西斯柯 (SYY) 2011 Q3 法說會逐字稿

Good day, everyone, and welcome to the Sysco reports third-quarter fiscal 2011 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 Neil Russell. Please go ahead, sir.

Thank you, Rochelle, and good morning, everyone. Thank you for joining us for Sysco's third-quarter 2011 conference call. On today's call you will hear from Bill DeLaney, our President and Chief Executive Officer, and Chris Kreidler, our Chief Financial Officer.

Before we begin please note that statements made in the course of this presentation that state the Company's or management's intentions, beliefs, expectations or predictions of the future are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. 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 July 3, 2010 and in the Company's press release issued earlier this morning.

On the call today we will discuss certain non-GAAP financial measures. You can find a reconciliation of these non-GAAP measures to the applicable GAAP measures on our Investor Relations website at Sysco.com. Also all comments about earnings per share refer to diluted earnings per share unless otherwise noted. With that out of the way I'll turn the call over to our President and Chief Executive Officer, Bill DeLaney.

Thank you, Neil, and good morning, everyone. This morning Sysco reported third-quarter sales of $9.8 billion, operating income of $427 million and EPS of $0.44 per share. Sales grew more than 9% over the prior year due mainly to higher prices and increased case volume. Higher prices were driven by an increase in our product cost of just over 5% compared to last year. Gross margin trends also improved compared to the first half of the year.

Operating expenses increased year over year due in large part to a $36 million charge related to the withdrawal of one of our operating companies from a multi-employer pension plan, higher fuel prices and higher pension expense. Earnings per share on a GAAP basis increased nearly 5% compared to last year's third quarter. However, excluding the multi-employer pension charge and a one-time tax benefit that Chris will discuss in a few minutes, adjusted EPS increased nearly 10%.

Amidst a slow industry recovery our associates did a very good job supporting our customers while producing record third-quarter results for Sysco. These results reflect both improved execution by our operating companies and a modestly improving market environment.

While the food service industry and overall economy continue to recover slowly, we and our customers have also been faced with the dual challenges of product inflation and rising fuel costs. While not yet appearing to have significantly dampened consumer demand, these unfavorable economic factors do create ripple effects throughout our business that may continue to create choppiness in our near-term results.

With that said, I want to emphasize our commitment to successfully executing Sysco's long-term strategy. The majority of our resources and activities remain centered on optimizing our core business. Our recent results reflect steady progress on this front. Specifically, we've had success in improving our customer retention and we've also increase contract sales this year in both our broadline and SYGMA units.

One of the most critical aspects of optimizing our core business is successfully carrying out our business transformation project. We've made good progress during the last few months and we recently achieved a major milestone by going live at our pilot facility in Arkansas. Just reaching the point where we were comfortable going live was a huge accomplishment. However, we're even more pleased that the implementation was such a success.

Implementations like this rarely if ever go off without a hitch. But the team was ready for the issues that did arise and they worked quickly and effectively to find solutions. So it's an appropriate time to pause for a moment and acknowledge all those on the team who have been working so diligently and effectively to ensure this project is a success.

We began this journey two and a half years ago and an extraordinary amount of work has gone into the project of thus far. While there remains a great deal of work ahead of us, I'm very proud of the team's efforts and appreciative of their dedication.

Now that the pilot site is live our plan is to take some time and evaluate the new system's performance. We will reassess our rollout plan in light of everything we learn, make necessary adjustments and then move forward with implementing the business transformation initiative at our first wave of operating companies.

In addition to optimizing our core business we're also committed to looking for acquisition opportunities both in and beyond the core. We're doing this mainly through building a pipeline of high-quality potential domestic acquisitions and also by looking at adjacencies and new geographies. We continue to make progress in this area and Chris will update you on our recent transactions in a few moments.

We believe that all of these efforts strengthen our strong commitment to supporting the successful growth of our customers. The investments we are making in our business are meaningful both in terms of their inherent financial commitment as well as the benefits we expect them to produce.

As the industry continues to recover I am confident that we are taking the right steps to secure a strong future for Sysco. Now I'll turn things over to Chris so he can provide additional details on our financial results for the third quarter.

Thank you, Bill, and good morning, everyone. Third-quarter sales were $9.8 billion for an increase of 9.1% compared to the prior year driven mainly by increased prices and case volume. Impacting prices was food cost inflation which we estimated to be 5.1% for the period. In addition, acquisitions within the last 12 months increased sales by 0.6% and changes in foreign exchange rates increased sales by 0.6%.

We mentioned the last quarter a holiday shift that impacted the second and third quarters. As a brief reminder, last year's third quarter included the New Year holiday which is one of our low-volume holidays, while this year's third quarter did not. We estimate that our reported increase in sales year over year in the third quarter would have been about 70 basis points lower on a comparable holiday adjusted basis.

Taking the holiday shift into consideration, we estimate real sales growth, which is sales growth adjusted for the impact of inflation, acquisitions and foreign exchange rates, to have been 2.1% in the third quarter and is an improvement over the second quarter.

Gross margin increased 7.6% or $127 million during the quarter while gross margin as a percentage of sales declined 27 basis points year over year to 18.6%. Strategic pricing initiatives continue to impact margins but to a lesser extent than in previous quarters with the magnitude of the impact estimated to be about 10 basis points this quarter, down from 15 basis points last quarter.

