西斯柯 (SYY) 2012 Q3 法說會逐字稿

Good morning, and welcome to Sysco's third-quarter fiscal 2012 earnings conference call. As a reminder, today's call is being recorded. We will begin today's call with opening remarks and introductions. I would like to turn the call over to Neil Russell, Vice President of Investor Relations. Please go ahead.

Thank you, Casey, and good morning, everyone. Thank you for joining us for Sysco's third quarter of 2012 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 2, 2011 and in the Company's press release issued earlier this morning.

On the call today, if you have joined us via webcast, you will notice that we are once again augmenting our comments with a slide presentation. You can download a copy of the presentation by going to the investors section of Sysco.com.

Non-GAAP financial measures are included in our comments today and in the presentation slides. The reconciliation of these non-GAAP measures to the applicable GAAP measures are included at the end of the presentation and can also be found in the investors section of our website.

All comments about earnings per share referred to diluted earnings per share unless otherwise noted. In addition, all references to case volume growth include total Broadline and SYGMA combined.

Lastly, I would like to remind everyone that our Investor Day event will be held at the New York Grand Hyatt Hotel on May 17 beginning at 8.30 in the morning. If you would like to attend and need information about how to register, please contact us for details. We hope that you will be able to join us. The meeting presentations will be available to view via the webcast and will also be posted on Sysco.com in the Investors section.

At this time, I would like to turn the call over to our President and Chief Executive Officer, Bill DeLaney.

Thank you, Neil, and good morning, everyone. This morning, Sysco reported sales of $10.5 billion for the third quarter, a 7.6% increase. Case line grew 3%, including acquisitions, and we believe we continue to gain market share in the industry, which has shown little to no real growth for a number of quarters.

Net earnings for the quarter were $260 million and reported EPS was $0.44. Adjusted EPS was $0.49 and excludes several items, including gross Business Transformation costs. On this basis, adjusted EPS grew 2% for the quarter. We believe this adjusted amount is more representative of the performance of our underlying business.

The modest improvement in market conditions we experienced in the latter portion of the second quarter continued through the third quarter, due in part to an unseasonably mild winter in much of the northern part of the geography we serve. Our volume growth for the quarter was solid across nearly all of our business segments as we improved our customer retention, increased our overall count penetration and attracted many new customers to Sysco.

Our cost control performance at the operating company level was very encouraging during the quarter, as well. Excluding the impact of fuel prices and prior-year multiemployer pension plan charges, we reduced our cost per cases shipped.

Conversely, gross margins continue to be a challenge. While 5.5% inflation and some difficult prior-year comparisons contributed to the margin erosion we experienced during the quarter, we must execute more effectively in that area of our business. This area is always one of keen focus and we have several initiatives in various stages of development that are designed to mitigate this pressure and still permit us to be highly responsive to our customers.

Turning to an update on our multiyear Business Transformation initiative and as we discussed in our second quarter earnings call, we implemented the new technology platform at our second pilot facility in Oklahoma back in January. While we saw significant improvement in the system's performance compared to our early experience in our first pilot in Arkansas, we did identify certain processes that require additional assessment and enhancement. We are addressing those opportunities now and are targeting a third rollout early in fiscal 2013.

Successfully implementing this technology platform is a critical component to our transformation of Sysco. Effectively driving a transformational change in a company such as the Sysco, which has enjoyed a great deal of success over the past 40 years, can be challenging at times. However, in our case, we absolutely need to embrace such change if we are to continue to perform at a high level in a world that is much different than just a few years ago. Notwithstanding the predictable bumps that come with this type of journey, we remain highly focused on positioning Sysco to be a top-performing company for years to come.

In that regard, we recently announced that Manny Fernandez has agreed to expand his role and become Sysco's Executive Chairman of the Board. Manny is an outstanding business leader with a deep technology background. His experience and capabilities will enhance the execution and expedite the implementation of our Business Transformation work. I've worked closely with Manny for the past three years and look forward to his input and support as we build an even more customer-centric and operationally excellent Sysco.

Now I'll turn things over to Chris so he can provide additional details on our financial results for the quarter.

Thanks, Bill, and good morning, everyone. For the third quarter, sales were $10.5 billion, or an increase of 7.6% compared to the prior year, driven mainly by food cost inflation, which we estimated to be 5.5% for the period. In addition, acquisitions within the last 12 months increased sales by 0.7% and changes in foreign exchange rates decreased sales by 0.2%.

Case volume for the quarter increased 2.9% year over year, including acquisitions, and 2.3% excluding acquisitions. We completed several acquisitions during the quarter, including European Imports, which we announced in late February and enhances our ability to address the specialty foods market. So far this year, we've completed eight acquisitions representing roughly $260 million in annualized sales. We are on track to achieve our goal of increasing sales by 0.5% to 1% through acquisitions.

We have a number of additional acquisitions at various stages of completion in our pipeline that we hope to close in the coming quarters.

Gross profit increased 2.1% during the quarter. Gross margin decreased 95 basis points year-over-year to 17.8%, pressured by an intensely competitive market and high levels of inflation. Operating expenses increased $28 million or 2% in the third quarter of fiscal 2012 compared to the prior-year period. The increase in operating expenses was primarily the result of a $29 million increase in salaries and related costs due to higher delivery and sales compensation and acquisitions. Also impacting operating expenses were a $24 million increase in gross Business Transformation expenses and a $10 million increase in fuel expense.

