西斯柯 (SYY) 2003 Q2 法說會逐字稿

Good day, everyone, and welcome to today's SYSCO Corporation's second quarter fiscal year 2003 earnings release conference call. As a reminder, today's call is being recorded.

At this time, for opening remarks and introductions, I would like to turn the call over to Mr. John Palizza, assistant treasurer. Please go ahead, sir.

Thank you, Carrie (ph).

I'd like to add my welcome to everyone for joining the SYSCO Corporation conference call for the second quarter of our fiscal year 2003. With me here today are Rick Schnieders, our chairman and chief executive officer; Tom Lankford, our president and chief operating officer, John Stubblefield, executive vice president for finance and administration, and Diane Day Sanders, vice president and treasurer, and Larry Accardi and Ken Spitler.

On the call today, I'll give everyone an overview of the quarter and then we'll turn the call over to Rick Schnieders for further discussion of our performance during the quarter and the question and answer session.

Let me start by reminding you the statements made in the course of this presentation are -- that state the company's or management's intention, hopes, beliefs, expectations or predictions of the future are forward-looking statements. Actual results could differ materially from those projected. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the company's SEC filings including but not limited to the annual report on Form 10-K for the fiscal year ended June 29, 2002.

With that out of the way, let me turn to our second quarter results. I'll start by summarizing our view of the quarter, and then dig into the detail of the income statement and the factors impacting it, and finish with some comments on the balance sheet and cash flow statement. I would characterize the second quarter as in line with our plan. Sales in the quarter were robust. Gross profit margins were under a slight bit of pressure and expense control is actually quite good in the quarter. The results of all this was a net earnings gain of 16.4% to $184.6 million. Earnings per share on a fully diluted basis rose to 28 cents, up 16.7% from a year ago.

With respect to the income statement, sales in the quarter once again showed a strong performance, increasing 13.6% to $6.349 billion, from $5.591 billion last year. Within the total sales number, real sales which we define as total sales minus non-comparable acquisitions and minus inflation or plus deflation ended the quarter up 7.6%. This continues our trend of sequential quarterly improvement in real sales growth.

Beginning with last year's second quarter, we have seen real sales rise in each quarter from a low of 0.7% to their current 7.6%. In fact, this quarter's real sales growth is the highest it has been since the first quarter of fiscal 2001. During the quarter, sales attributable to acquisitions added 6.8% to total sales growth. Sales from acquisitions consisted of SYSCO CERCA (ph), Abbott (ph) Foods, Pronamics (ph), and Asian Foods.

Deflation was 0.92%. As we looked at our weekly sales with the exception of the week surrounding Thanksgiving and Christmas, sales exhibited a very consistent, positive trend with very little variation between each week's sales gains over the comparable week a year ago. The only reason I except the week surrounding Thanksgiving and Christmas from the foregoing statement is that there's a fair amount of variability in the sales numbers based on when the week of Thanksgiving falls and on which day of the week Christmas occurs.

If you normalize for those factors the same positives sales trend emerges. In terms of sales broken out by our reporting segments, broad buying food service is up 14.2%, SYGMA rose 8% and our other category consisting principally of specialty meat, fresh point, and guest supply was up 14.8%.

Let me turn now to the topic of gross profit margins. Gross profit margins for the quarter declined 13 basis points to 19.71% versus last year's comparable period. There are really two stories here. Gross profit margins at our traditional broad line companies and gross profit margins at our SYSCO CERCA company. We continue to see gross profit margin improvement in our traditional broadline companies, although the gains in the second quarter were not as large as we have seen in the last few quarters. The continuing reason for gross profit margin improvement is our customer and brand mix.

In the quarter, marketing associate serve sales rose to 54.7% of broadline sales, up from 54.1% a year ago. Let me clarify that the number we are using for marketing associate serve sales does not include SYSCO CERCA, as we will not be comparable for another quarter. Marketing associate serve sales are typically the independent restaurants and other independent food service operators where we can add value and can fill their needs for a differentiated service and product offering.

Our 8,000 marketing associates continue to be one of the essential elements of our growth both in sales and in the continued rise in our gross profit margins. SYSCO brands, another key driver in our performance saw sales rise to 54.7% of marketing associate serve sales, up from 53.7% in the same period a year ago. As a percentage of total sales, SYSCO brand sales were 42.6%, compared to 42.1%, again, exclusive of sales at SYSCO CERCA.

I think we do need to address, however, the reasons why the gross profit margin increases at our traditional broadline companies were not as large as they have been in the recent past. As you might imagine, we spent a fair amount of time analyzing this question. We believe that slowing inflation last year comparing to diminishing deflation this year is principally responsible for the gross profit margin differential.

