西斯柯 (SYY) 2004 Q1 法說會逐字稿

Good day, everyone, and welcome to SYSCO Corporation's first quarter fiscal year 2004 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, Jake. I'd like to add my welcome to everyone for joining the SYSCO Corporation conference call for the first quarter of our fiscal year 2004. With me here today are Rich 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.

On the call today I'll open with an overview of the quarter and also give everyone some of the quarterly data we supply to help you understand our business. Tom Lankford will then cover operating performance during the quarter and Rich Schnieders will discuss strategic matters including progress on our national supply chain initiative followed by the question-and-answer session which Rick will moderate.

Let me start by reminding you the statements made in the course of this presentation that state the company's, our management's intentions, 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 10K for the fiscal year ended June 28th, 2003.

I have one final housekeeping item to cover before we get to the substance of the conference call. This is your last reminder for SYSCO's analyst field trip which we are holding on January 15th, 16, 2004 in Houston, Texas. This year we're featuring a full day of management presentations on Thursday, and on Friday we will be visiting the annual SYSCO merchandising show where our suppliers meet with our merchandisers to showcase new product lines and business building programs. It's a great opportunity to get a sense of the size and scope of the SYSCO merchandising effort, as well as an opportunity to meet some of our suppliers and get their view of SYSCO.

As we're a food company, we also promise that you will eat well, if you come, due in no small part to the fact that much of what you will be eating will be SYSCO brand food items. Invitations were sent out in early October so if you haven't been invited by now give us a call. Again, the dates are January 15th and 16th, 2004. Also, by popular demand we've added a small side trip to the field trip. For those of you who would like to see some of our state of the art facilities, we have a brand new 600,000 square foot distribution facility and a great custom meat cutting operation in Dallas which we have arranged to tour on the Wednesday afternoon before our Main event. Give us a call if you're interested.

Now for the first-quarter results. The quarter can be summarized as one of solid progress in sales. Gross profit margins faced a head wind of higher inflation but this was more than offset by expense controls which once again turned in a stellar performance. Sales in the quarter were up a total of 11% over last year's first quarter. Within that number, sales from acquisitions contributed 1.9% and inflation increased to 5%. Sales from acquisitions consisted of Abbott Foods, Pronamics, Asian Foods, the Denver distribution facility acquired from Marriott Food Services and the meat cutting operations of Colorado Box Beef now known as Buck Head Beef of Florida.

During the quarter we continued to see inflation, with inflation for the quarter rising to the rate of 5%. I will spend a little more time here than we normally would on inflation as 5% is a higher inflation number than we normally see. The inflation was principally in the categories of meat, dairy, poultry and canned and dry goods. However, all but one category of goods, equipment and small wares, experienced inflation during the quarter.

Let me give you our views on the major categories. Meat costs have been rising steadily for the last three quarters, and in the current quarter meat costs for our Broadline companies and our specialty meat companies rose between 10% and 12%. Today's undersupply of beef and hence higher pricing is related to a number of factors beginning with the drought in grain producing states in calendar 2000. Higher grain prices made it uneconomical to continue to feed cattle which led to the early slaughter of many cattle which was why there was an oversupply and therefore deflation in meat a year ago.

Today we have the converse, an undersupply exacerbated by the fact that many cattle coming to market today weigh less and Canadian beef is not being exported in significant quantities either to the United States or to other beef markets. The combination of lower supply coupled with higher demand for U.S. beef leads us to the conclusion that higher beef inflation will be with us until we cycle around against current prices.

Dairy has been one of the more volatile categories of products we buy ranging from almost 20% inflation two years ago, to 15% deflation a year ago, to almost 10% inflation this year. Our best estimate is that pricing in this area will settle out within one to two quarters. In the case of poultry, the average time to grow a chicken for market is 48 days so if the law of supply and demand works here, we should see higher prices bring in more supply and lower poultry prices within the next couple of quarters. Unless, of course, higher beef prices shift up demand for poultry leading to higher prices. Economists refer to this as the chicken shift effect.

Finally, the rise in pricing for canned and dry goods, while not as severe as the other categories I mentioned, seems to us indicative of the fact that manufacturers have reached a point where they feel they need to pass on some of their increased cost. Having said all that, the overall rate of inflation was fairly constant throughout the quarter.

Gross profit margins down 41 basis points from the same quarter a year ago, were more than offset by excellent expense control where expenses as a percent of sales declined 59 basis points compared to the first quarter of last year. The result was net earnings of $208.8 million. An increase of 14.4% over the first quarter of 2003. Earnings-per-share on a fully diluted basis rose to 32 cents, up 14.3% from a year ago. For the quarter, in terms of sales broken out by our reporting segments, Broadline Food Services was up 9.5%, SYGMA rose 16.2% and our other category consisting principally of specialty meat, fresh point guest supply and asian foods was up 24.4%.

