西斯柯 (SYY) 2007 Q2 法說會逐字稿

Good day everyone and welcome to today's Sysco Corporation Second Quarter Fiscal Year 2007 Earnings Release Conference Call. As a reminder today's call is being recorded. [OPERATOR INSTRUCTIONS]

At this time for opening remarks and introductions, I would like to turn the call over to Mr. John Palizza, please go a head sir.

Thank you. Allow me to add my welcome to everyone for joining us on today on the call. With me here today are Rick Schnieders or Chairman, Chief Executive Officer and President, John Stubblefield, Executive Vice President and Chief Financial Officer, Larry Accardi Executive VIce President Contract Sales and President of Specialty Distribution Companies, Ken Spitler, Executive Vice President and President of North American Food Service Operations, Larry Pulliam, Executive Vice President Merchandising Services, Ken Carrie, Executive Vice President and Chief Administrative Officer, Bill Delaney, Senior Vice President Financial Reporting and Kurt Drummond, Senior VIce PResident of Finance and Treasurer.

On the call today I'll give a brief summary of the quarter and then Ken Spitler will provide a detail overview of our operating performance during the period and Rick Schnieders will conclude our prepared remarks by discussing key financial results and updating you on the progress of some of our initiatives. This will be followed by the question and answer session which Rick will moderate. During the question and answer session in keeping with the procedure we established last we ask that you limit yourself to one question and a related follow-up question. This should allow time for everyone to ask a couple of question, if you have more question please feel free to get back into the queue.

I'd like to make one quick announcement at the start of the call. The 2007 Sysco Analyst Day will be held this September in Boston. This year we are working our good customer, Legal Seafoods to give everyone a great seafood dinner on the evening of September 20th, followed by a day of detailed revenue of our operations and business plans on September 21st. So hold the dates September 21 and 20 and we will provide more information we get closer to the event.

Now allow me to read you our safe harbor language. Statements made in the course of this presentation that state the Company's or management's intentions, hopes, beliefs, expectations or predictions of the future are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and actual results could differ materially.

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 risk factors contained in the Company's quarterly report on form 10-Q for the quarter ended September 30, 2006, and in the Company's press release issued this morning.

To start things off, here is a quick overview of the quarter. Please understand that all comparisons refer to changes between Q2 fiscal 2007 and Q2 fiscal 2006 unless otherwise noted. Sales were up 7.5%, reaching $8.569 billion. Sales for the quarter were reduced due to accounting pronouncement EITF 0413 which decreased reported sales by approximately $85.5 million or 1.1%.

Sales from non-comparable acquisitions contributed 1% to the quarter sales from six different companies, one fresh cut meat company, three specialty produce companies, and two SYGMA companies. Inflation in our cost of goods increased slightly from the first quarter with cost of goods increasing 2.6% in the second quarter based on our internal measure of inflation.

In Q2 we experienced slightly higher costs in canned and dry, frozen, meat, and produce categories. Continued lower pricing in poultry and dairy helped to offset some of the inflation during the quarter. Net earnings were $236.7 million in Q2, an increase of 15.9%, and diluted earnings per share were $0.38, up 15.2%.

In summary, we continued to achieve solid sales growth combined with lower expenses which resulted in good gains in earnings. At this point I will ask Ken Spitler to step in and provide a more detailed discussion of operations in the second quarter.

Thanks, John.

Before talking about our basic operations, I want to discuss a couple of accounting items that continue to impact the results. First, this is the third of four quarters in which we are non-comparable to the prior year on reported sales due to the effect of EITF 0413. As a reminder, this the accounting pronouncement requires that in situations where you purchase product from a customer and then later resale the product to the same customer, you net the purchase and the sale and only record the gross profit resulting from the final sale.

This situation arises four Sysco when our customer has a proprietary item which they have either manufactured or sourced, but they require our distribution and logistics capabilities to get the product to their restaurants. The result of this change in accounting principle lowered our reported sales in Q2 by approximately $85.5 million or 1.1%. Raised our reported gross profit margins as a percent of sale by 19 basis points and raised our operating expense ratio by 14 basis points.

The second item relates to our corporate-life insurance policies. This is the second of four quarters we are non-comparable on this issue. As previously communicated, in the first quarter, we elected to treat the insurance policies under the cost method rather than the previously utilized fair value method. The accounting change will eliminate the earnings impact of fluctuations in the fair value of the life insurance contracts.