It is important to note that fuel surcharges offset this increase, although they are reflected in gross profits. These operating expense items were partially offset by a $36 million charge in the prior year related to the withdrawal of one of our operating companies from a multi-employer pension plan, or MEPP.

Reported operating income increased $11 million or 2.7% and net earnings for the third quarter were $260 million, an increase of $1 million or 0.4% compared to the prior year.

As we have discussed on previous calls, we believe it is important to focus on the performance of our underlying business, excluding the impact of the Business Transformation Project and the impact of COLI, which had a minimal positive impact this year, but had a significantly more positive impact in fiscal 2011 periods.

In addition, last year's third quarter included the MEPP charge I just mentioned and a $10 million tax benefit. Excluding these items, adjusted operating expenses increased 2.6% and adjusted operating income increased 0.9%. Net earnings on this basis grew 2.8% to $290 million and EPS grew 2.1% to $0.49.

Turning to the impact of the Business Transformation Project for a moment, in the third quarter of fiscal 2012, gross project expenses totaled $49 million, and we capitalized $39 million related to the project. In the prior-year period, gross project expenses totaled $25 million and we capitalized $42 million related to the project.

Now turning to cash flow, cash flow from operations for the first 39 weeks in the fiscal year were $908 million. In the prior-year period, cash flow from operations was $666 million. As a reminder, we are paying the final $212 million in IRS tax settlement payments during this fiscal year. We had paid $159 million in cash in the first 39 weeks of the year and will make the final payment of $53 million in the fourth quarter of this fiscal year. In total, we will have paid the IRS $952 million over 12 quarters, including this final payment.

Cash flow from operations improved by $242 million in the first 39 weeks compared to the prior year due mainly to improved working capital management, the redemption of COLI policies, changes in accrued expenses and lower pension expense. Working capital has improved year-to-date due mainly to smaller increases in accounts receivable and inventories this year compared to the prior year. This is due in part to improvements in DSOs for receivables and inventories and in part to changes in inflation trends.

Lastly, as we discussed on the second-quarter call, we redeemed some COLI policies which benefited operating cash flows. This was an element of our previously discussed plan to reduce the market-driven COLI impact on our earnings.

Capital expenditures totaled $199 million for the third quarter and $633 million for the first 39 weeks of the fiscal year. This year, we are constructing new facilities in Long Island, Boston and Central Texas, as well as a major expansion in Lincoln, Nebraska, compared to having only one such major project underway a year ago. Our new facility in central Texas opened recently, which allows us to consolidate our facilities in Austin and San Antonio. With this move, we have the dual benefits of lower facility costs and room for growth in this important market.

Before closing, there are a few guidance metrics for fiscal 2012 that I would like to update. First, we now expect an increase in fuel expense of $35 million to $45 million this year, which is roughly $5 million higher than our previous guidance, and it is primarily driven by higher projected fuel prices.

As a reminder, we implemented a fuel surcharge with a broader customer base late during the third quarter of fiscal 2011, which is intended to mitigate the increase in fuel expense.

Fuel surcharges are recorded in sales, and therefore benefit gross profit. We have [wrapped] the implementation of this surcharge, as I mentioned, late in the third quarter, so the year-over-year benefit from the surcharge will not be as apparent in changes in gross profit and gross margins going forward.

Second, we now expect gross Business Transformation expenses for the year to be approximately $175 million to $195 million, which is roughly $55 million lower than previous estimates. We had previously expected to begin amortizing project costs late in the third quarter, but this did not occur. We now expect amortization to begin in early fiscal 2013 with our next planned conversion.

In addition, we expect to capitalize spend on our Business Transformation Project this year to be $145 million to $165 million. This is roughly $20 million higher than our previous estimate, primarily because of the timing of our next conversion in early fiscal 2013. As a result, we will continue to capitalize more of the project spend than originally planned.

This increased CapEx spend on the project has impacted our overall expectations for CapEx for this year. As a result, we now expect total CapEx to be approximately $775 million to $800 million in fiscal 2012, which is back in line with the original guidance we gave in our 10-K.

In closing, while we are encouraged by improving industry trends, we are taking action in many areas to improve profitability in both the near-term and long-term, and believe Sysco's unique capabilities and commitment to ongoing investment in our business provide a solid foundation for future growth.

With that, operator, we will now take questions.

(Operator Instructions) Michael Kelter, Goldman Sachs.

Hi, guys. I wanted to ask about the gross margin pressure. Is there a way that you might be able to tease out how much of that is from food inflation versus competitive pressures versus mix shift to lower margin business? And kind of I guess as a second part of that is if the current food cost environment holds, meaning the basket is probably going to be down a bit next year based on the spot market, will GM rebound in fiscal '13?

Obviously, I think you know us enough well enough now to know I probably can't answer it with the kind of precision you would love for me to answer it with. But let me try this.

I would say to you that it is clearly coming from multiple places. So you've got -- first and foremost, you've got our customers who are feeling a lot of pressure to continue to create traffic in their establishments. And that's where you see this difference in inflation, where the inflation at the restaurant is, we believe, running 2% to 3% and ours has been in that 5% to 7% so far this year. So there is that kind of a challenge that you work through there with your customer each and every day.