During the quarter, as part of our ongoing share repurchase program we repurchased 2.8 million shares. At quarter end we had 26.2 million shares remaining on our share purchase authorizations. Total debt at the end of the quarter stood at $1.305 billion. Consisting of $88 million of short-term debt. $22 million current portion of long-term debt, and $1.195 billion of long-term debt. Our long-term debt to total capital ratio sit at 34%, just slightly below our stated target range of 35% to 40%.

With that I'd like to turn things over to Tom Lankford who will give you more detail and color on the income statement and operations.

Thank you, John and good morning. Our first quarter of fiscal 2004 was in many ways a continuation of the major trends that we saw in the fourth quarter of last year. Sales growth continues its consistent positive trend. Similar to last quarter, all but one week in the quarter showed sales gains of 10% or better when compared with the same period a year ago.

Sales in your specialty meat companies were particularly robust even when you account for the higher inflation in that category. We're very pleased by the progress being made in our full [ph] meat operations in Chicago and New Jersey. In addition, we made progress in sales in the right areas. We saw only a small increase in sales to our unprofitable customers. While we had much better gains to our good customers.

Gross profit margins are the next area I'd like to discuss. Gross profit margins for the quarter declined 41 basis points versus last year's comparable to 19.35%. Just as we experienced last quarter, this decline can be explained by four factors; customer mix, company mix, product mix, and inflation. In the area of customer mix, our market and associate served sales for the total company grew at a very healthy rate of 10.2%. But our corporate, multiunit and local contract sales grew faster at a 13.3% rate. Multiunit and contractual customers tend to come in larger increments and impact gross profit margins until they become comparable. In the area of company mix, our SYGMA sales and our specialty meat company sales where gross profit margins are lower than in our Broadline Companies grew at a faster rate than our Broadline Companies.

With respect to product mix, our meat sales did have some impact on gross profit margins. There are a number of factors at work here. First, fresh cut meat is higher dollar, lower gross profit percentage product. As it grows as a percentage of the sales mix, and remember I said that the meat company sales were particular robust in the first quarter, there is an impact on gross-profit margin percentages, although gross profit dollars continued to increase nicely. Second, fresh cut meat saw a sharp increase in cost in the quarter. Although we continue to work hard to maintain our dollars per pound of gross profit, because we had a higher cost of goods the gross profit as a percentage of the sale dropped.

Total operating expenses as a percent of sales showed an excellent performance. Declining 59 basis points in the quarter to 14.36%. While we'd like to take complete credit for the decline and the expense ratio, I think we have to recognize here that the inflation, which impacted gross profit margins, also gave us some help on our expense ratios. A short-term rise in the cost of goods does not necessarily get translated into higher operating cost and, as a result, expenses as a percentage of sales will look more favorable. Even taking that into consideration, we saw very good expense control performance. By both our Broadline operating companies and our specialty companies in the first quarter.

You may recall that our last field day in June 2002, we began to talk about an increased emphasis on expense control. This is now the fourth quarter in a row where we have seen nice declines in our expense ratio. Now that our operating companies have traction on our expense initiatives, our expectation is we will continue to see expenses decline as a percent of sales. Our key expense trending metrics continue to show us making good progress on working more efficiently and effectively.

Our pieces per stop and lines per stop once again showed incremental gains which means we are selling more to each customer every time we make a delivery to them, and we are penetrating that customer's menu with more products. We also made gains in terms of pieces per trip, which means our trucks were fuller when they left the loading dock. Of particular note was our pieces per error statistic which improved 12%. This number is doubly important because not only is it costly to ship our own product, but also by cutting down on shipping errors we avoid disappointing our customers. The operating companies continue to make good use of best practices, with sharing of knowledge between companies as a key component in raising the level of performance of all companies.

The smaller contributor to the standing operating expense performance was corporate expense. These adjustments occur every quarter and involve a variety of nonoperating charges and credits. This quarter we recorded income of $5 million compared to the same quarter last year in which we experienced a $15 million charge for the cash render value of our corporate-owned life insurance. The net result was as a percentage of sales, corporate expense contributed 16 basis points to the total 59-basis point decline in the expense ratio.

At this point I would like to turn the microphone over to Rick Schnieders, our Chairman and CEO.

Thanks, Tom. And let me start by thanking all of our associates for a great job. They're out there every day helping our customers succeed and they deserve to be publicly thanked. We operate in a business where orders that are taken today are picked tonight and on the truck for tomorrow's lunch or dinner. It's a demanding business that requires constant attention to our customers' needs and our associates perform at a very high level all of the time. Next time you eat out remember that your food quite literally could have been on a SYSCO truck that morning. And it got there through the hard work and perseverance of our associates.

Next I'd like to address cash flows from operation. On a day sales outstanding basis and inventories and receivables increased slightly while payables decreased slightly compared to the close of the last SYSCO year, we view all these categories to be within acceptable ranges. In any given quarter there are fluctuations in these accounts, but it is our expectation that over the course of the year cash flow from operations after adjusting for deferred taxes, will approximately track net earnings. We continue to invest strategically to grow the business. Capital expenditures for first quarter were $103 million. Our estimate for total CAPEX for the current fiscal year is in the range of $490 million.

