西斯柯 (SYY) 2008 Q1 法說會逐字稿

Good day, everyone and welcome to today's Sysco Corporation first quarter fiscal year 2008 earnings 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. Rick Schnieders, Sysco's Chairman and Chief Executive Officer. Please go ahead sir.

Thank you operator. Good morning to everyone. Thank you for joining us to discuss Sysco's first quarter fiscal 2008 financial results. With me in Houston and speaking on today's call are Ken Spitler, President and Chief Operating Officer, and Bill Delaney, Chief Financial Officer.

But first, let me turn it over to our newly appointed Assistant Vice President of Investor Relations, Neil Russell.

Thanks Rick, and good morning everyone. Before we being, please note that 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 in a material manner.

Additional information concerning factors that could cause actual results to differ in a material manner 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 Annual Report on Form 10-K for the year ended June 30th, 2007 and in the Company's press release issued earlier this morning.

I want to point out a couple of changes to our reporting. The income statement and the press release includes a couple of additional line items. First, we added a line item to show gross margin dollars. Second, we added a line item to show operating income. Although both measure can be calculated from our previous reports, we decided to formally shown the line items going forward. Please understand that all comparisons given during the call refer to changes between the first quarter of fiscal 2008 and the first quarter of fiscal 2007, unless otherwise noted.

Also, all comments about earnings per share refer to diluted earnings per share unless otherwise noted.

With that out of the way, I will turn it back over to our Chairman and Chief Executive Officer, Rick Schnieders.

Thank you, Neil. Let me start by saying we had another solid quarter, delivering sales growth of 8.5%, and leveraging that into 16.2% earnings per share growth. We are encouraged by the fact that this is the fourth consecutive quarter where earnings per share growth has exceeded 15%.

We are pleased with how the new fiscal year has begun. We continue to take share in a difficult business environment, with high inflation continuing throughout the second quarter. We are executing our strategic business initiatives, and we are gaining traction from these initiatives across our operations. As we have communicated in the past, our initiatives are long-term in nature, and take time to fully implement. A key component of our strategy is to invest in our future, to find better and more efficient ways to serve our customers and drive profitable growth. We are always trying to help our customers grow, which positions us to participate in their success.

Now I would like to turn the call over to Ken, who will talk about how our operations performed in the first quarter.

Thanks, Rick. Overall I am pleased with our performance in the quarter. Sales growth was in-line with our expectations, and operating income increased by about 16%.

Our operating companies performed well. Similar to last quarter, our internal measure of product cost inflation remained higher than normal, averaging just under 6%. Our operating companies continued to manage their business very well in that challenging environment. Our ability to grow gross profit dollars faster than operating expenses was key to our results.

Something I said last quarter still holds true. While our operating companies performed well under the current conditions, we believe a modest inflationary environment over time is best for Sysco and our customers. We experienced low gross margins as a percent of sales this quarter, which is not unusual during times of high inflation. And virtually inflation favorably impact operating expenses as a percent of sales. This combined with effective cost management by our operating companies helped drive our growth in operating income.

Last quarter I shared a few metrics that helped drive the business. This quarter, I will expand on one of those topics. Miles driven. We are continually managing the miles driven in order to provide quality service to our customers, and to minimize fuel expense. As a result of increasingly impactful initiatives such as XY routing and designated delivery days, the number of miles driven increased only about 1% in the quarter. In summary, I am pleased with our operating results, and we are committed to continuous improvement going forward.

Now Bill will review the financial results.

Thank you, Ken. As Rick and Ken have just discussed, our first quarter financial results were strong. Earnings per share grew approximately 16% in the quarter, primarily driven by sales growth of 8.5%, and operating margin expansion of 31 basis points. Gross margin dollars grew 7.3%, while operating expenses increased only 4.7%. These results include a $16 million decrease in share based compensation year-over-year. We moved the grant date for incentive stock options from the first quarter to the second quarter of the fiscal year, and we expect the benefit created by this timing change to be partially reversed during the second quarter.

The first quarter results however, were negatively impacted by a $9.4 million charge for an anticipated accelerated future contribution to one of the Company's multi-employer pension plans. Cash flow from operations increased about $19 million, or approximately 11% in the first quarter to $192 million, primarily driven by our growth in net earnings. As we noted in the press release, capital expenditures were $132 million during the first quarter, which is in-line with our business plan. Such investment even in challenging times is necessary, if we are to achieve our long-term goals.

My last point of discussion will be the income tax rate. The effective tax rate for the first quarter of fiscal 2008 was 38.1%, a decrease of about 60 basis points from the same time last year. The decrease in the effective tax rate was primarily due to the net tax benefit resulting from the combination of two items. We recorded a tax benefit for a net operating loss carry-forward related to state taxes, which was partially offset by a tax provision for a foreign tax contingency. The net impact of these two items was a net benefit of about $5 million, which reduced the overall effective tax rate. While difficult to predict, we do not foresee this favorable variance continuing over the balance of the year. In summary, we are pleased with our financial results for the quarter, and encouraged by our overall performance for the past year. We remain focused both on contributing to the ongoing success for our customers, and achieving Sysco's long term financial objectives.