In fiscal 2002, our internal inflation numbers went from 3.7% in the first quarter to 2% in the second quarter. For those of you not good at mathematics, that's a decline in the cost of goods of 1.7% in a single quarter. It's a simple fact of business life that gross profit margins but not dollars are easier to maintain when the cost of goods is going down.

Conversely, in fiscal 2003, deflation went from 2.2% in the first quarter, to 0.92% in the second quarter. In a situation where costs are rising it is harder to pass along higher gross profit margins. The combination of pricing declines last year with increasing prices this year put pressure on gross profit margins. A smaller factor was the shift to marketing associates serve sales in our broadline companies was not as large as it has been in the past few quarters.

Having said all that, let me emphasize that gross profit margin gains by the traditional broadline companies were in line with our long-term goals. The increases just weren't as robust as we have seen in the past few quarters. Those of you who follow us regularly should recall that we have been talking for the past few quarters about a business plan that incorporates lower increases in gross profit margins offset by better expense control. That's exactly what we are seeing this quarter.

The gains in gross profit margins by our traditional broadline operating companies were offset by the gross profit margins at SYSCO CERCA operating companies, which operate at a lower level of gross profit and are still non-comparable. Our specialty companies had little effect on gross profit margins compared to the same period a year ago.

Operating expenses as a percent to sales showed very good performance, declining 20 basis points in the quarter, to 14.76%. Here we saw very good performance by our traditional broadline operating companies, aided by the SYSCO CERCA companies which have lower expense ratios. When we look at our key expense control metrics for our traditional broadline operating companies, they all improved. Our pieces per stock went up, so we were selling more to each customer every time we made a delivery to them.

Our line items per stop also went up, which means that more variety of items were being sold to each customer, increasing our share of that customer's menu. We also saw a nice improvement in our ratio of employees per 100,000 pieces shipped, which means that we are being more efficient in terms of manpower. Our pieces per trip improved, which means that our trucks were leaving our distribution centers fuller and our pieces per mile also went up, which means that our routing was more efficient.

Finally, our pieces per error went down nicely, demonstrating that our SYSCO order selector is helping us cut down on costly mistakes. Our specialty companies did not really affect our expense ratios either way this quarter. As we do in every quarter, we had a variety of charges and credits to corporate expenses. Although we did get some help from the markets with respect to the value of the equity component of investments which we maintain to meet obligations for certain non-qualified retirement programs, compared to a $15.5 million expense in the first quarter, other one-time expense items offset the gain.

The result is that the earnings number that you see this quarter derives from operating earnings. The result of all this was that pre-tax operating earnings increased to $313.8 million, an increase of 15% over a year ago. Moving through the rest of the income statement, interest expense was $17.5 million, up slightly over a year ago in dollar terms, but down slightly as a percent to sales, reflecting an increase in the amount of debt outstanding and a modest decline in the effective interest rate payable on the debt.

We anticipate that the level of interest expense in each of our next two quarters of the fiscal year will be around this level. The effective income tax rate remained unchanged at 38.25%, yielding net income of $184.6 million, up 16.4% over the second quarter of fiscal 2002.

During the quarter, as part of our ongoing share repurchase program, we repurchased 4,420,900 shares, giving us 652,030,164 average shares outstanding and on a fully diluted basis, 664,083,274 shares. At quarter end, we had 17.4 million shares remaining on our share repurchase authorization. On a fully diluted basis, earnings per share rose 16.7% for the quarter to 28 cents, up from 24 cents in the same quarter a year ago.

Turning to our balance sheet, cash at the end of the quarter was $128.6 million, up $12.7 million versus a year ago. Inventories rose 18% to $1.271 billion. Day sales outstanding of inventory calculated using average daily sales were 18.8 versus 17.9 at the end of last year's second quarter. Accounts receivable were $1 billion $878 million, up 16.5%, and on a day's sales outstanding basis were 23.9, versus 22.9 at the same point a year ago. Accounts payable were $1.408 billion at the end of the quarter, up 13.8% from the same period a year ago.

Total debt at the end of the quarter stood at $1.482 billion, consisting of $64.6 million of short-term debt, $22.3 million current portion of long-term debt, and $1.395 billion of long-term debt. Approximately 67% of our long-term debt was at fixed rates and 33% was at floating rates. Our long-term debt total capital ratio stood at 38.8%, right in line with our stated target of 35%-40%.

On the cash flow statement side, cash from operating activities was a strong $329 million in the quarter, and $457 million for the first half of the year. Capital expenditures for the first half of the year were $218. Our estimate for total cap-ex for the year is now $425-$475 million, down slightly from the original estimate of $450-$500 million. This simply reflects the timing of our capital project and not any reduction in the number or scope of projects.

