Sysco Corporation
Q2 2015 Earnings Call Transcript

Published: 2 Feb 2015

[Operator:]

Please standby. Good morning. And welcome to Sysco Second Quarter Fiscal 2015 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 Shannon Mutschler, Vice President of Investor Relations. Please go ahead, ma’am.

[Shannon Mutschler:]

Good morning, everyone. And welcome to Sysco’s second quarter fiscal 2015 earnings call. Today you’ll hear prepared remarks from Bill DeLaney, our President and Chief Executive Officer; and Chris Kreidler, our Chief Financial Officer. Before we begin, please note, that statements made during this presentation that state the company’s or management’s intentions, beliefs, expectations or predictions of the future are forward-looking statements and actual results could differ materially. Additional information about factors that could cause results to differ from those in the forward-looking statements is contained in the company’s SEC filings. This includes but is not limited to risk factors contained in our annual report on Form 10-K for the year ended June 28, 2014, subsequent SEC filings and in the news release issued earlier this morning. A copy of these materials can be found in the Investors section at sysco.com or via Sysco IR app. Non-GAAP financial measures are included in our comments today and in our presentation slides. The reconciliation of these non-GAAP measures to the applicable GAAP measures are included at the end of the presentation and can be also found in the Investors section of our website. All comments about earnings per share refer to diluted earnings per share unless otherwise noted. In addition, all references to case volume include total Broadline and SYGMA combined. To ensure that we have sufficient time to answer all questions today we’d like to ask each participant to limit their time today to one question and one follow-up. At this time, I’d like to turn the call over to our President and Chief Executive Officer, Bill DeLaney.

[Bill DeLaney:]

Thank you, Shannon, and hello, everyone, and thank you all for joining us today. This morning, Sysco reported second quarter fiscal 2015 financial results. Sales increased nearly 8% to $12.1 billion and adjusted net earnings increased 6% to $245 million. Adjusted EPS increased 5% to $0.41 for the quarter. Our second quarter financial results were generally in line with our expectations, as we delivered another quarter of solid operating performance. Most important, our associates remained highly focused on providing excellent service to our customers in what remains an extremely competitive market environment. We generated nearly 4% case volume growth during the quarter and effectively managed acute inflationary pressures in our meat and dairy categories. Specifically, case growth trends in our locally managed Broadline business were favorable in most of the geographic markets we serve. In addition, we generated solid case growth once again with our corporate managed customers in the restaurant and travel and leisure segments. Our performance during the quarter was due in part to the benefits we realized from our portfolio of business transformation initiatives, especially category management. As our ability to effectively integrate these initiatives in our steady-state operating activities has improved consistently over time. While we are pleased with our overall performance during the quarter, we did fall short of our expense management targets. Expense increases were driven primarily by higher incentive accruals, selling cost and delivery cost. Excluding certain items and the unfavorable impact of incentive accruals, operating expenses increased 4%. As I’ve mentioned previously, Sysco’s single largest opportunity for improvement remains more consistent execution across the organization. We are implementing tools to provide increased visibility to key performance metrics, as well as improved best practices. While we are seeing some level of improvement in this area and believe we are on the right path, we have more work to do. Regarding overall industry trends, current restaurant data shows modest signs of gradual improvement. NPD, which tracks restaurant trends, recently reported positive traffic growth in the mid-scale and casual dining sectors for the first time since 2008. This is encouraging news as the casual dining sector includes a significant number of independent restaurant customers, for whom we provide substantial value-added products and services. In addition, consumer confidence and employment metrics are, for the most part showing improvement. We are hopeful, lower fuel prices will further improve the customers -- the consumer outlook and lead to sustainable increase traffic and spend for our customer base. We remain intently focused on enhancing every aspect of our business. So that we are able to better support our customers, operate more efficiently and compete more effectively. Benefits from our category management initiative continued to gain momentum. We expect that all categories representing approximately $15 billion in annual spend will be launched into the market by the end of this fiscal year and that we will achieve the three-year cost savings target that we established prior to the start of fiscal 2013. In addition, we are working with our suppliers in a more strategic and effective way that we believe provides a meaningful platform for growth and innovation in our respective businesses. Turning to an update in our technology initiatives, we continue our merger integration planning with regards to technology and have begun certain fundamental projects necessary for integration. As we move forward in deploying our ERP platform our approaches continue to evolve. For instance, we have focused on broad implementations at the operating companies for several years, with a plan to convert the hub where our shared business services facility last. However, we have found that this created inefficiencies at SBS that would make further rollouts challenging. Thus, we are now moving forward with the rollout of SAP financial modules for general ledger, accounts payable and accounts receivable, as well as additional elements of the HR module, all of which are intended to make SBS more effectively in the near-term and make future ERP conversions at the operating companies relatively easier. While focusing on operational excellence is a key area for us we also have important work underway to identify new markets with opportunity for profitable growth. As we discussed last quarter, we’ve developed a robust approach to serve the fast-growing Hispanic restaurant sector. We estimate that we have 10% to 15% of this $10 billion foodservice market and believe we have a significant opportunity to better serve these customers and grow our sales. We made additional strides of this effort recently with the launch of our new multi-lingual website dedicated to support customers in this segment. The site includes news, tips, menu ideas and trend data intended to help Hispanic operators drive restaurant traffic, improve their operations and better address their customer's evolving needs. I’m extremely proud of the efforts and accomplishments of our leadership team over the last several months. As we announced last August, Mike Green retired from Sysco at the end of the calendar -- at the end of the calendar year after 24 years of distinguished service. On January 1st, Tom Bene became Executive Vice President and President, Food Service Operations, succeeding Mike. Tom reports to me and has responsibility for all business operations, sales, merchandising, marketing and revenue management. Tom is a proven commercial leader with deep expertise and a strong track record in the food service industry. Since joining Sysco early in 2013, he has helped drive major advances in category management, revenue management, sales capability and customer insights from segmentation. We’re fortunate to have such a capable leader to succeed Mike. In addition and also effective January 1, 2015, Scott Charlton, Senior Vice President, Distribution Services, now reports to me in an expanded role. Scott leads end-to-end supply chain operations, including warehousing, inbound and outbound transportation and replenishment. Scott joined Sysco in 2013 as well and brings great energy and expertise to our senior leadership team. Turning to an update on our proposed merger with the US Foods. Over the past 12 months, we have worked in good faith with the FTC, providing millions of pages of documents and explaining to them our industry and the merits of our proposed merger. We strongly believe that the combination of Sysco and US Foods will promote competition in where it's already a highly competitive industry by positioning us to provide significant value to our customers, including lower cost. Unfortunately, the FTC has taken a different view of the potential competitive impacts of the merger. While we respectfully but vigorously disagree with the FTC’s analysis, we announced today a substantial divestiture package that we believe fully addresses their concerns. At this time, the FTC has not agreed to this solution. So we will now present our position, including this proposed remedy, to the five FTC commissioners and seek to obtain their approval. We remain convinced that the proposed transaction is good for our customers, our associates and our shareholders. In closing, I'm pleased with our operating performance through the first half of our fiscal year. Case growth and sales growth were up 3% and 7% respectively, while adjusted operating income and EPS grew at a rate of 5% and 6% respectively. In addition, many of our strategic business initiatives are gaining traction and contributing to these results. As we move forward into the remainder of our fiscal year, we are committed to improving the consistency of our operational execution, successfully rolling out our portfolio of initiatives and further developing our plans to integrate Sysco and US Foods. This is a critical time in our history and we believe the strategic actions we're taking are vital to both strengthening our customer relationships and providing solid returns to our shareholders over the long term. Now I’ll turn things over to Chris, so he could provide additional details on our financial results for the second quarter as well as the agreement we announced this morning with Performance Food Group.