With that, operator, we will now take questions.

Thank you. The question-and-answer session will be conducted electronically. (OPERATOR INSTRUCTIONS) We will pause for a moment to assemble the roster. We will now take our first question from John Heinbockel with Goldman Sachs.

Couple of quick things. Rick, can you talk about the macro environment a little bit? Are you seeing any real tangible sign of a purchasing slowdown by your customers, or is that happening and you are simply picking up enough share to offset that?

And then secondly, kind of related to that, do you see your customers consolidating vendors or suppliers at a faster rate here, than they were six months ago or a year ago?

Thanks for the question, John, and in fact, I think it is fair to say, while not having terrific industry numbers, we don't see a lot of growth out there. However, to your point exactly, we are watching sort of the pieces, the new items that we are selling customers out there, and we feel very good about that. So to the second part of your question about consolidation, it is pretty hard for us to determine whether there is any consolidation, other than that is whether they are using fewer distributors, other than the fact that we are gaining share in this challenging marketplace.

How much is drop size growing roughly, say this quarter or last quarter? Do you have a sense of that?

Yes, average drop size, those numbers we have shared before, are running about where they have been the last couple, three years, which is in the range of 3 to 4%. 3 to 4% growth in the average drop size.

That has been fairly consistent. There hasn't be a pickup or a slowdown really of late, say the last couple quarters?

No, and as Ken sort of alluded to last quarter and this quarter, we continue to work with our customers to get those additional items, but also to make sure that we are routing our trucks properly, getting the right number of cases on the truck, and where we can, to do some consolidation to get our pieces, our average pieces up, and then that is frankly working very well.

Finally, the gross margin impact from inflation looked to be a little lighter this quarter versus last. Is that more a timing of pass-through of your cost? Is it more that? Or is the centralized procurement benefit picking up sequentially?

John, you know, we haven't done any sort of statistical analysis on that difference. I think the difference is not significant. The difference between the impact of inflation on gross margins last quarter and this quarter. We are still, as Ken alluded to in his comments, we are still pressure on gross margins related to the inflation. On the other hand, we are seeing, we are picking that up at the expense line, but even more than that, I think an indication of those operating companies and how hard they are working to control their costs, we are seeing the real pickup at the expense line, which is exactly where we expected, and where we have to see it.

The procurement benefits are picking up gradually, correct? There's no, there hasn't been any big step-up of late?

That is right.

Thank you.

Thank you.

We will now take our next question from Ajay Jain with UBS.

Good morning, I just had a quick question for Bill DeLaney. I think there have been a couple of instances, both last year and also in fiscal '06 as well, where you had some calendar shifts for accruals related to pension expense, and I was just wondering if you could talk about what the basis is for these timing adjustments on your actuarial assumptions?

The change we are talking about this morning is on our stock comp expense, not on the pension. In the past, I believe the issues on pension have been more or less annual, year-over-year, and a lot of that is driven by the discount rate that we are required to use the discount back the projected benefit obligations.

The change we are talking about today is on stock comp. That was a conscious decision. We didn't put it all in the release because it is kind of cumbersome. The long and the short of it, is primarily for administrative reasons, it just was becoming increasingly difficult to process the options, get them in front of our Comp Committee, and find a time that we could issue them outside of a black-out period, that would work for everyone.

In the interest of being more accurate and optimizing the time window, we pushed the grant date back from September to November, and in fact, we will be going to the Comp Committee with our recommendations this week, and there will be a final meeting next week, and those grants will be approved as deemed by the Committee next week.

So that is really all it is. It is more of administrative change. As we said in, as I have said here, we would expect a good portion at least of that benefit to reverse in the second quarter.

As relates to the stock compensation, you did mention that some of that, based on the change in the grant date, that benefit will reverse itself this quarter. Can you give any more specificity, and quantify how you see the comparisons in Q2, and also what your outlook is on an annualized basis for options expense for the full year?

It is one of those great questions that you would need to be a soothsayer to give you a precise answer. We haven't even gotten them approved yet. It is dependent on how many are approved, and the mix of the people that are involved in that package and a lot of other things.

So I think as far as I will go with you today is we would expect a portion of it to partially reverse in the second quarter, and I think we'd be in a better position by the end of the second quarter, perhaps when we release an earnings, to give you a little better view going forward. But I will tell you this, in the Q as we're drafting it today, we don't really expect this year-over-year change to be material.

I seem to recall last year the share repurchase activity was a little bit front end loaded. I was just wondering if you could confirm what the level of share buybacks were in the latest quarter?

Yes, actually, it was back end loaded I believe last year. It is just the reverse this year. We picked it up quite a bit, and Kirk is sitting right here.