So if you've been following this issue, the impact has declined each quarter as benefits from the program continue to build. We believe this confirms our view that these strategic pricing initiatives will increase our market share and grow our gross profit dollars over the long term.

The remainder of the impact to gross margin was largely driven by high inflation, although to a lesser extent than we've seen over the last few quarters because of better execution. As I just mentioned, inflation as measured by the estimated change in Sysco's product cost was 5.1% during the third quarter, which was an increase over the 4.5% reported during the second quarter of this year and a significant upswing from the 0.8% deflation reported last year.

The inflation we experienced this quarter was mainly driven by increases in the meat, seafood and canned and dry categories. While we experienced increases in many of our other product categories, these three represent about 40% of our sales and therefore had a larger impact due to the volume of business in those categories.

While you've heard us talk about meat inflation for some time now, the most significant change we saw in category inflation this quarter was driven by the severe cold weather that impacted crops in major growing regions such as Florida and Mexico.

While gross margin as a percent of sales was down year over year in the third quarter, once again gross margin dollars and gross margin on a per case basis increased. The latter is a clear indication that we are passing through inflation. Additionally, gross margin dollars per stop, which is generally speaking one of the most significant metrics we use to manage the business, also increased. The trend for this metric has been steadily improving for us over the last five quarters.

Also of note, broad line sales accelerated in the third quarter and so we didn't have a segment mix impact to gross margin as we did in the first half of the year.

Before we leave the subject of gross margins I wanted to discuss fuel costs for a moment. Fuel costs have consistently increased throughout this fiscal year and in the third quarter our average fuel price was up nearly 30% year over year. In response to this dramatic and sustained increase in fuel costs we made the decision in March to implement a fuel surcharge in the street side of our business. The vast majority of our contract sales already have fuel surcharges built in.

As a reminder, fuel surcharges are recorded in sales and therefore impact gross margin. Due to the timing of adding the surcharge the impact was not significant during the third quarter. But we expect surcharges to offset a substantial portion of our projected fuel increase in the fourth quarter.

Turning to operating expenses, we saw an increase during the quarter of 10.6% or $132 million. As we mentioned in our press release this morning, one of the most significant drivers of the increase was a $36 million charge related to the withdrawal of one of our operating companies from a multi-employer pension plan, or MEPP. Without this charge operating expense would have increased 7.7% and operating income would have increased 7.3% versus the 1.1% decline we reported on a GAAP basis.

For those of you who may not be familiar with MEPPs, they are essentially pooled pension plans that are union sponsored. Each plan is funded by more than one employer and each employer funds the plan according to its collective bargaining agreement. If one of the employers in the plan is unable to meet its obligations the others may be required to make up the difference.

This is the second time this fiscal year that we've been able to withdraw from an MEPP. From a strategic perspective withdraw from these plans produces the long-term financial risk that is inherent in multi-employer arrangements. At the same time we can continue to provide competitive benefits by moving the impacted employees into our corporate sponsored pension plan.

Other drivers of the increase in operating expense included higher payroll, pension and fuel expense. Payroll costs increased $36 million for the period. Higher case volume and pay rates drove some of the increase and, similar to last quarter, increased gross margin drove higher sales compensation. However total headcount was down about 1% compared to the prior year, so we're pleased with the way our operators are managing in this area. Also similar to the last two quarters, pension expense increased $15 million.

Lastly, fuel expense increased $14 million in the quarter. We currently anticipate the increase in fuel expense in the fourth quarter to be at a similar magnitude.

Income tax expense during the quarter decreased $9 million or 5.6%. This equated to a tax rate of 36.3% or 2.4 percentage points lower than last year's rate. During the quarter we developed plans that will allow us to utilize more of our deferred tax assets resulting in a benefit to us this quarter of about $10 million.

Net earnings for the third quarter were $258 million, increasing $11 million or 4.4% compared to the prior year. Earnings per share increased 4.8% to $0.44 including a $0.04 negative impact related to the multi-employer pension charge and a $0.02 tax benefit related to the recognition of deferred tax assets, both of which I mentioned previously. Excluding the impact of these two items, the MEPP charge and the tax benefit, adjusted EPS would have increased 9.5% which we are relatively pleased with.

Turning to our business transformation plan for a moment, Bill noted the major milestone we achieved recently of going live at our pilot facility in Arkansas. Let me take a moment to give you an update on this strategically important project from a financial perspective.

We put together the budget for this project roughly three years ago based on our best estimates of cost, benefits and scheduling at that time. As we move through the various phases of the project we're finding, as you might imagine, that some of our estimates and assumptions were pretty good and others we've had to revise along the way.

For example, as we mentioned previously, the testing phase of the project that we just completed was extended to incorporate a fourth round of testing. This was the right decision because we believe the additional testing had a lot to do with our success in Arkansas. We had built a measure of contingency into our $900 million project budget to handle just these types of situations.

Thus far we have consistently reported that we're on schedule and on budget and that's generally still the case. However, we're going to continue to emphasize that this is unlikely to be the first IT project in history to finish precisely on schedule and on budget.

We are currently evaluating everything we've learned through the rollout in Arkansas and what changes, if any, we need to make to our overall development plan. We will provide you an update of our fiscal 2012 expectations in August when we speak to you about fourth-quarter results. And we'll plan to update you on our five-year outlook as we have done in the last two years at Investor Day in December.