There is certainly the typical type of competitive pressure that goes along with that. There is -- that is on the sell. Now, there is also on the buy, where I think we have opportunities there to continue to find ways to work more effectively with our suppliers and that type of thing in terms of how we purchase the product.

And then I think the third thing -- and I think this is a little more clear this quarter -- is there is us, in terms of our mindset and our approach to pricing and trying to strike the right balance between being responsive to our customers and write in appropriate margin and that type of thing.

So it comes from all three. The reality from where I sit that makes this quarter a little different than the first half of the year is I just feel like we didn't do as good a job on the margin line in terms of what we can control and what we can influence in the short-term.

And I would just use an example -- and don't -- I'm not putting a pencil to this -- but I think we are in an environment today if you just listen to everything I just said and look at everything that you all look at, the environment today, I don't think it's an environment where anytime soon we are going to see margins turn around and necessarily grow. I do think there is opportunity to mitigate that pressure. And if we had just had maybe half of the erosion that we saw on the margin line or maybe even just two thirds of it, I think the tone of my comments and the tone of the release would have been a little different, where our earnings would have -- they would have been good to -- maybe not great, but they would have been a very acceptable quarter from our perspective.

So I think we are in a mode right now where our job is to continue to certainly be sensitive to our customers, work closer with our suppliers. But we've got to do a better job of managing the margin. And I think from a messaging standpoint, when you are selling a box of food -- and say our average box costs $30, $35 -- but some of the boxes in the area where we are seeing the most inflation, poultry, meat, those boxes can cost $45 and $55, it is very -- I don't think it is practical to expect that that is going to be passed along in a short period of time on a proportionate basis. But I certainly think it is appropriate to expect us to do a better job managing the pricing on that. And that is obviously what we are working on.

And you mentioned -- you actually referenced in your opening remarks several initiatives to improve gross margin. Could you, maybe to the extent that you are able, give us an idea of what kind of things you are thinking about and if there are any one or two that we should have our eye on?

I think it is going to be hard for you to have your eye on it, but I think the things we have our eye on is there are certain things that we do in terms of how we approach pricing and where we might make exceptions and that type of thing, and how we work with customers and suppliers that we just need to be more consistent throughout the organization. And so it is not one or two things; it's several things that go into how we price with both our large contract customers and also with our street customers, how we buy product and how we manage that process internally. And what I am really alluding to there is we have opportunity to execute better and, in particular, more consistently throughout the Company, and just make some better decisions there. So I can't get into a lot of granularity for obvious reasons, but I can tell you there is opportunity there.

And then lastly, maybe if you could talk a bit about the cadence of sales in the quarter. And I know it is not -- I hate to slice things so finely, but the changing casual dining sales trajectory intra-quarter this particular quarter was pretty significant, where you had a decent January/February and then a much weaker March/April. So curious if you can give us any color as to what you saw for the quarter.

We don't typically comment on cadence of growth month-to-month. Obviously, we read a lot of what you all write and we have a sense for what you are saying, which is -- I believe the industry view is that things did slow down in terms of growth in March and April. This quarter, as we talked last quarter, this is a back-ended weighted quarter for us; March is always going to drive our numbers. So anytime you got a bigger denominator, I think sometimes that will affect the growth rates as well.

But certainly the things that helped in January and February were the calendar. I believe we had -- I think the holiday helped us early on in the quarter. In the scheme of the overall numbers, that is not that big a deal. I think weather was probably the biggest thing. And we've kind of gotten to where we stopped whining about weather, but at least on this call, I am at least acknowledging that it clearly helped the industry. And it helped us from the standpoint that I think in some of your more metropolitan markets in the north, we saw and felt better volumes.

Now, I'll quickly add -- and I am not whining about it, as I said -- we were hurt in areas where you would expect winter to be beneficial. So the big ski areas in Colorado and Utah and Florida, we did not do as well in those areas. And so I'm not going to say it netted out, but it wasn't a totally positive thing from a weather standpoint.

So not trying to dodge the question too much here, but we saw good growth in the first couple months. It continued, maybe at somewhat of a lower rate. But I would have to tell you the biggest thing I think we are beginning to see -- and we don't comment on this on a month-by-month basis either -- is I think the rate of inflation is subsiding, and that is going to affect the top line as well. And hopefully over time, it will subside to a level where it is more in sync with what our customers can absorb.

Thank you very much.

Ajay Jain, Cantor Fitzgerald.

Good morning. My first question is just on the operating expense leverage, which I think was somewhat commendable. But you clearly benefited from the cycling of last year's charge for multi-employer pension expense. And just wanted to ask if there are any other factors that you can talk about behind the cost savings and whether or not any of the SG&A improvement has spillover effect into the fourth quarter.

Yes, I think we did some good things on the expense line. We tried to call out the things that I would characterize as nonrecurring or unusual. So the Business Transformation expense, because of where we are and the timeline was a little less than what we originally thought, and we did have the credit last year.

The point I made was at the operating company level, our cost per case was down slightly. Which is a big deal -- to manage your cost per case flat to down is something we are always trying to do, and at times we do it better than other times.

I think if you go and look at our first half of the year, certainly we had margin pressure. The first quarter, we didn't see the type of volume growth we would've liked to have seen. We did do better in that area in the second quarter. But we had opportunities just on execution in terms of the expense side in the business. And I just felt that our folks did a better job managing expenses throughout the Company in all facets, SG&A and operations.

