Sysco F4Q07 (Qtr End 6/30/07) Earnings Call Transcript

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 |  About: SYSCO Corporation (SYY)
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Sysco Corp. (NYSE:SYY)

F4Q07 Earnings Call

August 13, 2007 10:00 am ET

Executives

Rick Schnieders - Chairman, President and CEO

Kirk Drummond - SVP, Finance & Treasurer

Ken Spitler - President and COO

Bill DeLaney - CFO

Larry Pulliam - EVP, Global Sourcing and Supply Chain

Analysts

Jason Whitmer - Cleveland Research Company

Mark Husson - HSBC

Sean Roberts - Lehman Brothers

Steve Chick - J.P. Morgan

Ajay Jain - UBS

John Heinbockel - Goldman Sachs

Alex Patterson - RPM

Andrew Wolf - BB&T Capital Markets

Rick Lodewick - Searock Capital

Westcott Rochette - Bear Stearns

Presentation

Operator

Good day everyone and welcome to today's Sysco Corporation Fourth Quarter Fiscal Year 2007 earnings release conference call. As a reminder, today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the conference over to Mr. Rich Schnieders, Sysco's Chief Executive Officer and Chairman. Please go ahead sir.

Rick Schnieders

Thank you, Dana. And I would like to welcome everyone joining us this morning. We appreciate you taking the time to be part of our conference call. Let me start by saying I am pleased with our performances in the fourth quarter. We delivered solid sales growth of 8.5% and leveraged that into 19.5% earnings per share growth for the quarter.

As you may recall, in February we announced an organizational restructuring that took effect at the beginning of the new fiscal year. The intent of the restructuring was to support our goal of growing the business. Ken Spitler now manages all operations as President and Chief Operating Officer. Supply chain and sourcing now roll up under Larry Pulliam who reports to Ken.

I expect these changes to further align our different business segments and to improve productivity within the organization as we continue to grow sales and to progress with our business initiatives.

Our fiscal 2007 and 2008 are transition years, where we are in various stages of implementing our initiatives. We are pleased with the progress we’ve made and expect to continue to build on fiscal 2008.

We will start things off with Kirk Drummond taking care of a few administrative items.

After that, Ken will talk about how the business earned during the quarter. Bill DeLaney, our recently appointed CFO, will update you on our financial results for the year, and I’ll wrap things up with a few closing remarks and then open up the call for your questions.

With that said, I will turn things over to Kirk.

Kirk Drummond

Thanks, Rick. First we have emailed invitations for our 2007 Analyst Day to be held in Boston on September 20th and 21st. Please contact us if you have not received an invitation. In addition, on September 5th, Rick and Bill will address the Goldman Sachs Global Retailing Conference in New York. We’ll be delighted to see you there.

Now I’ll read our Safe Harbor language. Statements made in the course of this presentation that state the Company's or management's intentions, hopes, 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 concerning factors that could cause actual results to differ materially from those in the forward-looking statements is contained in the Company’s SEC filings, including, but not limited to the risk factors contained in the Company’s quarterly report on Form 10-Q for the quarter ended March 31, 2007 and in the Company’s press release issued this morning. Please understand that all comparisons given during the call refer to changes between the fourth quarter of fiscal 2007 and the fourth quarter of fiscal 2006, unless otherwise noted.

The net impact of EITF 04-13 will only be discussed from a year-to-date perspective because beginning with the fourth quarter we were comparable year-over-year as this standard was adopted in the fourth quarter of fiscal 2006. We were not comparable during the first three quarters of fiscal 2007. As a reminder, this accounting pronouncement involves revenue recognition or repurchase product from a customer and then later resell the product to the same customer.

The result of this change in accounting principal reduced our reported full-year sales growth by 7/10th of a percent from 8.1% on a non-GAAP basis to 7.4% during fiscal 2007. The lower sales increased our reported gross margins for the year by 12 basis points and it increased our operating expense ratio by nine basis points.

