Blackstone Inc (BX) 2007 Q2 法說會逐字稿

Good day, and welcome to today's Performance Food Group second-quarter 2007 earnings conference call.

As a reminder, today's call is being recorded.

For opening remarks and introductions, I would like to turn the call over to Mr.

John Austin, Senior Vice President and Chief Financial Officer.

Please go ahead, sir.

Good morning.

Thank you, Philip.

Good morning and welcome, everyone, to Performance Food Group conference call and webcast to review our second-quarter results for the second quarter ended June 30th, 2007.

This morning, I'm joined by Steve Spinner, our President and CEO.

Our call today is primarily intended to review financial results for the second quarter of 2007.

Our earnings release was issued this morning and a copy of that press release is available on our website at www.PFGC.com.

I will briefly address our financial highlights for the quarter and then Steve will provide more insight into our results and expectations for the balance of the year.

Before we start, let me remind you that certain of the statements we will make in this call are forward-looking statements under the Private Securities Litigation Reform Act of 1995.

These statements do involve risks and are based upon current expectations.

Our actual results may differ materially.

These risks are more fully described in our press release and our SEC filings.

We'll also make certain results regarding non-GAAP financial measures, as defined by SEC Regulation G.

A presentation of those most directly comparable GAAP measures and a reconciliation of the non-GAAP measures is also available on our website.

Looking at our financial highlights, net sales for the quarter were approximately $1.6 billion, an increase of approximately 8.1% from the prior-year quarter.

Sales trends in the quarter reflect an increase in street sales and a sequential improvement in real sales growth versus the first quarter.

A complete segment breakdown is also included in our press release.

On a consolidated basis, inflation was approximately 4.8% for the quarter, consisting of approximately 7.1% inflation in our broadline segment and inflation of 1.2% in our customized segment, which primarily surrounded the dairy, meat, and poultry categories.

Our gross profit increased $13.3 million to $206.5 million compared to the year ago quarter, while gross profit margins decreased approximately 14 basis points to 13.20% from 13.34% in the year-ago quarter.

The decrease in margins for the quarter was due primarily to the impact of inflation.

While inflation negatively impacted our percentage margins, our gross profit dollars were not as impacted by the significant inflation in meat, poultry, and dairy, and this is due, in large part, to the customary pricing in both multiunit business as well as center of the plate product categories, both of which are generally priced on a fee per case or per pound basis versus a percentage markup on cost.

And therefore, while the percentage margin was impacted, our gross profit dollars were not as impacted by this inflation.

Operating expenses -- continuing operations for the quarter were $183.5 million or 11.7% of sales, a decrease of 13 basis points versus the prior-year quarter.

The decrease in operating expense ratio during the quarter was in part a result of the higher sales due to inflation and improved operating efficiencies, partially offset by increased stock compensation costs and insurance expense.

Operating profit in the quarter was $23.0 million and our operating profit margin was 1.47%, reflecting a decrease of 2 basis points versus the prior-year quarter.

For the quarter, other expense amounted to $1.5 million versus $1.8 million for the prior year.

Interest expense and the loss on sale of accounts receivable were approximately $2.4 million compared to $2.2 million in the prior-year quarter.

This was offset by an increase in interest income to $861,000 versus $390,000 in the prior year, due to higher levels of investable cash as a result of our continuing positive cash flow.

Our effective income tax rate was 39.2% for the quarter.

The increase in the expected effective tax rate versus the prior year was primarily due to reduced federal tax credits.

We expect our effective tax rate for continuing operations to be approximately 39% for the 2007 full year, excluding the potential recognition of previously unrecognized tax benefits, which may occur as statutes of limitations expire.

Net earnings from continuing operations in the quarter were approximately $13.1 million or $0.37 per share diluted compared to approximately $12.2 million or $0.35 a share diluted in the prior-year quarter.

Excluding the impact of stock compensation expense, net earnings for the quarter amounted to approximately $14.2 million or $0.40 a share diluted.