Our National Supply Chain initiative is a key part of our investment spending in '04. The Northeast Redistribution Center is currently under construction with all of the exterior walls now up and over 40% of the roof in place. We estimate that the RDC will become operational in the fall of '04. That's calendar '04. During the fiscal quarter cost related to our National Supply Chain project totaled $31.4 [ph] million of which $8.9 million was expensed and $22.5 million capitalized.

I'd like to spend some time this quarter talking about returns. Here at SYSCO we measure literally hundreds of metrics to help us run our business. Two return metrics that we pay particular attention to are return on total capital and return on average equity. We think that both are key in assessing how effectively a company utilizes the funds employed in its business. It's important for a company to efficiently use the money that the shareholders entrust to it. We're proud to report with respect to both measures, SYSCO compares favorably with most other corporations in the United States.

Our return on total capital stood at 22.4% at the end of the first quarter. If you assume our weighted average cost of capital was 10%, this means that on average we're earning 12% more than the cost of funds employed in our business. There are a variety of reasons for this. But let me mention a few of what we consider the more important factors. First we understand our cost structure. We will not enter into contracts that don't earn a fair return for our shareholders. If this means we have to pass on some multiunit agreements that are priced too cheaply, we have the knowledge and discipline to do so. This industry is littered with the hawks of wrecked companies that failed to understand the requirement of getting a fair return for their services after taking into consideration all of their costs. SYSCO does not intend to be one of those.

Secondly, we're in a business where our fixed assets have a fairly long useful life. Our distribution centers can operate 20 to 30 years or more. While our delivery vehicles last from 7 to 10 years. We're constantly improving the productivity of our assets and reinvesting rigorously into our business. When we do invest in a new facility we apply the lessons from our diverse base of operating companies to make the facility as efficient as we can. For example, our new replacement facility in Dallas now opened just about a year, has productivity numbers that place it near the top of SYSCO after less than that year in operation. That's incredible.

Third, although we've been active acquirers of businesses over the years, our approach to the valuation of companies to be purchased is very disciplined and we work very hard not to over pay for an acquisition. Further, once an acquisition has been completed, we've learned how to make that acquisition a productive part of SYSCO. This discipline has served us well over the years as we've done over 70 acquisitions in the 30-year history of the company and have never taken an acquisition-related write down nor have we ever had any impaired goodwill.

Finally, we're believers in linking compensation to with what we wish to accomplish which is why return on total capital is key component of our operating company President's bonus compensation. As a corollary to return of total capital, let me also touch on return on average equity. If you're earning in excess over your total cost of capital and growing at an appropriate rate, the logical question is, how do shareholders share in that success?

We believe that one way they share is when we return funds to them in the form of share buy-backs. Beginning in fiscal 1992, SYSCO's undertaken a program that is systematically in total repurchased in excess of 220 million shares. As this strengths the equity base it has the effect of raising a return on equity faster than just through earnings alone. As with most things at SYSCO, we've done this in a prudent and controlled way while still maintaining plenty of liquidity to run our business, paying a sensible dividend and maintaining an appropriate debt ratio.

Let me finish by saying that we love the business we're in. It's exciting, creative and fun. America has continued to dine out through our most recent economic slowdown and now that we're beginning to see some improving trends in restaurant sales and travel, we're bullish on our business. I would encourage all of you go out and do some research on this topic by dining at your favorite restaurant. After all, our goal is to help our customers succeed and I can think of no better way to achieve that than by having a bunch of high rollers, such as yourselves, spending money in a restaurant near you.

We will now take questions from the folks on the call. Operator?

Thank you. Today's question-and-answer session will be conducted electronically. If you would like to ask a question you can do so by simply pressing the star key followed by the digit 1 on your touch-tone telephone. Once again, that is star 1. Do keep in mind if you're using a speaker phone, please ensure your mute function has been turned off to allow your signal to reach our equipment. We'll pause for just a moment to assemble our roster. Our first question will come from Bill Leach with Neuberger Berman.

Good morning.

Good morning, Bill.

I just had a question, it looks like your organic volume was about 4%, which was lower than you had been running, you had been running six to seven last year, is that the way to look at it or do you think the inflation number just distorted the organic volume trends?

Bill, this is John Stubblefield. I think one of the things we have tried to do in this particular release and will continue going forward, is that to provide all the components of our top line numbers and that is, what is the total sales, what component of that is from acquisitions and what part is from inflation, thereby giving you the ability to combine whatever numbers you need to to better understand where we are and the progress we're making.

In terms of the actual results for the quarter, organic number was close to 9% in terms of looking at the components of sales and real. So when we look at that combined and only backing out 1.9% for acquisitions, we believe we had a very strong quarter, especially when you consider what we believe the industry growth is at this point and from the numbers we can see, at best in the industry is flat after you take into consideration inflation.

