Sysco Corp (SYY) — Q1 2015 Earnings Call Transcript

Good morning everyone and welcome to Sysco’s first 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 within the meaning of the Private Securities Litigation Reform Act of 1995 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 www.sysco.com or via the 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 is 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 refer to diluted earnings per share unless otherwise noted. In addition, all references to case volumes include total broad line and sigma 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.

Thank you, Shannon. Hello everyone and thank you for joining us today. This morning, Sysco reported first quarter fiscal 2015 financial results. Sales grew more than 6% to $12.4 billion and adjusted net earnings increased 7.6% to $309 million. Adjusted EPS, excluding certain items, increased approximately 6% to $0.52 for the quarter, our strongest year-over-year growth in quite some time. We are pleased with the solid operating performance we delivered in our first fiscal quarter in the midst of ongoing challenging market conditions. While we were challenged with expense management in certain aspects of our business, we generated more than 2% case volume growth and managed acute inflationary pressures very effectively, as evidenced by essentially flat year-over-year gross margin. Our improved performance during the quarter was due in part to the benefits we realized from our portfolio of business transformation initiatives, especially category management. In addition, case growth trends in our locally managed business were favorable for the second consecutive quarter. Recent restaurant data reflects ongoing stagnant traffic trends but somewhat improved industry sales trends as food-service establishments increase prices to offset high inflation in meat, dairy, and seafood categories. However, while we believe that industry trends have gradually improved, that improvement has been more pronounced in certain geographic regions. In addition, while consumer confidence and employment metrics have strengthened somewhat, overall consumer spending remains restrained. Lastly, we’re hopeful that the recent marked declines in fuel prices will help to drive additional traffic to our customers. With that, we remain intently focused on enhancing every aspect of our business so that we can better support our customers, operate more efficiently, and compete more effectively. As I mentioned, benefits from our category management initiatives continued to gain momentum. We expect that all remaining categories will launch into the market by the end of this fiscal year and that we will achieve our financial savings target. Turning to an update on our technology initiatives, during the quarter we successfully executed a major software upgrade for the 12 operating companies using SAP. In addition, while we will talk more about the proposed merger in a moment, we continue our merger integration planning and sequencing work with regards to technology. We expect initial post-merger areas of focus will include 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 will make future SAP conversions at the operating companies relatively easier. While we're pleased with our accomplishments during the quarter, we did fall short of our expense management goals. Expense increases were broad-based and were primarily driven by increases in sales, delivery, and incentive accruals. On the sales side, we’ve begun to hire MAs in targeted markets and expect these investments to contribute to sales growth over time. In the delivery area, driver turnover and shortages continue to drive higher wages and overtime expenses. However, our single largest opportunity for improvement was more consistent execution across the organization. We are developing and implementing tools that will provide increased visibility to keep performance metrics as well as improved best business practices. We believe these enhancements, combined with our new functional structure, will lead to improved customer service, greater operational efficiency, enhanced cost management, and increased profitability. As we noted on last quarter's earnings call, we are also investing in some promising new sales programs and market-driven initiatives. We have developed several initiatives targeted at improving our customers’ experience. For example, our initiative to grow our share in the underpenetrated Manhattan market has been very successful. In addition, we’ve developed a robust approach to serving the fast-growing Hispanic restaurant segment focused on providing authentic products utilizing a dedicated sales team. Also, our commitment to solicit and listen to feedback from our customers, carried out under our customer-first program, has led to several important enhancements, including developing new technology that will ultimately allow our customers to track their delivery and an enhanced customer onboarding program aimed at increasing customer retention and improved sharing of best practices in our business review program. With regard to our proposed merger with US Foods, we've been in productive discussions with FTC staff on a solution to permit the FTC to conclude its review. Given the amount of work remaining and considering the upcoming holidays, we do not currently expect to complete the transaction before the first quarter of 2015. Our integration planning work is progressing well and we successfully completed a $5 billion debt offering just following the end of the quarter, as we prepared to fund the non-equity components of the transaction. Chris will provide more detail about this in a few moments. In closing, we are pleased with our topline and gross profit performance for the quarter and believe that our investment in business transformation initiatives contributed to this achievement. I would like to thank our 52,000 associates for their dedication and hard work that drove our favorable first quarter results. As we move forward into the remainder of our fiscal year, we're 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 truly is an exciting time in our history and we believe the actions we are taking are strategically the right priorities to both achieve our vision and enhance profitability over the long term. Now I will 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 first quarter, sales were $12.4 billion or an increase of 6.2% compared to the prior year. Food cost inflation was 4.9%, driven mainly by inflation in the meat, dairy, and seafood categories. Sales from acquisitions increased sales by 0.6%. However, this was largely offset by the impact of changes in foreign exchange rates which decreased sales by 0.5%. Case volume grew 2.3% during the quarter, including acquisitions, and approximately 2.2%, excluding acquisition. Gross profit in the first quarter increased 6%, nearly at the same rate as sales growth. Gross margin declined 4 basis points to 17.59%, reflecting the positive impact from our category management initiative and improved margin trends over the last few quarters. Operating expenses increased $136 million, or 8.6%, in the first quarter of fiscal 2015 compared to the prior year period. Operating expenses increased mainly due to a $67 million increase in payroll expense and a $41 million increase in certain item expenses. The most significant drivers in the increase in payroll expense were higher sales and delivery costs, as well as incentive accruals. Regarding the incentive accruals, during last year's first quarter we reduced certain incentive accruals based on our performance at that time. In this year’s first quarter, our incentives are generally accrued to higher amounts, reflecting the impact of recent performance and causing a year-over-year variance. Certain items totaled $43 million during the quarter and mainly related to the merger and integration expenses. The substantial majority of these costs related to consulting fees. Excluding certain items, operating expenses increased 6%. As Bill mentioned, we believe we had opportunities to better manage our operating expenses over the balance of the year. However, the cost increases in the first quarter will pressure our ability to meet our goal of achieving flat cost per case for the year. Operating income for the quarter was down 2.6% year-over-year. After adjusting for certain items, operating income increased 5.9%. Net earnings for the quarter were $279 million, a decrease of $7 million or 2.4% compared to the prior year. Diluted EPS was $0.47, a 2.1% decrease compared to the prior year. Adjusting for certain items, net earnings increased 7.6% to $309 million and diluted EPS increased 6.1% to $0.52. Capital expenditures, net of proceeds from sales of assets, totaled $190 million for the first quarter this year compared to $125 million last year. Cash flow from operations was $63 million for the quarter, as the first quarter is typically a lighter cash flow quarter for us due to seasonal changes in our business. This result was $107 million lower than last year's first quarter, which is the result of three major drivers. First, the cash impact of certain items increased $40 million year-over-year. Second, we made a $50 million pension contribution in the first quarter this year compared to none in the prior year period. This difference is simply driven by different timing regarding when we make cash contributions each year. Lastly, working capital usage increased year-over-year mainly due to an increase in sales and inventory driven largely by inflation. As a result of these year-over-year changes, free cash flow was negative $55 million for the first quarter. Turning to the pending US Foods merger, subsequent to the end of the quarter, we issued $5 billion in debt in six series over various periods from 3 to 30 years, with an average weighted coupon rate of 3.4%. We decided to go to market prior to closing the transaction in order to be ready to fund the transaction as soon as we were able to do so. The proceeds of the offering are intended to fund the various elements of the US Foods transaction. In addition, as we closed on the new debt issuance, we simultaneously terminated both the bridge facility and the pre-issuance hedges. As a reminder, after we announced the proposed merger, we put in place a $2 billion interest rate hedge as part of our risk management strategy against the portion of the anticipated bond issuance. Following the unwinding of the hedges, we paid $59 million in September 2014 to settle the hedge against our 10-year note issuance, which you will note is shown as a financing activity in our cash flow statement in the first fiscal quarter. In addition, we paid $130 million in early October to settle the hedge against our 30-year debt issuance, which will be shown as a financing activity 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 second quarter and the remainder of the year, there are several items I’d like to point out. First, with regard to our category management initiative over the balance of the year, we expect the year-over-year impact of these benefits in each of the first three quarters of the fiscal year to be relatively similar before moderating in the fourth quarter. Second, as we disclosed in last quarter's call, we continue to expect that corporate expenses will increase compared to the prior fiscal year. Due to the timing of these expenses quarter to quarter, we expect a more significant year-over-year impact in the second quarter. Third, we will recognize a $13 million write-off in the second quarter of unamortized debt costs related to the termination of the bridge facility, which occurred as we issued the new debt related to the transaction. This write-off will be recorded in interest expense and will be treated as a certain item when we report our results next quarter. Fourth, as a result of the issuance of the new debt and the unwind of the pre-issuance hedges, we will recognize approximately $14 million in additional interest expense per month beginning in the second quarter. This expense will also be treated as a certain item when we report our results until the merger closes. Finally, last year in the second quarter, our tax rate was unusually low, mainly due to the favorable resolution of certain matters. This will create a year-over-year timing difference from a tax rate perspective in the second quarter. In closing, while the business environment in the food-service industry remains challenging, we are encouraged by the progress we've made implementing our business transformation initiatives and believe we have many opportunities ahead to continue to enhance our customers’ experience, strengthen our operating performance, and increase profitability. With that, operator, we will now take questions.