[Chris Kreidler:]

Thanks Bill and good morning everyone. For the second quarter, sales were $12.1 billion, an increase of 7.6% compared to prior year. Food cost inflation was 6%, driven mainly by double-digit inflation in the meat and dairy categories. Sales from acquisitions increased sales by 0.8% and the impact of changes in foreign exchange rate decreased sales by 0.9%. Case volume grew 3.6% during the quarter including acquisitions and approximately 3.3% excluding acquisitions. Gross profit in the second quarter was $2.1 billion, a 6.1% increase. And gross margin declined 23 basis points to 17.25%. Benefits from category management contributed to our gross profit performance during the quarter. In addition, case volume growth advanced from the prior quarter and this increased demand aiding gross profit performance. In our higher margin locally managed Broadline business, case volume growth remained relatively steady and accelerated with our corporate managed customers. Certain items for the quarter totaled $133 million and primarily related to merger and integration planning expenses. Of this amount, $81 million was recorded in operating expense and $52 million was recorded in interest expense. Merger and integration planning expenses that impacted operating expense were associated with professional fees to assist us in managing integration planning as well as the legal and IT related projects. Work-related integration planning peaked in the second quarter and costs related to these efforts should decline going forward. Merger and integration expenses that impacted interest expense relate to the debt issuance during the quarter that is intended to finance US Foods debt upon closing of the merger. We're trading this interest expense of this certain item until the merger closes. After excluding certain items, adjusted operating expense for the quarter increased $108 million or 6.8% compared to the prior year period. This increase was driven by $115 million increase in payroll expense resulting from several factors. First, during last year second quarter, we reduced certain management incentive accruals based on our performance versus our objectives at that time. And this year’s second quarter, these same incentives are generally accrued at higher amounts, reflecting the impact of our recent performance and causing a year-over-year variance of $41 million. Excluding this year-over-year difference in incentive accruals, adjusted operating expenses would have increased only 4.2%. Second, pay to our sales organization was higher as a result of growth in gross profit dollars. These are costs we would expect to see given our performance for the quarter. Sales cost also increased although to a lesser extent as a result of hiring additional marketing associates over the last year. As we discussed last quarter, some of this increase in MAs is related to normal hiring to replace attrition and support growth. However, certain markets added MAs because they lost more than they planned when we implemented our sales reorganization a couple of years ago. As a reminder, it takes roughly 18 months for an MA to be fully productive. Third, as we’ve discussed in prior quarters, we continue to experience higher delivery costs in our Broadline operations. As Bill mentioned, we have a number of initiatives that are in various stages of implementation that we anticipate will help to reduce these costs and increase productivity to mitigate these increases. And lastly, payroll increased due to the newly acquired operations, including Metropolitan Poultry, the joint venture in Costa Rica we entered into last fiscal year and Iowa Premium Beef. Adjusted operating income for the quarter was $396 million, up 3.1% for the prior year and adjusted operating margin was 3.3%, down 14 basis points from last year. Our effective tax rate in the second quarter was 33.1% compared to 35.4% in the prior year period. The majority of this change is the result of reduced state taxes from legal restructuring as well as a growing base of business in international jurisdictions that have lower tax rate. Adjusted net earnings increased 5.5% to $245 million and adjusted EPS increased 5.1% to $0.41. Turning to cash flow, cash flow from operations declined $6 million to $452 million for the first half of the fiscal year. Cash flow from operations was negatively impacted by two items. First, the cash impact of certain items increased $96 million year-over-year, mainly due to merger and integration planning expenses. Second, we made a $50 million pension contribution in the first half of this year, compared to none in the prior year period. This difference is simply driven by different timing regarding, when we make cash contribution each year. With respect to working capital, our usage increased year-over-year mainly due to an increase in sales and inventory, driven by increased inflation and case growth. Cash tax payments for the first half of the fiscal year were $179 million, lower than last year due to a lower effective tax rate, which I discussed a moment ago and merger and integration planning expenses that reduced the taxable earnings. Capital expenditures, net of proceeds from sales of assets totaled $296 million for the first half of the fiscal year, compared to $247 million last year. Roughly, half of the $49 million year-over-year increase is due to the timing of investments in our fleet, with remainder coming from IT projects that are related to integration planning. Free cash flow was $157 million in the first half of this fiscal year, compared to $211 million in the prior year period. These results include the $96 million increase in the cash impact of certain items to cash flows from operations and the $50 million increase in pension contributions I mentioned earlier, as well as a $16 million increase in capital spending related to merger integration. After adjusting for these items, free cash flow was $324 million or an increase of $107 million. As we discussed last quarter, in October, we issued $5 billion in debt, the proceeds of the offering are unintended to fund the various elements of US Foods’ transaction. As we closed on the new debt issuance, we simultaneously terminated both the bridge facility and the related free issuance hedges, both of which were put in place as part of the financing strategy for the merger. Following the unwinding of the hedges, we paid $59 million in September to settle that hedge against our 10-year note issuance. In October, we paid a $130 million to settle the hedge against our third-year debt issuance, which is shown as the financing activities in our cash flow statement in the second fiscal quarter. The financial impact of the unwind of the hedges will be amortized into earnings over 10 years and 30 years respectively. Regarding our outlook into the third quarter and the remainder at the year, there were several additional items I’d like to point out. First, as discussed on the last quarter’s call, we continued to implement our category management initiative as planned and are pleased with the progress we’ve made in integrating this approach to our business. A favorable year-over-year impact has been meaningful to our performance over the last three quarters, but we expect it will begin to moderate in the fourth quarter. Second, regarding cost per case in our North American Broadline business, we had communicated in the last quarter that we expect that it would be difficult to meet our objective of keeping cost per case flat year-over-year. For the first half of the year, cost per case increased $0.10. While, we expect year-over-year cost increases to moderate in the second half of the year, we no longer