Coming back to the near term, I want to update our estimates of the EPS impact of the project on this year's numbers. We now expect the impact to EPS for fiscal 2011 will be in the range of $0.02 to $0.04 per share compared to our previous range of $0.06 to $0.09. As a reminder, this impact is the incremental cost net of the benefits from the project.

The reduction in our estimate is due mainly to our ability to capitalize more project costs. Our overall cash expenditures were generally as expected, but the extended testing period allowed us to capitalize a larger portion of these expenditures.

Turning to cash flow, in the first 39 weeks of the fiscal year we generated $666 million in operating cash flow compared to $477 million in the prior year period, due mainly to lower IRS payments and pension contributions this year, partially offset by a decline in working capital. Operating cash flow during the first 39 weeks of the fiscal year was impacted by several factors.

First, we paid $159 million in IRS settlement payments compared to $475 million in the prior-year period. We expect to pay $53 million in the fourth quarter of this fiscal year for a total of $212 million during the fiscal 2011. In fiscal 2012 we'll be the final $212 million in scheduled payments.

Second, we experienced a decline in working capital driven mainly by the increase in sales and case volume during the year.

Third, accrued expenses declined due mainly to the payment of incentive compensation in the first quarter related to fiscal 2010.

Lastly, cash contributions to our retirement plan have been lower in the first 39 weeks by approximately $100 million. As you may recall, we paid our fiscal 2011 contributions early in June of our last fiscal year and as a result we haven't made the quarterly contributions this year that we typically would have.

Capital expenditures totaled $137 million for the quarter and $454 million for the first 39 weeks, mainly related to a facility expansion and replacement, fleet replacements and investments in technology including our business transformation project.

At the beginning of our fiscal year we had expected to spend roughly $700 million to $750 million during fiscal 2011 on CapEx. However, due to timing changes for some of our facility expansions and foldouts, we now estimate total spend for the year to come in at around $625 million to $650 million for the year.

As we enter the fourth quarter it is important to remember that last year was a 53-week year for Sysco, so our fourth quarter this year will have 13 weeks versus 14 weeks in the prior year.

As Bill mentioned, we remain focused on building a pipeline of quality acquisitions. We are pleased by the current level of activity we are seeing in the marketplace and we've recently closed, or expect to close in a matter of days, acquisitions of companies that represent approximately $200 million in annualized sales. These transactions combined with the Lincoln Poultry transaction we announced in the first quarter mean we have acquired companies this year representing approximately $420 million in annualized sales.

In closing, we are encouraged by the results announced this morning. And while consumer confidence, housing and unemployment still have a way to go before reaching pre-recession levels, there are continuing signs that the general economic picture is improving.

Our financial results may continue to be a bit choppy reflecting the uneven nature of this recovery, but we believe that the business is improving. At the same time we continue to make investments in our business that we strongly believe will generate long-term benefits to our businesses and our shareholders. With that, operator, we'll now take questions.

(Operator Instructions). Greg Badishkanian, Citi.

Hi, this is Jeff Hones actually on behalf of Greg. Nice quarter, guys. Can you guys talk a little bit about your case line growth improvement through the quarter? I think you mentioned last quarter that January was hurt a little bit by some bad weather. So did you see any sequential -- do you see sequential pickups in Feb and March? And then just curious what type of momentum you're seeing already in April and early May?

Thanks, Jeff, this is Bill. Case line movements, it's really hard to characterize that on a month-to-month basis. If you go back to the second quarter, as reported it was soft compared to the quarter before, if you adjust for the holiday week -- still a little less but not quite as much of a gap.

So I would say this to you, we're pleased with the volume. We did see pretty good consistent growth throughout the quarter. We saw it in some places we hadn't seen it in two or three or four years like Florida which was really encouraging to see. We saw it in most of the country.

We were hurt by weather in January in the Northeast which we don't talk a whole lot about whether in the Northeast in the wintertime, but we actually hurt in the Southeast in Atlanta and that part of the country. But I also have to tell you that with a late Easter this year that probably more than offset it or at least equally offset it.

So I think with the call out that Chris made here on the favorable benefit of not having a holiday week, that it's pretty much straight up what we're reporting in that 2% range.

And then one last one on I guess inflation on center of the plate items. Are you seeing that inflation subside or have you just been able to pass more of that through to your customers?

We saw it subside a little bit in the dairy area, it's kind of coming back some. But we're not seeing it subside at all in the beef and meat area, over in the seafood area. And what we're also seeing now is it's starting to broaden out into other categories -- produce, there were some weather issues there. Produce is obviously very volatile. But I think Chris mentioned our grocery, dry grocery area, canned and dry.

The increase wasn't as much as what we saw in the meat area, but that's a very significant piece of our mix. So I think this inflation, all the commodities and -- I think it's working its way through the whole supply chain right now, you're starting to see it be positive in more areas whereas a couple quarters ago it was really driven pretty much by three areas for us, three categories.

You guys basically have been able to pass a little bit more of that through this quarter versus last quarter basically?

Yes. I mean, when you hear us talk about education, I mean that's three pieces. I think we're out there every day trying to grow cases in the right way, take share, pass along what we can and do that in the right way and obviously keep working on our productivity and our cost structure. So I would say we did a better job clearly in the third quarter in passing it along.

Great, thanks, guys.

Thank you.

Jonathan Ivankoe, JPMorgan.

Yes, a question again on the overall industry. Many restaurant companies are talking about taking more pricing in fiscal '11 than they have in '10 and I think even at levels we haven't seen for at least half a decade or so.