Hi, good morning. Thanks for taking my question. Just first, on the payroll increase, I'm wondering if you could just go into a little bit more detail in terms of the different buckets of the $67 million increase between the sales, the delivery expense, and the incentive accruals? And what sort of year-over-year increase in payroll was that overall for the first quarter? You mentioned it would be kind of difficult to achieve that flat cost per case for the year, so how should we think about payroll for the next couple of quarters?

I will start and let Chris assist me. Overall, your expenses, as adjusted, have increased by about 6%. Payroll and labor typically account for around 70% to 75% of our structure. I don’t have the exact payroll number, but that should give you a good idea. Our expenses come from different categories, particularly on the sales side. We have modestly started to grow our MA workforce again, particularly in specific markets, after making significant reductions in unprofitable territories 18 to 24 months ago. We’ve successfully expanded our territories and had a strong quarter, leading to a considerable increase in our gross profit and locally managed business. This growth positively affects the earnings for our salespeople and management due to our commission and bonus structures. The other major area contributing to payroll was delivery, where we are facing challenges in attracting and retaining drivers, especially in certain markets. Most of the payroll impact has occurred in these two areas.

I don't have a lot to add – just my comments about the incentive accruals are simply that last year we lowered a longer-term incentive accrual based upon where we are versus those targets in that particular incentive and that this year we are at target. So you’ve got the year-overlapping effect there. So that was a portion of it as well.

Great, that's very helpful. And then I was wondering if I could just follow up with one kind of bigger picture question. Could you talk about just the trends you're seeing maybe with respect to categories and the types of foods that are seeing strongest growth? The reason I ask is I guess we heard from McDonald's, maybe a week or two ago, that they were thinking about possibly pursuing some organics. I'm just curious with what you're seeing in trends in natural and organics and if your customer base were to increase focus on those types of products, where do you think you and your suppliers stand in terms of being able to cater to that?

We have observed trends around organic, local, and sustainable products for quite some time, with different interpretations by various audiences. The local aspect seems to be the most significant trend, especially since we have locally managed customers who are embracing it. Although it doesn't currently represent a large portion of our business, it's increasingly vital for two reasons. First, it is growing, and we want to keep pace with that. Second, for customers who prioritize these products, even if they comprise a small part of their purchases, they are very passionate about them. Thus, being able to supply organic, local, and similar products is essential for nurturing our relationships with these customers. Our suppliers are adapting to this demand. As we progress through category management, especially after our initial launches, discussions about these products will become a larger part of our conversations moving forward. Suppliers are actively engaging in this area, and we are collaborating to enhance our offerings. This trend is present and expanding, as those who seek local and organic options are very committed to their preferences, making it a crucial aspect of our customer relationships.

On the sequential improvement in the MA-served sales growth, could you help us think about where that's coming from? It sounds like, obviously, there's an inflation help and I guess there's more salespeople. Could you give us a little more color on how or what's driving that internally or externally, maybe it's the environment?