Actually, we evened it out a little bit for the first quarter. I want to say it is about 187 million, I think, in the first quarter.

So we have been pretty aggressive buying back this quarter.

Okay. But you don't have a, can you confirm the number?

I don't want to give you, hang on for a second. It is roughly 190 million this quarter, versus about 65 for the first quarter last year.

Great. Thank you very much.

We will now take our next question from Meredith Adler with Lehman Brothers.

I would like to go back a little bit to just Ajay's question about pension, because I didn't really understand what was in the press release about something about potential acceleration. What exactly have you done, and what do you anticipate needing to do?

Okay, Meredith, I'll take this one. It is Bill again. As we have disclosed, I think pretty consistently, we participate in several different multi-employer pension plans, which are essentially plans that our union employees are participants in, and we contribute to those plans. We have one such plan that is, in fact, in the past we disclosed that there is some underfunding issues in the aggregate in each, not in each of those plans but in the aggregate.

One of those plans, we have become more aware of in recent times, and in particular in the last month, that their underfunding situation is much more acute. In fact, even though we haven't been directly notified, we have reason to believe through third parties, that we will probably need to make an accelerated contribution here at some point in the relatively near future. So with that information, we went ahead with the best information available to us, and took a charge for about $10 million.

Okay. Great. And then I would like to sort of go back a little bit to the first set of questions about the macro environment. If you look at the public restaurant chains, they are clearly suffering tremendously. It is unclear whether that is all because of food inflation. A lot of that seems to be just about the consumer economy.

I was wondering whether you have any commentary on independent private restaurants, whether you are seeing similar kinds of issues, you said that growth has not been very strong. Do you see slowdowns in new units? Do you see people closing down? I think some people are very gloomy about the restaurant business, and I was wondering if you could comment. And then also, to what extent did higher food inflation cause either consumers or restaurants to buy less product?

Meredith, I will start and say that I think that the consumer confidence is not good at this point, causing this lack of real growth in the industry overall. And you see it in the retail sectors in general, I believe. You know, in terms of specific numbers, new operations opening, restaurants closing, independent restaurants closing, we really don't, that information would lag, but anecdotally, we don't see restaurants closing en masse.

I would point out to you that over the last few years, as you know, we have done a better job of stratifying customers and understanding our customer base better, and I would also say today that based on that, we have kind of a stronger core group of customers, and those customers tend to be in business for longer, very long periods of time, 10 years, 15 years, 20 years, and so that is kind of the heart of our business, and even, they have been through tough times before, 1990, '91, we'll all go through tough times together in the future.

But fortunately, our base of customers tends to be those that are going to hang on, they understand the restaurant business well, and we see less churn in our customers today than we did three, four, five years ago, because we you know, we were diligent about identifying sort of that customer group that we have out there.

I know this is almost impossible, but do you have any perspective on where food inflation will go for the remainder of this calendar year, and maybe into the first quarter of next year?

Well, again, we would have to be calling on the soothsayers. We are beginning to see just recently a little bit of softening in some categories, dairy, for instance which really needed to soften up. I am sure you have followed that Argentina has, you know that they've been out of the wheat market here for the last 10 months or so, and on Friday they announced they were coming back into the market. Wheat prices at commodity level are down just a bit month-over-month. So we don't want to get too far out in front of ourselves here, but we think there may be a little bit of softening of inflation over the next few months now.

Okay. Great. Thank you.

For our next question we will go to Jason Whitmer with Cleveland Research Company.

Rick, I know you talked a lot about anecdotal impact of business reviews. I was curious if you guys have done any quantitative impact on the impact you have had on independent restaurant profitability, something where you are really helping them drive either better top line sales, or more importantly, helped their profitability with their menu development, or things of that nature, if you have really been trying to track that as a big success point for your business?

I think we at some level, a certain number of customers will share their profitability with our operating companies, and with our marketing associates. And so again, very anecdotally, we do get positive feedback from our customers, and I have got some stories that I could tell, and I am sure most of the folks in this room have stories, where we have had a particularly strong relationship with a customer, we have helped them enormously and their business has grown.

So you know, absolutely, I think that that is happening out there. We have operating companies where we have done a number of business reviews with the same customer and at some point, the only way we are going to continue to grow with that customer is to help them grow their business. So I think anecdotally, you know, we don't have any statistics on this, but anecdotally we do have customers where we have made significant, we have provided significant assistance to them and their business as a result has grown, and they would honor that. I think they would say that that is true.

And a question maybe for Ken. I think when we met a little over a month ago in Boston, there was a summit that you guys held internally to try to really reconfigure or reset the bar on sourcing. What are some of the best wins and changes coming out of that over the six weeks or so?

Would you repeat that?

You held your own little sourcing summit internally? What have been some of the best action --?

Yes, yes. That was just a reset meeting to make sure that we were doing the best we could. Some of the learnings that we had out of that were how we rolled it out to the operating companies, that we were a little slow getting that out to them, so we have refined that process, and we are quicker to market with the roll-out. That was probably the most significant learning that we had out of it. There was a lot of just that sort of thing that we did.