But that's correct, the organic volume if you back out inflation is 4%?

Slightly over 4% for the quarter.

Let's review the bidding here. Total sales were up 11%. Sales from acquisitions were 1.8% and inflation was 5%. Now depending on your definitions here, organic sales is typically defined in a term that we have not used in the past, but typically defined as total sales less noncomparable acquisitions. Which would mean that if you're using that particular definition, check my math here, then organic is 9.2%.

Right.

In the past, we have defined real sales as total sales less noncomparable acquisitions and adjusted for inflation. If you want to do that math, please go ahead. But because that's a nonGAAP measure and we did not place a table in our press release, the lawyers are very touchy about what we say about it.

Right. But I mean, if we assume it was 4%, my question originally was, is that slightly disappointing since you were running at 6% to 7% last year.

Bill, this is Rick. I don't think it is. First of all, I think we should remember that we had a fairly significant weather-related event on the East Coast. We also had very high rates of growth last year so, long-term, we still stand by our goals that we've set for the organization, and we're still comfortable that we will continue to meet those goals.

Your goal isn't high single-digit organic volume growth, right?

Yes, that's right.

And one other question on your shares outstanding. They were about 2 million sequentially from the fourth quarter. Where do you standard in terms of your share buy-back, should we assume the shares will go back down as the year progresses.

Yes. That would be our normal expectation, Bill, as we go through the year we'll look at our share repurchases and trend down over the course of the year in terms of our average.

Okay.

Bill, if I could add one other comment to this question about growth, we've got 8,000 marketing associates and probably 5,000 other people that support them out there. And we send them out every day to grow sales and they think in terms of what I'll call, double-digit growth in sales. But we don't handicap them as to whether it's inflation. If you think back when you have normal 2 to 4% inflation what they're doing is entirely appropriate. We don't go in and say, look, now there's high inflation so you have to grow it more than that. I don't think this is an unusual period at this quarter too we're passing through.

Okay. Thanks a lot.

Thank you, Bill.

Our next question will come from John Heinbockel from Goldman Sachs.

Hey, Rick, if you guys try to get your arms around looking at cases moved, whatever you would look at internally to the health of the foodservice customer, let's say as you went through the quarter or even the last couple of weeks, what do you guys look at and what's your sense on the health of the customer be it economy related or is the rising inflation having an impact on demand? Recognizing unit, real growth might be, not a good barometer, what do you look at and what's your assessment of the foodservice demand today.

As we indicated, we look at that pieces per stop number which is up about 4% year to year. Same thing is true on lines per stop which should be an indication of the general activity within our individual accounts. If we look at the sort of broader economic news that's out there, John, we feel pretty good. One of the categories that have been suffering here for the last couple of years as you know is travel, and we've begun to see that turn around pretty effectively, guest supply, of course, which is their business is very much affected by what's going on in business travel and leisure travel and we see good indications there that, indeed, what we read in the newspapers is true, when we have improved travel numbers, that, of course, helps our restaurants in those locales whether it's Orlando, New York or wherever. So I would say that we're very encouraged at this point and look forward to a good second quarter.

What would the pieces per stop growth have been last quarter or the quarter before that, same pick up, slow down?

No, we've seen an acceleration in that number over the last couple of quarters.

Okay. Secondly, I would have thought by now you'd have more success, when I look at your gross margin, passing along some of the cost increases along to your customers. Last quarter it was kind of sudden, it happened at the end of the quarter. It's been kind of stable now for three months. What's the dynamic there? I can't imagine it's competition, by choice choosing not to pass it along and not give them price shock in their business or when do you think you're able to pass that along?

I think, of course, the inflation we're measuring right now is year-over-year so we're still running hard to keep up and, in fact, I would say that our operating companies, as Tom may have alluded to, have done an outstanding job of appropriately pricing the product. But we're also experiencing, and that's one of the challenges in our business, a lot of moving parts and that is mix changes in terms of customer mix, but product mix is a big part of that too and as the specialty companies, I think we indicated very nice growth in our specialty companies, a big chunk of that is the meat companies, they're experiencing inflation and although we have some deterioration then in the gross margins, gross percentage margins, the gross profit per case is actually significantly better and would relate then to some expense improvement.

So I think we're, we feel like we've got our arms around the pricing, our systems today are better than they've ever been. Our ability to communicate with those operating companies, so on kind of a equal footing basis I would say that we're doing a good job.

How much of your cost increase have you passed along, do you think, in meat and dairy and I guess those are the two main culprits? You passed along 90% of what we've seen to date in your cost, or 100%?

I would say 99%. It's really again, I would say that our systems, the way we're able to monitor that pricing today versus even four or five years ago is significantly enhanced, and our operating companies are doing a good job and we communicate all the way down to the field, right to that individual marketing associate. So I'm confident we're recovering, and we'll continue to recover those cost increases.