expect cost per case to be flat for the full year. Instead, we now anticipate an increase of approximately $0.05 to $0.10 for the fiscal year. Third, with regard to fuel expense, we have been evaluating the impact on our business of the recent decline in crude prices. While diesel prices have declined more than 20% over the course of the fiscal year, our program of entering into forward fuel purchase contracts smoothes the impact of price changes over time. As a result, we did not have a material change in fuel expense in the second quarter or first half of this fiscal year. However, we do expect a roughly $15 million decline in fuel expense over the second half of the fiscal year. This modest projected benefit will likely be offset to some degree by lower fuel surcharges. Fourth, as a reminder, we continue to expect to report approximately $40 million in incremental merger related interest expense per quarter, which we will exclude from our adjusted numbers until the close of the merger. And finally, I wanted to speak for a moment about our outlook for share repurchases. Our approach to repurchases for the last several years has been to buyback shares throughout the year, with the goal of keeping shares outstanding relatively constant. However, during this fiscal year, we have not been in the market buying shares due to the pending merger. This is half the effect of increasing our shares outstanding in the first half of the fiscal year due to the exercise of employees’ stock options and RSU grants. We are not prepared to comment about if, or when we may resume buying back shares. However, if we bought no shares for the remainder of the year, we estimate that our diluted shares outstanding may be greater than $597 million shares for the fiscal year. This estimate is dependent on the level of stock exercises that occur and does not include the impact of the shares to be issued in conjunction with the proposed US Foods merger. Turning to an update on our proposed merger with US Foods, we believe that the divestiture agreement we announced today fully addresses the FTC’s concerns. Upon closing of the Sysco- US Foods merger, this definitive agreement will include selling 11 US Foods operating locations, representing $4.6 billion in annual sales to Performance Food Group. Sysco would receive $850 million in cash in return from PFG. The divested markets will expand Performance Food Group's geographic footprint in the U.S. and enable it to compete more effectively for both larger and smaller customers. The divested locations are Corona, California; Denver, Colorado; Kansas City, Kansas; Phoenix, Arizona; Salt Lake City, Utah; San Diego, California; San Francisco, California; Seattle, Washington; Cleveland, Ohio; Las Vegas, Nevada and Minneapolis, Minnesota. In addition, Sysco and Performance Food Group have signed a multi-year transition services agreement to ensure a smooth transfer of assets from US Foods to Performance Food Group. As PSA provides various support services and personnel to help Performance Food Group succeed as the new business owner in these locations. Clearly, this development has implications for our synergy expectations. It’s important to remember that integration planning work has been underway over the past year, which has enabled us to refine and enhance our confidence in our synergy estimates. As a direct result of this work, we determine that growth synergies related to the transaction were substantially higher than previous estimates. After reducing our revised synergy estimates to reflect the facilities to be divested, we now expect net annualized operating synergies to be at least $600 million after four years. Our current expectation is that operating synergies will begin to accumulate in year two, following the close of the transaction. In addition to operating synergies, there were substantial financial synergies related to the transaction, including interest savings, totaling approximately $150 million annually and cash tax savings from the realization of acquired NOLs, totaling approximately $150 million. We expect to realize both of these financial synergies in the first year, following the close of the transaction. We have also updated our expectations regarding the cost to integrate the two companies. We continue to expect that incremental merger expenses will total approximately $700 million to $800 million over four years. In addition, we expect the incremental capital spend to require to integrate with total approximately $300 million to $400 million over four years. Now, while the actual gross cost to integrate will be higher than those incremental costs I just mentioned, we expect to fund a portion of these costs from our current operating and capital expense run rates. We now expect the transaction to be accretive in the second year following the close of the transaction, excluding cost to integrate the company and deal-related amortization. And with that, operator, we will now take questions.

[Operator:]

[Operator Instructions] We will take our first question from Karen Short with Deutsche Bank.

[Karen Short:]

Hi. So just to focus on the transaction a little bit. I mean, maybe can you give some color on where you think the issues are with the FTC in terms of you both not being in agreement? And then maybe follow-up, just some color on the facilities that are being divested, the customer type EBITDA associated with the facilities, things like that?

[Bill DeLaney:]

Good morning, Karen. I will start and I don’t know how far Chris can go with that second part, but I will give a shot at that. One of the things we want to be carefully of this one is that, we don’t want to be in a position where we’re trying to articulate a point of view with the FTC. They will have plenty of opportunity to do that. So what I would say is a good, a very high percentage of the conversation over the last several weeks and really months has been around their concern of -- they believe that there is a national market. They believe that there are customers out there that will only buy from distributors who have a national footprint. We disagree with that. We see and live that every day where customers -- some of these larger customers will buy from multiple distributors, they might buy from regionals or multi-regionals, they may buy from us and/or US or PFG, and they obviously buy from specialty firms. Some may buy from only a few of us. Some may actually put most of their business with one or two of us. But our point of view is that when we compete for that business, we are competing not just with US Food and PFG, but DMA, but with a lot of regionals, who are now multi-regionals. And even in the situation where certain customers will work with a fewer number of distributors that opportunity to work with more is always in the room when you are negotiation our peer new business. So, I think, again, I can’t make their case for them, but I think that’s been where we spent a lot of the time in the conversation of how we address their concerns about how these customers continue to get good service and appropriate pricing. And that is why we ultimately, even though we disagree with the position, we are willing to put forth the divestiture package which we believe from our perspective, based on our knowledge of the business, our knowledge of the competitive landscape should allow PFG to go out and compete very well in the way that the FTC would hope. So that’s my best way of describing it today. As we've said, we will have some more opportunity to speak with the FTC and the five commissioners here over the next week or two and I am sure there will be more information coming out of those meetings.