Okay. Last question, Rick, there was a chart a couple years ago, I remember seeing it very frequently, in terms of the number of operating companies that had an operating margin, you know, above 6%, above 7%, something to that effect. I think if I recall, almost two thirds of them were above 6%. Has that changed materially over the last couple years, into something like sourcing or the RDC, or whatever else you have in your strategic road map does that change the earnings power potential of any of the operating companies?

Well, I think it does, Jason, but maybe even more important that that, it is kind of all those things together, but it's also just the ability of that management team or those management teams that were not at 7%, that were at 2 or 3%, their ability over time to kind of get their arms around the business, and manage the net margins of the business upwards.

So I think it has changed, but as you will also recall, I am sure, is that those operating companies that were toward the lower end of that graph, generally tended to be the newer operating companies, either because they were acquisitioned, so time is really a big factor, kind of a big factor for all of us.

We talk about how it is taking time for us to institute and install these initiatives. That is absolutely true. Same thing with an operating company. It just takes time to get your arms around all the moving parts to drive your earnings higher. That chart in terms of the shape of it would not be significantly different. The newer companies we have today are toward the lower end, and those that are more mature generally tend to be better, at the higher end of the chart.

Great. Thank you.

For our next question we will go to Greg Badishkanian with CitiGroup.

Just a few quick questions here. On just following up on food inflation, would you say that, sounds like it is sort of a neutral impact to your bottom line, in terms of dollar, EBIT dollars, is that right?

I think that is right. I think that is absolutely right. The bigger concern that we have and Bill has said this for a while, is that as inflation, high inflation goes on for too long, the real impact is to our customers' business, and that consumer confidence level. And causing the consumer rather than eating out three or four times a week, to eat out two or three times a week. That is the biggest, by far the biggest impact to our business.

And when you look at your independent customers, you know, are they doing a better or worse job relative to the large chains, in terms of passing on those price increases to their end user?

Well, I think the truth of the matter is that some are doing better, and some are not doing so well. We don't have any real statistics on that. But I will also say that we have worked hard in business reviews, and more broadly to help our customers understand the importance of adjusting their pricing in this market. And I think we put out a marketing piece a month ago, Ken, to kind of emphasize that very point.

We do see that our independent customers are a little more nimble with the ability to change their menu, and change their menu pricing than the chains are.

If you are a pizzeria and your dairy costs go up 25 or 50%, it is kind of hard to pass along real quick.

Right. And just sort of moving over to acquisitions, are you seeing take out multiples coming down and companies looking to sell?

Well, it is a bifurcated market out there. I think you have seen the big public deals, and the extravagant multiples that they have been able to command. On the other hand, we today have the largest list of, continue to work the largest list of smaller acquisitions that we have ever had an opportunity to work. I think there, as in anything, there are opportunities, there will be opportunities at the larger end, the larger acquisitions. I think that the multiples will get more realistic over time. But we continue to look at every possible new partnership that we possibly can. We are still very actively engaged in assessing the acquisition market.

And sometimes it takes time for the sellers to reconcile that the take out multiples have come down, and so have you seen that, like over the past few months, or do you think it will take a little more time for the take out multiples to come down some?

What we are seeing, there is still a fairly high expectation out there, that we think will take a little while longer to mitigate itself.

I think the other thing is some of these folks have to decide whether they are really sellers or not. There's being a seller, a multiple of 12, 13, there is being a seller at a lower multiple. I am sure within their own organizations they're having those discussions.

Exactly. Hey, thank you very much.

(OPERATOR INSTRUCTIONS) And now we will take our next question from Mark Husson from HSBC.

I want to ask a question about gas prices, and about the overall kind of structure of your distribution system. When you think about regional distribution centers, you know, what kind of stress testing did you do in thinking about $3 a gallon, $4 a gallon, $5 a gallon, and does an RDC have a much better gallon burn profile, if you like, than the previous sort of structure in the Northeast?

Well, I think where we see it is in, when you look at sort of the piece number. You want to look at it right down to the case level Mark, and so absolutely, and the RDCs allow us to keep the trucks fuller. The inbound trucks fuller into the RDC, the outbound trucks to the operating companies. So there is a huge benefit there, particularly longer term, as we move more and more inbound freight through those RDCs. It is a big environmental positive environmental impact, and a big impact in terms of the cost.

The other thing that is happening that we feel very good about is that we are shipping more product by rail into the RDCs than we anticipated. And as you might expect, I mean, on a per case basis, the rail is about one-half what truck is. So there are a number of opportunities, in terms of sort of optimizing the costs, the fuel costs, if you will, as well as the environmental impact that we have. So we are going to have a smaller carbon footprint going forward.

I am assuming the fold-outs do the same thing.

Absolutely, because we are closer to the customer, no question.