The deferred tax provision for our first 26 weeks was $213 million, of which $108 million was in the second quarter, as we continue to realize the benefits of the reorganization of our supply chain. We expect the cash flow effect of the tax deferral related to the supply chain reorganization to continue at about the same level for each of the next two quarters. Beginning in fiscal 2004, the cash flow going forward will be less, although incrementally positive.

Related to this issue, but over on the balance sheet, I would like to point out that within the liability section of the balance sheet, deferred taxes have been broken up between current liabilities and other liabilities. The current deferred tax liabilities, $158.7 million represents taxes, principally resulting from the deferral, which are now payable within a year. This is a new entry as prior to this time the deferred taxes relating to the supply chain reorganization were not payable within a year, and were therefore all included under other liabilities.

Now, before I confuse anyone further on this issue, let me turn to the topic of deflation. During the quarter, we saw deflation of 0.92%. The deflation continues to come in the categories of dairy, fresh and frozen meat, seafood and poultry. In three of these categories, however, there was a slowing in the rate of deflation from the first quarter of this fiscal year. The exception was poultry where there was a modest increase in the rate of deflation. These are the same categories that have been deflating for the past few quarters, and we believe we are seeing the beginning of the end of deflation in these categories.

At this point, I would like to turn the microphone over to Rich Schnieders, our chairman and CEO so that he can discuss our recent acquisitions and operational achievements during the quarter.

Thank you, John.

Before I get to our activities in the quarter, I'd like to talk about the agreement we signed with Starbucks last week. We've entered into an agreement with Starbucks giving SYSCO the exclusive right to distribute Starbucks coffee to food service customers. We are very excited about this transaction, and we believe it will be beneficial to all concerned. What SYSCO gets out of the agreement is the ability to offer our customer the best known name brand in premium coffee. One that brings the highest quality possible to our customers. What Starbucks gets out of the agreement is access to SYSCO's 8,000 marketing associates, and the distribution efficiencies from our 64 broadline distribution companies. In short, we can service our customers better and Starbucks gets much better sales reach and distribution depth. Both companies benefit from what is a growing trend of featuring premium named products in restaurants. So we would encourage you to go out for a cup of Starbucks at your earliest convenience.

Now I'd like to talk about several items of interest in the quarter. In terms of acquisitions, this quarter marked the third full quarter of SYSCO CERCA in our numbers. We continue to be pleased with the results we're seeing there and continue to characterize them as slightly better than planned. Gross profit margins at SYSCO CERCA have improved sequentially in each of the quarters since we acquired them. We're concentrating on programs to improve our mix of street versus multi-unit customers and increasing the presence of SYSCO brand in Canada. We are increasing the number of marketing associates in Canada, and making sure that existing street customers are receiving adequate attention from their marketing associates.

On the SYSCO brand side, we are making very good progress. Last quarter, we began shipping SYSCO produce, Fry-On, our premium brand frying oil, and our Butcher's Block boxed beef into Canada. And we're seeing very good acceptance of these products by SYSCO CERCA customers.

This quarter, SYSCO brand products being purchased by SYSCO CERCA companies include our frozen French fries, SYSCO brand canned tomato products, Arrezzio pizza and Pasta Labala (ph) pasta products. We have quite a number of other products slated for introduction in our fiscal third quarter. Frankly, we like what we are seeing up north and are quite pleased by the progress SYSCO CERCA is making.

During the quarter, we completed the acquisition of Abbott Foods, a broad-lined food service distributor in Columbus, Ohio, and acquired Asian Food, a specialty food service distributor for the Asian restaurant market. We also acquired, Pronamics (ph), the national distributor for (inaudible) brands in Canada. And at the very end of the quarter, we purchased certain assets and some of the business of Arriot (ph) food service distribution business in Denver, Colorado.

We estimate that on an annualized base the sales of these four acquisitions should add up almost -- should add almost half a billion dollars to our top line sales. Our long-term goal is to add 3% per year to our sales via acquisition, and we're making good progress towards that goal this year.

In other important developments in the quarter, we signed an agreement to acquire land in Oxnard (ph), California, for our second broadline foldout in the Southern California area, and we broke ground for the construction of our first redistribution center in Front Royal, Virginia. We see a bright future for the food service distribution industry, and we're running real hard to stay ahead of the curve.

What I'd like -- with that, I'd like to start the question and answer session. Operator, we will ask for the questions.

Thank you. The question and answer session will be conducted electronically today. If you would like to ask a question, please press star one on your touch-tone phone. Again, that's star one to ask a question. Our first question will come from Bill Leech (ph) with Banc of America Securities.

Good morning.

Morning, Bill.

I have two questions. John, on the PNL there's a positive swing and other income. It's not a big deal. But I was just wondering was there anything unusual in there? Looks like you had a $2.6 million credit.

Yes, Bill, this is John Stubblefield. It is pretty typical to have some small items, non-recurring items that flow through that area. Nothing exceptional this quarter.

