Sysco Corp (SYY) — Q2 2015 Earnings Call Transcript

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, and subsequent SEC filings, as well as 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 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 are included at the end of the presentation and can also be found in the Investors section of our website. All comments about earnings per share 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 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, 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 importantly, 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. Our ability to effectively integrate these initiatives into 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 costs, and delivery costs. 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 that lower fuel prices will further improve the consumer outlook and lead to sustainable increases in traffic and spending 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 initiatives 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, particularly regarding 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 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 effective 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 opportunities 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 food service market and believe we have a significant opportunity to better serve these customers and grow our sales. We made additional strides in this effort recently with the launch of our new multilingual 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 customers' 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 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, 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 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 what is already a highly competitive industry by positioning us to provide significant value to our customers, including lower costs. 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 rates 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 both to strengthen our customer relationships and to provide solid returns to our shareholders over the long term. Now I’ll turn things over to Chris, so he can provide additional details on our financial results for the second quarter, as well as the agreement we announced this morning with Performance Food Group.

Thanks, Bill, and good morning, everyone. For the second quarter, sales were $12.1 billion, an increase of 7.6% compared to the 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 rates 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, which increased demand and aided 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 expenses and $52 million in interest expenses. Merger and integration planning expenses that impacted operating expenses 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. We are trading this interest expense for this certain item until the merger closes. After excluding certain items, adjusted operating expenses for the quarter increased $108 million, or 6.8%, compared to the prior year period. This increase was driven by a $115 million rise in payroll expenses resulting from several factors. First, during last year’s second quarter, we reduced certain management incentive accruals based on our performance versus our objectives at that time. In this year’s second quarter, these same incentives are generally accrued at higher amounts reflecting the impact of our recent performance, 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 costs are expected given our performance for the quarter. Sales costs also increased, although to a lesser extent, due to hiring additional marketing associates over the last year. As we discussed last quarter, some of this increase in marketing associates is related to normal hiring to replace attrition and support growth. However, certain markets added marketing associates 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 a marketing associate 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 in various stages of implementation that we anticipate will help to reduce these costs and increase productivity to mitigate these increases. 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% from 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 rates. 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 the different timing regarding when we make cash contributions 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, which is 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 the 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 affecting cash flows from operations, 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. In October, we issued $5 billion in debt; the proceeds of the offering are intended to fund the various elements of the 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 $130 million to settle the hedge against our third-year debt issuance, which is shown as 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 of the year, there are 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 into 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 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 expenses, 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 expensive in the second quarter or first half of this fiscal year. However, we do expect a roughly $15 million decline in fuel expenses 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 expenses per quarter, which we will exclude from our adjusted numbers until the close of the merger. Finally, I wanted to speak for a moment about our outlook for share repurchases. Our approach to repurchases over the last several years has been to buy back shares throughout the year, with the goal of keeping shares outstanding relatively constant. However, this fiscal year, we have not been in the market buying shares due to the pending merger. This has affected our shares outstanding in the first half of the fiscal year due to the exercise of employee stock options and RSU grants. We are not prepared to comment on 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. This 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, enabling 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 spending required to integrate to 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 costs to integrate the company and deal-related amortization. With that, operator, we will now take questions.

Hi. So just to focus on the transaction a little bit, 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 with some color on the facilities that are being divested, the customer type, EBITDA associated with the facilities, things like that?

Good morning, Karen. I will start and I don’t know how far Chris can go with that second part, but I will give it a shot. One of the things we want to be careful of 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. What I would say is that a good, a very high percentage of the conversation over the last several weeks and really months has been around their concern that 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 some of these larger customers will buy from multiple distributors. They might buy from regionals or multi-regionals, and they may buy from us and/or US Foods 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 Foods and PFG, but with a lot of regionals, who are now multi-regionals. Even in situations where certain customers will work with a fewer number of distributors, the opportunity to work with more is always present when negotiating new business. So, again, I can’t make their case for them, but I think that’s where we spent much of our time discussing how we address their concerns about how these customers continue to receive good service and appropriate pricing. 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 and the competitive landscape, should allow PFG to compete very well in a 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.

Okay. 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, the $600 million synergy, does that actually include any operating profits associated with the TSA with PFG?

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

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 profit associated with the TSA.

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.

So just a few questions 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 were thinking before, is that more buckets that you hadn’t anticipated, or are these buckets that are just bigger? And if there are buckets that are bigger, what might one or two of those buckets be? Lastly, I assume all other terms of the purchase on your end remain the same, that none of that has changed?