You are closer to the customer, but then the inbound freight doesn't look quite as good, presumably.

No, actually, the real important thing on the inbound freight is making sure that those trucks, those inbound trucks, whether they are coming into an RDC or coming into an operating company, making sure that those trucks are full. When you open that back door, it is stacked to the ceiling.

To push it a little bit further, if you had, I don't know, some catastrophe in Venezuela or something, and you had to deal with $5 a gallon, and you are having a meeting right now, what would be top of the agenda to discuss?

I think we would have to look at expanding fuel surcharges for sure. But the other thing I think kind of works, silver lining in this whole thing, is that we are closer to our customers than our competitors. We do do a better job of routing those inbound trucks, so no matter, we are all going to pay essentially the same price for fuel. We just do a better job on a per case basis on moving that product.

I can add to that by saying that on the outbound side, we would be looking at reducing miles, and reducing the number of deliveries than we currently make. If you are getting 3, then we would go 2, if you are getting 2, we would go 1, that sort of thing. It is all about miles.

And in our discussions so far, because we have been in a fairly high fuel environment here for a while, our discussions with our customers as we have gone to better routing has been quite positive. You know, they understand. They are just like the rest of us. They pull up and fill their cars up. They read the newspapers. So our customers appreciate the spot that we are all in. Not just the distributors.

Okay. Switching gears, if I could please, just on U.S. Food services, this any sort of update, any answers coming out of that business, any reorganization or any change in behavior?

They are closing one facility in Cincinnati. That is the only public information we've seen so far. We have not seen any sort of strategic move on their part.

There are still a lot of rumors, Mark, but we can't put a finger on anything.

Very finally, very finally, (laughter), the deferred tax benefit, any update on whether or not you are going to be allowed to keep it?

Well, we certainly think we are. We are still in the process Mark, and essentially where we are at now, I don't think it has changed much since we were in Boston, or even since we drafted the K. We have obviously taken a position, the IRS has pushed back, and we are in the appeals process now. It's going to be, I think the next step is probably to get an Appeals Officer and moving along at a fairly deliberate pace. I don't think we're going to have a whole lot more new news, at least from what I understand, until the spring, and perhaps later than that. We could still be a year away from this thing, running its course one way or another.

We certainly continue to believe our facts are strong. Obviously at the same time we are now in an Appeals process. So we will play it out. Great. Thank you.

For our next question we will go to Steve Chick with JPMorgan.

Hi. Thanks. Good quarter under the circumstances, I think.

Thank you.

Wanted to, had a couple of questions. Is maybe for Ken, how many, are you still on track to increase your sales force by 4 to 5% this year? And do you have the, what the increase was for the current quarter?

I do. It is 5.1 on the customer contact people. We are really looking at 4% this year, which is really would make me happy if we could stay in the 4% range. Right now we are at 5.1.

Okay. So you are at 5.1, but you think you might come in at the lower end, you looking to -- ?

I would be happy with 4%.

Okay. All right. And then maybe as it relates to that, your sales target of 7 to 9, I know it is a long-term target, you didn't have it in the press release today.

And given kind of the volatility of what's around us and some of the comments on macro, can you kind of confirm post your quarter end, that you are still pretty happy with how sales are trending and that the 7 to 9% figure is a pretty good range to continue to think about for this year?

Yes, sir.

All right. Well, that is helpful. And last two, if I could, if you could give us an update on the Florida redistribution center and when you expect it to be in operation and as it relates to that, maybe for Bill, you know, I have had a tough time estimating your depreciation and amortization, which comes in a little below what I would estimate, and I don't know if when the RDC comes into play if the D&A starts to kick in on that facility, so if you could kind of speak to that a little bit?

I will answer the first part of that as we are right on schedule with it. We are to start ramping up in April as planned.

I guess the way I would look at the other, Steve, is just look at in the context of our overall capital expenditures. We are at the higher end of I guess our range, if you will, in terms of percent of sales.

One of the reasons is because of the ramp-up in the Florida RDC. So I don't know that I want to specifically comment on depreciation as it relates to that construction, but I think you should continue to expect us to be in that 625, give or take, zone for CapEx for this year.

Right. Well I guess because what I am looking at because you're at the high end of kind of the CapEx plan but in the last two quarters the depreciation expense has been growing. It was year-over-year I think 0.4% this quarter. I have a feeling that some of that might be, in April, does that Florida facility, does the depreciation start to kick in on the Florida facility when it goes into operation in April?

Yes it is capitalized until it goes in, and then it starts to kick in.

Okay.

Yes.

And then maybe Bill, a little bit in the weeds but just on your, the breakout of your sales, intersegment sales looked like they were flat year-over-year. We could talk about it offline if you want. Do you have any -- do you have a sense of why that is, or is that impactful?

Can you define intersegment for me, just so I am answering the right question?

Intercompany?