Diluted weighted average shares for the quarter amounted to approximately $35.3 million in 2007 and $34.8 million in the prior-year quarter.

Our balance sheet continued to be very strong.

Our days sales outstanding in receivables decreased by 1 day compared to the first quarter and remained flat versus the prior-year quarter.

Inventory turns decreased -- I'm sorry, increased 1 day versus the first quarter but remained flat also compared to the prior-year quarter.

And Accounts Payable float decreased slightly 4% compared to the first quarter and 7% versus the prior-year quarter.

In second quarter, depreciation amounted to $6.6 million and amortization to $700,000 in the quarter.

Pretax stock compensation expense was $1.9 million.

Capital expenditures were $14.8 million, resulting in free cash flow of $7.6 million for the quarter.

As we look ahead to the remainder of 2007, based upon the current trends in our business, we expect internal sales growth on a consolidated basis to be in the upper single digits for the year, depreciation to be in the 25 to $29 million range and amortization to be in the 3 to $4 million range.

We expect capital expenditures to be approximately 70 to $75 million and a significant portion of these capital expenditures are continuing to be directed toward the completion of new distribution facilities in our broadline segment and continued investments in information technology.

As part of our information technology initiatives, we are implementing new financial and rebate and contracting applications, which will enable us to continue our initiative to centralize certain of our transactional accounting processes and will improve the overall efficiency of our financial reporting process.

We believe this will create a more effective organization and further drive standardized processes.

We expect to incur approximately $13.5 million related to this implementation throughout the remainder of 2007, which is included in our CapEx guidance.

We do expect to complete the implementation in 2008.

We also expect to incur pretax stock compensation expense of approximately 7 to $7.5 million for the full year, which represents an incremental increase of about 2 to $2.5 million for the full year.

Given the expected rollout of our new customized business and current operating trends, we expect net earnings per share from continuing operations in the third quarter to be in the $0.36 to $0.40 range and for the full year to be in the $1.35 to $1.42 per share diluted.

The range of dollars is $1.35 to $1.42.

With that, I'll turn it over to Steve Spinner, our President and CEO.

Good morning, and thank you for joining us.

Our strong second-quarter results demonstrated that Performance Food Group's commitment to driving results through our core strategy is paying off.

Our net EPS from continued operations increased to $0.37 and our 8% earnings growth exceeded our expectations despite significant inflation, indicating that our initiatives are on track and our execution is sound.

With our associates' continued commitment to PFG's key strategies, we are continuing to see improvements in our service levels, productivity, training, and implemented technology.

We continue to realize significant progress in the transformation of our Company toward a more standardized position and focused organization.

Our expanded technologies have continued to improve our customer service levels and our sales force continues to drive higher margin sales growth.

We've seen a sequential improvement in real sales growth despite higher inflation trends and street sales continue to grow, up 11% over the previous year's quarter.

We also saw meaningful improvements in our broadline category management objective.

In further support of our operational excellence strategies, we continue to invest in information technology.

As part of this commitment, we have recently undertaken an initiative to standardize our core financial systems, including applications for earned income, Accounts Payable, and general ledger.

We believe that the standardization and centralization of these processes will drive greater cost efficiencies, support our long-term category management initiatives and serve as our platform for further growth and expansion.

Performance Food Group is financially strong and our team is committed.

We're focused on executing our strategies and building on our core values as we continue to build the foundation for our Company's long-term success.

Here are some highlights from our second quarter.

Our training sales force continued to make progress in achieving our growth objectives, including successfully increasing our higher margin street sales.

We anticipate continued productivity gains and positive top-line sales momentum in the coming quarter, as we continue to leverage our investment in driving profitable sales growth to independent restaurant operators.

Inflation for the quarter was approximately 5%.

We experienced significant inflation, particularly in product categories heavily dependent on corn, including meat and poultry, as well as dairy.