In Q2 operating expenses were higher compared to fiscal year 2006 in part because last year we incurred a 3.6 million gain for the carrying value of the life insurance assets. With that on out of the way, let's now focus on the fundamentals of the quarter.

During the second quarter we continued to execute on our operating plan which resulted in strong sales growth and lower operating expenses. We continue to outpace industry growth with sales up 7.5% in the quarter including the impact of EITF 0413.

Our business review process and initiative to grow the number of customer contact personnel both contributed to our strong sales growth. We conducted approximately 20,000 business reviews year-to-date with our U.S. customers, an increase of about 11% over the same period last year.

We continue to see strong sales growth at these customers, and it is our plan to continue performing reviews for the years to come. Sales were also helped by continuing to increase our customer contact personnel which grew by 151 employees since the start of the year. Gross profit margins increased 2 basis points in the quarter to 19.3% including a 19-basis point improvement due to the impact of EITF 0413.

In turn, gross profit margins reflect a decrease on a comparable basis. The primary cause of lower margins was the impact of inflation on our customer and supplier pricing.

In addition, certain lower margin segments grew faster than our broad line during the quarter. Total operating expenses were 22 basis points lower than last year in spite of EITF 0413 causing an increase of 14 basis points which resulted in a year-over-year improvement of 36 basis points on a comparable basis. As expected, operating expenses were favorable due to pension and share-based compensation expenses.

Ending the quarter about 13.7 million and 12.6 million lower respectively. As productivities increased through the system and processed improvements we continue to leverage payroll related costs with wages and benefits as a percent of sales decreasing in all areas except selling. Sales expenses were flat as a percent of sales.

As we continue to add customer contact personnel as planned. We have also begun to see lower expenses in other areas as specific initiatives begin to pay dividends. Our initiative to lower energy costs across operations is well under way, and we are pleased with the results. The operations group has begun -- has been installing devices to monitor and better control electricity usage in the operating companies. We feel this will provide substantial gains in the future. Offsetting some of the reductions in the operating expenses were higher strategy initiative costs and bonus expenses.

As you may recall from previous communications, we began the strategy initiative in the third quarter of last year. Costs for our strategy initiatives, some of which related to sourcing and integrated delivery were 11 million higher in the second quarter and 21 million higher year-to-date. Bonus expenses were 7 million higher in the second quarter and 15 million higher year-to-date.

One other item to note is that our tax rate was 56 basis points lower than last year which was primarily due to tax benefits related to share-based compensation. I will finish by saying that we are pleased with the direction of sales and the vitality we see in the customers we serve. We are seeing favorable trends in key areas of our operating expenses and expect to continue building on this momentum.

Now for the final portion of our prepared remarks our Chairman, CEO, and President, Rich Schnieders will share his thoughts on financial results as well as provide an update on some of our key initiatives.

Thanks, Ken. Halfway through fiscal 2007 I am pleased with the overall results and encouraged by some of the trends we're seeing. We're beginning to see a return on several initiatives and our focused on other to say ensure we deliver solid results down the road. In terms of sales growth we delivered growth well in excess of the industry average of 1% to 3%.

Sales growth was down slightly from the growth in the first quarter in part due to severe weather conditions and certain areas of North America. Winter storms in the Midwest and northwest impacting sales to both U.S. and Canadian customers. However, the business review process and our initiative to grow the number of contact people provided good, positive sales trends. We continue to experience strong sales growth through business reviews with no slowdown in sight.

As previously stated by Ken, our operating expenses were down significantly from last year. We are leveraging operating costs at our broad lane operating companies. Embedded in the corporate cost structure are incremental costs for bonuses and for our strategy initiatives which represent continued investment in the future of our business. We're starting to go see a return on our earlier investment such as personnel and energy management. Payroll related costs as a percentage of sales are down in all cost centers except selling. We're experiencing lower electricity usage as a result of our energy initiative.

One final expense topic to touch on is diesel fuel. Fuel costs in Q2 were relatively flat compared to the prior year period. Much improved for what we've seen during the past five quarters. We've purchased forward fuel contracts that cover a significant portion of usage through the balance of calendar '07. The fixed pricing on the contracts will limit our exposure to major price changes over the year. I feel good about our progress in lowering operating expenses but also realize we have to continue to improve. Cost reduction in an ongoing process, and it is important for us to build off this momentum.