I think it is – I honestly don’t think the environment has changed that much. We went through kind of this weather cycle last year where it was really rough, December through February, and so that certainly impacted everyone. And then a rebound in April and May where sales came back pretty strongly. We’ve lapped a lot of that now. I think the market is kind of where it’s been. I think it's almost month to month, you see one report – one month where consumer confidence is up, or the restaurant operators’ confidence is up, the next month it’s down a little bit. So I don’t think there is any distinct change in the pattern there. From our perspective, we’re a year or two years now into these initiatives, both in terms of category management and also some of the segmenting work we've been doing with our sales and marketing teams. We have a program called back to basics that we are out there with – and it allows us to both focus more in certain segments and at the same time use that as an opportunity to enhance training with our sales force. So we’ve seen some positive trends there. As I noted in my comments, some of this is more geographically specific. And so I think at least from what we see, certainly the South in particular where we are here in the Southwest has been strong for a while now. In the West, it looks like we’re seeing some improved results there, and I don’t know how much that is macro. We had a foldout out in Southern California last year; we’re through that and we’re starting to see the rewards from that investment that we made at Riverside last year. I would say the last thing I guess from my perspective is just the stability of where we are in our initiatives. We’ve been – we’re two plus years into all these initiatives. That first year, year and a half, it had a very significant impact on our sales force. As I said earlier, we reduced a lot of unprofitable territories; that has an impact. It took us a while to kind of hit our stride in category management. So as we’ve matured in rolling out these initiatives, I think it's become more business as usual and we’re just executing better. So I think little bit maybe on the macro, little uneven, little geographic there, and I just think that a lot of this change that we’re driving out, we’re getting better at it and more stability within the sales force.

Can you just as a follow-up before I get back in queue, could you annualize what the growth in the MA looks like, even if it's not maybe contributing a lot like right now?

Andy, I don’t know if that’s something we've done before. I’d just tell you that we are growing in a number of MAs and it is modest. I think let me comment at this way. The way we are evolving, I think in terms of our thoughts on MAs and salespeople and territories in particular is to grow those territories at a level that we anticipate opportunities for sales growth and to try to stay ahead of that. So some markets might be mid-single digits, and in other markets, it might be flat to low single digits.

So Bill, on gross margin, where do you guys sit now with price investments? Are we at a point, even when the category management benefit subsides, are we finally at a point where gross margin can be managed flat year-over-year?

The honest short answer is I don't know. Certainly that’s our goal, and we expect that due to the ongoing nature of the market we're in, which is large and has low barriers to entry with many participants. However, there is not much growth right now. We continue to see significant pressure in the market, and as I've mentioned, particularly regarding the caveman initiatives, those efforts are starting to pay off and help us counter some of the pricing pressures you've mentioned. In our recent quarter, we faced considerable inflation in certain areas, and I believe we managed to pass that along appropriately. Most of the margin improvements this quarter came from reducing costs in our cost of goods and sharing those savings with our customers.

Do you think that level of price competition has been worsened by the merger situation, as people may see some business opportunities while you are in limbo, or not?

In some markets, the situation has likely impacted US Foods more than us. They appear to be facing more challenges. There might be competitors trying to take advantage of that circumstance, but I believe that in the early days, it seemed more significant; that has somewhat stabilized. I don’t see it affecting our team. We have kept our staff focused, and while there may be some instances of it, overall, with approximately $12 billion in sales for the quarter, it hasn't been a major factor for us.

And then just lastly, back on the growth in MAs, did a lot of that pre-date the plan for that pre-date US Foods, and is most of that in non-overlapping markets or it's both?

It has nothing to do with US Foods. It was essentially part of our profit plan for the year. I have mentioned in previous calls that we removed around 1,000 unprofitable territories from our business over what we expected to be a 12-month period; however, it was completed in 3 to 6 months, which had a significant impact. Most of our operating companies and markets managed that well. In some cases, we didn't handle it as effectively and moved too quickly, leading to some negative consequences. So, this is really about us, as a management team, deciding to refocus on our normal operations, which involve growing territories based on our assessment of opportunities. Therefore, I wouldn't link that to US Foods at all.

It's Lauren Wood on for Ed. Just another question on gross profit. So it looks like the spread between gross profit growth and volume growth improved again this quarter. Can you maybe talk about how much of that could be attributed to internal initiatives like category management, how much of that could be attributed to inflation, and how sustainable do you think this is going forward?

Well, okay, I think when you look at the growth in gross profit dollars, we've acknowledged that there is a lot of inflation in that, so that is part of the – that 6% growth we’re talking about in sales and gross profit dollars inflation, piece of that. However, inflation also makes it more difficult to keep that spread relatively close. So that’s where I was saying I felt even though the market continues to be very competitive that we did a nice job there and that takes you to the initiatives of which we think category management in particular has now kicked in, in a meaningful way, allowing us to manage our cost of goods more effectively and also to invest in our customers along the way. I think it's mostly the initiatives, as I said earlier, are contributing to that. And I think on the inflation front, we just did a nice job there of keeping that spread as close as we did.