Intercompany, yes, I am sorry. Your intercompany sales were kind of flat year-over-year and it's usually grows a little higher than that. I don't know if it's the mix of your customer base? We could certainly take it offline. I don't know if you --

We might go offline on that one. I don't have an answer on that one.

Fair enough. All right. Good quarter. Thanks.

Thank you.

(OPERATOR INSTRUCTIONS) And we will now take our next question from Alec Patterson with RCM.

Good morning. Just curious, the sales growth in the Other specialty segment, it has continued to decelerate, just wondering how much of a boot inflation or deflation may be appearing in that number, maybe just a general comment about it?

We got hurt on the produce side and the meat side, on both of those.

Hurt means deflation, or hurt means lost sales?

We had some, I think we had lost sales on the meat side, some lost sales due to high prices, so customers somewhat trading down. On the produce side, produce is the most volatile category that we have, so the inflation/deflation swings in produce are so dramatic, that I think what we're seeing in the produce is some deflation, but not universally in other categories of product. So we are still, going back to we are still seeing overall pretty high inflation generally.

And regarding the inflation number, essentially you could read it as if you had the right base numbers, flat sequentially? Is it fair to say that the rate of inflation, kind of the second derivative here is decelerating, and does that allow you to capture more pass-through?

I think if it is kind of a delta question, yes, I certainly think that we have seen a slowing in the rate of inflation. In fact, if you look at the just numbers quarter to quarter, a slight decline in inflation.

So going back to our earlier conversation, we might see, based on early information about wheat, dairy, some other, cheese particularly, we might see a softening of that inflation number. But I wouldn't think about it in terms of going back to our normal 2 to 2.5, or 2.5 to 3% inflation levels.

Not to be negative here. This is Bill. That is a good question and that is a fair answer, obviously, but I think you have got to balance, a very, very slight maybe slowing in the acceleration two quarters in a row for our customers, where their costs are up substantially. I would describe our market environment right now as quite challenging as it relates to price.

In other words, there may be a greater capacity for pass-through to be recognized in you gross margin trend, but don't immediately translate into accelerated volumes?

I wouldn't translate it into either, that is obviously a prerogative. All I am trying to say here is it's still 6% inflation, or 5.9 or whatever. I don't know that our statistics are that precise, that I would draw a huge conclusion on deceleration. I think it's a very tough environment, we are certainly hopeful that it will start to decelerate. I wouldn't bank on that one right now as we sit here today.

Okay.

And then just lastly, maybe for you, Bill, the debt structure, any further thoughts on how you are looking at it going forward? I see in this quarter where basically share repurchase and debt taken on, kind of one for one almost. Is there a fresh set of thinking, maybe a rating agency's point of view on debt structure formulating amongst you all?

No. We are certainly cognizant and staying close touch with the rating agencies, and folks that we do our banking with, and that type of thing. We continue to review our capital structure. Don't take this the wrong way, the way I would characterize that, I don't think that is one of our primary issues right now internally in terms of that.

We are comfortable with where we are. We do see opportunities to take our leverage up. With everything that has been going on with the financial markets the last few months, we are going to take our time and evaluate what makes sense for us.

But I am talking strategically, capital structure-wise, the way you look at it. My understanding is the way you look at your debt capacity is kind of an arcane way of looking at it. I was understanding that maybe it was evolving. Has there been evolving of it?

I didn't know if it was arcane. 1980s approach it has been described as. We continue to look at it strategically if you will and we do think we could take on more leverage, and run the company very, very well. All I was trying to address, at this point in time, it is not a #1 priority for us.

Understood. Thank you.

We will now take our next question from Andrew Wolf with BB&T Capital Markets.

Thank you. Good morning. To try to get to your real sales growth in broad line, should we just use the overall product cost inflation, or do you have a more specific number you could share with us?

I would do the math on what we have given you, and you will be in the ballpark.

The other thing on the broad line is I noticed that the growth there is good, it's outpacing the corporate growth, but this quarter at least, a slight downtick in the MA served sales, as a percent of broad line.

In a non-inflationary environment it would pretty easy to say, yes the market share is down a little bit internally, or the chains are up. But given that it might be easier to pass through inflation to chains, and so on. On a case basis, or on a volume basis, could we reach the same conclusion that inside broad line the chain business is doing a little better, growing a little faster than the independent, or is inflation skewing that?

No. I think what you're seeing is we started up a new large customer during the first quarter, and they ramped up pretty rapidly, ramped up very well. It is not a difference in inflation at the chain rate versus the independent rate.

It is just the new customer. As we talked about it so many times, Andy, you know those big customers come on in chunks, and the growth in the independent market comes on just in very small increments, so that is all that is.

Okay. Thanks. And just returning to the fuel side, now that diesel is sort of back up, and some people are predicting it is going to start heading up a lot, I have just done some back of the envelope. About two to three bips of exposure for every $0.10 year-over-year increase in diesel? That is unhedged, using some numbers you guys have put out in the past. Is that in the ballpark? I don't know if you want to comment on it.