I mean, what are you seeing in terms of not only their receptivity in terms of higher prices? But I think more importantly as the industry overall improves are you seeing some of your food service competition getting more competitive on price or is that something, because of cost inflation and fuel, that you're seeing even less competitive on price?

And obviously what I'm trying to understand is how, via strategic price investments, we're less in the March quarter than the December quarter while you were expanding in case volume? I mean does that say something specific about your competition?

I'll start and let Chris finish, maybe, on the strategic pricing initiatives. I would say, John, those are two different issues. On the strategic pressing initiatives, those are some areas where we chose to go at some things in an aggressive way where we feel we have an opportunity to take share and it's going to take a couple years to get a payback on that.

To the broader question of taking price increases in the industry. We're seeing what you're seeing in terms of what the restaurants are beginning to be more receptive and to pass it along. This is just my view; I mean I think that's a combination of two things. One is the nature and the level of the inflation is getting higher and higher and it's more broad, as we just mentioned.

So on the one hand I think we're all at a point where we have to pass it along to some extent. But I also think it tells you that they're feeling a little bit better about their business. And some of the surveys we see would confirm that.

So I think as people get more confident that the growth, albeit modest, that they're seeing in their business is going to be able to sustain itself, that does give you the confidence to pass along increases in a way that maybe you wouldn't have been so comfortable doing six or nine months ago. So I think more broadly there's just a need to pass it along because all of our costs are going up. But I think people are modestly more confident right now.

And Bill, in terms of your competition, and this is obviously a marginal change question, are you seeing your competition more or less price aggressive in this current environment -- again, with inflation, fuel costs and improving in case volumes? Are you see sensing that they're increasing via the pressure on you or perhaps even decreasing the pressure on you?

It obviously depends on the competitor, but I would have to tell you that the competition -- the sense of competition on the price line value line right now is as intense as it's been. I don't think it's getting more intense, but we've been at a pretty acute level here for last year and a half and we're not feeling it subside at all.

Okay, thank you.

Yes.

Mark Wiltamuth, Morgan Stanley.

I wanted to dig in a little more on the inflation issue. When you talk about executing a little better is it just that you're more on top of the increases as they're coming through and the marketing associates are better manned to deal with that? Or characterize what was different the last couple quarters versus this quarter on the pass-through of inflation.

I think, Mark, is some of it is what I just went through which is the environment that we're in. So while on the competitive side it remains very intense and very competitive, on the customer side I think we are working more effectively with our customers and helping them find ways to pass these increases along in the right manner. So, I think that's part of it.

But look, the other part of it is just we weren't pleased with our results in the second quarter and we went back to the drawing board and looked at everything we're doing and we've got eight broad-line companies out there [in that segment] and a bunch of specialty companies, so there's no magic buttons we're pushing from here.

But I can assure you that the focus on striking the right balance between case growth and margin management and expense control has been heightened and we're encouraged with what we saw this quarter. So it's a combination of things.

Were you actually getting any pushback from customers saying, look, these increases are too big, I just can't take them? Or how is that going?

I'm sure our marketing associates get that pushback every day and that's -- I think you work through it and you try to make good decisions each day depending on the customer and their particular sets of circumstances. So, ultimately our job is to get our customer to understand how -- what it takes for us to be successful and in the end we're only successful if they're successful. So at some point we're trying to paint a picture for them on how they can manage their menu more effectively and pass these increases along to their customer in the right way.

But as we all understand, it's not easy. The biggest difference -- we've managed through inflationary times before, as we've discussed in the past. What makes this one different is the environment that we're still coming out of. And when you hear us talk about choppiness or uneven recovery, that's kind of what we're getting at which is it's hard to categorize (technical difficulty) where we're making improvements or how our customers are dealing with this in a consistent way because it's case-by-case and one month might be a little bit better than the next month, that type of thing (technical difficulty).

And lastly, on headcount you said you were down 1%. Are you still working to add back MAs in certain areas for strategic reasons?

We're looking at (technical difficulty) relative to what our expectations for growth are over the next (technical difficulty) 12 or 18 months. So yes, we're already making (technical difficulty) slightly and we'll continue to try to (technical difficulty).

Okay, thank you.

Ajay Jain, Hapoalim Securities.

Yes, hi, good morning, and thanks for taking my question. I just had a question on (technical difficulty). I think, Chris, you had mentioned that the non-capitalized portion was going to be down relative to what you budgeted before. Can you just confirm the actual dollar amount that was expensed in Q3? And based on what you're expecting right now, can you give the outlook for the fourth quarter?

Yes, Ajay, we actually don't talk about the specific dollar amounts to be (technical difficulty) we've given is that, and I think it goes back to the 10-K. We expect expenses to be about $25 million to $45 million higher for the year. And we're not updating that guidance at all. We expect the cash outlay to be $260 million to $280 million for the year and, again, we're not updating that guidance either.

All we've really said is that our guidance that we gave early in the year of $0.06 to $0.09 we've adjusted down. And this is incremental impact, so it's not the same as cash outlay. I've adjusted that (technical difficulty) down to $0.02 to $0.04. And the difference in the entire adjustment was the fact that we were able to capitalize more than we originally thought because testing ran longer than we had originally planned.

Okay, thanks for that. And then can you also talk a little bit more about the multi-employer pension that (technical difficulty). Was this plan that you just exited an isolated issue? And is there any potential that you might take and other earnings hit if you decide to exit another plan in the next year or so?