While inflationary trends are a challenge, we are confident that our pricing methodology, including our Web-based pricing strategies and processes, are helping to deal with this effectively.

Let me make some comments about customized.

Our customized segment generated sales of approximately $611 million in the second quarter, an increase of approximately 4.5% from the previous year's quarter.

Customized experienced inflation of approximately 1%, resulting in real sales growth of approximately 3.5% in the quarter.

The increase in sales for the quarter was the result of growth primarily with existing customers.

Gross margins for the quarter increased 15 basis points compared to the same prior-quarter period.

Our customized segment has been successful during the past quarter in leveraging its available capacity to drive operational efficiencies and enhance our service to existing customers.

In July, we announced that PFG had entered into an agreement with O'Charley's Inc.

to be the exclusive distributor for both O'Charley's and Stoney River restaurants, which will add approximately $200 million in annualized revenue.

We expect that this business rollout will be completed in the fourth quarter with expected startup costs in the third and fourth quarters of this year.

While this rollout is later than originally expected, we are excited about the addition of O'Charley's to our customer base.

Recently, we also completed a rollout of an additional $50 million in annualized revenue with an existing customer.

PFG customized continues to lead our industry in service levels, technology, and cold chain management.

We continue to see strong demand for our services from national restaurant companies.

Let me make some comments about our broadline segment.

Broadline segment generated sales of approximately $954 million, an increase of approximately 10.5% versus the prior-year quarter.

Inflation was approximately 7% during the quarter.

Our street sales continued to grow at a strong rate of approximately 11% in the quarter, as we maintained our focus on growing these higher margins sales.

For the quarter, street sales represented approximately 48% of broadline sales.

PFG's investment in our street sales force continued to achieve results and fuel the growth of higher margin street business in the quarter and we expect to gain continued productivity from our sales team in the coming quarters.

As a result of our standardized training curriculum, our gross margin per delivery increased approximately 6%.

Our sales of PFG brands to street customers continued to grow and increased by 16% for the quarter.

PFG brands now represent 26% of total street sales and we anticipate continued growth in PFG brands to reach 30% of total street sales by the end of 2008.

These results are particularly encouraging as well as strong indication that our focus on growing our sales force, account penetration and our commitment to driving up service levels are each delivering results.

In addition to this street sales focus, we will continue to be opportunistic in developing profitable new business opportunities with multiunit customers in the broadline segment.

While gross margins in broadline were negatively impacted by inflation, our initiatives are working.

Gross profit per piece was up 3.4% versus prior-year quarter, a clear indication that our sales training on account penetration is working.

Our category management has already completed nine supplier reviews year-to-date; 13 reviews are currently in process.

Our category management programs will continue to contribute favorably to our gross margin and we expect our initiatives on driving SKU profitability enhancements of our negotiated programs and reductions in cost of goods to contribute favorably to our operating margin this year.

Implementation of our new rebate tracking technology will further support this core strategy.

In the area of operational excellence, we continue to achieve improvements in our warehouse efficiency and service levels.

Our productivity improved for the year as total pieces shipped per hour increased by approximately 3.8% over the prior-year quarter.

Warehouse expenses have decreased 31 basis points as a percentage of sales from 2004 through second quarter 2007, further confirming that our efforts to standardize and centralize processes are driving savings.

We also continue to increase our service levels to customers.

The implementation of our proprietary GPS-based onboard truck computers has been completed in our broadline fleet.

Fleet efficiency has improved as a result of our operational excellence initiatives.

Assuming annualized 2007 sales, our sales have increased approximately 20% since 2004.

And as a result of standardizing our fleet, our revenue per truck has improved approximately 29% during that same period.

So to recap Company-wide, we are extremely pleased with our second-quarter results.

We exceeded our earnings expectations despite the impact on margins from inflation.

We continued our positive momentum increasing street sales and we're seeing sequential improvements in real sales growth.

We continue to improve our operational productivity as our standardized warehouse and transportation platforms move forward.