[Karen Short:]

Okay. And can you provide us with any color on the customer types of those facilities and EBITDA dollars? And I guess just a follow-on on that. In terms of the synergy number, is the $600 million synergy, does that actually include any operating profits associated with the TSA PFG?

[Chris Kreidler:]

So on the first part of your question, Karen, I am not going to get into the detail of facilities or the EBITDA, the package, but I will generally say, because I think it addresses what you’re trying to get out there that it is a representative package, if you will, of US Foods. I don’t think there is a disproportionate amount higher or lower of EBITDA or disproportionate type of customer services out of these facilities than US Food as a whole. That is generally correct, but I am going to leave it there just in terms of describing these package of facilities. I am sorry. Remind me the other part of your question, please?

[Karen Short:]

Well the $600 million, I mean you obviously said during this whole integration process, you’ve identified additional synergies, but you’re very comfortable with the $600 million that you originally put out there? I am just wondering if the $600 million includes operating. I’d assume there is operating profit associated with the TSA, with PFG, does that $600 million include?

[Chris Kreidler:]

No, it doesn’t include any operating profit associated with the TSA. TSAs typically are constructed so that you’re reimbursed for your costs, you don’t technically make any money. If you do, it’s very small amounts of money, but the way these things are constructed, you usually just reimburse for your expenses.

[Karen Short:]

Great. Thanks.

[Operator:]

We will move on to our next question from John Heinbockel with Guggenheim Securities.

[John Heinbockel:]

So just a few questions on the -- right on the transaction, the $600 million, that does not include any financial synergies, correct? Number two, when you found incremental synergies right beyond what you’re thinking before, is that more buckets that you hadn’t anticipated or buckets that are just bigger? And if there are buckets that are bigger, what might one or two of those buckets be? And then lastly, I assume all other terms of the purchase on your end remain the same, that none of that has changed, that’s it?

[Chris Kreidler:]

Okay. John, if I can, I will take those in reverse order.

[John Heinbockel:]

Yes, sure.

[Chris Kreidler:]

Yes, nothing changes in the transaction that we had negotiated with US Foods. That remains the same in all aspects. You are correct on the first question you asked. The financial synergies I described which the two biggest ones are interest savings over the two combined pro formas and the use of the NOLs, those are not included in the $600 million. Financial synergies, we expect to achieve in the first year after closing the operational synergies, we expect to start occurring in the second year after closing. And then the middle question there really around where we would find the additional synergies? When we put our first synergy number out on the table I feel like I have to keep reminding ourselves as well as everybody else, it was with essentially publicly available information. We didn’t have a lot of additional information. We had some experience at Sysco dealing with some of these buckets of opportunities. We had done some category management work. We have done route optimization. And so we knew that this is what we’ve been able to do, what can we do if you can buy and then we made some assumptions. And we made prudent assumptions but not overly really aggressive. We are going to be candid about that. As we’ve learned a lot more about this, I would say every bucket probably increase in size, certainly around merchandising and supply chain, it will say inbound and outbound delivery transportation. Those buckets got quite a lot larger. So we’ve found it across the board, but in certain places we found more. And so we rebuilt synergies from the bottom up using more information through our integration planning efforts. There is still a lot of information we are not allowed to have access to and we are abiding by all those rules. So we expect that when we eventually close and we get access to some additional information, we will true this up again. But we’ve made pretty good assumptions and we are still being what I would call prudent. We are not being overly aggressive or overly conservative.

[John Heinbockel:]

All right. And then lastly, you talked about wanting to sort of tighten up expense control, where are the biggest opportunities? And then secondly, is that something that can be done while you are in the early stages of doing the US Food integration, or is that something that has to come later?

[Bill DeLaney:]

John, I will start there as well. I think in terms of the biggest opportunities, they are generally always going to be on the operational side. So some of our G&A costs are up this year, a fair amount of that was planned some of the work we are doing with these initiatives in the technology area. Our selling costs are up a little more than we planned, but our gross profit is higher. So that one doesn’t concern me as much. That takes you to the supply chain operations, and we’ve just got more work to do there in terms of improving our productivity at a rate commensurate with where our costs go up. And we tend to be very good in this area but we’ve got a lot of initiatives going on in this area as well. I’ve mentioned Scott and he has been with us a couple of years. And with our new enterprise structure, his functional group working hand in hand with our operating company leadership to basically strike the right balance between what we need to do support our customers each and every day but also putting better and more consistent best practices, monitor them better, get our compensation schemes in line with our productivity. So a lot of work to be done in that area and more to do but I would say, that’s what the biggest opportunity is.

[Bill DeLaney:]

As far as the merger, I would say, on the merger, Chris talked to this. And I let him address it again. I think we’re seeing opportunities through these synergies to do better. The challenge there will be to do what we’ve done, a nice job so far. I mean, so far, when you hear me speak, we’d be really proud as management team and frankly all of our folks. We’ve done a nice job of being able to separate all the work and all the hours and the pressure is going on with the integration planning and still be able to run our business pretty well. So that’s the biggest challenge I see post close here as to -- continue to run these businesses but drive out at that point of synergies. So I think, when we get to that point, we’ll talk to you more and we’ll have to come up with some ways to speak to how we’re making progress here and still making sure we’re shipping groceries in the right way to our customers.

[John Heinbockel:]

Okay. Thanks.

[Operator:]

Our next question will come from Greg Badishkanian from Citi.

[Fred Wightman:]

Hi. Good morning. This is actually Fred Wightman on for Greg. Last quarter you guys mentioned that there were some labor shortages in delivery drivers, has that situation abated? And are you guys seeing any other pockets of labor pressure?