Okay, and just as a follow-up, can you give us any more color on maybe what categories you've addressed more recently and how that process is going?

Well, I tell you, we’re into waves 6, 7, 8 – we’re well into it now. I don't have all the categories in front of me. I know we have done some poultry categories, and I know bread and rolls were a big one, but we’re now into categories where there are double-digit subcategories if you will. So we’re into the core of the entire offering right now.

Hi. Just a couple of questions on the integration costs. So you're now kind of at $130 million cumulatively, and I guess the first question is, are we now kind of at the point where this is about as far as you can go without actually merging? And then the second question was, is this included in the original $700 million to $800 million in guidance that you gave on integration expenses or is that in addition to?

Hi Karen, to address the second part of your question, we included some assumptions for pre-closing merger integration expenses within our original guidance of $700 million to $800 million, and it's fair to say that we've exceeded that assumption. We will provide a new estimate for the overall costs and share what we’ve spent, which we disclose on a monthly basis. Clearly, our spending has been higher than initially planned. Regarding the first part of your question, there are ongoing tasks we can accomplish. However, there's only a limited amount of information we can exchange between the two companies before closing the transaction. We do what we can on a business stream basis and some work in clean rooms, but certain tasks cannot proceed until we officially close. There's still work ahead, although perhaps not at the same intensity and level as we've experienced over the last 10 months. I believe we've made significant progress, and the teams have invested tremendous effort. We have a clear plan for merging the two companies, and the more time we have, the smoother our integration execution will be once we start that process.

Okay, that's helpful. And then I guess just to follow on that, I guess within the bucket of this $130 million, can you maybe give a sense of what the dollar amount that would be for Sysco employees that have fully dedicated to the integration planning versus the actual just pure consulting fees?

Yes, the vast majority of it is consulting fees, Karen.

And then just last question was on the update of the business transformation to other OpCo's this coming year, any idea what the plans are?

Yeah, I'll start here; Bill may want to chime in. As we said in prior last couple of calls, we just did a major upgrade at the SAP software itself which went well and now we’re focused on doing what we will call some functional rollout of SAP. So Bill mentioned in his opening remarks accounts payable, accounts receivable; we will do some additional rollout of some HR functionality etc. and that has a double advantage. One, it helps our shared services, and secondly, it also helps us as we begin to do merger integration; once we’re allowed to do that, it helps us achieve synergies faster. So that’s the focus that we have for our SAP rollout now. Those types of things, once we do them, actually make rollouts in the operating companies easier because we’re converting – we’re transitioning less at these operating companies when we actually go back to rolling out at operating companies. As we go through this process, we are obviously looking at the overall integration plan from a technology perspective of how we will roll out operating companies in the merged enterprise.

I think the only thing I would add there is – in the broader way of looking at business transformation, we’ve talked about category management. This is going to be a good year to continue to launch the rest of the categories this year. We’re pretty much through the SG&A work, and so you’re not seeing a lot of new benefits coming from that; that was the work that I alluded to earlier that we did the first year and year and a half. There is a lot of work still going on on the operations side, supply chain side of business in terms of optimizing our efficiencies, our processes, our pay plans in the warehouse and delivery, and we’re really not seeing those benefits to the degree that we will down the road. So again, in the broader way of looking at business transformation, there’s still a lot going on that our operating companies are dealing with right now.

I wanted to talk a little bit more about category management. I think you've spoken in the past that it wasn't just a simple SKU rationalization process, but it's clearly having a very nice benefit on the gross margin. Can you talk a little bit about exactly what's happening and how that's leading to the gross margin improvement?

Certainly. From our viewpoint, the critical point is that we have established a strong process. We have integrated individuals at various levels who possess category management experience from different industries. We have learned from past challenges and realize the importance of not only developing our current team but also bringing in experienced professionals. Our leadership, particularly with Tom Bene, Bill Day, and his team, has been commendable. The process involves collaborating with suppliers to build partnerships, which will vary across suppliers, while maintaining a focus on customer needs and growth opportunities. Through this collaboration, we can harness insights from our suppliers and enhance our own understanding through customer engagement and marketing efforts. This allows us to identify where customers are inclined to spend their money and where we have excess SKUs that are not performing well. By working closely with suppliers and achieving success, we can generate savings for customers, suppliers, and ourselves, leading to efficiencies visible on the cost of goods side. This transformation is driven by technology and represents a significant shift for our company, emphasizing a customer-centric approach and ensuring a beneficial partnership with suppliers for everyone involved.