So I think we just executed better on that line. And that's a line we are going to have to continue to address, both structurally as well as just day-to-day management, to mitigate the margin pressures that we can't totally overcome.

Okay. And can you confirm if there was a significant payroll head-count-driven benefited this latest quarter?

I'll let Chris take that one.

Really nothing to be called out, Ajay.

Okay. And as far as the change in the outlook for pension expense, Chris, can you confirm what is behind the updated guidance, and if that is on the multi-employer side or presumably with your corporate-sponsored pension plan?

I may not be understanding your question. We actually didn't change our pension guidance. It has been the same all year. Was there a different question?

No, I'm sorry -- I was just -- I was going off of your presentation materials; I though the pension expense was indicated to be $25 million lower than fiscal '11.

Yes, and that has been the case. For the year, we said it would be down about $28 million roughly, about $7 million per quarter, and that has been consistent during the year. That is one of those items you set in the beginning and it is pretty much that it's set for the year. So I was just calling out that on a year-over-year basis it is lower and that is one of the reasons why the costs are lower.

Okay, sorry. My bad. Finally, I understand that you were able to eke out some gross profit dollar growth this last quarter. But assuming that you are going to market now with a more aggressive pricing structure, the gross margin impact seems to be increasing each quarter. So even as inflation seems to be moderating, do you have any color about the gross margin outlook for the current quarter in June? Could the impact be more than the 100 basis points from Q3? Thanks.

The only color I have is we need to improve, as I said a couple times now. So I certainly hope not, and as I mentioned in my prepared comments, it is an area of keen focus here. So we need to bring that number back. As I said to Michael, at this level of inflation, I don't know that it is realistic that we can totally reverse it, but we certainly need to lessen that variance.

Great. Thank you.

Ed Kelly, Credit Suisse.

Good morning. Could you maybe talk about what the impact was in the quarter from -- the net impact, I guess, from New Year's Day shift and a leap year on the volume front?

You know, I think it helped. As I -- I've been trying to be as descriptive as I can here. Leap year is always a good thing. You get an extra day. So I'm sure that helped -- and the holiday thing.

But I think when you line that up over a 13-week period and if you look at it in those months, I don't think it is that big a deal, to be totally honest with you, Bill.

We did take a look at that, and frankly, we didn't think it was enough to call out specifically. I think Bill is right, it helped a little, but it is really not material.

I think the weather was probably a bigger help than anything.

Okay. Could we come back to the gross profit again? And I want to try to approach it a different way. Because there's a lot of questions on margin, and I'm not so sure how -- I know margin is relevant, but maybe we can look at it a different way.

If we think about gross profit dollar growth, which was a couple percent this quarter, your business is really all about driving more cases through the network. And gross profit dollar growth was less than real kind of volume growth if you thought about it for the first time in a while. I wanted to get your thoughts on going forward, is that how we should be thinking about this business? Can you grow gross profit dollars faster than volume? I'm just trying to figure out the best way to model this, because up until now, you have actually been doing a pretty good job there.

I think -- I'm happy to come at it anyway you want. We certainly look at it every way we can. I think it is a good callout on your point there, and that is the unacceptable part of it. We can't grow gross profit dollars at a lower rate than what we grow cases.

What I'm trying to acknowledge is what we've seen here the last few quarters and what I think we may see for a while is G.P. dollars may grow somewhat slower than the sales dollars grow. But that is, I think, where we are not pleased with the quarter. We should have -- we certainly sought to grow the gross profit dollars at a higher rate. And I think if you looked at the first half of the year, it was closer to mid-single digits, that type of thing.

So that was our callout, and I think that is a very fair way of looking at it. But no, I would not -- we are certainly not planning the business around growing gross profit dollars at a lower rate than case growth. That is not acceptable.

That is something you can fix quickly, meaning like over the next quarter or so, or does that take longer?

I think it is just something that you fix each and every day in our business, and you bring focus to it. I think at the operator, our operator level, we don't necessarily talk about it quite like that. We try to get people just more focused on their categories and on their customers and so on.

But I take your point and I actually agree with it, that when I look at our business, I look at everything, clearly. But if there is kind of three lines that jump out, one is volume growth, two is gross profit dollar growth and three is cost per case. So those are the three things that we are very focused on. And I think, again, in terms of how I approached my comments, we are pleased with the volume growth, we are pleased with the cost per case performance and we are not pleased with the gross profit dollar growth.

Okay. And Bill, could you give us your assessment of sort of Business Transformation so far? We've got Manny coming in. It looks like there has been some delays in the rollout again. Just help us understand, I guess, what is happening and where the project is today versus kind where you thought it would be.

We are going to talk at length about that next week, but I will kind of dive in here and try to give you some color. Essentially, we've had some delays, and then we had another delay here after Oklahoma. We are not happy about that, but the reality is this is new ground for us, and it is better to deal with these issues now in terms of getting the system to perform at a level, or at least close to a level that is going to need to perform. So you (inaudible) not to get too deep into this and then have to fix a lot of things after the fact.

With that said, I think what you are seeing from the Board is we certainly can benefit from Manny's input and Manny's experience and the relationships he has in this area. And so he is going to work closer with our team and with me personally to make sure we are striking the right balance here in terms of driving this out at an appropriate pace, but also in a way that it delivers the benefits that we expect it to.