[Bill DeLaney:]

Good morning. We did speak to that. We still have some of those situations. It’s abated some. The source of that is really two-fold, one, over the last few years -- we will see what the next few months bring with the price of oil but over the last few years, several of our markets are very much energy driven or intensive. There is a lot of good jobs out there on the energy side. Some of those jobs are very competitive or more competitive in terms of lifestyle and wages to what we offer. And so in those markets where energy has been strong, we struggled to some extent, too early to tell if that’s going to abate. The other part quite candidly is we’ve had some internal issues in certain markets where as we’ve centralized some of our hiring practices and begun to coordinate that process between the OpCo and our SBS center. Certainly, we went pretty fast and aggressively and there were some markets where we didn't execute as well we should have. So we're also catching up in those areas. So there is still a handful out there too that we have some issues but it has abated and I would expect it to continue to improve.

[Fred Wightman:]

And then you briefly mentioned this in your response to the last question but you mentioned that some geographies were performing better than others? Have you seen that trend become more pronounced especially in some of these oil producing regions?

[Bill DeLaney:]

I’d say, it’s pretty pronounced in Southwest and we’re seeing that for several quarters now. I would also tell you -- interesting right now when we look at the numbers up December, January or early February, if you recall, we had some really severe weather last year when we had -- we’re getting more weather now over the last week or two. As you look at the markets, you can kind of see where the weather impacted last year and whether weather didn’t impact last year. So I would say, the Southwest and the West Coast, in particular, were doing well. It’s hard to tell how much of that is the market and how much of that is our leadership in those markets but those two in particular. And right now looks like quarter is off to a pretty good start in terms of their season.

[Operator:]

Moving on, we’ll take Andrew Wolf with BB&T Capital Markets.

[Andrew Wolf:]

Hi. Thanks. Good morning. Just wanted to check, Chris, on moving the accretion to your two -- what that means for dilution in year one? I don’t know if you saw but I did put on my own estimate around $0.15 if you divested $5 billion of US Foods service assets and I just used value as I think suggested just their average blended operating margin. Just would like to know, if you think that’s at least in the ballpark in terms of reasonableness?

[Chris Kreidler:]

Andrew, I would -- I have to be very careful to comment about your own estimates and your own modeling, so apologies for that. But look, originally, we believe based upon initial modeling that we thought it would be accretive in year one as we have refined all of our estimates, not just the numbers but the timing of the numbers and then overlaid the divestitures, we think its year two that is accretive. Frankly, I’m not prepared to talk about year one dilution or anything yet. We’ve got more work that we need to do to pin that down. So best I can tell you is we’ve shifted some stuff based upon when we think we’re going to be rolling certain initiatives and where -- how we think we’re going to go after some of the synergies and that’s affected our -- when we’re going to achieve accretion.

[Andrew Wolf:]

But I mean, you would as well as the divestures, I mean, clearly your …

[Chris Kreidler:]

Yes.

[Andrew Wolf:]

…selling them below what you’re paying for? Okay.

[Chris Kreidler:]

Yes.

[Andrew Wolf:]

Just wanted to ask a procedural question on the FTC, I think it’s all implied but I just want to make sure I understand it. It sounds -- so you secured agreements from the commissioners to meet with them, the five commissioners and to make your case? And does that been -- have they then agreed to vote what they want to conduct their vote at that point, once you've done in the next few weeks meeting with them or the next couple weeks?

[Bill DeLaney:]

Look Andy, I think there is one thing I think at this point of the FTC we do agree on is that its time to move this process forward. And we have plenty of time to talk and educate and listen and negotiate or whatever. So what we’re at is they basically signal to us that it’s time to meet with the commissioners and so we’re preparing to do that. And of course along the way, since they’ve signaled for quite time their concern. They’ve articulated earlier, we’ve had parallel discussions with PFG. And so we’re able to poll that agreement together here over the weekend. We just fell it would be in everyone's best interest, including our customers and our associates to kind of have better knowledge of what’s really going on. There has been a lot of weeks, so we just fell it made a lot of sense. If we’re going to visit with the commissioners to have this agreement in place so that we can look them in the eye and tell them exactly what we are prepared to do and there is no uncertainty in terms of our ability to do it. So that’s a little color, I guess from my end. Chris, you want to add anything on process?

[Chris Kreidler:]

Actually, I think that covers it well. One thing probably I’m going to speak a lot to is what happened after we meet with the commissioners. There is nothing defined at that point. That is the next step that’s what we’re talking about and it’s hard to talk half that point but that’s what we are. Its time to move this thing forward as Bill said.

[Andrew Wolf:]

And just one other thing on this the deal on talking with the commissioners. Now the PFG deal, is it -- how would you think of your sense of how the commissioners view that deal as it stands? You think it’s ambiguous. Have they signaled that that is not enough that could be enough or is it I guess, that’s what you’re going to discover. How should we think about whether the deal you struck with PFG is going to way with the FTC commissioner?

[Bill DeLaney:]

I think you should look at it from the perspective of what we’re saying, which is we’ve had a lot of time and a lot of opportunity to have discussions with the FTC and as well as address remedies to concerns that they have, which we don’t share but which we certainly want to address because, it’s disruptive type business, it’s disruptive to the business that we are acquiring and it’s disruptive to our customers. So, we are trying to find a remedy here and obviously they haven’t agreed anything at this point. So, I think it will be determined.

[Andrew Wolf:]

Okay. Can I just ask one another, just a number question on the adjustment statement? The $78 million in merger integration costs this quarter was about $40.5 million last quarter and talking about the last quarter was mainly consultants. Chris, you might have talked about this, maybe I didn’t understand it. But what is the majority of that stuff up in the merger spending?

[Chris Kreidler:]

Yeah. It is mainly consultants, yeah. But that’s majority of that $78 million is what we call professional fees for outside consultants that are helping us. Some of the uptick came from legal, from the fact that we have started some foundational IT projects that are going to be necessary for integration, so some of that stuff kicked in to the quarter. As we also said though, our merger integration planning it’s -- I think the word we use and it’s probably the word, a peak. It will be coming down from there and so that’s what we work for the quarter.

[Andrew Wolf:]

Okay. Thank you, and good luck with everything. Thank you.

[Bill DeLaney:]

Thanks, Andy.

[Operator:]

Meredith Adler with Barclays has our next question.