Secondly, also, if you have hedged at all when prices were lower, what your hedge ratio might be at this point?

The first part of that I think is we would like to maybe take that offline, have you call Neil and we will just verify that. Frankly, I don't think we have that number.

We haven't really calculated that way, Andy, so we need to look at that.

And the second part of your question?

Have you hedged out any of your fuel exposure at this point?

Beyond the end of the year, December, not beyond that.

So we have been hedged through this calendar year but those contracts run out at the end of the December, so we have some exposure as we go into the second half of the year.

Into the current, inflation, can you say how much you've hedged out currently that we could sort of subtract out of your exposure?

It is about 60, 70, two-thirds.

Okay. Great. Thanks a lot.

Technically, we don't hedge, we just have contracts forward on things. I don't know if that matters, but --

It is for the accountants in the room.

Right.

For our next question will go to Bill Leech with Neuberger Berman.

Good morning. I was a little bit confused about your option guidance. Should we plug it was $0.15 a share last year, should we just plug in $0.15 this year, just to pick a number?

The option guidance was for the second quarter. We would expect the benefit from the first quarter to reverse partially. For the year --

Annual forecast, should we just assume it's the same as last year?

Assume it's not material, it might be slightly less. It's not material.

Second quarter last year it was $0.04 a share, which was pretty material, about 10% of your reported earnings.

When I say it's not material, I am talking about the change year-over-year.

This year should we put $0.05 or $0.06 in? I know it is a just non-cash item, but it does affect your reported earnings quite a lot.

Whatever expense you used for last year, if you use the same expense for this year, I think you will be within a penny or two.

For the second --

For the entire year.

But in the second quarter --

I think it will be on the favorable side. There is a lot of variables we don't have our arms around until these options are granted.

When you say you are going to have part of the benefit in the first quarter reversed in the second quarter. Does that mean we are going to have an $0.06 charge in the second quarter?

No. It means you might see half of the benefit, 16 million, I will let you guys do the math, it was about a penny and-a-half at 16. Let's just use dollars. Because the taxes get a little interesting here. Let me take a minute, that is a good question. Let me frame it up a little bit. The reason you have that kind of volatility or one of the reasons from quarter to quarter, in terms of when the grant date is designated is because of the makeup of the folks who get the options.

And the way the accounting works, I am going to keep this pretty high level, but to the extent that you've got folks that are in their, toward the end of their tenure, and they are vested in our retirement plans and able to retire, the way the accounting venture works, is you have to expense the full amount of value of those options for those folks who tend to be some of your higher paid people, at the time that the grant is given. That is why you see the skewing from one quarter to the next and again, it is unfortunate in terms of the communication side but we just thought administratively it was better to put the grant date out to November this year.

For the tax rate, should we use 38.3?

No. I would look at last year's tax rate. I wouldn't use any lower than that. We will keep you posted. This was kind of a one-time benefit or net benefit as we talked about the accounting professional requires you to that benefit in the quarter, then it becomes realized. The gross part of this benefit was a state tax law change, so we took it all here in the first quarter. I would look at last year's tax rate. It could be a little bit higher, or a little bit lower.

And for our next question, we will go to [Chris Rusch] with Piper Jeffrey.

Hi, good morning. On the inflation issue again, I don't mean to belabor the point, I know you guys don't like to focus on it, you have been getting a lot of questions on this issue, but I know that 2 to 2.5% is really your sweet spot, that is an inflation level that is probably actually good for your customers. At 6% today, we are obviously a long ways away from that.

If you could help frame it for me. If 2% is a positive, 6% is a negative, you know, what is a neutral level? How do you look at that? Do you see us reaching that at some time this year? Thanks.

I think a neutral level is in the 3% range, probably not north of 3%. Again, we would have to have a shaman or soothsayer in here, to get us to a good prognostication of what is going to happen. We just don't know.

To your point, we don't like talking a lot about it but we understand these questions are all on point. This is not a normal environment. We understand that we need to speak to it. Frankly, it is something that we try to speak to with as much clarity as we can, how much it impacts sales, gross profit margins and expenses.

It is a hard thing to get your arms around. It clearly helps you on your expenses, and it clearly hurts you on your GP percent, and we can debate the sales side of it philosophically. At the end of the day, we are talking about it because it has had an impact on the last couple quarters.

Thanks a lot. Good quarter.

Thank you.

Follow-up question from Meredith Adler from Lehman Brothers. Your line is open. Please go ahead.

Sorry about that. I didn't want to hog the call last time. Back to the question about inflation. Obviously, it has the impact it does, gross profit dollars and expense percent, because you have a fee per case, as opposed to, and you pass along the cost of the products. What percentage of your revenues are you passing along the cost and just getting a fee?

Meredith, we haven't really disclosed that in the past. Keep in mind, it's not just -- we have fee per case business, but we also have a large of percentage Markup. We have both types of pricing. That is our challenge even internally, it is not obvious how it impacts you in terms of the percentages. We have both types of business out there. That is a number we haven't shared in the past.