Let me jump in there, too. We've talked about to date Business Transformation primarily around the rollout of our new ERP system. And I think one of the messages you are going to hear from us next week pretty loudly is really helping the audience understand that Business Transformation is very, very broad and it includes a lot of stuff that is going on inside the organization, one extreme of which is the rollout of this ERP system.

And again, we are going to give you as much color as we can about all of the different things that we are working on. We are going to try to help you understand better which of those streams of initiatives have benefits that can be achieved in advance of an ERP and which of those are really tied to an ERP implementation, et cetera.

So I'm saying all this only because when we think of Business Transformation around here, it is much more than just how quickly can we roll out the ERP system. As Bill said, it is a critical part of the future success of the organization, so we are, frankly, solidly supportive of it and we've got to get it done and all those things.

But at the same time, we are not waiting to do everything that we need to get accomplished for that ERP system to be fully rolled out. And again, we hope to give you a lot more color on that next week.

Do you think -- you had mentioned in the past that fiscal '13 would be the peak year for expense for the project. Is that still the case?

I think going back a year and a half and two and half years ago at Investor Day, the numbers clearly showed that the peak year would be 2013. Now, when I've been asked about that since that time, what I've said is we've not put out new guidance for costs and expenses yet. We will get into some of that next week and we will update you on where we think the peak is, et cetera.

I think, again, the way to -- you didn't ask me, you asked Bill -- but if you asked me how I look at this at least from a cost perspective is we are going to have costs for the ERP rollout and additional Business Transformation stuff for the next several years, obviously, until we get this thing all the way completed. We are also going to have benefits from Business Transformation that we're going to start to realize throughout this.

I don't want to go back to talking about the net -- cost net of benefits. We hope to be able to show you those kind of independently. But I don't want to just fixate on the cost side of the equation. We really want to give you more color around what we believe the benefits are going to be as well.

I think just to kind of wrap it from my end here, and we will talk obviously more next week, Business Transformation is just something we need to do. And that is what I was trying to talk about. We need to go to market. We need to make some changes in terms of how we go to market. And that is a big deal in terms of how we've been running the Company here for the last several years. And we need to do that because the landscape in the world that we are competing in and servicing customer in is a lot different than it was even three to five years ago.

The technology platform, as you hear us talk about that, is a very critical, foundational part of the entire spectrum of Business Transformation. But as we get deeper into this thing and as we hit some bumps here and there, we also have the opportunity to adjust our thinking on what defines Business Transformation, what other things can we do to create some benefits along the way. And those are some of the things we will talk about next week.

I feel like I dodged your question, so let me answer a little more directly in terms of the costs. While I can't tell you what a peak is yet, here is what I think we have said and we'll continue to say. 2013 will be more expensive than 2012. That should not be a surprise. As we start to depreciate this thing, we ramp up our shared service center more, 2013 will definitely be more expensive than 2012. But I don't have visibility on for you as I sit here today is whether '14 or '15 will be higher or lower or the same as 2013. Again, we hope to be able to talk more about that next week. We are still looking at all of that data as it flows in.

Okay. Thank you.

Mark Wiltamuth, Morgan Stanley.

Bill, maybe you could talk a little bit about the competitive environment and what do you think your competitors are feeling? Obviously, you've had a gross margin hit this quarter and case wise we've gotten a little better, but what do you think is going on for the competitors out there? And are you seeing any further weakening that may cause some of them to exit the business?

Good morning, Mark. Great question, hard to answer because we don't obviously get a lot of visibility to their -- we don't get any visibility to their financial results. So a lot of what we get is somewhat anecdotal. My sense is that the larger players, the better operators' scale are doing okay. And I think this kind of market over time will be good for the people that have scale and who have the capital to invest in the business.

So my sense is they are doing fine and I'm sure they are having to compete very hard on the margin line as well, but obviously I don't have visibility to that. I think maybe we are beginning to see, and I'll let Chris speak to this, there's thousands of competitors out there as we've talked before. I think perhaps some of the smaller ones are beginning to think even harder about what their future is in terms of the industry and that type of thing.

I'm not saying it is a large-scale phenomenon, but I think it is probably getting harder both for our smaller competitors as well as for some of the smaller operators in the space.

Yes, I'll add to that. One of the things that we sense from the market, and again it is more anecdotal than anything, is everyone is highly focused on cost right now. So that should tell you something about where the top line is with some/all of our competitors.

It is easier if you've got some size and scale to get some cost structure improvement. I think the smaller players while they may be great companies and highly competitive in their own markets, it is harder for them to get their cost structure down significantly. And it's becoming harder for them to -- I believe harder for them to compete, and frankly we are starting dialogues with more of them these days than we have been.

Just a question on the roadmap here on the Business Transformation. So I think the plan previously was you would do the second market and then do waves of opening. So now you are inserting one more third-market test and then the waves of openings come. And is that moment where you hit the waves of openings, is that when you start depreciating at that point?

Actually -- and I don't know exactly what I said on our prior call, so I'll just say it new and fresh -- is we will start depreciating when we go to the next company. Now, you are right, originally we thought we would be going to a small wave of companies next. We're actually going to go to, we believe, one additional company, as Bill said, in the early part of the new fiscal year, probably a month or so later than we had originally intended. So that would trigger depreciation. And that is an accounting determination of when we are putting the machine into service.

And so that is still the plan, and that is the only reason, frankly, the depreciation didn't start in the third or fourth quarter, as we had not rolled to that next conversion yet.