We anticipate continued improvements in information technology as we standardize some of our financial systems throughout this year and into 2008.

We remain focused on our core initiatives and we are making progress.

Our second-quarter results demonstrate our commitment to moving PFG forward.

In the coming quarters, we will continue to focus on improving on our earnings as we enhance our broadline category management programs, roll out new distribution programs in customized and continue to drive improvements through our core strategies and operational excellence and increasing sales to independent operators.

Now we're ready to take your questions.

(OPERATOR INSTRUCTIONS).

Simeon Gutman, Goldman Sachs.

Thanks.

Steve, implicit in the back-half guidance, it appears to be consistent improvement in broadline EBIT margin.

So as you go from a quarter with some pressure to a sequential and consistent rebound, what are the things that changes the margin?

Is it better pass-through of inflation?

Are your initiatives more fully ramped up?

How do you get comfortable with that inflection point?

It's a little bit of everything.

What you have to try to keep in mind is when you have series of significant inflation like we have, using percentages is very difficult.

It's very deceiving.

I don't have a good feel for what inflation is going to bring in the third and fourth quarter of the year.

A gut check would be that sustained periods of significant inflation tend to be unlikely.

However, we have enough controls around our web-based pricing model, our training of our sales force, that we can push through the inflationary increases as fast as possible.

It is very difficult to keep up with it when it's 7% in a given quarter.

We expect, as I said in the commentary, the category management initiatives, the category reviews all of those things have a significant impact in driving EBIT growth throughout the rest of the year.

And in that context, has inflation leveled off?

Did it level off toward the end of the quarter?

It really -- you know, it's hard to comment on inflation in any one given point in the quarter.

It was significant in the quarter.

I really can't give you a feel for where that is going to be in the third and fourth quarter.

Okay, and then if you can, I don't know if you did this analysis, but if you can strip out the inflation impact to just the broadline business, how do you think some of the core initiatives that you've been working on, how would EBIT margin in broadline have performed?

Yes, we actually did that analysis and while we had significant erosion in gross margin due to inflation, if you normalize the inflation our actual gross margin percentage would have increased.

Yes, it was actually -- Simeon, we did it, and the assumption we made was, okay, if you kept the gross profit constant and normalize the sales level to a more normalized level of roughly 3%, we would have seen a nice improvement in gross margins.

That's I think a decent directional analysis.

It's not a perfect analysis.

But given where the inflation was, and the fact that a lot of those categories are priced on a sense per pound, I think that's a good directional indication.

Okay.

And then lastly, on the O'Charley's business, should EBIT margin of that business be consistent with the customized average?

I know over time, that's probably right, but up front, is that close to correct?

I think generally over the course of time, that's correct.

Okay, thanks a lot.

Steve Chick, J.P.

Morgan.

Thanks.

Good quarter.

I guess a couple of questions.

John, did you quantify what the startup cost would be with the O'Charley's contract?

And should we think about those costs being equally in Q3 and Q4?

Yes, I think it might be a little bit more loaded toward the third quarter than the fourth.

It's -- we haven't historically quantified them.

I will say for a new customer rollout, it really depends upon the geography and things like that, but they have normally been in the couple hundred thousand to $0.5 million range.

I would say it's probably going to be a little bit more weighted in the third quarter, given the ramp up in stocking warehouses and hiring drivers and those sorts of things, but will bleed into the fourth quarter as the rollout continues throughout the fourth quarter.

Okay, that's helpful.

And second thing, it looks like your CapEx guidance maybe was lowered a little bit for the year.

I thought normally it was 75 to $85 million.

That's correct.

We started the year kind of giving a 75 to $85 million range.

Most of the time, we try to be pretty disciplined about our CapEx.

We've gone throughout the year.

A lot of this trend is related to some significant expansions and replacement warehouses that we currently have underway, so those plans have not changed.

I would say the timing of the spend seems to be creeping a little bit.