Okay. And I was wondering how much acquisitions will add to revenues the next two quarters, if you know that?

Probably be right around where it is this quarter. Well -

For this quarter.

Well, next quarter it will become comparable with CERCA in the fourth quarter. So that's about 4.5% of sales that will drop off as an acquisition number, and then everything else is roughly what we just said in the call, which is almost half of - on an annualized basis, half a billion dollars, just divide that by four.

So say another way, we'll probably have something in the neighborhood of 3% to 4% I would guess in the fourth quarter as compared to where we were this quarter.

And the third quarter would be 7% like this quarter?

That's correct.

Okay. Very good. Well, congratulations on another great quarter.

Our next question comes from John Heinbackle (ph) with Goldman Sachs.

A couple of things. You talked about the gross margin and expense trends. If you look at it sequentially, meaning the expense control got a lot better this quarter and gross was under normal pressure, how can you -- if you look at that versus U.S. and Canada, you know, on both sides, where are the trends going? You know, what's driving that on both ends? You know, can you touch on that?

Well, on the expense side, we see the improvement coming from the U.S. broadline companies.

Okay.

And CERCA is running fairly consistently. CERCA is, I think John may have mentioned this -- sequentially we are seeing gross margin improvement at CERCA, which we would expect because of the introduction of SYSCO brand. But we - and we do continue to see improvements in gross margins in our SYSCO broadline companies, although at a slower rate than we have over the last few quarters.

Yes. And the expense thing makes sense. On the gross margin side, that's what confused me a little bit in that CERCA is improving, it was in there last quarter, it's in there this quarter, it's improving. Gross was down, but traditional -- I guess traditional broadline was up. So I guess there were other things besides traditional broadline and CERCA that would have been down that would have accounted for that, or is that not right?

Well, I think what we really have here - and again, this is John Stubblefield -- is that we also have a shift in the mix a little bit. While our customer base that we service from our MAs, our salespeople, grew nicely, in fact grew about the same rate as they had in the past quarter, our other businesses grew a little faster. So we have somewhat of a shift of mix in there that's also causing the margins to look like they didn't perform as well as they had in the past.

John, I think really what we were saying is that we had very good gross profit margin performance in the previous quarters by our traditional broadline companies, which overcame the addition of CERCA into the mix. This quarter, the gains by the traditional broadline companies were there, but they were not as large and the addition of CERCA into the mix pulled the overall broadline operating companies to -- into a decline in the gross profit margins.

Okay. And then secondly, just inventories up 18 and the receivables up 16.5. How much of that is -- which is probably a little higher than you'd like. How much of that is seasonal, how much of that is timing of acquisitions? And, you know, are there things in place to kind of move the growth rate down over the next couple of quarters?

This is John Stubblefield again and you certainly hit on the major components of why one quarter from the next our inventory and accounts receivable, DSOs may be impacted. Let me go to the DSO for accounts receivable first. This last year, we have renegotiated two contracts with two of our largest customers quite favorably for both parties I might add. However, part of that renegotiated -- renegotiation results in about a half a day increase in our overall DSO as a result of that renegotiation. Again, we're quite pleased with that, so we think it's very much in line with the quality of the customers we're dealing with. But for a couple more quarters we will have year over year comparison issues as we factor that in. Plus, one of the customers is growing very rapidly and with their longer DSO days does impact the overall total.

The other part of it is seasonality. And this -- we use a five-week period for calculating DSOs both on inventory and accounts receivable, and it so happens that this five-week period had two holiday weeks in it where previously it had only one holiday week in it. That also impacts the raw number if you will, on the DSO. And of course acquisitions certainly give us the opportunity to help us -- or help them bring their days down. So all in all, taking all those factors into effect, we are really not uncomfortable either with the accounts receivable or the inventory DSOs at this time. But as always, we're aware and we're working with the companies very closely to make sure they stay on the same trend that we've established now for many quarters.

Okay. Thanks.

Moving next to Mark Hudson (ph) with Merrill Lynch.

Yes, hi. Just on other items again, not the line item, but other items. But I think you said that in the SG&A you had some offsetting benefits -- sorry, costs to the gains that you got from the employee insurance plans. Can you just explain what's going on in there?

This is John Stubblefield again. And, Mark, not to get into the minutia too much, we had a charge for an unwind of a -- an insurance policy that was -- that's in the footnotes of the proxy. That was a small charge. There were some other very minor items when you look at it in the full context of an organization this size. If you look at what was the actual market equity gain that we had from this quarter from our insurance policies, it was right at $5 million. So we're talking about pretty small numbers, plus and minus that impacted it.