Thereafter, we are not really commenting yet about what the conversion cycle or rate or run rate or roadmap was going to be at this point in time. We will give you, again, more color on that next week.

But it is not our goal to put out there a set number of companies for next year or a pace. It is more along the lines of here is the progress we hope to make in the next year, and it will, I am -- almost certainly be a range. If we've learned anything about this, it is that the best-laid plans don't always come to fruition, and so we will range it appropriately.

Are the cost savings more linked to the number of operating companies that are using it, or is that there are other activities that might generate cost savings as well?

So let me go back to the comment I made earlier, about Business Transformation in general -- again, as we've gotten into this thing over three years now, there is quite a bit that we have been able to identify in terms of cost savings, other enhancements that are not directly tied to a new ERP system being rolled out into our companies. As we have identified those and we've discovered how we can accelerate those, we are obviously going after those sooner rather than later, and they are not tied to any number of companies being converted.

There are obviously other benefits, opportunities that are still tied to us having a new ERP system in all of our operating companies. Those, of course, would be weighted more towards the more companies, you have the more benefit you get. Those are things that primarily are tied to the types of business processes and functions that will be put into our shared service operation. So the more companies you roll out, the more of those functions we can consolidate into our shared service operation and begin to realize some of the benefits.

Okay, I guess we'll hear from you next week. Thank you.

John Heinbockel, Guggenheim Securities.

So Bill, a couple things. Where do you think you are with your analytics around pricing -- and I'm getting back to the gross margin question -- with respect to demand elasticity, and an ability to forecast or tell what the elasticity is per item in certain geographies? So where does that capability stand, and if it is not where it needs to be, what would you do to make that more robust?

Great question, John. Good morning. I would say to you that -- in terms of the way I am interpreting your question, I would say we have a lot of work to do in that area, pricing in terms of more sophisticated or scientific pricing. But we have done some work there and will continue to look at it.

The balancing act here is -- again, don't hold me to these percentages -- but let's just say that roughly half of our customers have some form of contract and the other half don't. They work with a marketing associate and that type of thing. So what we are always trying to do is balance the value of having, say, a more scientific approach to pricing with the value of having that marketing associate in front of the customer, taking that order and really understanding what is important to that customer today in terms of their order. And frankly, down the road, over the next one to three months, in terms of running their business. So our marketing associates typically -- and even our presidents probably typically -- don't think in terms of elasticity, but that is what they do. They are making a judgment call every time they take an order -- what is the right balance in terms of maximizing that order, supporting the customer in terms of what they need and striking the right overall price, not necessarily per line item, but for that order in general.

And so that today, and as you well know, historically, has been handled in a very decentralized way through our sales folks and through the operating companies on that large segment of our customer base. I believe there is opportunity to do more sophisticated work in that area, but it is work that it is in its formative stage with us at best right now. And I think that will be one of our key -- that is one of our key initiatives that we've called out and that we will talk a little bit about next week, but frankly, will take some time to develop.

So I guess my answer is there is opportunity there, but I don't necessarily see a scenario where you go all the way to one extreme and you want to be totally pulling levers from a centralized location on a group of customers that still are going to be somewhat -- their decisions are going to be driven what is happening in that local marketplace, what is happening in their establishment. So I still think that local salesperson and local operating company visibility is going to be very important.

So to follow on then -- and I agree, you can't measure it from Houston. But having said that, do the systems exist today to give the marketing associate more information on that? Do they have -- can they access it? Is it more an issue of training so that they are more familiar with the how the elasticities work?

Again, I'm going to stay from the word elasticity. They have more visibility -- they have a lot more visibility today, John, than they did, say, five or seven years ago to certain things in terms of cost movements and that kind of thing. They have more visibility today than they did to some other things a year or two ago. I would say two things; one is our ability -- to your point -- to train effectively that will lend itself to execution. And then secondly, what else can we provide them, in terms of not just maybe what's happening with our customers within what we see, but what else is happening in the marketplace. And that is a whole different level of analytics that is very difficult to get to, but may provide us an opportunity down the road.

So they certainly have more information than they've had in the past. But your point is a valid one. There is training opportunities here and there is execution opportunities, and then there is a whole other body of work, which is what else can we provide, both at the central location as well at the local location, to make smarter decisions that are in the best interest of both our customers and ourselves.

So we're making progress, John. I'm not trying to dodge you here; we're making progress. But this is a big opportunity for us over the next three to five years.

When you think about tying that back into the macro then, if we are going to see disinflation here, which we probably should, that 5.5 should be 2 a year from now or quicker. What do you think the elasticity is that in itself creates demand? So we lose a couple hundred basis points in inflation, we gain some percentage of that in unit demand, and I assume -- would you agree that it is not one for one, right?

Yes, it is not one for one. I'm not even sure that is the key variable anymore. I think if you and I were having this conversation five or 10 years ago, we would be talking about that. I think what is more important is the mindset of the consumer and how our customers see that and their ability to absorb price increases and to get traffic, to make themselves more profitable.

So I think it is actually -- the psyche of the consumer is more important than that right now. But where the lowering of inflation, if it happens gradually, would be beneficial is it just creates less of a gap between what so far we've had to absorb and what we are able to pass along.