And how do you deal with pushback from a customer who says, oh, I'm madly in love with my particular vendor, don't do anything? Do you just keep that item around or are there financial incentives for them to shift vendors?

I believe we've improved in this area by focusing on understanding our customers, listening to their needs, and engaging them in meaningful conversations. Overall, I feel we've made significant progress. The key is to engage in dialogue to pinpoint the issues as clearly as possible and to approach solutions by presenting options and timelines. In some cases, depending on the customer and the importance of the item, we may not be able to convert them. However, in most cases, there is an opportunity for conversion. It's crucial to share some of the financial aspects with them, and we have become better at tailoring timelines that suit our customers. While it would be great to achieve everything within 90 to 180 days, if it requires six months to a year to do it properly, that's what we will pursue. Ultimately, it boils down to listening to our customers and striving to understand the reasons behind their concerns. It may be a straightforward economic issue, or they might be open to changes; we just need to effectively communicate the benefits of the alternative product, which can take time.

Okay. And then I have a question for Chris. You did mention that cost per case this year might not be down the way you'd hoped it would be or it might not be flat as you'd hoped it would be. Is it the things you talked about in the first quarter, specifically transportation, but MAs and incentive comp that are the reason you don't think you'll make the cost per case goal or is there something else that you're thinking about?

Yeah, it’s more than that, but it’s something we didn’t talk about – I think in Bill’s prepared comments, he described that as pretty broad-based, and so we had some increases almost across the board in different areas, some of which we expected, certain pension-related costs and things like that, and some of which we didn’t. Delivery expenses continue to be upbeat, and they were up pretty significantly last year. We talked about the sales compensation expense, things like that. So as we look here at the end of Q1, what we’re really calling out is our cost per case is up significantly. We had a flat goal for the year. We have a lot of areas to go after, and we will go after those, but we’re pointing out that there’s going to be some pressure on us achieving that goal. In no way are we going to give up on the goal, but we are calling out the fact that it’s going to be harder because we are starting, if you will, on the trench; we’ve got to dig our way out of it.

Hi, thank you. Could you explain a bit more about the different performances in certain regions? Is this primarily a reflection of consumer health in those markets, or are Sysco's initiatives influencing these results?

I would say that when we observe some noticeable changes, it's likely due to the health of the local or regional economy. In the Southwest, for instance, the economy has been strong and dynamic for quite some time, and we've had several large operating companies in that region performing well over multiple years. There are certainly differences when comparing the South and the West to the North and Northeast to some degree. We have strong individuals and leaders across the country, and I believe initiatives are being developed and executed consistently everywhere. On the margin, it's more about the economy and how well we're executing. The positive aspect is that we are achieving success in all our markets right now. I wanted to clarify some points regarding the calls where we often get questions about competitiveness. We see it as just as competitive as it has been for a while; however, we believe there are two or three markets with slightly more favorable economic conditions and consumer outlook.

Lastly, in talking about the US Foods merger and the FTC review, you did use the word solution, which implies you're working on addressing a concern. If there's any other color you can give us there or are you considering divestitures or was that always part of the plan?

Well, I think you have to go back to where we were. So I would just say this – we are at a point now where we’re certainly talking to the right people. We’re having the right conversations, and it's taking longer than what we originally projected. With that said, we really had never been through anything like this before. So it's really hard to get too concerned about that aspect of it. I will go back to the comments I made when we announced the deal back on December 9. We think the strategic value of this opportunity is significant. We think it's very pro-competitive. We think it’s going to be very good for our customers over time. We certainly think there is complexity to it, and we need to get a good return on it. As we said on previous calls since then, we have shared a lot of information with the FTC, we've had a lot of meetings with the FTC, and I think they are up to speed now in this industry. It’s taken some time; it’s an industry where, as you know, there aren't a lot of other public players, really, other than us currently, so it’s just taking more time than we thought to give the information to the FTC, get it digested, and begin to have these conversations. Bottom line, we’re looking for a successful outlook. We are looking for a solution. We just think at this point it’s going to take longer than we originally projected.