Okay. One final thing. To what degree are you benefitting or do you think you'll benefit from the many supermarket strikes that are out there today? Do you see any benefit or do you think you will?

We'll probably have some benefit. More people are eating out. Unfortunately, as we speak we've got issues with very severe fires in a number of locations around that Southern California area. So there's going to be some balance there also. But we would anticipate if that strike goes on for a while we'll continue to gain minimal, hard to even quantify, but minimal share.

Okay. Thanks.

Thank you.

Thank you. And if you find that you are question has been answered, you may remove yourself from the queue by pressing the pound key. And we will now move to Mark Husson with Merrill Lynch.

Yeah, I don't want to flog a dead horse on the gross margin, but you said 99% has been passed through. Clearly that wasn't 99% pass through in the last quarter. Is it at 99% now or where are we?

When you say last quarter, do you mean the fourth quarter of '03?

No, no, the quarter just reported. In the current quarter, I mean PPI seems to be growing very substantially and it's not clear that anybody's been able to pass through all the cost increases on the protein side yet.

Mark, I think that we do an excellent job of passing along a fair amount of our sales and particularly in the protein area on cents per pound, so if you have a $95 case and now it's a $100 case, we don't have any more gross profit dollars for that case but we also don't have any more expense of delivering it. When you see it, there's a balance there. We think that our system does an excellent job, probably, not probably, we lead the industry in having systems that are able to accurately reflect what happens to cost.

Right. So we ought to be looking at SG&A dollars against gross profit dollars and that's way you think about it?

Yeah.

And then the other thing I'd like to ask about is the deferred tax, it still seems to be rising significantly and in my simplistic mind I had thought after four quarters or so it starts to level off. Can you just talk us through how that works through this year.

Mark, this is John Stubblefield and at the risk of everybody's eyes glazing over on a conference call, let me try to walk through some of the impacts that happens with deferred taxes. Understanding that in our first fiscal quarter we don't pay any taxes on a normal basis, those tax payments are due October the 15th and December the 15th. So there would be no payments made for any taxes that would have been due as a result of our first quarter. Having said that, we will see in this next quarter that comes about, about a 50% of what that current liability shows on the tax side being paid out. So we will have a significant cash flow reduction as a result of paying out the first part of those deferred taxes in this fiscal year.

And then following on to our third fiscal quarter we will have a appropriate payment in that third quarter and fourth quarter as well. So part of it has to do with just the normal timing of when tax payments are made. So what we had then in essence is that going from our current deferred liability that we would have had at the end of last fiscal year, flowing up to what is now termed accrued income taxes on our balance sheet, which we paid out during the course of this year. And then what we then have is then the addition of our current deferral due to our cooperatives that would go to the first quarter balance sheet.

So, again when you look at the total taxes that are due, we will continue to see our total tax amounts slightly rise through the balance of this year, while we start making tax payments on the deferral. Mark, hopefully that helps, and we'll certainly be glad to spend some more time offline if people have some additional questions. I think Diane Sanders has a comment.

I just wanted to add one thing. I think a lot of people are used to looking at that deferred tax line in the cash flow statement as the effect of all of these tax adjustments. There's really a couple of things you have to look at and, like John said, we can talk offline but you've got some provisions being offset by taxes coming due. So it's not as simple as looking at that one line, Mark.

That was my point, actually. Thank you very much. One final question, it's a sort of philosophical question. We've done a lot work on RIC recently and your returns seem extremely high. At what point do your returns get too high. Is there such a thing as the return on invested capital that's too high? Does it become attractive for say, Warren Buffett who's out there looking at how to grow his business?

We've asked ourselves that same question actually and whether we have passed up on some opportunities, whether it's an acquisition or whatever, but as we look at our business, and our ability as we said in the call itself, our ability to continue to squeeze out more gross profit from those trucks and from those facilities, and we still have more room to go, we think we can move the return numbers even higher than they are today at no expense to the overall growth of the organization.

Okay. So you're not seeing any meaningful sabre rattling from alternative foodservice institutions? Are you seeing anything more from [Inaudible] CEO?

It's too soon, that's been about a week and a half or two weeks, too soon to know at this point. We would, if I can say this, we would expect more rational behavior once they have permanent leadership in place at the company.

Thanks very much.

Now moving on to Jeff Omohundro with Wachovia.

Thanks. I wonder if you could expand a little bit on your comments on the growth in business, particularly on the SYGMA side seeing some momentum there, maybe talk about that and the outlook. Also, if you could address the impact the growth in that business has had on your gross margins anyway to quantify that? Thanks.

Well, as we indicated in the release and in our comments this morning, SYGMA is growing very nicely. Some small portion that have growth is coming from new customers. We've picked up some additional business in chains that we already had but we've gotten some more units, if you will. I'm sure you saw Wendy's numbers. Wendy's is our largest customer at SYGMA and at SYSCO. Wendy's had a fine quarter. Sales were up I believe 11%. That certainly having an impact on our business.