[Meredith Adler:]

Very informative. I’ll actually go back and talk a little bit about operations and just want to understand. You had 6% food inflation and when you do the simple math, you wouldn’t end up with volume growth of 3.3%. But obviously what that means is that you have the inflation, but your sales didn’t go up necessarily by 6% because of inflation. Is that right?

[Bill DeLaney:]

As you’ve stated that’s right. Is this -- is the question why?

[Meredith Adler:]

Well, I may guess that the assumption then would be that you are still having trouble passing a long inflation?

[Bill DeLaney:]

I think there is many of reasons, Meredith. I think some of it is mix, right. So, lot of inflation is in this higher dollar cost, boxes of meat and dairy this last quarter. So it’s partially mix. It’s certainly is partially, as I’ve talked in the past alone to your point. So one of the things we do with customers continually, especially now is to try to listen to them, understand what their needs are, understand where they are going with their menu. And if there is some more cost effective ways for them to buy from us and to still position their menu, advantage is where and that’s what we do. So if they can offer more poultry dishes or other types of ally card items that is the plan maybe what they’ve formally done with cheese or with beef then, there is some of that going on as well. I mean, our case growth still is very good in these inflationary categories I think it’s the mix I think it’s -- trying to find the right price point if you will for our customers. And I think it is hard to imagine inflation, but our point is we’ve been doing a better job of it here over the last year or two. And I think category management speed is beginning to help also and some of our other initiatives in terms of product training, in terms of our sales people being able to sit down have good propel conversations with our customers. So it’s a lot of things, but probably mix would be as big as any.

[Meredith Adler:]

And those comments about mix, is it fair to assume that the category management process has come up with -- I won’t say identical, but similar kinds of things? I mean, you’ve said in the past that it’s not just about reducing SKUs. So category management is about helping the customer buy better items, or more cost effective items?

[Bill DeLaney:]

No, not exactly, what we -- the goal is with category management is to help our customers and ourselves frankly optimize -- in our case optimize their SKUs over time, There is plenty of work still to be down there, help them use those products that we are bringing to them to augment their menu in the right way, maybe changing up a bit makes sense. But for both of us to make commitments for the customer to commit with us and for us to commit with our suppliers to take cost out of the system and to be able to buy these products better, and to realize those savings both on Sysco’s bottom line as well as the bottom line. And I think, we are starting to see nice traction there on that part of it. Longer-term, we as an opportunity to really differentiate ourselves in the marketplace with expanded product lines, maybe broader not as deep, perhaps in some of the SKUs they don’t move as fast where we can have more customize offerings to customers as we better understand their needs and better understand the process. And then also use this platform to bring more innovation to the offering. So in the short-term, I would look at it as an opportunity to partner more strategically with our customers, buy more efficiently, and to pass some of those savings along to the customer base. And for both of us to optimize our SKUs with the long-term goal of being able to really bring more innovation and more differentiation to the product line.

[Meredith Adler:]

That’s very helpful. And then just one quick question, maybe for Chris about fuel surcharges. Can you say how much of the cost -- it’s hard because you’ve been hedged, but if you give up the fuel surcharges, how much does that offset the benefit of lower fuel prices?

[Chris Kreidler:]

Yeah. Let me come at that from this direction. First, I mean, fuel charges are a bit different, when you think about it with our larger customers and our smaller customers. With larger customers, we may have contracts that are pegged to certain fuel price. They may go up, they may go down. They last for periods of time. That’s not something that you just “give up” because they were structured into the cost structure of the contract. Fuel surcharges on the street are different and obviously they can change on a daily, weekly, monthly basis. So the concept of quote, giving them up doesn’t -- it’s harder for me to address. I will say this. We look at fuel, when we look at what’s happening to fuel. We did not raise fuel surcharges, when fuel prices started going up and that was kind of one of the luxuries of our forward buying strategy. It gave us time to asses what was really going on before we needed to react. Now that they are coming down, we are looking at it actively to see what’s appropriate in the market and for our customers and we’ll continue to look at that. But we wanted to flag is, it’s a big story out there. There is a reason why it doesn’t impact our fuel cost because of the way we smooth on an ongoing basis. So it hasn’t in the first half, we are flagging that it will, to the extent at least to $15 million, which is in our overall cost structure is a very small amount. But that’s what we need to look at when we think about the fuel surcharges, how much of that amount might need to be mitigated with adjustments to the surcharge.

[Meredith Adler:]

Great. Thank you very much.

[Operator:]

[Operator Instructions] We’ll move on to Edward Kelly with Credit Suisse.

[Edward Kelly:]

Yeah. Hi, guys. Good morning.

[Chris Kreidler:]

Good morning, Ed.

[Edward Kelly:]

Two quick questions for you. Chris, just one follow-up on the $600 million in synergies. Since -- ever since the deal was announced, there was lots of talk around potential negative synergies from things that customer overlap. I don't know to what extent you’ve had the ability to take a deeper look at that and maybe some color there would be good and also the $600 million net. Does that basically contemplate any possible negative synergies as well?

[Chris Kreidler:]

Yeah. Look, we continue to look at that. Early on, we obviously needed to make some assumptions just to figure out what we thought an appropriate, what the return would be in, whether it was an appropriate return to the amount of investments. So, we made some assumptions. As we’ve gone toward the integration planning process, we’ve continued to refine our thinking there and one thing I can tell you is there is no good science around predicting that. I can make a guess, you can make a guesses, and we could be wildly different in our guesses. And then secondly, there is no real way to measure it even after the fact. So what we’ve done instead is just try to get into what would cause a customer to want to leave and then what can we do reason by reason to medicate that risk. And so we’ve spent an inordinate amount of time through all of our integration planning teams to go after those issues. Everything that we are working on is based on the principle of we want to make this as at least disruptive to our customers as we possibly can, our customer and US Food’s customers as we possibly can. And so we are not spending a lot of time trying to estimate potential disruption or losses of customers. We are spending all of our time trying to make sure that we know what might cause them to leave and how we’re going to address that right out of the box so they don’t leave. Now to address your question, we are calling these net operational synergies because we do believe it takes into account what we might see in the way of disruption. But it’s our estimate and we frankly hope that we’re going to be wrong and it’s going to be better than that.