I had a variation of some of the questions asked earlier on how you're managing your gross margin so well with this level of inflation. I think if your cost of goods is going up and you're passing along the higher food costs, the gross margin percentage should still decrease, even with higher gross profit dollars; at least that's the way the math is supposed to work. So can you comment if you're getting any unusual support from the vendor community that's helping you out? Is there anything else that might be driving the gross margin trends, such as incremental vendor support that's on top of the cost savings initiatives that you talked about earlier?

Yeah, Ajay, I think as we discussed on the last two or three calls, I would agree with your first point that when you have significant inflation, especially in the categories we called out here, you’re looking at double-digit inflation for at least the last couple quarters, meat, seafood, and dairy. You generally cannot pass that along as fast as you’d like, and frankly in many instances, it's not even appropriate to do that. So I will go back to something we’ve been doing for years: we work with our customers, we work with them on their menus, we look at alternative products that would make their offerings in their item selection and their menus more attractive. We do that through our product specialists or company chefs and obviously through our marketing associates and our counter executives. So we do all those things. It is harder to pass it along, and that's why I was referring to earlier, I think it remains very competitive from a pricing standpoint on the street. There's nothing special going on with vendor support. What I was speaking to a couple other times, is when we say that we believe the category management is beginning to deliver the results that we projected for it, that does play out on the cost of goods side. When you are able to form some strategic partnerships with your suppliers and as you get deeper into the category launches and you begin to execute those throughout the enterprise, it takes months to really cycle through all that, but that does translate into savings, and that's what I think you're seeing: where we are buying better but nothing other than the fact that the process for category management is beginning to mature.

Okay, thank you. And I don't expect you to respond further to potential FTC issues, but I wanted to see if you can comment on one practical aspect of any divestitures you might need to make. So specifically, for some of the national accounts that are currently handled by Sysco or US Foods, if there is a change of control on some Broadline facilities that you might need to divest, how would you deal with the issue of those national accounts and who's going to supply them under a change of control for any regional Broadline facilities?

As you say, we’re not going to comment on that. It’s all part of it. That discussion, Ajay, is all part of the process.

Okay, thanks. If I could just ask one final question, you talked about higher corporate and payroll expenses, but can you comment on the level of integration and planning costs we should assume going forward? Does that spending moderate or could it potentially be higher over the balance of the year, based on how you're allocating those costs?

Good question. What I said earlier was I don't know that we will be running at the same intensity that we've done over the last 10 months. I'm not going to sit here and expect them to moderate or diminish significantly, but I think we’re probably seeing a peak and we’re probably going to be flat to moderately down. I'm saying that without actually having a forecast in front of me, but I don't anticipate any new significant expenditures in the way of merger integration expenses other than some of the ones we called out in terms of interest expense and things like that which will continue to account for the certain item until we close.

I have two questions please. First, you mentioned in your prepared remarks turnover and shortages related to your delivery drivers I assume. Is that fixable with compensation, is there anything else to kind of understand why you are seeing a pickup in turnover there? In other words, is it something that you can reverse or has the market for these individuals gotten that much more competitive?

John, Bill here. I think it's fixable in most markets. I think there are things that as we brought in some of our talent acquisition to work in the more central locations, it’s taken us some time as an organization to adjust just to see how that works between the OpCo and the shared services groups. So we've had some challenges out there and we have addressed those. I would expect from that standpoint things will get better. With that said, there's a handful of markets just because of the underlying economy and in particular drilling where it’s very difficult to compete for drivers. Nationally, there is a shortage of drivers. So I think it’s all manageable; it’s just harder to manage today than what it’s been. I would expect that you'll see an improvement there over the next 6 to 12 months.

I have a question about the restaurant industry, particularly regarding casual dining. We noticed an uptick in August, September, and even October compared to July, which was the highest volume month for the quarter but also the lowest when looking at it year-on-year. Is this trend reflected in the broader data as well? In other words, was July the low point for the quarter, and has there been an improvement since then? Could you provide more insight into the industry?

I actually don't know that I've seen that. My sense at least from, for example, some of the feedback we get in surveys from operators is that July and August were stronger, and September they weren’t, as you said about what was going on in the business and maybe their outlook. It's still good. The metrics we're looking at, people are still reasonably optimistic of the operators going forward, but my sense is actually it was stronger earlier in the summer than in September.