Yes, I hesitate to call it an isolated incident as we obviously have other multi-employer pension plans out there. Our general strategy is we look at all of these plans one at a time. Some of them are we'll say in worse shape than others. They give us some concern and this is one that frankly we've had some concern about. We look for opportunities to exit those plans when we get them and this was an opportunity we had and we took it for strategic reasons.

We've got some multi-employer plans that are in good shape and then again we've got some that aren't necessarily as bad as this one, but we'd prefer them be in better shape.

I think one of the points to remind folks of, and we do put this in our 10-K but it bears reminding -- the data we get on these multi-employer pension plans is very outdated. I think that the latest information we have on these plans right now is December 31 of 2009. And so (technical difficulty) we don't have performance for 2010 or 2011.

And so whether it's well-funded or under-funded is -- you're really looking back a year and a half and making a best guess. And the charge that we take this year will be trued up for our actual performance for the end of this calendar year. It's the best guess that we have at the time and frankly we're hopeful that their performance has been better during the lasting 18 months of March.

Okay, thank you. If I can just ask one final question. If you look at the comparisons for incentive compensation in the fourth quarter, to what degree is -- could that be a material issue in the fourth quarter? Is that a potential headwind? And then also, do you expect any anomalies with the tax rate this quarter based on your current expectations?

Yes, let me -- I'll try both of those and Bill may weigh in. On incentive compensation for the third quarter, one thing again, you'll see it in the Q when we file it tomorrow. I don't know that we break this out or not, but the $36 million of payroll incentive for comp increase, about one-third of that was an accrual for a corporate bonus incentive and frankly is a catch-up.

We did not have an accrual for the year based upon the first two quarters or the first half-year performance. And so we've effectively put on three quarter's worth of accrual in one quarter. So from that basis it was probably a little heavy in Q3. If it goes up in Q4 frankly it's due to performance and I'll say the same thing about the field compensation. If that number is heavy in the fourth quarter, again it's going to be driven by case growth and gross profit growth, which is a good thing.

Ajay, this is Bill. I don't usually hope for headwinds. I'd love to have one in the fourth quarter, but I think we had pretty full accruals last year, so I don't think that's going to be a big issue.

As far as the tax rate, no, we don't have anything on the horizon that would cause me to think that we're going to have anything significant on the tax line. That could change fairly quickly. The thing that we normally are talking about is COLI and, again, we can't predict what's going to happen with COLI during the course of the quarter.

Okay, great. Thank you very much.

Andrew Wolf, BB&T Capital Market.

Thank you, nice quarter. Bill, I just wanted to get back to (technical difficulty) on how the business trended during the quarter. Did you say it got up to a little over 2% and that's sort of where it's at? Or was there any (technical difficulty) that we should (technical difficulty) tell us about?

Yes, I think I acknowledged that (technical difficulty) when you go through all the adjustments that we verbalized here that you'd be around 2% the way we characterize volume growth or real growth, I guess. Andy, the only point I was trying to make is it's very difficult to ascribe a cadence a month at a time. I didn't comment on April because we don't do that, as you know, during the quarter.

But April happens to be a month where we had a late Easter, that's good, but at the same time Mother's Day is falling on a different week. So it's really hard to spell (technical difficulty) anything in one quarter. What I'll remind you, and I know you know this, is in the third quarter in particular, March is a critical month so we had a good March and we needed to to have a good quarter.

Thanks, that's (technical difficulty) helpful. (technical difficulty). Any noteworthy changes in your customer segments? Were the higher end restaurants starting to do better or continuing to do better? Anything in the 1% or so sequential pickup in real sales?

It's hard for us to kind of tell that from here to be honest with you. We have certainly had some perspective, but we also look at everything that you look at. The best I can ascertain at this point -- there's some -- I won't call them conflicting, but there's some contradictory data or anecdotal views out there. But I think the (inaudible) side continues to do well and their traffic appears to be up a little bit. I'm not really sure what's driving that necessarily but it seems to be good.

I think as you get into casual dining, family dining, the traffic isn't up that much if at all, but as people go out today they seem to be spending more than in the past. So (technical difficulty) for the most part those folks are seeing a little bit of an increase.

What's harder to gauge is just the overall industry number because we go to different sources there. Some (technical difficulty) people believe right now that the market is still (technical difficulty) relatively flat. So in a few months we'll know that a little bit more accurately. So I'd say the family, casual dining is holding its own, maybe up a little bit based on increased purchases. And on the high end I would say that that's doing better.

Okay, this (Technical difficulty) might be for Chris. On the fuel, the $14 million this quarter and your expectation we'll see where that goes. But was any of that recaptured through the contract pricing? I know (technical difficulty) Bill said you're going to -- or you said you're going to institute a surcharge against -- or for independents. But is that $14 million -- I'm not sure I heard it right, was any of that recaptured through to contract pricing this quarter or is that the amount that wasn't?

No, we actually note fuel costs separately from fuel surcharges. Fuel surcharges go through gross margin. So what you'll see in the Q tomorrow -- we'll break that out for you. But fuel expenses or the (technical difficulty) side was up $14 million. Fuel surcharges are always on for the contract side of the business, so there was an offset there.

On the street side of the business, that's where I said we'd put in a fuel surcharge starting in March. It had very little impact for this quarter, but we do expect it to have a good offsetting impact in the fourth quarter to the increase. And we will be -- I think we do this in our Q tomorrow -- updating some guidance on Q4.