We see where maybe two quarters ago you saw some in the QSR sector, you saw some slowing. There seems to be a bit of resurgence there right now and then SYGMA has gone out from just quick service, they're now in casual dining, quick family or whatever we're calling some of those middle tiered categories today, and they've picked up some of that business and it's having an impact on their growth numbers also. So in general, I would say that that business is pretty good right now.

And any way to quantify the margin impact?

No, clearly it is a lower gross margin, net margin business for us but we don't clarify any further than that and when it does grow faster than the rest of our business is growing on a percentage basis, then it does have some impacts and squeezing, if you will, those percentages.

It would correspondingly have some contribution to lower SG&A too.

Thank you.

Thank you.

Now Eric Larson with Piper Jaffray will have our next question.

Good morning, everyone.

Good morning, Eric.

In the quarter, obviously we're looking at just another gross margin question, it appears that mix is probably even more of an important factor than inflation. What is your mix of meats to total, to your revenues today?

The specialty meat companies are under 3% of total sales. Fresh and frozen meat runs about 16% of Broadline sales.

Okay. And that obviously is growing at a faster rate than the rest of the company as well.

Yes, it would be.

And then you talked about sales to your unprofitable customers growing less this quarter than to your profitable customers. The way you sort of position it is, you looked at that like the glass is half empty. Is it because the unprofitable customers just don't have the high enough drop rates yet? Wouldn't it be more of an opportunity for you than maybe looking at it half empty?

No, we're looking at it as the glass being half full. In fact, that is not by accident that that category customer is growing. That's by design and we made some small illusion to that during the call earlier. And our companies are operating companies are, because we know our cost better than we ever have before, they're addressing issues with those unprofitable customers, they're getting bigger orders from them or we're reducing the service to them or in some cases we're increasing the prices. So it's not so much that the customer, each customer in that category is not growing. It's that we're managing the business in such a way that that category will not and should not grow.

In going back to an earlier question, if we look at our better and best customers, we see better growths in those categories than we've seen in the last two years. And those are kind of real year to year comparisons, good year to year comparisons, so we see nice growth in those categories of customers. So part of that is their business being good. Part of that whole formula is our capability to manage those customers more effectively, to stratify them, to segment them and then to have specific programs in place to address their needs and to address SYSCO's needs.

Okay, thanks. One follow-up, one of the statistics that you folks have shared in the past and I don't believe I've heard it recently, is that you had periodically share with us the number of operating companies that would be operating under let's say a 4% EBIT or pretax margin number. Do you know what that number of operating companies would be, let's say below a benchmark of 4% today.

Below 3%. I know the number for below 3%, Eric, it is zero today.

Of comparable companies.

Of comparable companies, Broadline operating companies, a total of 66 or 67 companies, zero are below 3%.

Whoa, that's impressive. Thank you, everyone.

Now we will move to Bob Cummins with Shield and Company.

Good morning, everybody.

Good morning, Bob.

A lot of discussion today has been about the effect of your meat companies on gross margins. A couple of quarters ago we were talking about the effect of your Canadian subsidiary on profit margins. Can you bring us up to date on how their profitability is developing, as well as their growth in sales?

Bob, as you know, we had several initiatives that we wanted to put in place when we acquired the company, now over a year and a half ago. The first was to introduce SYSCO brand to the Canadian marketplace in a much bigger way, and we now have 800 SYSCO brand products being distributed up in Canada. Produce, meat, et cetera. And we're finding that those products are being very well-received by the Canadian marketplace. So we're happy with that. We're seeing the percentages of revenues generated by SYSCO brands in Canada grow significantly.

The second initiative or second general direction that we wanted to follow in Canada was to help operationally. As you know, SERCA before we acquired them was owned by a retail grocery business, good folks, but they didn't really understand the foodservice business. So we've been able to deploy foodservice techniques in their operations in terms of how they pick product, how they deliver product to their customers and maybe more importantly, how they sell product and communicate the values of SYSCO brand and other products we sell out there. And on both those fronts, I would say that we're ahead of plan and very pleased with the overall operation of that total entity and all of Canada today.

Let me add a couple things to that, Rick. One is as we have been comparable on our Canadian acquisition now for two quarters, we've seen year-over-year gross-profit margin increases which means that overall they are helping our gross profit margins as compared with the first year where they were a drag on gross profit margins. However, as they are roughly 5% of sales, the impact is not that great. You have to multiply it by .05.

Right. Okay. That's helpful. Thank you.

Now we will move to Ken Zaslow with Morgan Stanley.

Morning.

Morning, Ken.

Can you comment on why you think the improving economy had a relatively limited impact on your real sales growth?

Difficult question to answer. I would go back again and say that weather, for the pluses we picked up in the economy, the weather probably took it away from us. And then also I would go back and say that as we managed those categories of customers in that bucket we call unprofitable, I think we see some impact there too.