I would also echo what I said earlier. Gross profit is a function of a lot of things. You've got to move boxes. It is a function of how we price. It is a function of how we move prices within our system, transfer pricing, if you will. And it's how we buy. So there is other things we need to do on the buy as well, and that really comes down to reassessing how effective some of our strategic relationships are with our suppliers, and we are beginning to do that.

All right. And then lastly, right now, the plan for the third operating company is to be in test for roughly how long? And then when you start to the rollout, what is the capacity within the organization to do this? Meaning I don't know how you -- whether you're going to measurement it by quarter or what, but what do you think the capacity is to get companies rolled out?

We are going to roll out, as we said, the third conversion in the early part of fiscal 2013. We don't really have any intention of having a set period of time to watch the system before we make additional determinations. We will actually put in place the schedule that says unless we find something that is material, we will keep going and we will do more.

We are not really, again, commenting about how many more of these things we will do. We will talk a little bit more about that next week. But I will plant kind of a concept is in the past, when we've talked about the rollout for the ERP system, frankly, we've put out there what we hoped to be able to accomplish, which ended up being a fairly aggressive rollout schedule, and we put the numbers out there appropriate for that rollout schedule. And we are learning a lot in the process. It tells us that it is aggressive or it was aggressive, and we might want to be a little smarter about how we roll this thing out.

The way we hope to be able to talk about it next week is, look, this is a process that is going to be continuing for a while. There is a pace that we need to do that is a relatively conservative and smart and prudent pace. But if we get legs underneath us, if we start seeing great responses from the first few rollouts, we will be ready, willing and able to go faster. But that is not going to be the way we plan it. We are just going to be ready to do it if we start getting some great news out of the system.

So again, I think we will talk a little bit more about that next week. But right now, we are not talking about any number of companies per quarter or per year.

All right. Thanks.

Karen Short, BMO Capital.

A couple questions on gross margin, and I want to kind of focused on Broadline versus SYGMA. And maybe I'll separate this out into sales -- or case volume in Broadline and SYGMA and gross margin. Can you maybe just talk a little bit about each segment directionally, which is seeing slightly better than you might have expected case volume growth, and which is seeing less gross margin erosion? Maybe just kind of talk directionally about each of those.

Let me take the first part. I don't know that we can say a whole lot about the second part, Karen. But in terms of growth, I would say -- and I alluded to this in the comments as well -- we saw good growth in all the segments, I would say, with the exception of our FreshPoint. The produce markets last year were a lot more volatile, and so that created some challenges this year in terms of both top-line growth as well as margin management in that area.

So I'd say the Broadline, with the exceptions of some of the -- maybe the weather-sensitive areas, where we had some -- perhaps some better performance in places that characteristically we wouldn't see in the winter up north, and some weaker performance in some of the more vacation spots, I would say generally, the case growth was good throughout. It was good in Canada.

SYGMA had good case growth, the earnings pressure -- they did have earnings pressure more -- they have had more pressure on earnings this year than the last two years where they've had really strong years. Meat companies, we've integrated into the Broadline now. So I don't want to call out too much here, but I would say it is generally pretty good, with the exception of the produce side of the business.

But would it be fair to say SYGMA has gotten more competitive directionally than Broadlines?

No, I wouldn't say that. I think we try to be competitive on both. I think probably one thing I should say, because sometimes I think it gets understood, we've seen good growth, pretty comparable rates of growth both on the contract side of the business, including SYGMA, as well as the street side of the business. So I think sometimes people think all of our growth is coming from the contract side, but the reality is it is pretty balanced. It might have been slightly steeper on the contract side, but not that much. Now, we've invested in margin to get some of that, to be fair, but we are seeing good growth on both sides of that equation.

Okay, that's helpful. And then just looking at gross margin, if you said it, I didn't catch it. Is there -- can you kind of give a directional split between the competitive environment and inflation on the gross margin pressure you saw this quarter, like 50-50?

I tried there; I obviously didn't do very good. I'm almost looking at it a different way. So I think in one bucket, you can put the customer and what they can absorb, you can put the competitor, you can put the supplier relationships and you can put, for lack of a better term, what is in between our ears, in terms of what we think we can do. All right? So that's one bucket. It's impossible for me to tell you how much is one or the other. That is why you hear us talk about competitive pricing environment as opposed to competitive competitor environment.

The other bucket, I think, is just the math of inflation, which is what I was trying to bring out. Which is at this rate of inflation, I don't know -- percentages are not quite as relevant as they are when you have two to three points of inflation, whether you are looking at margin or whether you are looking at cost. Dollar growth -- at the gross profit line, dollar growth at that operating income line becomes very important.

So the way I'm just trying to compartmentalize in my head is what level of margin erosion could have still provided a quarter that would have met our expectations. And again, I will let you do the math on that, because I don't know what your expectations specifically were. But I would say if we had half of the erosion on a percentage basis, we probably would have been pretty pleased with the quarter.

Okay, that's helpful. And then I just was curious on the CapEx, your CapEx for the year comes up about $50 million to $75 million. I think you called out $20 million was Business Transformation. What was the remaining bucket?

Actually, the increase on the annual CapEx is really almost entirely made up on the increase on the ERP system, the comparison between the quarterly and the annual. But going back to the range of 775 to 800 from where we were last quarter is almost entirely made up of the ERP increase, the amount of additional capitalization there, which is $20 million year-over-year, I believe, but it is about $40 million quarter-to-quarter.

Got it, great. That's all I had.

Meredith Adler, Barclays.