The Northeast RDC continues to ramp up case volume. We're currently shipping about a million cases per week and still expect to increase the volume to about 1.3 million cases by fiscal year end. We saw an inventory decrease in the Northeast during December as the operating companies began to adjust safety stock. Construction is under way in the second RDC located in Florida. We expect this RDC to be operational during the third quarter of fiscal 2008.

Last quarter we spent time discussing sourcing, one of the major focus areas within our strategy process. Let me bring you up to date. We recently completed Phase I and are pleased with the participation from our suppliers. This phase included the rollout of six product categories for which costs are now being negotiated centrally. The next phase is in process, and includes another 20-plus product category and is more than $1 billion of annual purchases. While it is still early to quantify the results for Sysco and our customers, we're encouraged by what we've seen thus far.

Last week was Sysco's 2007 sales, merchandising and marketing conferences in Houston. It gave us the opportunity to talk to key personnel from all over North America American broad line operating companies and is many of our suppliers. The theme of the conference was changing the way we view buying and selling.

We're exploring smarter ways to grow our business. We presented the latest and greatest products in every category, provided fresh ideas for building sustainable growth and introduced new additions to Sysco's arsenal of sales tools. I will share one conversation with a supplier. He expressed concern about the supplier/customer relationship becoming a race to the bottom in terms of cost. The continual push to lower costs can sometimes be at the expense of quality.

We found at Sysco that there needs to be a balance in the food service business. Cost is important, but quality is equally important which is the driving force behind our Sysco brand products. Our business is more than just squeezing margins to distribute product. It is about getting the right infrastructures to our customer when is they need them.

The conference was a great success, and we're excited about the new tools our operating companies can use to further develop their businesses. In closing, I am encouraged by our results, and we've seen numerous positive trends developing. I also realize we need to capitalize on our opportunities and to grow -- continue to grow the business.

We're looking for sales growth to improve as our investment in selling and headcount matures and we continue getting closer to the customers through strategic acquisitions and fold-outs and we are looking for further cost control across the organization as we better leverage sales growth. Operator we will now take questions.

[OPERATOR INSTRUCTIONS] We'll have our first question from Meredith Adler Lehman Brothers.

Hey, guys, I would like to focus a little bit on the strategy initiatives you talk about, kind of understand where that shows up, is that corporate, and are those items as you see as recurring or is that going to level off at some point? Will you continue to add to those costs, just trying to understand that better.

Meredith, no, those -- the impact of those initiatives shows up at the operating companies, and we'll continue to show up at the operating companies. It is not something that's reflected in any sort of corporate numbers. And, in fact, no, we have so much work to do there will be no flattening out, both outed sourcing side and on integrated delivery which is really running our delivery and warehousing functions more efficiently, and we just have an enormous amount of work still to do there. The operating companies over the years have done a tremendous job in terms of driving their costs and driving the costs lower, managing the gross margins, managing their sales, but now it is important for us to first of all buy like a $33 billion organization as opposed to a collection of 172, $300 million companies, and we can also gain significant benefits by operating certain warehouse functions, certain delivery things in a more standardized way. There is no flattening out on the horizon.

Then my question is actually about corporate because you usually focus on performance of the operating companies, but I believe your corporate expenses have been going up even if you put bonuses aside. Could you talk a little bit about what's happening at the corporate level?

Well, I am kind of look to go John Stubblefield now. I will start off and ask for his help, but frankly if you take bonuses out, and you take out pension, you take out stock option expensing, corporate expenses, I don't see any increase in the corporate expenses.

The one area where we continue to show some increases is in the IT area, and the reason that shows somewhat at the corporate level as opposed to being distributed out to the operating companies, whenever we make a strategic decision at the corporate level that over the longer-term will benefit the whole of the organization, we may or may not allocate those additional costs out if on the front end they may well be higher than what they had been incurring in order because remembering that we're very heavily incentive-based compensation at our operating company level as we are at corporate, but to penalize them for longer term strategic decisions on the short-term doesn't the proper direction to take. In some instances instead of allocating those cost out which we would normally do for direct-incurred costs, we will go ahead and hold those at the corporate level until such time as we've normalized. Now, having said that, what that does mean that you still have to focus on the bottom line and look at the overall results of the organization.

The other impact that Meredith we had and that was in the first quarter but certainly impacted the year-to-date numbers, and that's the COLI adjustment where we took $39.7 million expense in the first quarter because of the change in the accounting. That would show an increase in corporate expense.