So what we're interested in obviously is profitable growth, and we're today better able to segment, stratify our customers and then have those specific programs in place so we can direct our efforts more effectively and get the kind of growth that we need in this organization.

Ken, this is John Stubblefield. As and again as we look at the industry in total, I don't think we saw this industry decline as much as maybe other segments of the economy declined during the most recent downturn. At the same time, we may well not see as on the front end the uptick in the growth of this industry as the economy begins to recover. So from that respect, we may have some economic, from a macro sense, upside yet to come down the line. Because once again, we believe this marketplace today in terms of the overall industry relatively flat.

Okay. The next question I have is, you've discussed a new sales force structure particular with the business development manager. When do you think that'll actually have an impact on your top-line growth. Has it impacted this quarter or are we still in the sense of building up that, we just haven't gotten the full impact yet?

I think that it, Ken, I think it's had an impact already when you look at our pieces per stop and lines per stop. That focus on helping individual customers improve their business I think is already having an effect. So we're seeing it and it gives us more of an opportunity to focus on our better customers and less focus on the customers that want to divide their business up in many ways.

I would say also, I agree with Tom. I would say also we still have huge upside on that whole sales force transformation, so I think they will accrue for us over the next several years.

Has the business development managers actually started getting like the big fish customers yet or are we still going to be waiting for that? I think that was one of the things you indicated before.

Yes, but let me be clear. The big fish customers are not the big chains. These are big, they're big independents in local market places and we do a great job. When our operating companies perform well as they attack those big fish, we have a high success rate and let me give you one small example, one mundane example if I can. When we bring a big fish customer into one of our operating companies and we go through our explanation of the benefits of SYSCO brand and the services that we can provide to the customer and how we can help them with their business, the success rate when we do that is absolutely phenomenal so to the extent that an operating company, individual operating company is good at that, they continue to get real benefit from it.

So, again throughout SYSCO it's always been and throughout our history, it's always been we're an autonomously run organization, we think that has immense benefit for the company and for our shareholders and it takes us longer sometimes. And so we're patient, but we want to see that continuing incremental improvement in every piece of our business. And so those companies that do a good job are reaping the benefits and all will be on board as we go forward.

Thanks a lot.

Ken, when you like the big fish customer, our local operating company level the quarter million a year, or half million dollar a year account is a really big fish. A million dollar account is a whale and it takes an awful lot of those to move the needle on a $25 billion plus corporation.

That's fair. Thanks a lot.

And we'll move to Steve Chick with J.P. Morgan.

Thanks. Actually, I wanted to ask about, I guess the assets that you purchased during the quarter, I guess one was smart and final. I think those types of file lists and so forth are included in real sales; is that right? And if so, if you could quantify that, the contribution during the quarter?

Steve, that's right. Those sales obviously are in our total sales number. When you look through that list of companies that we acquired that we listed as part of that 1.9% of acquisitions growth for the quarter, the smart and final assets weren't in that. What we typically do not do is quantify the fold-in assets that we buy as they occur during the year. One of the difficulties in doing that is that in those market places where we are doing a fold-in, we already have a very strong presence, which we did in three market places that this company covered, and so trying to distinguish how many of those dollars are actually retained on that type of acquisition is very difficult. It's not as clean cut, clear-cut as when we do an outright acquisition of an entity.

The other issue here is that there were some customers that clearly we did not want to retain as part of this acquisition and those customers went away very quickly. So we're very reluctant to quantify those fold-in numbers because of the complications I spoke to.

Steve, I would also say, I mean, just to put it in perspective. The numbers, the total numbers from those fold-ins are quite small. The bottom-line benefits are nice although again will not move the needle for us. I would also say that our activity in terms of fold-ins is at a high point and we've got processes in place today to bring them into SYSCO in a very effective way so we'll see more of those. The dollars will never be huge, but the impact to an individual operating company will be nice.

Have you done a lot these types of acquisitions in the past or the return prospects now and the opportunities call for doing them now? Have you done a lot of these in the past?

Our history's been that in the past we have and I'll say the past going back over 10 years, we did a fair number of these. In the intervening 10-year period, we've not done a lot of them because we have concentrated on the larger stand-alone acquisitions and we see this as a particularly good opportunity at this point to look at some folks in a localized marketplace that may be ready to make a different decision with their business, so we think there's probably a better opportunity today than what there has been in the past.

Another way to say that, I guess is that we're getting more telephone calls right now, so there seems to be something in the marketplace where individuals are considering what they want to do with their family-owned businesses.

Okay. And within the cash flow standpoint, the amount that you paid out for the quarter for acquisitions, does that approximate, I guess these deals that you did?

Yeah, that's a number of deals that we did, both those that we set out as a separate item and the fold-ins that we spoke to, plus there could be some small amount from earn-outs that would go into that so a combination of several factors.

Okay. Thank you.