Yes. Could you -- thanks for that. Couple of other things. Just on the Starbucks contract, I remember in distant past I used to cover U.S. office products and they had an exclusive contract for distributing Starbucks products to office environments. Here at Merrill Lynch for instance, we have I think -(inaudible) Marriott runs our canteen in the Starbucks there. I know you supply (inaudible), but let's say Lehman Brothers didn't have (inaudible) their canteen and they had Starbucks coffee, would you then have the exclusive right to go in and supply Starbucks to Lehman Brothers?

The agreement is primarily for food service customers which would be -- are primarily our independent operators out there, Mark, the 370,000 customers kind of one-up operations.

Okay. So this is just really for the marketing associate customers, is that right?

I'm sorry, Mark?

So it's primarily for the marketing associate -

It's primarily for the marketing associate and contracts that existed --contracts that existed with contract customers, like a SODEXO (ph) will be grandfathered so they continue to be served by their current distributor.

Another question. Just say that there's a diner down the road that doesn't have Starbucks and wants to get Starbucks, would you be obligated to just drop off Starbucks to them and wouldn't that be an uneconomic drop size?

It would be an uneconomic drop size and we have arrangements for mutual decision making in those regards, and in that case, we would not serve that customer. However, we would be happy to take all of their business and then serve them the Starbucks. As a matter of fact, we've had some very positive calls from customers and non-customers alike.

And then finally on CERCA, the comparable store sales --obviously you're going to be cycling CERCA at some stage and I know we're not there yet, and a lot of things could change, but would you expect the comp store sales to be dragged down by CERCA when it comes into the mix or improved by CERCA?

I would anticipate that it would be about the same as we're experiencing. The Canadian economy in general is -- has been perhaps even just a little more robust than the U.S. economy, and so I would not anticipate an impact to any degree one way or the other.

Okay. And one final point I guess is on deflation. At -- those sort of lags involved in passing on pricing increases and decreases to the customer base, with deflation decelerating now as in the current quarter, can you just talk us through what you're seeing right now in terms of your ability to realize gross profit dollars?

Well, I think that's exactly right. It's what John alluded to. It just takes a little while as you see a deceleration and deflation to catch up with your pricing. And so some small portion of our slowing improvement in gross margins has been because of that very fact. But we have -- you know, I guess one thing that gives us great comfort is that we have such outstanding systems, our enterprise-wide systems (inaudible), we can see what's going on literally on a daily basis all the way down to a case -- an individual case. You know, individual case that's being shipped, that level of transaction. And so we are able to -- our companies are able to respond to those changes in the marketplace.

But are you catching up now? I mean, do you have any visibility on you being able to do that? I mean, a lot of people are concerned that the pricing environment in general is still extremely weak and there's a lot of resistance from retailers of all sorts to pass on any price increases that may be out there, and people are concerned that the distributors have to eat the gross margin hit, are you actually beginning to be able to pass it through yet?

Yes. I think we are almost again on a daily basis as we work with our salespeople, and I have -- of course, we have all read about that concern about deflation in the retail environment. Our business is a little bit different than that. And by having those individual marketing associates in the accounts working with our customers, I think that we're able to respond fairly effectively and look pretty confident that we'll, you know, appropriately be able to get our pricing in line with our costs.

All right. Thanks very much.

And Eric Larson (ph) from U.S. Bancorp has our next question.

Hello, everyone. Nice quarter. I'd like to dive into a little bit on some of the competitive environment as well. I believe our whole report of the earnings and disclose that U.S. (inaudible) sales were down a little bit more than mid single digit which was -- it looked like fairly disappointing sales. Are you still realizing any benefit from disruption of customers from that particular competitor?

Well, you know, those kinds of numbers are pretty difficult to measure even with our good systems out there. But frankly we feel pretty confident that we indeed are gaining share on the competitors and we recognize that there are certain discomforts on the part of some of their employees and some of their customers. So we're taking -- we're like good business people, taking advantage of those where it makes sense for us.

Okay. Thanks. And in terms of the acquisition environment, it seems that it has been -- it's been pretty aggressive the last 12 months or so. Are there more opportunities today, you know, given that maybe some -- this environment is a little more difficult for some of the smaller people and is that more opportunity in the next 12 months, or do you think that's a lot of the good opportunity is something you've already captured in the last three or four acquisitions?

Well, you know, again, acquisitions has always played an important role in our growth plans and we will continue to seek out those acquisitions that particularly meet some of our needs. I think great examples of that this last quarter was the Abbott acquisition that fit a need in geography and also with our Asian Foods acquisition which fit a very specific customer need. So we think there are lots of good acquisitions out there. We see the marketplace still very, very open and viable in that regards, and we will continue to look at them and they will be a part of our plan going forward.

Okay. Thanks.

We'll go next to Jeff Omehundro (ph) with Wachovia Securities.

