change at all from an industry perspective as you're heading into fiscal '19?
Ajay, I actually think we see a lot of positive trends still in the industry. So I don't think we see really a lot of negative headwinds relating to industry performance. If you look at the quarter 2 for various parts of the industry that were fairly positive, certainly still some traffic challenges across some of the segments, but the spend was up very nicely. And so I think we continue to feel pretty good about it. The food-away-from-home, while growing less maybe than it did for a while, is still positive. And so we're seeing pretty good trends. And we think that not the least, which is like this delivery trend, you think about food delivery, the results we're hearing is they're seeing pretty significant growth, like 40% to 50% growth in that area. So that just creates more opportunities for consumers to get the products they want from restaurants. So we're seeing a lot of positives.
Okay. And obviously, you finished the three year growth plan on a high note. And I think, Tom, you mentioned in the prepared comments that, that figure excludes Brakes. So if that's the case, I estimate you did something like $105 million of operating income growth in Q4 alone. That's 3x more than the prior quarter. So does that sound right? I think you were at $526 million through Q3.
Yes, Ajay. I'll take that. It's Joel. I mean, so obviously, part of that is some seasonality. Our third quarter typically is a smaller quarter. So it's just purely -- excuse me, compare Q3 and Q4. Again, I wouldn't expect that to actually be similar. And as we talked about heading into this quarter, I guess, you're correct. It is -- there is no impact whatsoever Brakes with that number. It is a -- we had a strong quarter. We anticipated some year-over-year impact on some corporate expenses that we had in the prior year versus this year, but in general, we had a strong quarter and certainly finished the year and the three year plan out in a strong way.
Okay. And just finally, I think you had some kind of calendar shift in the reporting for Brakes. So Joel, I think you mentioned that Brakes didn't play a role in the fourth quarter performance, but I thought that there was some kind of a change to conform to your fiscal year ending in June from December at Brakes. So can you quantify if there was any benefit as a result of vendor allowances in the latest quarter for Brakes in terms of the year-over-year incremental impact, if there was any?
Sure. So we don't quantify specifically. What I can say to you is you're correct. We did talk about a calendar shift that impacted, I'd say, negatively the first half of the year and more positively the second half of the year for Brakes. However, that had zero impact at all on our three year plan. The vendor allowances you're referring to in any sort would actually be anything would be in their business and that would all be within Brakes and so there's no impact at all in any of the numbers that we had as far as our three year plan. It's a very pure number and we exceeded it, what we actually had called out earlier. We came out ahead. We feel very good about it.
Your next question comes from John Ivankoe from JP Morgan.
I wanted to go get back to a couple of questions ago and tie that in to your prepared remarks where you mentioned the additional delivery options. I mean, clearly, we understand some drivers don't necessarily need CDL licenses and they can be in sprinter-type vehicles. But I wanted to get a sense, are we beyond pilot at this point and you're kind of thinking about doing that where it makes sense nationally? And secondly, does this type of service make sense to be driven in that your main operating companies? Or are you considering a number of smaller distribution facilities, I guess, kind of spokes, if you will, within different metropolitan areas can actually be closer to the customer to where the driver can go back and forth and reach more customers in a day than just operating out of the operating company itself?
So I'd say, look, we've been in pilot mode for a while and we've looked at both what I would call metro urban markets as well as more standard operating companies and we have learnings from each of those. We will continue to add these in the market. We feel like it's -- the results have been positive. And it's really -- there's no one set situation. These are not fill-in -- these are not recovery-type vehicles, meaning if we have something that's missed or a product comes in late that we get it out to the customer, this is actually part of our everyday delivery and routing. And so we're seeing lots of different benefits in different markets for different reasons, but a little bit of all the things you talked about are certainly options for us and something we'll continue to learn about and as we expand it.
And when you look at the total addressable market, I mean, how much do you think that the total addressable market for Sysco grows just because you can -- it's a different kind of customer, it's a different amount of case volume requirement, maybe in some cases, you actually pay for delivery? How big of an idea is this, if you're ready to talk about that?
Well, first of all, it's still very early as we're going through this learning, but I don't necessarily think it opens up a new market for us. I think it's just being more efficient with what we do today. And whether it's the size of the drop and we have a smaller vehicle than a larger one making that drop or allows us to get into some places that are a little harder to deliver to, but I don't think necessarily opens some new market for us.
There are no further questions at this time. This concludes today's call. Thank you for your participation.