Okay. John, if I can, I will take those in reverse order. 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 are the two biggest ones, 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. As for your middle question about 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, and everyone else, that it was based on essentially publicly available information. We didn’t have a lot of additional information at that time, although we had some experience at Sysco dealing with some of these buckets of opportunities. We had done some category management work and some route optimization, and we knew the extent of what we could do. We made prudent assumptions but not overly aggressive ones. Now that we’ve learned a lot more, I would say every bucket probably increased in size, certainly around merchandising and supply chain. Those buckets got quite a lot larger. So we’ve found it across the board, but in certain places we found more. We rebuilt the synergies from the bottom up using more information from our integration planning efforts. There is still a lot of information we are not allowed to have access to, and we abide by all those rules. So we expect that when we eventually close, and we gain access to some additional information, we will true this up again. But we’ve made reasonable assumptions and remain prudent; we are not getting overly aggressive or overly conservative.

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

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. 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 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 are rising. We tend to be very good in this area, but we have a lot of initiatives going on here as well. I’ve mentioned Scott, and he has been with us a couple of years. Our new enterprise structure is working hand in hand with our operating company leadership to strike the right balance between what we need to do to support our customers each day while also putting better and more consistent best practices in place and monitoring them better, getting our compensation schemes aligned with our productivity. So there is a lot of work to be done in that area and more to do; I would say that’s our biggest opportunity. As for the merger, Chris spoke 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 continue running the businesses while also driving out those points of synergies. So the biggest challenge will be to continue running the businesses while also delivering on those synergies.

Okay. Thanks.

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?

Good morning. We did speak to that. We still have some situations. It’s abated some. The source of that is really twofold: 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 are 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 compared to what we offer. In those markets where energy has been strong, we have struggled to some extent. It’s too early to tell if that’s going to abate. The other part quite candidly is we’ve had internal issues in certain markets where 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 as we should have. So we're also catching up in those areas. So there are still a handful of issues out there, but it has abated, and I would expect it to continue to improve.

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?

I’d say it’s pretty pronounced in the Southwest, and we’ve seen that for several quarters now. I would also tell you – interesting right now when we look at the numbers from December, January, or early February. If you recall, we had some really severe weather last year, and we’re getting more weather now over the last week or two. As you look at the markets, you can see where the weather impacted last year and where it did not. I would say the Southwest and the West Coast, in particular, are 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 look like the quarter is off to a pretty good start in terms of their season.

Hi, thanks. Good morning. Just wanted to check with 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?

Andrew, I have to be very careful to comment about your own estimates and your own modeling, so apologies for that. But look, originally, we believed 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 it's 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 the 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 how we think we’re going to pursue some of the synergies, and that has affected our timeline for accretion.

But I mean, you would as well as the divestitures, I mean, clearly you’re selling them below what you’re paying for?

Yes.

Just wanted to ask a procedural question on the FTC. It sounds – so you secured agreements from the commissioners to meet with them, the five commissioners, to make your case? And does that mean they have 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?

Look, Andy, I think there is one thing we agree on at this point with the FTC: It’s time to move this process forward. We have had plenty of time to talk and educate, listen, negotiate, or whatever. So we are at a point where they signal to us that it’s time to meet with the commissioners, and we’re preparing to do that. Along the way, since they’ve signaled their concerns for quite some time, we’ve had parallel discussions with PFG. We thought it would be best to have better knowledge of what’s really going on. There have been a lot of weeks, so we felt it made a lot of sense, and we’re going to visit with the commissioners with this agreement in place so that we can tell them exactly what we are prepared to do without any uncertainty in terms of our ability to do it. So that’s a little color from my end; Chris, would you like to add anything to the process?

Actually, I think that covers it well. One thing probably I’m not going to speak a lot about is what happens 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. It’s hard to speak to at this point, but it’s time to move this thing forward as Bill said.

And just one other thing on this deal. Can you provide color on how the commissioners view that deal as it stands? Do you think it’s ambiguous? Have they signaled that it’s not enough or that it could be enough, or is it all implied? I guess that’s what you’re going to discover?

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, as well as address remedies to their concerns, which we don’t share. But we certainly want to address them because 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, and obviously they haven’t agreed to anything at this point. So I think it will be determined.

Okay. Can I just ask one more question, just a number question on the adjustment statement? The $78 million in merger integration costs this quarter was about $40.5 million last quarter. You were talking about the last quarter being 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?

Yeah. It is mainly consultants, but that's the majority of that $78 million. Some of the uptick came from legal, from the fact that we have started some foundational IT projects that will be necessary for integration, so some of that stuff kicked in during the quarter. As we also said, our merger integration planning peaked in the second quarter, and those costs will begin to decline going forward. We’re literally reviewing those every month to assess how many consultants we need. It’s too hard to call frankly where we’re going to be in the process and what work needs to be done.

Okay. Thank you, and good luck with everything.

Thanks, Andy.

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?

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

Well, I guess the assumption would be that you are still having trouble passing along inflation?