But I would say it's a combination of that timing issue on some of the construction projects and just being as -- a little bit more disciplined on some of our normal maintenance CapEx is kind of steering us toward the bottom end of the range (multiple speakers) target, yes.

All right.

And have you said how many -- like are you adding -- physically adding new broadline distribution centers?

The two that we have going underway, one is in Springfield, Massachusetts, which is a replacement facility.

We were completely out of space and bursting at the seams there.

And then we also have a replacement facility going in down in south Georgia, where that was also a very old facility that was in need of some significant upgrades, so we have a replacement facility going there.

They're not greenfield facilities.

Okay, great.

So I guess the -- the net number of broadline operating companies or distribution centers that you will have in operation will be -- they will be the same.

The same.

Correct.

Okay.

And last, if I could, just the street sales growth is obviously pretty impressive and well actually, I'm sorry -- did you say what the increase in sales people was for the quarter?

We did not.

We did not.

The actual increase was fairly moderate.

I think it was about a little over 3% for the quarter, and that was more an issue of timing than anything else.

We're comfortable with our overall annual guidance of about 10%.

Okay.

And with the sales growth that you saw, is that growth within existing street accounts or is it winning of new accounts or maybe a little bit of both?

Can you speak to that?

It is a little bit of both.

If you recall, we talked about the fact that we have some situations where we split territories and we fuel new reps with existing customers to help get their growth on track.

You heard some of the commentary around training and account penetration, increases in gross profits per drop, so certainly a portion from the sales growth came from increasing in existing customers.

And we also had a fair number of new customer wins as well.

So it's three basic areas that it comes from.

Okay, and is that coming from kind of other large competitors or would it be more from regional competitors in these areas or is that kind of both as well?

It's both.

It's all of the above.

Okay.

Great.

Thanks.

Meredith Adler, Lehman Brothers.

This is Ivy standing in for Meredith.

Can you -- is it possible for you to give more color on how you plan on managing inflation going forward?

I know you said you have some Web-based tools that should help your salespeople, but can you give us a little bit more insight into kind of how that works?

Yes.

There's two ways that we price.

For our chain account customers, the chain accounts have usually negotiated long-term prices on products and that kind of keeps inflation down to a much lower level.

If you look at the customized division, we had 1% inflation.

And the last couple of quarters, we had some deflation.

So the customized division is not as impacted.

If you go to the broadline side, again, we do have about half our business is in the chain side.

So the same thing does apply.

On the chain side, since we do mark up, usually as a fee per case, we are still driving the same gross profit dollars to the bottom line, but our margin shrinks.

When you jump over to the street side, those customers tend to be priced week to week so they are much more subjected to the impact of inflation.

And there's a variety of ways that we pass through that inflation.

We do have a proprietary Web-based pricing tool that suggests pricing very quickly when markets are either increasing or decreasing; in this case, increasing.

However, when you do get 6, 7% inflation, it is very difficult to pass it along as fast as we're getting the increase.

Now over the course of time, you will pass through that inflation over the course of several months.

Again, it's very hard to look at percentages either in expenses or in EBIT margin when you're dealing with a high period inflation.

When you look at the actual dollars, our dollars in almost every category except expenses are increasing, which is an indication that we are having a lot of success in passing through some of the inflation.

Okay.

Let me ask.

Is it possible to talk about kind of which categories it's easier to pass the costs along in, and kind of how long is that lag or how long does it take to pass those costs along?

You know, the commodity products generally have the most amount of inflation associated with them in this particular quarter, and for the last quarters, it's been around dairy, proteins -- any commodities that are heavily based on corn as feed.

Typically those prices change week to week.

Those are not long-term negotiated contracts.

So as the prices go up, we pass them along.

There are some cases where prices could go up midweek.

We try hard not to allow that happen so we would be a little bit behind.

But over the course of a couple of weeks in theory, you should be able to pass through those pricing increases.