[Edward Kelly:]

Okay. Good. Thank you. And then my just one follow-up question here. You’re growing gross profit dollar per case. Again, this is I think the fourth quarter now that we’ve seen it. So it obviously speaks positively about the business, speaks positively about the industry. But I was curious about is how much of it is sort of internal initiatives, things like category management versus just a better industry outlook as well? I was wondering if you could maybe help parse that out for us.

[Bill DeLaney:]

Great question, hard to answer, Ed. I think we’re hopeful on the -- some of this positive consumer sentiment that’s been out there for a while begins to get to our customer base and that will translate into more industry growth. Our quarterly numbers as you track them, you see they have been float around between 2% and 3% here over the last few quarters. We do have a positive growth for the locally managed customers now, which we didn’t have a year ago. So that’s a big part of it which coming back to mix and the different way customer mix. We’ve spent, as you can appreciate, a lot of time and effort over the last 15 months with best practices and how to manage margin better and still effectively deliver customers need in terms of offerings. But clearly the category management is driving a fair amount of it right now. And we’re doing a better job of integrating it as I said in my prepared comments into the everyday business activities. So I would say that’s a large part of it.

[Edward Kelly:]

Great. Thank you.

[Bill DeLaney:]

Thank you.

[Operator:]

Moving on to Vinnie Sinisi with Morgan Stanley.

[Vinnie Sinisi:]

Hey, great. Good morning. Thanks for taking my question. I wanted to ask you guys about the ERP rollout. It seems like parts of it are going to continue to move forward here. I know on the past you’ve said that with the merger pending that you are kind of taking a bit of a step back on some of those processes. So can you just kind of recap for us all in terms of -- is this now going to really restart here or are some parts of it or which parts of it will still be waiting on the outcome of the merger?

[Bill DeLaney:]

Good morning. I think it’s more of what we talked about over the last couple quarters in terms of, we are not doing new deployments right now until we have a better sense for where the merger is going to play out and when and some of the geographic issues that will come with that. But what we’ve been able to do and we did -- when we talked about in the last earnings call, we’ve been able to go in and put in some significant enhancements into the software that are now being utilized by the 12 OpCos that are on and the core SAP software platforms. And the other thing we are doing more of, which we spoke to here today, is taking some of the other applications, whether they’re financial or HR, maintenance that type of thing, even for the SA -- even for the non-SAP OpCos bring those into SPS, accelerating network to where SPS is now, supporting in certain areas, not just the 12 OpCos that run SAP, but these are the functional support software packages as well. So to summarize, I think it’s a combination that we’re continuing to enhance the support around and the software that the 12 OpCos are using as well as beginning to leverage SPS in a different way and as I said. So, A, we’re providing better services to the 12 OpCos today, but also when we do begin to redeploy again, those future conversions can go more, more smoothly. And then we’re still -- we’re going to defer any further deployments until we understand the timing of the merger a little bit better.

[Vinnie Sinisi:]

Okay. Great. Very helpful. Thank you. And then just as a follow-up. Going back to the 11 facilities that were called out today, any further color that you guys can give in terms of perceived market share or the competitive stands in those areas? And then also just as a matter of process, I just want to make sure that I'm correct here. When dealing with the FTC, so those 11, the proposal of those 11 facilities you kind of have already gone to the first level of discussions. And now it’s in a sense being escalated to the five commissioners. I just want to make sure that that is correct.

[Bill DeLaney:]

Yes. So let me be clear or try to be clear. We’ve had multiple discussions over multiple months with the FTC. And we are trying to the best of our ability to understand not just the nature of their concerns and the depth of their concerns and the breadth of their concerns, but also how we think we can remedy those concerns based upon our knowledge of this industry, based upon our knowledge of how to shift groceries to customers and our knowledge of competitive positioning. So this package is a package that we have developed that we believe addresses their concern. We have received no approval from the FTC at any level in this package.

[Vinnie Sinisi:]

Okay. And then just, I guess maybe you can say so much at this point, but any further color on the specific markets where these 11 are located?

[Chris Kreidler:]

No, we’re really not going to get into the talking about market share and the individual markets.

[Vinnie Sinisi:]

Okay. Now totally understandable. All right. Great. Thanks very much. Good luck going forward.

[Bill DeLaney:]

Thank you.

[Chris Kreidler:]

Thank you.

[Operator:]

We move on to Ajay Jain with Cantor Fitzgerald.

[Ajay Jain:]

Hi. Good morning. Thanks for taking my question. I guess Bill, based on your prepared comments on the merger and the objections by the FTC staff. I'm just wondering if your announcement with Performance Food could really set the stage for litigation with the FTC. So if the process goes in that direction, do you think you can wrap up any potential litigation and complete the merger process? By the time the agreement is set to expire, I think that deadline is in September if I'm not mistaken. So do you feel like you're potentially running out of time to the extent that's an issue at all?

[Bill DeLaney:]

So I want to make I am answering this right. We think we have ample time if we do end up in some litigation to work through that and still bring that to some type of closure before the expiration of the merger agreement.

[Ajay Jain:]

And just finally on -- as a quick follow-up on the merger-related expenses, can you just quantify little bit better how much you expect that to moderate in the back half of the year?

[Chris Kreidler:]

I would love to be able to have a forecast for merger-related expenses and certain of those line items. I can do that. I can say these consultants were, we don’t need them anymore and these consultants we still do. But a lot of just depends on what we’re doing in the fourth quarter -- in the third quarter and the fourth quarter of the year. So it is rather difficult to estimate those expenses on a go forward basis. So I mean to say they’re moderating, they’re certainly not going to go to zero. There is work that we are going to continue to do to prepare, but we’re certainly looking to stand down any teams that have completed their work. So that we can reduce those expenses and we look at that literally every month to decide how many consultants we need here supporting us. But it’s too hard to call frankly where we’re going to be in the process and what work needs to be done.

[Ajay Jain:]

Okay. Thank you.

[Operator:]

Next question will come from John Ivankoe with JPMorgan.

[John Ivankoe:]

Hi. Great. Just really quickly from me at this point. The overall trend of inflation kind of going forward, calendar ’15 and if not calendar ’15 at least, back half of your fiscal ’15 and just in terms of, where you see it trending and from a gross profit per case perspective it was potentially kind of getting back into a place where passing out pricing can be easier to the customer in relation to a previous question? Thanks.