But if you X'd out the things we know change, like stock options and pension, you're saying that corporate hasn't gone up very much other than IT expense?

In strategy we identified strategy $11 million, but for the quarter and $20 million for the year, but that shouldn't -- those are the numbers. Otherwise the net numbers if you take out option expenses, pension expense and COLI, it is actually -- and the bonus, take the bonus consideration, it is actually corporate is growing slower.

Strategy I thought you said was in the operating company?

Oh, no, I am sorry, the cost for strategy, the benefits -- thank you for clarifying that. The benefit and is the operating are in the operating companies, the costs are at corporate.

Got it, okay. I'm sorry. Thank you very much.

Thank you.

Thank you, Meredith.

We'll go next to John Heinbockel, Goldman Sachs.

Rick, a couple of related questions. Where do you think Sysco brand sales as a percentage of MA or broad line, where do you think that ultimately kind of finds its bottom, and I imagine that was a fairly significant gross margin impact this quarter or no?

No, I don't think it is a significant impact to the gross margins, John. In fact, what's happening, I am going to ask Larry Pulliam to give us a little more clarification here in just a second. In fact, what's happening is most of the loss in Sysco brand percentages is coming at the lower end of the scale which is specifically I am sure you remember reliances are kind of our price label, price brand, and it is that one that's where we're seeing some deterioration in the percentages, but, Larry,let me ask you to add to that.

Yes, John. We kind of discussed this a little bit at the last quarter, and I think you probably know, we watched the Sysco brand very, very carefully. We manage and benchmark it in every category by operating company, by brand, by SUPC, a lot of different ways, and it is very important to us, and we watch the progress, so as we plan out the future, and I will say we don't know specifically where it is going to end up, but what we do know is is that as Ken said earlier, we're going to make sure we have the right products for our customers. Having said that, we've seen some I think pretty incredible growth in some of our high-end brands, supreme, for example. Natural produce is a good grower, Newman's own, our Citrus Natural organic lines, Butcher Block and several of the other high-end Sysco brands are growing both in sales and in case growth. The other more commodity-driven products that fall, usually fall within our reliance category is decreasing, and you know what? We made the decision that we want to have the right product available to our customers and in some cases we feel like a supplier brand or packer brand better meets their needs and so we feel very comfortable with that progress as a matter of fact?

John, this is John Stubblefield. Just to add to that a bit, I think one of the things you got to take into consideration also as we look at the Sysco brand as a percentage of our total sales is what is that trade-off on the top line in terms of additional products or additional pricing opportunities maybe to increase the top line to our customers, so I think it is the mix that's important that gets us to the right leverage on the bottom line.

Sysco brand gross profits would be up nicely year-over-year, gross profits in dollars?

Yes. The high-end Sysco brands are doing very, very well, and then of course the low end brands, they've never been a huge profit contributor. They've been a product we made available to the marketplace, so I don't see a significant impact to the margins on that particular segment of the business.

Finally, what's the trend in broad line drop sizes? Is that growing, and by how much do you think?

When we looked at the trending metrics in the quarter, we saw a nice pick-up of about 1 to 2% in terms of drop size, pieces per drop size. Which is a very nice improvement.

Thank you.

We'll go next to Mark Husson HSBC.

Good morning. I just wanted to explore the inflation impact you're seeing right now. We see this kind of bad inflation that pops up every now and then in commodity prices. Can you say whether that's leveled off now? Are you having smore success in passing this through to the customer base and I guess the follow-up is going to be as you move to more central buying, will you be less at risk to these kind of commodity moves throughout the year?

Well, Mark, inflation is now -- well, as we mentioned in the script, 2.6% which is just about exactly at historical levels. We consider historical levels to be 2 to 2.5%. That allows us to pass along the increases in pricing much more effectively than when we're at significantly higher levels of inflation as we were in the last couple of years when we got up in that 6% and 8% range. It is just very hard to keep up, so the 2% to 2.5% range is actually I think pretty comfortable for us allows us to manage the pricing appropriately and work with our customers to do the kind of substitutions we might want to do without destroying the product mix itself. I think inflation is at a good point for us, and I think we can manage it effectively.

But you had said on the press release, I guess, that you had some problems passing through inflation as a comment on the gross margin. I am just wondering what that meant, then, especially as you've got some capture on central buy, you would expect gross margin to say improve and not go the other way.