But again, keep in mind on commodity products we're generally working on a sense per pound basis as opposed to a percentage markup, so you are going to see some deterioration in the overall percentage but the gross profit dollars are protected.

Okay.

Thank you, that's great.

I have just one last question.

Going back to the business that you recently won, O'Charley's, I know you said you would expect to see costs or you're going to bear some costs in the third and the fourth quarter.

Do you believe that will go into 2009?

And what's the likelihood of bringing on another customer this year for the customized business?

I think the costs will be in the third and fourth quarter of this year.

And again, typically in the customized business a lot of work goes into negotiating with a customer and a lot more work goes into gearing up and getting that program started.

The original guidance that we gave was that we would introduce a new customer at some point this year.

So, and O'Charley's we are extremely proud to have them join our customer base.

So no, we're not giving any other guidance to new customers in this year.

Okay, thank you.

I appreciate it.

Ajay Jain, UBS.

Good morning.

First, just on the O'Charley's business that you picked up, you talked about the ramp-up in start-up costs earlier.

Can you also give a little bit of clarification on the timing for revenue contribution and how that ramps up?

When do you expect to be at the run rate level of $200 million?

Ajay, we expect the rollout to kind of go through the fourth quarter.

So, we really don't expect a lot of contribution this year.

But by January 1st, we should be at a, kind of a full run rate and fully up to speed there.

Okay.

And should we infer then that the ramp-up for the startup costs don't spill over into '08, that this business probably won't be better than breakeven until you're ramped up by year end?

Yes, that's probably getting a little more granular than we want to comment on customer pricing, but it won't contribute a lot this year.

Okay.

And then just on interest expense, I seem to recall your interest expense guidance at the beginning of the year, including the loss on sale of receivables, I think it was supposed to be in the range of 8 to $9 million for the full year and since you've obviously -- you have had some cash on the balance sheet, I'm just wondering if that 8 to $9 million is still the right range for interest expense all in?

I think that -- to be honest, I would have to go back to our guidance at the beginning of the year.

If you look at loss on sale of receivables and I guess net interest expense through the third quarter -- through the second quarter, we're kind of at $4 million.

So I think -- I wouldn't anticipate a lot of changes in our current run rate.

We expect to continue to be positive free cash flow for the year.

So I think something in that range is probably reasonable.

Okay.

And just one last question if I could.

Just on depreciation expense, I noticed there was just a little bit of a sequential decrease in the quarter.

I mean very small in terms of the magnitude, but since we usually expect some sequential increase each quarter, is there any specific reason behind the slight decline in Q2?

Actually I'm looking at the three months ended June and our depreciation was $6.6 million for the current year versus $6.3 million in the prior year.

We had a slight decrease in amortization.

That went from $845,000 down to $747,000.

I think that was the --

Yes, I wasn't talking about year-over-year, just sequentially.

Off the top of my head, first quarter, I don't have those numbers in front of me.

But I'll call you back, Ajay, and talk to you about it.

But there's nothing structurally or significant there.

No.

Okay, great.

Thank you very much.

Eric Larson, Piper Jaffray.

Good morning.

Good quarter, guys.

A question on your customized customers.

It's fairly well-documented that a number of your -- several of your customers -- have experienced same-store sales slowdowns.

And I think in past periods, they continue to open it up to sort of new stores so that I don't think you had a real significant impact on your total revenue, but that seems to be changing as well.

Can you just give us a general feel, without sort of naming specific customers, but how that business from a core growth rate looks going forward?

You know, we continue to not only benefit from new store openings, but we also, I think to a greater degree, benefit from new product categories that we take on from existing customers.

And that has been fueling a lot of our growth, as the majority of our customers, or all of our customers, have a high degree of confidence in our ability to service their location.

So we're very comfortable with our -- certainly end of '07, '08 growth with the customers that we currently have.

In terms then -- (technical difficulty)

Product categories?

Absolutely.

Okay.