I mean, as I said in my statement, we expect fuel costs for the fourth quarter to be up $15 million to $20 million. We expect the fuel surcharge to be up $10 million to $15 million. So those will be substantially offset.

Okay, that's clear. The only other -- just on other income, there was a big pickup there. Could you just tell us what the source was or just clarify (technical difficulty)?

Yes, it was actually two transactions. In the third quarter of fiscal 2011, so this third quarter, we recognized a gain on the sale of a facility up in Canada that was about $4.5 million. In the third quarter of last year we recognized a loss of about $3 million on the sale of our Jamestown, New York facility. So that year over year [lap] of that looks pretty big.

Actually one more. And then also housekeeping, (technical difficulty) COLI (technical difficulty) de minimis, because it looks like stock market (technical difficulty) is that right?

We don't talk about COLI unless it has a significant year-over-year impact. So we didn't talk about COLI.

Thank you.

John Heinbockel, Guggenheim Securities.

Hi, guys. A (technical difficulty) couple of things. Bill, it seems very encouraging that price pass-through is picking up and there has been no sign of demand dampening, which I think maybe most of us might have expected some of that. Are you seeing that anywhere if you look at categories, geographies, is there any early sign of demand getting a little bit by inflation or no, not yet?

John, I think there's -- I'm not going to call them out, but I think there are some geographies and you can probably guess (technical difficulty) where they are, where the economy is still in a tougher placement. Maybe some others, whether you look at it in an absolute sense or relative to a year ago, and so where you have high unemployment, that type of thing -- higher than average obviously is pretty high in general right now.

So yes, there are one or two markets that we see -- where we don't see as much growth as we might see in some other areas. But generally I would say it's been pretty consistent across the country.

As far as categories, I wouldn't say that I notice anything there that's worth getting into. I think, again, these things need to be managed. There's always pushback. We try to make good decisions with our customers through our MAs and it's our job to manage it.

So in these high inflation categories, that's typically where you're going to see the pushback because (technical difficulty) it's big increases and often it's on items that cost a lot. So we continue to work through that and, like I said earlier, when you hear us speak about execution, that's just where we feel like we're managing it better. But look, there's still work to be done here, I can tell you that.

Does the fact that the volumes are behaving as well as they are give you more confidence to put more pricing through (technical difficulty) I would imagine that if the volumes were negative, so we should see more of that?

Yes, I think it does. And (technical difficulty) same answer I gave in the context of our customers. It gives you more confidence but we're also at a point where we need to. And again, the key, and I've said this a couple of times, it's really important. The key is how we do it.

It's not just necessarily just passing along a price increase, it's working with the customer on their menu, working with them on different items, (technical difficulty) perhaps substitute items, working with them on specials, those types of things. All the things that our MAs are trained to do, business reviews, all that type of thing. So you (technical difficulty) try to do it in the context of how can we help get through this together and still both of us run our businesses better.

The other thing, inventories were up a decent amount year over year. Is there a lot of forward buying (technical difficulty) taking place? And do you think that's an opportunity to offset margin going forward?

No, we don't think we do (technical difficulty) forward buy activity. I wouldn't say that that's coloring (technical difficulty) the numbers. The inventory increase is really driven by the case and overall performance and then we did have DSOs went slightly the wrong way on us this quarter, so that accounted for a little bit of the inventory as well.

But I mean, is (technical difficulty) forward buy an opportunity? From the -- you've got inflation for the first time in a while, your carrying cost is pretty low. Is it more you really don't want to take advantage of it or you don't see the opportunity from the vendors?

Well, I don't think we have any great expertise to begin with in terms of forward buys. We do a little bit, John, in certain commodity areas. So, yes, generally we just philosophically don't believe that that's part of our value package to be honest with you. So we try to be smart and where there are opportunities we'll take advantage of them.

But our role we see is of being a marketer and a distributor (technical difficulty) we don't really -- we don't go real big into that area at this point. We don't -- frankly, John, we just -- we don't have -- we'd have to do a lot more work in the whole risk management area I think to take a bigger step in that area.

And finally, with the Arkansas test what one or two things totally surprised you? You mentioned issues that you resolved, maybe surprised you negatively, what one or two things surprised you positively as you go forward to a bigger test?

Yes, I think there's really no negative at this point, there's just -- there's delays, there are performance issues. So I would say on the testing side, Chris alluded to this, we did extend testing. We pushed the go live date back appropriately so, because (technical difficulty) do more testing. So I wouldn't call that a negative; I think we made the right decision. But I'm trying to give you some color on how things play out.

The thing we're working on right now is what we call performance. So more consistent response time, shorter waits more of the time, that type of thing. So we've made great strides just getting to the weekend, as I mentioned, was a huge stride and we've made good strides in the last three weeks. But there's still work to be done on that, there's some work to be done in the reporting (technical difficulty) area.

But the bigger issue, and this -- I apologize to the people from Arkansas who are listening right now. The broader issue for us is to take stock of what we're learning through this pilot and understand what that means as we go forward with this first wave.

So we've got to do everything we can to help Arkansas operate their business at a high level, but at the same time we're taking a step back and looking at different things that we've learned from the processes that we put in place and the feedback we're getting from our MAs and customers.