Thanks. I wonder if you could discuss a little bit the trends you're seeing in SYSCO brand sales? I see that year over year it's up, but sequentially it's off a tad. I wonder if you could provide some additional color on that? And also, you mentioned the progress you're making with CERCA selling SYSCO-brand products. I wonder as a percent of sales where that stands, and as you cycle CERCA I assume you're going to bring that into your reporting. Where would your SYSCO-brand sales as a total percent including CERCA, where can we expect it to be in Q4?

Well, I think we'll continue to see the similar type improvement in SYSCO brand percentages. Over the last several years, we have introduced some fairly significant programs in terms of dollar volumes into the SYSCO brand repertoire, portfolio, if you will. For instance, our Butcher's Block, which is a brand of premium meat products, boxed beef, steaks and ground beef and -- along with our Buckhead beef and our Newport beef, introducing those as the steak programs as SYSCO brands.

So we have had relatively large programs that were introduced into our portfolio that -- over the past several years we have seen nice increases. So I would anticipate that we'll continue to see SYSCO brand growth in the fourth quarter in numbers that are similar to what we've seen this quarter. But it's still a big emphasis on what we're doing. There are new programs, we have two new brands that we rolled out just last week to our companies, our operating companies at the merchandising conference. So we'll -- we are continuing to focus on that, and frankly the CERCA numbers, although we're just beginning to accumulate those now, around SYSCO brand, they will not have enormous impact on the total SYSCO brand mix at this point.

But the opportunity, again, of course as we said all along relates very closely to our ability to sell SYSCO brand in Canada. We feel great about that, it's being accepted. The SYSCO brand produce for instance, we're now shipping SYSCO brand produce from Salinas, California to St. Johns, Newfoundland, which is about 4,000 miles, I think. It's going very, very well.

Great. Thank you.

Jack Murphy (ph) with C.S. First Boston has our next question.

Good morning. Just quickly on the sales. I wonder if you could try to give us a sense of how much of the improvement in real sales growth comes from growing the existing customer base or I should say growing within the existing customers, essentially the same store sales of your existing customers versus how many new accounts you're adding and if it makes any sense to assume that in this economy given how much smaller your competitors are, they have a competitive advantage there?

Well, I mean, in terms of new sales, we're continuing to see nice new sales improvement. I mean, we should be candid here I guess. We've talked about this with the analysts in terms of, in fact, we have a number of customers that are not as profitable as we'd like. And we too often bring some of those into the fold. But we're seeing, as John indicated when he talks about the pieces per stop and the lines per stop, a good measure of our account penetration and we're gratified to see in this environment particularly our pieces per stock going up and our lines per stock going up, which means that we're selling more items to our existing customers, and we're selling larger quantities of the items on average than we were selling -- of all the items.

So from a new sales perspective, you know, we're gaining new accounts and we're also doing a fairly good job of penetrating those existing accounts. We still have a lot of room to grow. That's still our big opportunity. We have said many times that our penetration and our average independent customers about a 35 share and that's the number we're focused on. Many of the programs that we've designed and developed are directed toward growing that share number.

So just based on the emphasis that you're providing there, I would assume that the majority of the real sales growth is on the increased penetration and not from really an increase in the average number of accounts?

No, I would say the dollar sales - the total dollar sales growth would be coming primarily from new accounts.

Okay.

Although we're making progress on the penetration side. But, you know, that progress is marginal or incremental, but it's -- that little improvement as you drop off an extra case to a customer with a truck already going there is, you know, most of the gross profit ends up being net profit.

All right. Okay. And one last question, just I'm getting back to the tax rate for a minute. Where should the effective tax rate set a while, where we're at in the past quarter, is that where we're going to be once you cycle through all of the changes related to the -- you know, the inventory -- or the supply chain changes?

Yes. Really it's not going to impact our effective tax rate. You know, one side is GAAP, some of it's on the books, the other side is on the tax returns we filed. The referrals coming on the tax return side which doesn't have an impact on our effective rate -- the effective rate we're currently at, I believe we will continue to run there for some period of time.

So we should just see an increase in the deferred tax liability to a certain point, and then that will roll over and just keep getting smaller?

Well, not keep getting smaller. We believe it will incrementally grow from the level that we hit at the end of our fiscal year. We believe incrementally from that point, it will continue to grow. However, we will then start also making those tax payments on that amount that's been anniversaried in that deferral. So, again, the deferral is in place. It's continuing to grow forward at the same rate, however we will have tax payments that begin to be made off of in fiscal 2004.

Got it. Thanks.

We'll go next to Andy Smith (ph) with A.G. Edwards.

Hello, everyone. Could you give us some more detail on some of the expense reduction techniques that you guys have used to help the expense line?