A lot of the -- we are the industry leader as it relates to managing casual dining in cold changes tradition, handling fresh products.

We believe that we are the only and the best choice and so that certainly has evidence in the fact that we are beginning to and have in the last year, taken on far more categories of products that fit into that distribution model.

Okay.

Have any -- has change of ownership, did any of those customers have any impact or anything demonstrable to your business unit?

No, in our business, as long as we do a great job of servicing the customer, we don't expect to see any change due to who owns them.

Okay, great.

Thank you, guys.

Jeff Omohundro, Wachovia.

Thanks.

Just two.

First, maybe you could update us a bit on your capital structure thinking.

I recognize you want to keep financial flexibility for these periods of growth initiatives.

Sure, Jeff.

When we exited our fresh business about two years ago, we bought back a fair amount of stock, returned 400 million to shareholders, which was about 21% of our float at the time.

And we felt comfortable with that level.

Obviously we were trying to position ourselves to take advantage of what we were hoping to see as far as the M&A environment picking up.

Obviously that hasn't materialized yet although we're still hopeful it will.

Certainly, the US Foodservice transaction we think could be a catalyst for that.

I think our radar screen is really kind of over the next six to 12 months that we would expect to see something.

If it doesn't, we're going to need to be opportunistic and continue to evaluate what the right capital structure is.

We do recognize that the current capital structure is not the right long-term capital structure for the Company, but we really want to see this M&A environment kind of play out.

So stay the course for now, wait and see what might emerge and that would drive future change in capital structure?

Correct.

Okay.

And the second question, maybe update us a little bit on what's driving the faster growth in the PFG brand versus the growth of the other broadline or the street side.

Jeff, as you know, we've made a significant commitment to growing our sales to independent restaurants.

And we've done that by significantly growing our headcount and we started that initiative a little bit over a year ago.

And we think that, certainly in the broadline segment, that's going to be the primary catalyst for not just top-line growth, but long-term EBIT margin expansion growth.

On the customized side, we're still confident and this is based around the number of customers that expressed an interest in looking to do business with us, that we will take on a fairly significant customer roughly every (technical difficulty) [two] years.

And if you recall, our sales growth in the customized segment tends to be fairly lumpy in that we take on a new customer, reach some capacity, add some capacity, take on a new customer.

So those are the two primary vehicles for growth.

Thanks.

Alec Patterson, RCM.

I just wanted to get a little more flavor on the broadline business and on the margin.

I know, the percentages don't get carried away with, but in terms of your ability to generate leverage still with the gross profit bringing it up, I think you said around 3.5%, all in, were you able to generate leverage over your operating expenses?

Yes, we were in this particular quarter, and I would expect that we will continue to do that.

The majority of the expansion that we will get in gross profit dollars per drop and in gross profit, in general, will be, again, increasing our higher margin street sales and the largest portion of the margin expansion will come from our category management initiatives.

As we get our hands around more and more full category reviews and supplier reviews, we expect that that will fall directly into our gross margin.

And the implication of a roughly 3.5% gross profit [punit] increase running less than the inflation of 7, you weren't able to fully pass through all the inflation, your COGS inflation.

Is that the correct way to read that?

Yes.

Okay.

Do you expect to at some point?

Is there still a catchup phase here or is this pretty much as much as you think you can realistically get?

I think if -- I should say when inflation moderates, because if you look back at the history of inflation, there haven't been a whole lot of periods where you have 6, 7% inflation for long extended periods of time.

So one might logically think that when inflation does moderate, you will ultimately get back to where you need to be and pass through the inflation that you have had in the previous quarters.

I guess I was trying to get a read on your customer pushback, whether you're feeling like you're hitting some sensitivities here at these levels and thus it's going to take a while to your point about eventually getting it?

I can't really comment as to specifically when other than history and experience would tell us that it probably takes a couple of months or some period of time after periods of high inflation to fully pass through that inflation to the customer.