Another question I have for you. I know that the procurement opportunity is still just getting off the ground. But what is your plan in terms of sharing that benefit, and would it be your anticipation that we would actually be able to see the benefit ourselves, in looking at the gross margin, or would the majority of it be passed along?

Well, we are still working through to understand how this is all going to shake out, frankly, Meredith. So the answer is we don't know, and the other sort of complication is that sourcing is now integrated with everything else that we do.

So just identifying a benefit, specifically from sourcing, is very, very difficult to do. So we're kind of wrapping all this together, RDC, supply chain work that we are doing, sourcing and other work that we are doing in terms of our strategic initiatives, and to pinpoint where the benefit might show up is very, very difficult at this point in time.

Okay.

I think to be straight with you, Meredith, I don't think you will be able to see the benefit in terms of our public financial statements, we will continue to account the way we account. As we get deeper into this, through the use of our metrics, also just by having more products, items in the game, if you will, we should be able to better speak and even before we start speaking, to better evaluate internally the progress that we are making on these initiatives. The Summit meeting that Ken was asking about, a lot of that discussion in those meetings was just to make sure internally we're doing as good as we can in terms of execution.

We are still very early on. I know we got into this in the conference up in Boston, and there was some confusion or maybe disappointment in our lack of direction, but it is real difficult to sit here today and talk about gross profit expansion, when you have got the kind of markets that we're working in right now. We will continue to look at it internally with some of our metrics, and as we see things and if we think they are appropriate and material and relevant, we will share them with you.

Just a couple of clarifications. You mentioned about U.S. Food Service, that they were closing a facility in Cincinnati. Is that a your market where they have been competing with themselves, so that will sort of open the market up, or is that just something else they are doing?

I think it's something else. I don't think that's a market that they have two units in.

Okay. And then you talked about you had a very long acquisitions list. And I wasn't sure whether that meant just your own list of opportunities that you are focused on, or is that where you have some reason to believe that the owner is interested in selling, or might be interested in selling?

That is where we have fairly solid information that the owner at least at some level is interested in talking about selling the business. However to Bill's point, sometimes there are those psychological hurdles. Initially they say they want to sell, and then later on they think twice about it and change their mind.

Right now we have got a very active list. Honestly most of those are relatively small. But it is good consolidation, a lot of them will be fold-ins, those are particularly profitable to us. We fold them into an existing facility. So it is a good pipeline out there right now. But they tend to be the smaller opportunities.

The only thing I would add to that is just that what has been going on in these financial markets, I think we are getting more calls from the smaller businesses that might be looking to sell. I think that is somewhat predictable with the uncertainty in the markets. That tends to be somewhat of a reality check for folks.

The larger people, I think they have to go back to the drawing board, and strategically look at their businesses, and what they want to do. We wouldn't expect to be seeing a whole lot right there now, and we are not.

As we suggested earlier, two things like government regulation and high fuel prices can be particularly challenging for somebody that is in a small segment of the business. They run a lot of miles. They don't have a broad base of product to put on those trucks. So this is a challenging environment, as you know, and I think that causes some of these folks to think about monetizing what they have built over the years.

I have one more question. Have you noticed any marked difference in the business by geography?

The Midwest is a little bit softer right now.

Great. Thank you very much.

Thank you.

We will now take our final question, it is a follow-up from Steve Chick with JPMorgan.

Hi, thanks. You mentioned a large customer win, I think, within the quarter. Did that start off at the beginning of the quarter, and is that a customer that you won from U.S. Food Service?

It started actually in the fourth quarter, Steve. It has ramped up pretty, all the way in the first quarter here. And it came from a variety of sources. The business was spread out.

Okay. That is helpful. Second, obviously, when your Q gets filed, we end up seeing a little more of the profits by segment. I don't know if you, do we have to wait until then or Bill, can you speak to maybe where the profits were?

You had a pretty good level of margin expansion this quarter, in operating margin. Once we get the Q, do you have what the corporate overhead pieces might be, just broadly? Is it where the margin expansion came from by segment, or do we have to wait until the filing?

We are going to file on Thursday. We have spoken to a lost the corporate benefit in terms of the stock comp, and you'll see there is a modest benefit from COLI and pension, and that type of thing. There is some good benefit there and then there is modest leverage at the operating line.

All right. That is helpful. Thank you.

That does conclude today's question-and-answer session. I would now like to turn the call over to Mr. Rick Schnieders for closing remarks.

I want to thank everybody for participating in the call today, and I also want to thank you for your continuing interest in Sysco. As you can probably hear from our call today, we are pleased with our current performance, and we are also pleased with our direction for the future. Have a good day, and remember, eat out often at one of your favorite restaurants! Thanks. Bye.

That does conclude today's presentation. Thank you for your participation. You may now disconnect your lines.