We have to remember that in terms of the sourcing initiative, we're very, very young into that. We've done six product categories. We're just beginning the next 20-plus categories, so that's not having a huge impact at this point. I mean we're very confident that it will have an impact for Sysco and for our customers. Your point going back to our comments in the script that it has had an impact on margins, I think it's had an impact, but it doesn't have, it is kind of responding to your question about historical basis. It does not have the kind of impact it has had in the past when we've had those significantly higher inflation rates of 6% and 8%.

Okay. So inflation wasn't good, but it wasn't bad?

Yes. I think that's right.

Okay. Thank you.

Actually I think it was okay.

[OPERATOR INSTRUCTIONS] We'll go next to Jason Whitmer, Cleveland Research Company.

Thanks. Good morning. Rick, I wanted to go back to something you briefly said before you concluded in that you're trying to balance the cost opportunities with quality and things of that nature. As you look at your strategic initiatives and a lot of the opportunities, whether it be through strategic sourcing with RDC, how are you looking at trying to reinvest some of that if any particularly within the pricing complex out there, near term and long-term? Is there any specific thoughts and magnitude on timing of things like that?

Yes. I mean two answers. One is on the short-term frankly our pricing methodologies are not very scientific, and we are, however, passing on -- we are sharing that with our customers, sharing some of that sourcing benefit with our customers, a portion of that that. In the longer term as our pricing becomes to use the phrase more sophisticated, we will do that on a selective basis when we have an opportunity to grow a particular category of product or when we have an opportunity for strategic customers to acquire strategic customers or to penetrate strategic customers, so I think absolutely we're going to share some of it, but we'll also use some of it for the earnings of the company.

And my follow-up question is really on the infrastructure changes that are likely forth coming. Certainly you bring more things through Houston or regionally in general. Have you been going through sort of a reorg with the operating companies and obviously the question always comes up how are the cultural shifts being managed near-term and long-term?

Well, culturally, and I will let Ken and Larry respond to this also. Culturally, I think we have made what I would call significant progress. In fact, the operating companies have been very, very supportive of the sourcing initiative and the integrated delivery initiatives, and we're getting great compliance in the operating companies. This is a bit of a new way for us to work, but the support, the enthusiasm, the spirit of the operating companies as usual has been just terrific, so anything to add there, Ken?

Jason, we spent an awful lot of time working and making sure that everybody is on the same page that we are. They in the operating companies are very anxious to -- and understand the benefits of these initiatives and have bought in. That doesn't mean we don't have a bump in the road here and there, but they're totally bought in, and if the compliance has just been better than we have expected, so as we go through our changes the way we do business in the operating companies, the success so far has been really good.

Jason, I would add that we spent a lot of time on sourcing from corporate, but we also Incorporated a lot of people from the operating companies to help us along the way. This is not just a corporate initiative if you will. We've made a lot of changes, so in fact corporate procurement now is just doing work differently. We in some cases have stopped doing some work we did before and have concentrating on a new way to provide the lowest total procurement costs for our customers. Having said that, I think there is another fundamental maybe we even under estimated, and that is that Sysco operating companies are performance-based organization, so whatever we do that is good for them and good for our customers and good for our earnings, they jump right on, and I think they see this as a very positive move for the organization, so culturally, I think it fits very well with what we've been doing for the last 35, 36 years.

Great. Thank you.

Keep in mind it is not just sourcing, too. It is other operational initiatives, too, where we've implemented a different process of implementation.

Thank you very much.

Thank you.

We'll go next to Ajay Jain of UBS.

Just a couple questions. I realize in the past you said there would be no separate or ongoing visibility on the financials for the RDC given that it's now fully integrated facility. At the same time I remember at one point you indicated that it was expected to be better than break even for the fiscal year, and I was wondering if there has been any change in that assessment directionally? At a minimum would you be able to confirm that benefits should exceed the costs for the year?

We would stick by our previous suggestion that we anticipate it to be positive for the year.

And at this point is it fully loaded with inventory and fully operational?

It is fully operational, all functions within the RDC operating companies so things like the PAL,DPAL, transportation system, all of that is fully operational, but we're not as I mentioned in the script, we're at a million cases a week right now, and we're calling full-ramp a million three. In fact, the facility will do significantly more than that, but that's to get us to where we would like to be. I will also tell you that as we said in the past, I think in the last quarter the operational metrics are actually exceeding our expectations, exceeding our business case, so we feel very good about the RDC, the first one of course. We are now moving ahead aggressively on the second one after having some land issues, actually having some ground issues for construction, but we're under construction in Altach, Florida, and we anticipate that will go more smoothly than the first one because we ironed out a lot of the bugs you find when you open something as big and complex as that.