And then just lastly on this gross margin, by extrapolation here, if the operating margin was down roughly 8 basis points, obviously gross margin was down greater than that.

Yes.

In broadline, it was down much greater than that.

Do you have a figure?

It was about 56 basis points.

Okay.

When you normalize for inflation, actually that swings it the other way.

And it actually showed a nice increase in gross profit margin.

So it was a fairly significant impact on your percentage margins.

But again, in those categories, it was not as big a drain on your gross profit dollars, and I think that's to Steve's point about during these periods of high inflation, it's difficult to look at the percentages stand-alone.

Understood.

Thank you.

Ann Gurkin, Davenport.

Good morning.

I just have one thing left.

Overall, forecast for the overall restaurant industry, real growth rate in '07?

Ann, the best read we have is through Technomic.

They did scale down their forecast for both total sales growth as well as real sales growth slightly by about 50 basis points.

I want to say real sales growth, they are now forecasting to be about 0.7%.

The beginning of the year, real sales growth was around 1.2%.

Great.

That's all I have.

Thank you.

Andrew Wolf, BB&T Capital Markets.

Good morning.

Congratulations on such a solid quarter (multiple speakers) environment.

Steve, in the past, I have asked this; I know it's not an easy question to necessarily answer.

But do you have any sense of how the independent class in total or at least using your group as a proxy, your customers, how they might be performing relative to the chains?

Obviously, the public chains are struggling particularly with traffic and to the greater construct it's their [per] check going up.

But do you have any -- given that independents can be more flexible when they're changing their menu and pricing and so on, can you speak to that in any way that might be enlightening to us?

Sure.

I can talk to you about some data that came out for the first quarter.

I haven't seen it for the second quarter of the year.

2007, the independents had some real challenges growing overall.

In the first quarter of this year, independents began to grow fairly significantly in specific categories, which was a very positive movement for us, given that we're so focused on growing sales to independents.

And high periods of inflation does cause a lot of pain for independents in the sense that it's difficult for them to pass through those increases in commodity pricing in a timely fashion.

But the data suggests that there's a lot of innovation coming out of the independent restaurant group and that the independents are, again, growing at a pace that is more commensurate with where we've seen independents grow over the last five years.

So fairly optimistic.

At least the data points to that.

Okay, thanks.

And gross margin, just, to what extent, Steve, you just sort of spoke to some progress in category management, which I link to central buying and if you don't, just let me know.

But can you just update us on that and how -- where you are at versus plan and is this something that -- I think you might have alluded to it in the prior quarter, but -- the prior answer, an answer to a prior question.

But is this something that you are looking for to kind of accelerate and begin to really contribute to earnings growth?

Yes, like I said before, the largest part of our gross margin expansion in broadline will come from our category management initiative.

In the commentary, we talked about implementation of a new IT infrastructure that will dramatically improve our ability to bill, track, and pass through and we expect to get that completed mid 2008.

But we are at plan with our category reviews, our vendor reviews, our supply reviews, and each time we conduct one of those reviews, and those are very timely and very time-consuming, we see significant benefit from getting those completed.

We are not on a centralized buying program and don't expect that we will in the near term.

What we are on is a program where we are conducting the national reviews centrally and then the operating companies are participating in the programs in which we negotiate.

So very confident that we are on track, on plan with the category management initiative.

Okay.

Thanks a lot.

We have a follow-up question from Meredith Adler.

This is Ivy again.

Just last quick question.

Wanted to know if you guys had seen any change in terms of the competitive environment or pricing with the US Foodservice deal.

Generally the answer would be no.

We've got certain markets that change quarter to quarter, but across the country, no significant view of -- no significant change.

thanks.

Thank you all for joining us today and for your interest in our Company.

We are looking forward to a continued strong 2007 as we further build on our foundation of a more standardized, efficient and focused foodservice distribution company.

Thank you again and have a great day.

This does conclude today's conference.

Thank you for your participation.