With that out of the way, I will turn it over to Ken to talk about how our operations drove the financial results in the fourth quarter.

Ken Spitler

Thank you, Kirk. Overall, I am pleased with our performance for the quarter. Total sales growth was in line with our expectations and we increased pre-tax earnings by approximately 19%. While growing earnings at twice the rate of sales is likely not practical over the long term, it is gratifying that our operating companies delivered such a strong performance. I prefer not to focus on inflation, but the 6% inflation we experienced during the quarter was higher than normal and much higher than that of the previous three quarters.

Our operating companies managed their business very well in that challenging environment. I am particularly encouraged by our ability to grow gross profit dollars faster than we increased operating expenses during the quarter. In other words, our operating companies worked with their customers to effectively pass along higher product cost while doing an excellent job managing expenses. While our operating companies performed well under the current conditions, we believe a more modest inflationary environment over time is best for us and our customers.

With that said, I'd like to spend some time talking about how we managed the business to increase sales, control expenses, and grow earnings. On the sales side, we look at the number of business reviews we've done, the number of customer-contact people we've added and the level of lost sales we've experienced.

Our business reviews have become a core part of how we operate. We focused these sessions on helping our customers grow, so that we can grow along with them. Over time we've seen significant improvements in the sales from these customers that have participated in our business review process. While we expected this growth we are also encouraged that reviews are significantly improving customer attention, in other words growing of sales.

The most effective way to impact sales growth is to reduce lost sales. These business reviews are a real competitive advantage for us. The scope and scale of what we do cannot easily be duplicated by our competitors. In addition, we increased our customer contact group by 5% in fiscal 2007 and expect to add another 4% to 5% in fiscal 2008.

On the expense side, I'll review a number of important metrics that are vital to leveraging sales growth. In the past years, we saw a real opportunity to control our transportation cost by increasing the number of cases delivered per truck. We have been very effective in improving this by moving from approximately 585 cases per trip in the year 2000 to approximately 695 cases in 2007.

We are now also focused on managing the number of miles driven. We are working on a number of initiatives to reduce our miles driven per route.

Two other numbers I'll look at -- our errors per 1000 cases shift, and injuries per 100 employees. Errors create customer dissatisfaction and increase our cost of handling, because we essentially handle a case multiple times to correct the error.

In the past, we used to make about three handling errors per 1000 cases delivered. Today we make less than one. Safety is of the utmost importance, primarily from a quality of life perspective for our employees, but also from a workers' comp expense perspective.

We have reduced our annual injuries per 100 employees from nearly 10 to less than six over the past several years. Although these metrics that I have reviewed with you are a small subset of the ones we look at, we have hundreds of operational metrics. They are intended to give you an idea of the level of detail we use to improve our productivity and grow our business.

Now, Bill will review the financial results. Bill?

Bill DeLaney

Thanks Ken, and good morning everyone. As Rick and Ken have just discussed, our fourth quarter financial results were particularly strong. Our operating companies manage our businesses effectively, and the spike in food cost inflation contributed to the significant expansion in our operating profit margins as well.

Turning to our financial performance of fiscal 2007; sales surpassed $35 billion, pre-tax earnings grew 16% and diluted earnings per share increased by 18%. Sales grew 7.4% including the impact of EITF 04-13, which reduced our reported sales growth by 0.7%.

The operating leverage that accompanied our sales growth is encouraging, and these results are especially gratifying since we were rebounding from a challenging year in 2006.

Free cash flow defined as cash flow provided by operating activities of $1.4 billion, less capital expenditures of $603 million, approximated $800 million for the year, a significant improvement over the prior year. We expect our capital spending to range between $625 million and $650 million in the New Year.

Acquisition activity was modest in fiscal 2007. In addition, we returned nearly $1 billion to our shareholders through dividends and share repurchases.