I think there are many reasons, Meredith. I think some of it is mix, right? So a lot of inflation is in these higher dollar costs, boxes of meat and dairy this last quarter. So it’s partially mix. It’s certainly partially, as I’ve talked in the past. One of the things we do with customers continually, especially now, is try to listen to them, understand what their needs are, and determine where they are going with their menu. If there are more cost-effective ways for them to buy from us to still position their menu, advantages, we want to find those opportunities. For instance, if they can offer more poultry dishes or other types of a la carte items than they would have done with cheese or with beef, we’re aiming to facilitate that opportunity as well. Our case growth still is very good in these inflationary categories, and I think it’s the mix, we are trying to find the right price point for our customers. Catgory management is also helping in this area, as are some of our other initiatives regarding product training, in terms of our sales team having good discussions with our customers. So it’s a lot of things, but probably mix would be the biggest contributor.

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?

No, not exactly. What we want to do 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 done there. We need to help them use these products that we’re offering to augment their menu appropriately, and we should look at whether changing things up a bit makes sense. For both of us to make commitments, we need to get our suppliers to commit to taking costs out of the system so that we can buy these products better and realize those savings. I think we’re starting to see nice traction there in this part of it. Longer-term, we have an opportunity to differentiate ourselves in the marketplace with expanded product lines – perhaps broader, not as deep in certain SKUs that don’t move as quickly so that we can offer more customized offerings to customers as we better understand their needs. And then we’ll also use this platform to bring more innovation to our offerings. So in the short term, I see this as an opportunity for both us and our customers to partner more strategically, buy more efficiently, and to pass some of those savings ultimately along.

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?

Let me approach that from this direction. First, I mean, fuel charges differ when you think about them regarding our larger customers versus smaller customers. With larger customers, we may have contracts pegged to certain fuel prices; 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, or monthly basis. So the concept of “giving them up” doesn’t really apply in the same way. I will say this: When we consider fuel and what’s happening there, we did not raise fuel surcharges when fuel prices started to rise. Our forward-buying strategy provided time to assess what was going on before we needed to react. Now that they are coming down, we are evaluating the situation, trying to determine what’s appropriate in the market for our customers, and we’ll continue to look at that. It’s important to note, though, that the impact on our fuel costs has been slim over the first half of the year due to this strategy, and we expect it to see a modest projected decline of around $15 million over the second half of the fiscal year. However, this will be partially offset by lower fuel surcharges. What we need to look at is how much of that amount might need to be mitigated with adjustments to the surcharge.

Great. Thank you very much.

Yeah. Hi, guys. Good morning.

Good morning, Ed.

Two quick questions for you. Chris, just one follow-up on the $600 million in synergies. There was lots of talk about 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?

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 return would be, including the amount of investments involved. We made some assumptions, and as we’ve gone further into the integration planning process, we have refined our thinking. One thing I can tell you is there is no good science around predicting that. I can make a guess, you can make guesses, and we could end up being wildly different. There is no real way to measure it even after the fact. What we’re trying to do instead is zero in on what would cause a customer to want to leave, and determine how we can address those issues. Our integration planning is focused on making this as little disruptive to our customers as we can. Everything we work on is based on this principle, and so we are not spending a lot of time trying to estimate potential disruption; rather we are focused on how to ensure customers stay. 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 potential disruption. But it’s our estimate, and frankly, we hope that we’re going to be wrong, and it’s going to be better than that.

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 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 help parse that out for us.

Great question, hard to answer, Ed. We’re hopeful that some of this positive consumer sentiment that has been out there for a while will begin to reach our customers and translate into more industry growth. Our quarterly numbers, as you have tracked them, have floated around between 2% and 3% over the last few quarters. We have a positive growth for the locally managed customers now, which we didn’t have a year ago. That’s a significant part of this, coming back to mix and the different customer types. We’ve spent considerable time and effort over the last 15 months on best practices and how to manage margins better while effectively delivering customers’ needs. But clearly, category management is driving a fair amount of that right now. We’re doing a better job of integrating it into our everyday business activities. So, I would say that's a large part of it.

Great. Thank you.

Thank you.

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 in the past you’ve said that with the merger pending you are taking a step back on some of those processes. So can you recap for us all in terms of – is this now going to really restart here, or are some parts of it or which parts will still be waiting on the outcome of the merger?

Good morning. I think it’s more of what we talked about over the last couple of quarters. We are not doing new deployments right now until we have a better sense of where the merger is going to play out and when. Some geographic issues will come with that. However, we have been able to 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. Additionally, we’re taking some of the other applications, whether they’re financial or HR-related maintenance, even for the non-SAP OpCos, bringing those into SPS, and accelerating our network to where SPS is now supporting certain areas. 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 leveraging SPS in a different way. So we’re providing better services to the 12 OpCos today, and when we do begin to redeploy again, those conversions should go more smoothly. For now, we’ll defer any further deployments until we understand the timing of the merger better.