Great. And I don't know if you can comment on this or not, but given that you've got the extra corporate costs for implementing all of these different growth initiatives, as you take that into account with the expense leverages from options and pension, bonus and warehouse expenses, do you think the year-over-year cost comparisons should improve even further over the rest of the year compared to what you saw? The first half?

This is John Stubblefield. We're very encouraged with the operational costs and the direction we're seeing going there. One of the things we tried to do is give you some additional visibility into the financials this quarter. You certainly had visibility to the options and the pension expense reduction this year, but there is some -- while they're not necessarily one-time, there are some exceptional costs, non-direct operating costs if you will that offset some of those costs pretty much so that when you look at the bottom line, you're really getting back to the real operating results of the organization for the period. As Rick said, many of these costs are costs that we will see reoccurring in the future, but we also believe they're costs that will directly result in net gain benefits to the organization in the near-term and certainly in the longer-term.

And lastly, just on the inflation discussion, my understanding has been that there generally shouldn't be any negative impact in terms of gross profit dollars from higher inflation regardless of gross margin impact. Is there a fair read-through in terms of your second quarter performance?

As we talk about inflation, we have to remember that as good as we are about passing through costs, about 50% of our business is done contractually which says you always have a lag built into that in terms of when that contract reprices, it could be weekly, it could be monthly, but there is a built-in lag in our system. At the same time we do have some inefficiencies in our processes because we have over 5,000 people out on the street contacting customers, managing those price increases, so there always is a little bit of lag, but I guess I will say that structurally we don't see any changes to our gross margins that we find uncomfortable.

What we see is a normal sort of lag as prices rise, as we begin to incorporate those increased costs into our pricing, and we'll see that benefit stay at the same levels as we would come to expect.

Ajay, this is John Palizza. Your assumption is correct, is it supplies to product that is are priced on a per pound plus a fee basis or per case plus a fee basis which is a lot of our contractual business in the meat business, and meat as we know is one of the larger inflation categories this quarter.

Okay. Great. That was it. Thank you very much.

Thank you.

We'll go next to Eric Larson, Piper Jaffray.

Good morning, everyone.

Good morning, Eric.

Just a quick question on some of the weather events that took place in late December early January. Obviously your Noble division in Denver that whole area was basically shut down. Was there an impact in the fourth quarter and/or would there be a carry over impact in the first quarter related to all the weather conditions in Colorado?

Eric, we can tell how long you've been following us in calling our Denver operation Noble Sysco. We actually changed the name a couple years ago, but many of us like you remember the grand name of Noble in Denver and Albuquerque. As we suggested in the call earlier, yes, there was an impact to sales in the second quarter, our second quarter, fiscal second quarter, and, sure, there has been some impact in the third quarter in January from the weather that we saw. It was pretty as you know, it was pretty broadly-based running from roughly New Mexico to Vermont, so it cut a pretty good swath. The good news is of course with Sysco's geographic dispersion and our diversity of products and customers, it has an impact to the business, but it doesn't have a catastrophic impact because we're kind of all of that mitigates, products, geography, customers mitigates the impact of any one event.

Rick, I just have to say it will always be the Noble division to me. I probably will keep saying that for years. When you look at kind of Q1, it tends to be -- it tends to be a fairly much back-end loaded quarter, kind of the March quarter. Is that still pretty typical of your trends as well, Rick?

Yes. No question, Eric. March makes the quarter, but we remain very optimistic about the direction as we said in the script that trends are very, very positive.

Okay. Great. Thank you, everyone.

Thank you.

We'll go next to Bob Cummins, Shield & Company.

Good morning. Thanks.

Hi, Bob.

I want to be the first one to say fair well to John Stubblefield who we've know for quite a few years and wish him all the success in the future and hello it Bill Delaney whose a familiar name from years gone by.

Good morning, Bob.

Hi. I wanted to follow up on the RDC program. You mentioned essentially that Virginia is in the black as you calculated. As you roll out the program across the country, will this have a meaningful positive impact on your costs and your profit margins based on your experience to date, and following up on that, what's the timing now for the construction of the third and fourth RDC locations?