[Chris Kreidler:]

I don’t think we are there yet, John. I do think we are beginning to see some subsiding in the trajectory of the inflationary rate. So, hopefully, we have peaked here at the 6%. It’s still early this quarter. The individual categories are moving around. Right now, the bulk of the inflations we see here today is more in the meat side and dairy beginning to level out. So we don’t make predictions or give guidance. But I -- you really asked two questions. I think the inflation overtime, over the next six, nine, 12 months, should subside to some degree. I don’t know where it ends up. But, hopefully, less than the 5% to 6%, because as we always said that’s not good for our customers and that’s why sometimes it’s a -- actually most of time, is how to pass those along as fast as you would like. So I think we are seeing a little early, but too early to call until get into March and April, and we kind of back into the heavier volume months.

[John Ivankoe:]

Thank you.

[Bill DeLaney:]

Welcome.

[Operator:]

We will move on to Kelly Bania with BMO Capital.

[Kelly Bania:]

Hi. Good morning. Thanks for taking my question. I guess, just another one related to the merger. Just based on your discussions with FTC over the last year and what their concerns are? I am just curious how you would characterize what you perceive is the likelihood that the FTC will accept this proposal as a remedy. I mean, does this address all of their concerns in your point of view?

[Bill DeLaney:]

I appreciate the question. I don’t think I am in a position to really address the likelihood. There maybe other people out there that can give you a better handle on that. I would just continue to say that we believe strongly in this merger. We believe it’s pro-competitive in what’s already and incredibly competitive industry. We believe it’s good for our customers. Clearly, there will be some disruption. So I am sure there has been some concerns convey to the FTC and to us from that standpoint. But that’s not unusual mergers. We spend a year and tens of millions of dollars preparing integration plan to mitigate as much disruption as possible and we think over the medium-term to longer term. This is very good for our customer base. This is going to be for our shareholders. We think it will actually raise the bar for competition in our industry, which long-term is good for everybody in our industry. So we believe strongly in our case and that’s probably all I can should and can comment on.

[Kelly Bania:]

Okay. And then, just maybe another follow-up, how were these 11 DC selected, just give us some quick math, I think, you still have about 80 DCs and these look even like they are either larger or more highly productive than the average? Just any comments there would be helpful.

[Bill DeLaney:]

Yeah. I am going to start and Chris can give you probably little more, essentially, I think, you can see as if you put together all the color we are trying to provide today. We try to put together footprint that would address, the Western part of United States in a way that we complement the current footprint FTC has, which is across the country, but it’s a little less dense in the West compared to U.S. So what you are seeing there primarily is an attempt both with large and medium sized facilities to address that.

[Kelly Bania:]

Okay. Thank you very much.

[Chris Kreidler:]

Thank you.

[Bill DeLaney:]

Welcome.

[Operator:]

We will move on to Mark Wiltamuth with Jefferies.

[Mark Wiltamuth:]

Hi. Good morning. So, one of the challenges on the divestitures, is there anyway to guarantee that the customers really follow the facility divestitures? And I wonder if there is anyway you could give us from a big picture standpoint, what the market share on the national accounts look like before and after the divestiture?

[Bill DeLaney:]

Well, there is no way to guarantee. But, again, we have done a lot of work on the integration planning and working through this TSA agreement with PFG to address that and Chris has been leading that work. So I’ll let him take that.

[Chris Kreidler:]

Yeah. I mean, one other things, as I said in our integration planning, one of our primary principals was the least amount of disruption to our customers, US Foods customer. We took the same approach in our discussions with PFG and obviously, they care a lot about that as well and so we’ve structured it in a way that we believe it’s going to be least disruptive to those customers. So if you think about our customer that’s being serviced out of the call it Denver facility for US Foods today, that same sales person or the same trucks, food coming out of that same facility is going to go to that customer ones it is owned by PFG. So we believe that’s the least amount of disruption to the customer and as long as they continue to get good service at fair prices and value, we don’t believe there is a reason for them to want a change. So I’m agree with Bill, there is no guarantee, but I believe we except this stuff in a way that’s the customers will continue to get good service and good value going forward.

[Mark Wiltamuth:]

Are there long-term contracts that transfer and is there a non-compete agreement or anything like that on going after this customers?

[Chris Kreidler:]

Yeah. There is a lot of things that will be contained in the 8-K, which we will file later this week. So I’d encourage you to look into that. There is an enough in there, I think, keep you busy for awhile. But as you might imagine we intend to and FTC, of course, would want us to set PFG up for success here and again, and do it in a way that our customers don’t feel or experience that disruption. So everything that’s necessary to make that happen we put into the TSA or the agreement.

[Bill DeLaney:]

I think just to illustrate that for maybe -- from a layman standpoint. What Chris and Russell and our teams have done is basically, as you look at, don’t just look at this facilities, from a customers perspective, they are going to be position at the same sales persons, same driver, the same customer service team in this TSA agreement, which you can look at, once we get it out in the K -- 8-K. We have taken a lot of measures to position PFG to be successful as they transition that business. So we have done a lot of things to position them for success early days here.

[Mark Wiltamuth:]

Okay. And I know you’ve address this, the $600 million synergy number, but you stand back and look at the deal from a broad perspective, US Foods have lost earnings power, while it’s been waiting for the transaction to close. If you look at where they are today, add in the synergies, where do you think you will be on EPS accretion by year four or five?

[Bill DeLaney:]

We have not given and I’m probably not going to today give any kind of forecast for earnings accretion. We obviously have re-looked at the transaction based upon everything that’s happened over the year and based upon this divestiture package and we still feel this is a very nice return for Sysco and our shareholders. We have got to, obviously, get the deal close and then we have got to work on executing against the synergies and we now also and will be a little more, add a little more complexity, we also need to work on the divestiture package and make sure that that set up alright. As long as we continue to service the customers ours and US Foods, we get a very nice return out of the transaction and that’s where we are focused on.

[Mark Wiltamuth:]

Okay. Thank you very much.

[Chris Kreidler:]

Thank you.

[Operator:]

And ladies and gentlemen, we have no further questions. At this time that does conclude today’s conference. We do thank you for your participation. Have a good day.