Okay. Great. Very helpful. Thank you. Just as a follow-up; going back to the 11 facilities that were called out today, can you provide further color on perceived market share or the competitive stance in those areas? I just want to clarify a point: When dealing with the FTC, so those 11 proposed facilities, you’ve already had the initial discussions, and now it’s being escalated to the five commissioners. I want to confirm that’s correct?

Yes. What we’ve done is spent multiple discussions over multiple months with the FTC, trying to understand both the nature and depth of their concerns. The package developed is designed to address those concerns, and we believe it is satisfactory from our perspective based on our knowledge of this business. However, we have received no approval from the FTC at any level in this package as of yet.

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

Okay. Totally understandable. All right. Great. Thanks very much.

Thank you.

Thank you.

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. 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. Do you feel like you’re potentially running out of time to the extent that’s an issue at all?

We think we have ample time if we do end up in some litigation to work through that and still bring that to closure before the expiration of the merger agreement.

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

I would love to be able to have a forecast for merger-related expenses. I can say these consultants were, we don’t need them anymore and these consultants we still do. But a lot of depends on what we’re doing in the fourth quarter and the third quarter. So it is difficult to estimate those expenditures on a go-forward basis. 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 working to stand down any teams that have completed their work so that we can reduce those expenses. We review this every month.

Okay. Thank you.

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, in terms of where you see it trending and from a gross profit per case perspective it was potentially a place where passing out pricing can be easier to customers in relation to a previous question?

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 inflation we see today is more on the meat side, with dairy beginning to level out. We don’t make predictions or provide guidance. However, we think inflation over the next six, nine, or 12 months should subside to some degree. I don’t know where it ends up, but hopefully less than the 5% to 6% because it is not good for our customers, which is why it can sometimes be a challenge to pass through price increases as fast as you would like. So it may be a little early, but too early to call until we get into March and April.

Thank you.

Welcome.

Hi. Good morning. Thanks for taking my question. I guess, just another one related to the merger. Just based on your discussions with the 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 from your point of view?

I appreciate the question. I don’t think I am in a position to really address the likelihood. There may be others who can provide 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 an incredibly competitive industry. We believe it’s good for our customers. There will clearly be some disruption, and I am sure there have been some concerns conveyed to the FTC and to us from that standpoint. But that’s not unusual with mergers. We’ve spent a year and tens of millions of dollars preparing an integration plan to mitigate as much disruption as possible, and we think that over the medium- and long-term, this is very good for our customer base. We believe it will raise the bar for competition in our industry, which is good for everyone involved. So we believe strongly in our case, and that’s probably all I can say on that.

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

I think, just to summarize, we’ve been careful to address both the larger and the medium-sized facilities to complement the current footprint the FTC has, which is across the country but less dense in the West compared to US Foods. What you're seeing is an attempt to successfully address that.

Thank you.

Thank you.

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

Well, we can't guarantee that. But, again, we have done a lot of work on integration planning, and Chris has been leading that work. I’ll let him take that.

We are focusing on making this as least disruptive as possible to our customers and US Foods customers alike. We have built the package to help Performance Food Group accomplish that objective. So, if you think about a customer being serviced from the Denver facility for US Foods today, that same sales person or truck and food coming out of that facility is going to go to that customer once it is owned by PFG. The transition services agreement facilitates that.

Are there long-term contracts that transfer, and is there a non-compete agreement concerning going after these customers?

Yes, a lot of that will be detailed in the 8-K, which we will file later this week. So I’d encourage you to look for that. There’s enough in there to keep you busy for a while. As you might imagine, we intend to establish PFG's success, and we’ve taken measures to ensure that our customers do not feel any disruption in the process.

To illustrate that from a layman standpoint: As you look at these facilities from a customer perspective, they will be handled by the same salespersons, drivers, and customer service teams through the TSA agreement. We have put a lot of measures in place to help PFG transition smoothly as they take on this business. We are making sure the transition is as seamless as possible.

Okay. And I know you’ve addressed this with the $600 million synergy number, but you’ll stand back and look at the deal from a broad perspective, US Foods has 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?

We have not given and I’m probably not going to provide any kind of forecast for earnings accretion. We obviously have re-looked at the transaction based on everything that’s happened over the year and based on the divestiture package, and we still feel this is a very nice return for Sysco and our shareholders. Obviously, we have to get the deal closed, and we need to work on executing against the synergies. Additionally, while this adds a layer of complexity, we also need to work on the divestiture package and to make sure that set up is right. As long as we continue to serve customers in a seamless manner, we expect to see a strong return from the transaction, and that’s where we are focused.

Okay. Thank you very much.

Thank you.