Yes. In terms of meaningful benefit to the organization, absolutely. As you recall, we did front end load all the RDCs with costs, particularly the fairly significant IT costs which ran somewhere around a couple hundred million dollars, and so that's not although there will be some additional IT costs, nothing of that size, that scale, so we anticipate that the more we open, the better it gets frankly. And that the margins will be impacted, the costs will be impacted, but most importantly our customers will be impacted in a very positive way, and that will drive sales growth. So absolutely meaningful. We don't have a schedule for three and four.

I mean we're looking at getting Florida up and running in '08 as we mentioned in the script, and then we do have the land purchased for the third one in northern Indiana, and we don't have land purchased for the fourth one yet. We're in the process of doing some modeling right now to determine just how many and exactly where the rest of them should be located, so that work continues on, but we feel very obviously we feel good about it. We wouldn't continue on if we didn't, but as we said earlier, the business case is actually were exceeding the business case right now even though we're not quite as full ramp yet.

Great. Great. Thank you very much.

Thank you.

We'll go next to Alec Patterson, RCM Investment Management.

Good morning. Just a couple ones on operating expense. You mentioned fuel looking flat year-over-year. Were you talking in dollars or in margin?

As a percent of sales, as a percent of sales.

Okay. So it is creeping up with so to speak units, is that a fair way to describe it?

Not at the same rate. In fact, the miles driven were significantly fewer as a percentage than the sales growth. If you look at percentage of sales growth which if you add everything in is roughly 8.5% or 8.6%, the miles driven were significantly less than that.

So you're still feeling kind of a year-over-year fuel per gallon increase, but what I am getting to is you talked about how you hedged this and so we should expect this to continue to be creeping up not quite at the rate of sales but creeping up?

What should be creeping up?

The fuel costs.

The fuel costs per gallon?

All in.

No. All in I would say we're expecting to be flat.

Uh-huh.

Fuel costs should be flat.

Oh, okay. Good. And then you mention in the release that warehousing costs were getting further under control. You talked about the trying to reduce the utility bills, et cetera. Was that specifically what you were referring to or is there more to it than that?

There is more to it than that. In fact, I think we also said that personnel costs are lower in every category except sales which means that warehouse and delivery are lower, and that's not just related to energy although there has been significant progress made in energy use in our operating companies. I guess another way to look at that is it is also productivity. It is productivity improvements that we're seeing also.

Okay. As opposed to an actual head count reduction, this is just a leverage effect.

Absolute leverage effect, great way to say it.

Okay. And then on the bonus increase you talk about 7 million in the quarter, 15 year-to-date, and does that imply a run rate, and I presume this is an accrual?

Yes, it is an accrual, and we're not giving guidance on the run rate going forward. We want to give you insight as to the results in the first two quarters.

Would it be fair to say that's up fairly significantly in percentage terms to say last year?

It is. It is not a large percentage as you can imagine, 7 million on 8 billion, but it is up as a percent based on the increase.

Okay. But I presume that this number is somewhat is based upon a forecast of actual earnings growth for the year?

That's precisely correct.

Okay. And then the IT spending you mentioned on the RDC where you've spent hundreds of millions on that and it is more or less behind you, was the IT spend amortized or all booked?

That was all -- it is capitalized in the category where is it could be capitalized and expensed where it was appropriate to expense it, so the predominance of it was capitalized.

And does that capitalization run out shortly or is that for several more years?

That's for several more years.

Okay. And then lastly on the centralization effort, the 20 categories you're moving to with a billion purchasing power, are those predominantly overwhelmingly merchandise sales items or if some of these or a lot of these you mean its that you're using SG&A type items?

That's all merchandised for resale, all of that. We today have a process by which we're buying truck and is oil and tires and that sort of thing, but what we're talking about here in the sourcing initiative is strictly items for resale.

Okay. Great. Thank you very much.

Thank you.

We'll go next to Stephen Chick, J.P. Morgan.

Hi. Thanks.

Good morning.

Ken in your remarks I think you said that the sales contact personnel increased by 151 or today, and I think that's a little lower than what I had been maybe estimates, and lower than your run rate of a year ago.

It is.

Okay. Are you still -- what percentage increases at in sales contact personnel and are you still striving for an increase of 7% by the end of the year?

Typically we're behind on that probably 50 people or so, and I am looking for usually the second half of the year right around January is when we do a lot of people -- add a lot of marketing associates. We have training classes, really be able to judge where we're at the end of the third quarter, but right now we're running a little bit behind which is not disturbing, but I wish we had about 50 or 75 more right now.