And we'll take our next question from Mariann Kotas with Munder Capital Management.

Yes. My question deals with projected inflation and I'm wondering if you can give me a total expectation? And then, Tom, could you address the beef and pork side of that inflation question?

Total, our expectation would be the 2 to 2 1/2% range in normal times. We are still a couple quarters away from that I'm sure. There is some movement over the last few days, I think in terms of the reintroduction in larger quantities of Canadian beef most likely starting in the January time frame. Once that Canadian beef, which represents about 8 to 9% of U.S. consumption, once that starts flowing back into the U.S., I think we'll see reversal in our current trends of high inflation in beef. So, a little bit hard to say but I guess our expectation, the way we model things, we're talking about in normal times 2 to 2 1/2%, but as I said, we're still a little ways away from that.

Is it still 4ish for the next couple quarters?

Yeah. That's probably a good guess.

We're reading tea leaves, but that's our best estimate at this point.

And you had a question for Tom in regard to?

Yeah, to address the beef with a little more detail and pork.

Well, beef, of course, we get hit on two sides. One with our Broadline companies where as we mentioned earlier, it's about 16% of sales and then with the specialty meat companies work, of course, that's almost all of their sales. We've seen beef hit a high mark last week of, I believe it was $102 a hundred weight, been higher than that which is unprecedented. But, again, our system, when we have a new cost it changes our cost, it changes our sale. We think that we pass that on through. It's just that now you got higher dollars and you got less, as a percentage the gross profit dollars fall but as well as the cost of doing business falls concurrently with that.

When you take the combination of the lower herds and the impact of this removal of the ban on Canadian beef, where do you see the beef prices falling to?

I'm not our beef expert. We can certainly have someone get back to you with an expectation. I mean, we've got some experts in our beef area that could probably answer that better than I do. I guess the other selling aspects that I ought to point out in this time was the reach levels like this, because there's a shortage of the most desired products in the marketplace, and I think that our size and the partnership that that we've developed with many of these suppliers are going to ensure that we continue to have the products our customers need before some other people in the marketplace might be able to get exactly what they want.

Okay, thank you.

Thank you.

Thank you. And due to time constraints we'll take our last question from Mr. Mitch Speiser with Lehman Brothers.

Thanks very much. Can you talk about the -- I got a few questions but the first one is on the RDC's. You mentioned it'll be operational in the fall of '04. I believe last quarter you were saying summer '04. I'm just wondering where you might be experiencing some delays and if that does affect that $275 to $325 million target for the cost of getting this first one up and running.

It really doesn't impact the cost. We have moved it back a bit and I will tell you that it's all in software, software development and integration. We have done extensive testing on the software packages that we're using. They're the most sophisticated available. I will say that we are very pleased with the capabilities of the software to do what we expect it to do. It's just really in timing of the integration itself with our systems and with each package together. So the transportation system has to work with the warehousing system, has to work with the order entry system, et cetera. And, again we're very pleased with it. We're just being absolutely sure that everything is working properly before we turn the switch on.

And then I would say also that even opening in fall of '04 there will be, as we said before, there will be a ramp-up period, so we're not going to see this huge impact to our business the first two, three, four months. I mean, it'll take a little while. But the dollars, the dollars are right in line with our expectation.

Great. And moving along, can you give us a sense of what percent of your street customers also use U.S. foodservice and within those customers are you seeing stronger sales growth? Perhaps you're taking more share within those existing customers?

Frankly, Mitch, we don't have much of a idea. I will give you one kind of surprising thing. When we do acquisitions, stand-alone acquisitions we do overlays of their customers versus our customers, we do that in a very confidential, we use a third party. We never see the data but we want to see the percentages, and we're always dumb founded to find that the overlap in our customers versus the potential acquisition is so small. Generally running less than 20%. So it just confirms for us that we still have enormous opportunity out there in the marketplace.

Great. And moving along, your ROE, it actually declined a little bit sequentially from the fiscal fourth quarter. It's been rising I think for about five consecutive quarters. I was wondering if you could just comment on that in particular?

Mitch, I believe that in the fourth quarter we took a charge against equity for other comprehensive income related to the pension plan performance and that lowered overall, that took a large drop to shareholders' equity which would raise the ratio. This quarter, of course, we didn't have that. And so it was much more in line with just earnings and share buy-back.

Got it, understood. And moving along, in October--

The last question, Mitch.

In October, can you give us a sense of food cost inflation has actually upticked since September?

No we don't, at this point we don't see any significant changes in the inflation.

Great. Thanks very much.

I thank you, Mitch.

And that will conclude today's question-and-answer session. I will turn it back to Mr. Palizza for closing remarks.

Thank you, Jake. Thank you, everybody for being on the call. If there is additional things that you need cleared up, please give me a call at 281-584-1308. Thanks.

Thank you all.

And that will conclude today's conference. We do thank you for your participation and you may disconnect at this time. Have a wonderful day.

Thank you.