Yes, John -- John, of course, spoke of the SOS, the SYSCO quarter selection system. We see nice improvement in our error reductions, and every time we don't mis-ship a case to our customer, you know, that's a big improvement. You know, when we roundtrip a case, we think we have had a loss of about $25. So every time we don't do that, we think it's pretty nice.

The other broad categories I would say is that we - our best business practices, we continue to improve our benchmarking with our operating companies, so each of our operating companies can see how they're performing versus the rest of their colleagues out there. That continues to be to become more mature in our operations. Pay for performance, our activity base, pay for our drivers -- we continue to add drivers to that program, and we -- we're doing a better job of sort of implementing it as we do add drivers. So I would say those are the three. The SOS, pay for performance and the best business practices continue to really help us leverage on the expense side.

Thank you.

We'll go next to Steve Scheck (ph) with J.P. Morgan Chase.

Hi. I had a question I guess on your real sales growth, and maybe if you can give us a sense of post quarter end where sales might be trending, and as we look into the third quarter, you know, the comparisoning, it's a little bit more difficult and then into the fourth even more so. Would you expect -- or can you give us a sense of what level you'd expect maybe as you head into those two quarters?

Well, John indicated -- John Palizza indicated that we continue to see an acceleration and a rate of sales growth, and I would say that at this point we're very comfortable with that trend continuing. Now, there could be blips out there. I think everyone is worried about what might happen with this war in Iraq. But on a trend, for the midterm, I would say that we're very comfortable. I would repeat what I said at the end of my comments opening up and that is, we just see a bright future for this food service distribution industry and we're gratified with all the gloom and doom we hear about retail sales, et cetera, that our business continues to be very vibrant. We see excellent activity, particularly in the independent restaurant segment of our business. That's where we're gaining share. So we're just very positive, Steve, about the environment that we're operating in and the position that SYSCO is in to respond to that environment.

Okay. One separate question. The -- with acquisitions and the 3% acquisition growth per year, do you have a sense or do you think about it ever going beyond North America? And if so, I mean, what type of horizon do you think that might take? Or how much thought have you put into that?

Well, we have -- as we said publicly that we have looked at Europe, for instance, and we've done some research there. We have no immediate plans. If and when we did something in Europe, it would be done very, very cautiously, most likely in a joint venture environment. But we don't have any immediate plans to do that. We continue to look at the market. The trends in Europe are essentially the same as they are in the U.S. Although the eating out frequency is not as high as the U.S., again, the sort of aging population, the increasing affluence, et cetera, bodes well for that industry. But it's a complex market. There are lots of opportunities, however, still in the market that we serve, in North America, in the U.S. and Canada. And we have -- you know, we have a small share of business, and as we think about how we might expand our business with our existing customer, whether that's in healthcare or the hotel market, we just have a lot of opportunity right here.

Okay. Thank you.

You know, the other thing I would add, is we continue to look for foldouts. We announced recently that we purchased land in Oxnard, California, for our second foldout out of our Los Angeles company.

So that's - that would be part of our continuing strategy. We have about six markets on our list right now that we want to continue to work on and prioritize those and build our business. That's been a very successful strategy for us.

Thanks.

Thank you.

We'll go next to Andrew Wolf (ph) with BBT Capital Markets.

Hi, and congratulations on the quarter. A question on -- when you bring in a new independent street customer, compared to the base, typically, is the gross margin there a little lighter? And I would imagine also the SYSCO brand penetration.

Well, for sure, the SYSCO brand penetration is going to be smaller than average because it takes us a while to -- you know, to build that story, to provide the customer with the benefits that SYSCO brand --that will accrue to the customer by them buying SYSCO brand. In terms of the margins, I think that depends a great deal -- they can be lower, they can be average. It depends on the maturity of the marketing associate and where we've got mature marketing associates, opening accounts, you know, from the very beginning sell the benefits of not only the SYSCO brand but of our service systems. I think that we don't see a diminished return in terms of the gross margin. When you have younger folks out there, that's one of our opportunities, to continue to train them, do a better job of bringing them into the system so that they can sell those benefits, the benefits of the SYSCO system to those customers early on. But it is a challenge.

In terms of the mix as it came in this quarter where you described you got a lot of new customers and typically at least in a stronger economy or the competitive environment is a little different, you get increased penetration which is clearly as you pointed out very accretive to gross margin. What I'm getting at is if you're winning all these new customer, it strikes me that maybe that's just a little diluted to the gross margin. I don't know if you've done that analytic look internally.

We haven't done that analytic - we are getting new customers from our competition out there. But I think you're right, I think it's something we should take a look at.

The other thing on gross margin is I don't think you gave this up, but if you would, what would have been the gross have been excluding CERCA?

Andy, we don't comment on the breakout between CERCA and the rest of the broadline food service companies.