John, I thought I'd weigh in just with my own thoughts. It's a bit of a shout out to the teams here. But I think one of our surprises was that fairly quickly we were dealing with what I'll call moderate issues instead of really big issues. After two and a half years of this journey is still described and (technical difficulty) the massive amount of people that we had working on this project, you build up this expectation just from fear that something horrible is going to go wrong and you're going to have to go backwards or you're not going to be able to ship groceries.

And even though we've talked about mitigation strategies every time we've talked about such a big project, you don't know how all that is going to work until you flip the switch. And I would say that we didn't have a problem shipping groceries and the team did a fabulous job tackling the issues as they came up. And as I said, fairly quickly we were down to what I'd call moderate and then down to (technical difficulty).

I don't want to say anything is a minor problem, but in a pilot (technical difficulty) frankly I think we expected worse. The other thing just to note is a lot about turning on the pilot side in Arkansas, we also turned on our Sysco business service center here outside of Houston in Cypress, Texas, which is our -- frankly our shared service center back office function.

So a ton of work has gone into preparing that group for the changeover as the operating companies go live. So again, flipping that switch and seeing the success was very -- a very welcome thing.

Yes, I think, John, just maybe (technical difficulty). The way we defined success on this thing was we were able to ship groceries on time and accurately on Monday morning. And so we had some bumps along the way but -- and we're still working through some things. But that's how we define success and that's why we're calling this a successful launch.

Just lastly, have the MAs there fundamentally changed how they're spending their time? And is it too early for that to increase productivity? Where has that gone?

Again, this is a pilot site, so I would say it's a little early on that front. Right now we're trying to get (technical difficulty) through the transition. Certainly some of them are I'm sure, but I would say those are things that we'll look at over the next 90 to 180 days. Right now we're very focused on the system and all that goes behind the system.

So I'm sure there's some of that that's happening, to Chris's point, the SBS is a new environment for them and they're adjusting to that. But I would expect you -- or us to be able to see that improvement as we get three to six months into it. But that probably is more relevant as we get into the first wave and the subsequent waves. This is truly a pilot where we're trying to learn as much as we possibly can before we go forward any further.

All right, thanks, guys.

Meredith Adler, Barclays Capital.

Thank you very much. I want to go back to something Chris said about having paid pension early at the end of last year. Did that change the way pension was expensed or only a cash impact?

It's only a cash impact, Meredith. We still expense it quarterly, we just sent the cash early, frankly, to take advantage of what we thought were good market conditions. And given the results of our pension investments for the year we're pretty happy we did it.

Great. And then I'm assuming that if you've been able to apply fuel surcharges (technical difficulty) in this latest quarter, the competitive environment must be allowing you to do that. The others are also taking fuel surcharges, is that fair to say?

We did some pretty -- we've done this in the past, Meredith, and then we've unwound them (technical difficulty) on the street as well at the appropriate time. So we did some sort of (technical difficulty), if you will, analysis and different competitors are doing different things. And so essentially this is an example of something where if someone is going to do it consistently around the country it's going to be Sysco. So we did it, and we really didn't think too much about the competitors.

Okay. And then I know that you got a question about forward buy, which it doesn't sound like you want to take that risk really. But often distributors just naturally have inventory profits for when there's inflation in the dry grocery category, obviously not in perishables, it turns too quickly. Is there some reason to believe that you'll be able to realize some inventory profit?

We typically have that running through in our variance every quarter to the extent prices are going up of course. Whether you'll see significant quarter-over-quarter improvement, one, it's hard to say; and two, I wouldn't expect it. So, yes, I don't think you'll see much from us in the way of significant increases from inventory valuation.

(Technical difficulty) on average about every 20 days, Meredith. So there's not much time for that (technical difficulty).

No, I guess, but some categories are (technical difficulty).

There will be in some of the nonfood categories.

Yes. But again, (technical difficulty) the average days on hand that we have across all categories including the slowest of categories is not significant enough that we'd roll that much of an improvement (technical difficulty).

Got it, okay. And then I have a question about -- you talked about because (technical difficulty) the testing went on a little longer and you were able to capitalize more. Can you give us some sense -- I don't think you'll (technical difficulty) want to tell us how much has been capitalized. But can you give us some sense of what the depreciation period would be for when you capitalize those things?

Yes, generally sometimes (technical difficulty) when I do this, but I call it the machine. So when we capitalize (technical difficulty) we're basically saying we're building the machine and at some point we start depreciating the machine. We did that when we turned on Arkansas effectively. And generally that's going to be capitalized over seven years.

Okay. And when does it start being capitalized? When will that seven -- if it's already started presumably?

It has now started, yes.

Okay, great. And the other investments for the business (technical difficulty), are most of them going to be seven-year depreciation?

No, it's going to vary, I'd say on the short side there will be some things we do that are three-year investment -- or three-year depreciation periods and some of the SBS investment, which is building plant equipment will be materially longer than that.

Okay, thank you very much.

Colin Guheen, Cowen and Company.

A question (technical difficulty) on the inflation and the real growth dynamics that are going on now. I guess historically at a 5% inflation level you would expect some demand destruction (technical difficulty). Are the operators out there saying or feeling that they have some pent up pricing given the deflationary environment? And thus we're seeing stronger pricing power halo maybe coming forward or is that not the way to look at it?

Can you give me that one again? I'm not sure I understood the question.