Okay. Is the base to you I don't recall how many total contact personnel you have. Is it roughly 10,000 or about a 1 --

It is about 10 plus.

It is 10/5 for total customer contact personnel. It is about 8,000. It is 8,000 for marketing associates.

Okay. And then second thing to clarify related to the kind of 30,000 foot long-term I guess you could sigh guidance that the RDC benefits will exceed costs, and your reaffirm of that by the end of this year, for this quarter are you kind of at that level now? Did you speak to that?

We didn't speak to it. You're talking about for the third quarter?

No, the quarter that just passed. Are benefits at that point where you exceeded the costs of it or are we still a little behind there?

We are at our expectations or a little ahead.

We're very pleased with where it's at.

We're very pleased with where it's at.

I think that's all you're going to get Steve.

Thank you.

Thank you.

We'll have our final question from Andrew Wolf, BB&T.

Thank you. Just on the RDC, I think looking at some past transcripts, back in September you said you were doing about a million cases a week, and could you explain, maybe your last answer alluded to it, and maybe you don't feel pressed given that the metrics are good, but is there any kind of vendor related thing where you got to train the vendors or work with them as you had to in the past? Is there anything retarding the progress you're trying to make or is that just the plan?

The only thing that's really retarding things right now I would say is mostly related to the season, so we're going in -- we went into the second quarter you're coming into the holidays. You're into now January and February which as you know, Andy, slow times of the year, so it is mostly just related to demand out there, but seasonal demand, nothing unexpected, so we have no -- sure we've sorted of suppliers in and out of the modeling, but at this point we don't see any issues related to the supplier and is achieving our goals.

Plus we bring them on in groups, and one of the things around December with the holiday season we're pretty reticent to do that, so again we bring vendors on in groups which mean when is you bring them on in groups you have groups of items that come all the time so you see these spikes, sort to speak, the way we bring them on.

Great. That sounds very understandable. To the costs you alluded to and called out in the release for the strategic initiatives, I just want to try to understand, you may have hit upon this and I didn't understand it, but in any case those are gross numbers, right, first of all they're not net of associated benefits?

No, no, those are just gross numbers, just the expense side of it.

And are they just for the people who are actually doing consultant fee costs or also include certain investment costs as you're implementing at the I guess operating company level or in Houston, the central buy willing and putting the infrastructure in?

It is people and consulting only.

But are some of the people part of the central buying office or is it also just the strategic group, the people within the group?

Well, there is some kind of mixing now as the process moves forward, and a lot of the sourcing work actually takes place in BSCC and in the operating companies, and so there is -- there are those costs that get a little muddled if you will, but we're trying to be as honest with ourselves as we possibly can, and those are the all-in costs related to getting this work done with no net of benefits.

Okay. Just a follow-up to one of the questions was you got 20 categories to come. I mean that doesn't sound like it comes close to the opportunity in central buying. First of all, is that accurate, and secondly, you've done six, you've got 20. Are you just going to end it there or do you have 10s more beyond that?

We have many, many more, not to suggest that we would ever buy everything through this process, but we have lots -- we're just getting started here. We actually -- the second group, the 20-plus categories, we're calling that pilot. We still have an enormous amount of learning to do yet, and as we suggested earlier, it's gone very, very well and the operating companies have done an outstanding job folks in strategy and corporate office, but we have lots and lots of opportunity. It is just getting started.

Okay. And the last question on that -- on central buying is when will it exceed -- well it really start to ramp up as something that will save the Corporation a lot of money?

We're not talking about that right now, Andy. We haven't disclosed anything in that regard, but I would say I would just say something that either we said in the release or the script, and that is that we're very encouraged by the process, by the progress we've made.

Okay. Thank you.

You bet. Thank you.

That does conclude the question and answer session. I will turn the conference back over to Mr. Rick Schnieders for any additional or closing remarks.

Thank you, operator. I would just like to take this opportunity first to thank our operating companies. We've mentioned several times in the call, what Yo people's work they have done, Yo men and Yo women's work they've done in regard to these new strategy initiatives. They've just really, really moved forward with the right kind of spirit and right results, and net overall we feel very, very good about the business as I hope has been conveyed here this morning and in the release, and lastly just to remind you we have our analyst day in Boston in September, and we would look forward to everyone coming and visiting with us there. Thank you all for participating in the call, and we'll talk with you soon. Bye.

That does include today's conference. You may disconnect at this time.