Could you comment on what the -- you mentioned you had some sequential increase and you have had in the -- in all the quarters since you had CERCA. Could you give us a flavor or range or whatever for what that looks like?

The most we would say, Andy, is that that's incremental. I mean, it's not huge, but it's in the right direction and we're very comfortable with it. It's more than meeting our projections and we would think that a lot of it is related directly to SYSCO brand, but also our ability to change the mix of that business.

And that's important, because this is a long-term process. It's not about raising the margins with the existing customer base. It's about changing the mix of the customer base, and that's an education process on our side with our people, and at the same time, spreading that coverage in the marketplace so that we're bringing in those customers that we provide the biggest benefit to.

Okay. Thank you.

And we have time for one last question that will come from Mitchell Spicer (ph) with Lehman Brothers.

Thank you. Good morning. Just a couple of questions. First, on the real internal sales, just wanted to make sure I got it right, that your forward outlook I take it is still in the 6% to 9% range?

That certainly is our long-term plan, and what we've seen in the most recent quarters is that, that plan is very much achievable.

Okay. Secondly, last quarter it was mentioned that the industry is growing about 2% -- the restaurant industry I believe 2%, plus or minus 1%. I was wondering if there is any -- I know there's no hard data on that, but since then, have things stayed the same or improved or deteriorated any?

Well, Mitch, it depends on who you believe. I mean, the macro statistics on this stuff and the projection are pretty squeaky, and whatever you're getting is probably as good as what we're getting.

You have probably seen the projections, the National Restaurant Association is expecting calendar '03, normal growth at 4.5% and real growth of about 1.8%, and that's how many years in a row. Of course, that's just the restaurant industry, that's not the whole food industry. But that would certainly tell us that there's a lot of positive momentum out there.

Okay.

So your question, then, that 2% plus or minus one is probably as close as anybody will guess.

Okay. So it seems like you feel that nothing has changed over the past quarter in terms of those trends?

No, not at all.

Okay. A couple metrics you gave us last quarter, I was wondering if you had them handy. Just the order selector I believe was in 57% of the operating companies last quarter, 93% of your operating companies had margin improvement in the quarter, 60% margin over 6%. I guess the activity based compensation was at about one half of the company. Do you have updated numbers for those?

Well, the SOS is currently in 21 broadline operating companies. The -- I didn't add up the number of operating companies that had operating margin improvements this quarter. And I think I'm going to punt on the last one you asked for.

Well, the AVC - and I don't know the number exactly either, but the -- we continued to install and increase the number of drivers or delivery associates who are on the activity-based costing. So that's just kind of a long-term process, but we're getting there and very solidly, and every time we install those systems within an operating company and do that effectively, the improvement in terms of our cost per case, for instance, and our productivity is, you know, it's great. I'm very pleased with that.

I think the plan calls for adding of between six and eight companies a quarter to AVC.

That's a little on the high side, but that's a goal.

Great. And just quickly moving along, you mentioned the soufflé effect last quarter in terms of the business trends, kind of firm around the edges, soft in the middle. I was wondering if that trend has continued?

Well, we continue to have a bit of a soufflé economy here which is firmer on the edges and softer in the middle, but they're all performing quite nicely.

There's not any that -- of any particular concern at this point in any region.

Yes. It's -- the economies on the East and West Coast or the operating companies on the East or West Coast are doing a little bit better than the ones in the middle of the country.

Great. And this is the final one. On your redistribution centers, it sounds like summer of '04 it will be operational. If you could just maybe walk us through just quickly what, you know, in terms of inventory, how you see the initial stages affecting your inventory, or if you expect it to be, you know, pretty seamless in terms of the inventory transition from the operating companies to the RDCs. Thank you.

Yes. Mitchell, as I think we said many times, we're very conservative in how we approach any of these projects, and what we would expect to see on the short term and because we will do this very incrementally is that we'll see a slight build-up in inventories as we move into an RDC, as we become comfortable with that process. We will then see a decline of inventory on a like -- supplier for company for company basis. But it will take us some time do that, because our first objective is make sure we don't impact negatively the customer and we'll do everything we need to do to make sure that doesn't happen. We'll watch it very closely, but I would see a slight upswing in inventories as it relates to that RDC in that region, and then as we get comfortable and confident with that process, then we'll see the inventories come back down. But this whole ramp-up project will take six to nine months once we start into it.

Thank you.

Okay. Let me take this opportunity to thank everyone for calling in, and I'll repeat for the third time, you know, we're very -- we feel very good about the industry itself, the vibrancy in the industry. The independent operators continue to do well and that's the core of our business. And just overall, our business is very solid in all sectors, geographically and from a customer perspective. So thank you again for calling, and we're pleased to report to you this morning.

That concludes today's teleconference. Thank you for joining us.