Thanks for taking my question. We talk a lot about inflation and passing it along, but maybe you could talk about -- I think you said you got some business by being aggressive. Could you talk a little bit about what you're doing to go after business, and are there particular customers or segments of the business that you are being particularly aggressive about?

I'll start with that one, Meredith. I think what we have -- what I've tried to say is that we've been -- are aggressive in growing our business in terms -- and I think in a market like this, we certainly should be. I don't know that any of the issues we are talking about today, whether margin pressure or managing cost or Business Transformation, I don't think any of those would be a whole lot better if we didn't grow the cases, and I would argue that they would be even more acute challenges.

So the first place we start -- and we've had to do a little more of this over the last year or so than in the past -- is we are kind of defending our own turf a little bit more than we had in the past. We have a lot of different people that come after our customers, obviously, and we have a lot of customers, we have a lot of good business out there. So we certainly have, I think, dug in over the last several months and tried to work with our customers in every way we can, in terms of drop size, in terms of the delivery days, in terms of products, and ultimately, where necessary, in terms of price points, to give ourselves every opportunity to retain business.

And then our most profitable business beyond what we retain is the business that we grow within the account. And so as we see opportunities where we might have 20%, 30% share of wallet and we see opportunities to grow that business, we certainly -- and this is not something new. I think maybe the degree of it is a little greater than in the past. We go after that business hard and we find creative ways that make sense for the customer and us. And sometimes that may result in a price accommodation with the expectation that we will get more business and larger drops, and that that should fall to the bottom line on the expense line. And that is why traditionally, I have always focused more on the sales line and the operating income line, and then tried to explain those deltas between the two lines above gross profit and expenses.

And of course, the third area is an area where we are always, I think, very proficient, which is going after new accounts. And our best reference for new business is current customers. And I think it is just that is just the environment in terms of what it takes to go after -- if we are going after business we don't have, that is typically somebody else's gold account.

So we are coming at it from all directions. But I would tell you -- they are all important, but I think if there is a little bit more emphasis on the other in the last 12, 15 months, it has been more on making sure we don't lose business with the quality customers that we do have, and we find acceptable ways to retain that when other people come after us.

Okay. And then a question about the Business Transformation process. You folks did actually invest in a shared services facility in Houston, but obviously, I don't think it is being fully -- anywhere near fully utilized at this point. I was wondering whether there are dis-synergies caused by the delay in rolling out the ERP system.

Yes, absolutely correct, Meredith. I think we've talked about that on a previous call, that one of the reasons why these numbers, these expenses are high right now is that we've got significant costs out at our shared service center. Because you have to ramp up in anticipation of additional converted companies. And so you don't get to kind of scale, if you will, until you're pretty far down the road.

Now, we've tried to be sensible -- once we got more of an idea about the pace of conversions, et cetera, we tried to be sensible about getting the ramp-up or getting too far ahead of the ramp-up curve. But even still, in the early days of these things, they cost more money than the benefits that they derive for you, and that is going to continue to be the case for a while.

Okay. And actually, I want to go back to Bill and sort of follow up with my first question to you. I guess -- you made a comment, I think, last quarter about the most important thing was to drive case volumes, and if you were successful, the profits would come. And I don't know, I've been around a really long time and my experience is that you may drive volume, but sometimes the profitability of an industry just goes down permanently after that kind of aggressive behavior. And of course, it sounds like everybody is being aggressive. Could you comment or whether this is a phase for the industry or have we set a new lower bar in terms of profitability?

I think as far as I'm going to go today, Meredith, is I think what we've acknowledged for quite some time now is that we expect the rate of growth in this industry to be modest at best, perhaps even flat. And that we believe that our abilities and capabilities and scale should translate into us being able to grow faster in the market.

Clearly, as I've mentioned here, even a couple times today, we are in a different environment than where we were three or five years ago. So I think a lot of industries are going to be challenged with profitability.

So let me try to connect the points. I think you quoted me pretty accurately. I do believe that we should be out growing cases and growing volume, not at the expense of profitability at all levels. But I guess I'm confident in our people and our systems that we will turn those sales and those incremental business into profits.

Now in the short-term, obviously, we are seeing some pressure there and there is some execution issues and that type of thing. The connection I guess would be that doesn't mean that we don't have to do some things differently. And we will talk some more about that next week as well. But it connects to some of the things that Chris alluded to, in terms of what is Business Transformation.

So certainly, I don't think I can just say it is a phase. I think we have moved into a part of time in terms of the business world -- our industry is no exception -- where the consumer expectations and our customers' expectations are more acute and more specific than they've ever been. And so price, product quality are always going to be important.

So I think it is all the above. We need to continue to grow our volume. We need to grow it the right way. We need to continue to take our cost structure down, both in terms of our day-to-day execution, as I mentioned earlier, but also looking at our structure overall in terms of our operating costs, our product costs, how we work with suppliers and all that as well.

And then clearly need to manage our margins along the way. So it is not one or the other. But no, I don't think it is a phase; I think we are in a new normal, so to speak, and we need to do all of the above. My only point is to just cut or to try to squeeze too much out of that on the margin line at this point in time, I'm not confident that takes us where we need to go as a company.

Great. Thank you very much.

(Operator Instructions) Ladies and gentlemen, that does conclude our Q&A session, and our presentation for today. We appreciate your participation, and you may now disconnect.