Yes, I mean normally when you're seeing 5% inflation they've got to have some demand destruction (technical difficulty) if you look historically I think at the business at these (technical difficulty) inflation levels. Are the operators feeling because you're lapping over deflationary period that they have some pent up pricing ability and therefore are willing to take price? And then they do have that with the consumers or (multiple speakers) characterize the -- I guess the willingness to take price right now at the operator level?

I think going back to some of the earlier questions, I would say that they're reluctantly taking price increases right now because they know they have to to run their business. But I think it has very little to do with the fact that there was deflation a year ago. The memory bank in this business is not real long.

So I think it's just more of a perception of (technical difficulty) what they need to do to run their business and a little more confidence than maybe a couple quarters ago that their business is going to be in better stead than what it might have been before. So I think there's a higher degree of confidence on the modestly -- a higher degree of confidence on the next few months and just the reality that that's what good business people do.

Okay, great. Thanks a lot.

Bob Cummins, Wellington Shields & Co.

Good morning, everybody. I have to say as a long-time shareholder I'm pleased to see your stock up $4 to a new 12-month high today, in case people haven't noticed. It's great that (technical difficulty). And I wonder if you can elaborate somewhat on your acquisition strategy.

I see for the year to date you've spent quite a bit more on acquisitions than you did a year ago during the same period. But is that likely to be stepped up further? And in particular, are you emphasizing regional acquisitions to strengthen your position where you maybe don't have the market share that you would like? And to what extent would your expansion of (technical difficulty) more international operations as you go forward?

Let me start with the domestic stuff (technical difficulty) that we've talked about pretty much everywhere we've gone. Most of you that cover the industry know that there are a few large players, but (technical difficulty) when you get down past maybe number 15 the numbers drop off. Even though we've got over 16,000 competitors in the industry, the size of those competitors drops off fairly quickly.

We decided that we can wait around and try to strike relationships and hopefully get some opportunities (technical difficulty) to acquire some of the biggest players in the industry. Or frankly, we can go out and do what Sysco has always done extremely well which is form relationships with all of the other companies that are out there at least as many of them as we can and what Bill referred to as the pipeline of quality transactions.

So people that we meet today may not have any interest in selling today, but if they get to know us, we get to know them three or four or five years down the road they may have a family of (technical difficulty) want to sell; hopefully we can get the phone call. We've been building that pipeline, it takes a while to build that pipeline.

So the answer to your first question is we've actually now closed or are within days of (technical difficulty) closing about $420 million worth of -- I should say that differently. Acquisitions that represent $420 million worth of sales, and so that's I'd say an increase in performance and tempo.

We've said publicly that we'd like to do at least a half point of sales generation every year through acquisitions (technical difficulty), internally we'd like to do even better than that. But you've got to have a willing seller as well as a willing buyer. So we'll take them as they come.

So we're going to work on a little bit smaller transactions, we're going to keep working on regional opportunities, to your point, where they make sense for us and where we have an interested party on the other side. We'll build those relationships and we'll try to work through those deals as (technical difficulty) they're available to us.

Moving to the last part of your question, we said that the three strategic streams that we're working down, one being broadening our US and Canadian opportunities, the core, as we call it, to the adjacencies, the third one in there is international.

We continue to look at other geographies and try to understand where we might find something that would be a good fit for Sysco where we could add some value and we could set up Sysco for long-term growth in new markets and we'll continue to look at those opportunities.

Being a (technical difficulty) Texas-based company, is Mexico an option?

Mexico (technical difficulty) is always an option, but just a little bit of timing. We've (technical difficulty) looked at Mexico before. I think when you look at countries like Mexico and maybe other developing markets, one of the questions becomes how would you go in and that would probably be a market where we'd want to affiliate ourselves with a partner, that type of thing.

So we have some good relationships with a couple organizations in Mexico and we'll continue to (technical difficulty) look at that. And to Chris' (technical difficulty) point, we're right now highly focused on the core, but at the same time, if we can find some strategic opportunities that will either help us better differentiate ourselves with our customers (technical difficulty) adjacent side for example, or provide a broader platform to grow with in future (technical difficulty) then we'd like to do that. But it's a whole different approach and (technical difficulty) process and highly strategic.

And (technical difficulty) how is your Irish operation performing?

Oh, they're performing great. I was over there -- Chris and I were over there for some investor meetings a month and a half ago and we stopped by and spent an afternoon and evening with their people and their management team. And when you factor in what's going on in that country we're exceptionally pleased with the effort, enthusiasm, they're growing the business.

There's a lot of pressure, as you would expect, on the profit line. But they're performing very well and we couldn't be more pleased with the people in that company.

Great. Just one final question. I see that your share buyback expenditures so far this fiscal year are way up from prior year, and that is understandable. I'm not going to ask if you're going to cut back on that. But what would be your strategy between (technical difficulty) stock repurchases and keeping that money on hand to use it for acquisitions?

Actually, Bob, our strategy on share repurchases, as we've talked about it, has been really just to offset dilution from options issuances. The reason it's heavier this year is as we entered the year with the share price where it was and the plans that we have in front of us, we set a target for how many shares we thought we needed to buy back.

Then the share price declined and suddenly we didn't need to (technical difficulty) that many shares. And so we haven't had a lot of activity here recently. But our strategy right now is not to increase the share repurchase program and it's not to spend a certain amount of money. It's frankly just to offset dilution.

Right, I understand. Okay, very good. Well, thanks for all the information.

Thank you.

And that will conclude today's conference. We thank you for your participation.