I also want to provide some perspective on the earnings impact of several unrelated but significant items this past year. Specifically, the favorable impact of reduced pension expense and stock compensation expense, together with comparatively higher gains related to our company-owned life insurance, was largely offset by incremental incentive accruals and expenses incurred related to our strategic business initiatives.

Looking forward to 2008 and acknowledging that, with the exception of pension expense, these items cannot be projected with certainty. We now expect the aggregate impact of the change in these items to materially impact our fiscal 2008 financial results.

I'd also like to share some additional perspective on income tax expense for the year. Our tax rate in the fourth quarter of fiscal 2007 was comparable to the fourth quarter of '06. The overall annual rate declined from 39.35% in 2006 to 38.25% in 2007. This decrease is primarily attributed to a lower stock compensation expense and greater company-owned life insurance gains I mentioned a moment ago. While difficult to predict, we do not foresee a significant change in our tax rate for fiscal 2008.

In summary, we are pleased with our financial results. We understand that one quarter is not a trend maker. We've always focused on producing solid, sustainable operating results and will continue to do so. More recently, we've begun to develop processes and metrics in conjunction with our strategic initiatives. These tools will further sharpen our focus and enhance our ability to accomplish our long-term goals.

With that, Rick will share his closing remarks.

Rick Schnieders

Thank you, Bill. As mentioned before we had a strong fourth quarter and fiscal year, with solid sales growth and exceptional expenses leverage. By the end of 2007 we moved strategy from the formative stage to the implementation stage. It was particularly gratifying to achieve a major milestone of $1 billion in net earnings for the first time in our company's history. I am optimistic as we begin fiscal 2008. I feel strongly that we have the right initiatives and people in place to executive these initiatives.

We got back on the growth record in fiscal 2007 and I believe we will continue to build on our momentum. We are beginning to see some of the benefits of our initiatives, but keep in mind it's early. We have a ways to go and the benefits will come over time. We are the largest player in the competitive industry. We continually invest backend of the business to allow us to maintain and grow our competitive advantages, which we expect will enable us to continue growing the business into the future. We hold the strong position in the industry and we are working on continually improving it.

Throughout Sysco's history, our growth has consistently outpaced that of the foodservice industry. We are encouraged with the progress of our business initiatives to date and remain confident that the successful execution of these initiatives will position us well to participate in the growth and success of our customers for years to come. Therefore, although the industry growth has moderated somewhat in recent years, we are targeting 7% to 9% annual nominal sales growth going forward. This target excludes the impact of major acquisitions, which to the extent they are completed will produce additional sales growth.

We expect to continue to improve our operating leverage, which should allow us to convert this sales growth into low-to mid-double digit annualized earnings growth.

Operator, we'll now take questions.

Question-and-Answer Session

Operator

(Operator Instruction) And we'll take our first question today from Jason Whitmer of Cleveland Research Company.

Jason Whitmer - Cleveland Research Company

Hi good morning, good quarter.

Rick Schnieders

Good morning, thank you.

Jason Whitmer - Cleveland Research Company

Rick, can you help us with maybe a review of your 45 strategic initiatives -- you obviously referred to them multiple times, or maybe with where you’re at within your own progress report, where you expect to be maybe within the next 12 months, 12 to 24 months? Maybe one of the most important leverage for your company going forward? Thanks

Rick Schnieders

Yeah, thank you Jason. In regard, and I will ask my colleagues to help me here, but in regard to the major initiatives, we certainly are pleased with the progress we have made with the RDC. We are at full ramp to the North East and operations there are going very well.

The construction in Alachua, Florida is also going along very well. So, we are pleased with the RDC and two other important parts of the National supply chain. Our DPR -- the Demand, Planning, Replenishment system which is been rolled out independently RDC to other operating companies -- that's going well.

And we are particularly pleased with the third piece of the national supply chain and that's TMS, the Transportation Management System, which is now in place for all operating companies across the system.

The second major initiative would be sourcing, and sourcing is going along very well. We are completing the second tranche, we had our first small kind of pilot in sourcing that represented about six product categories and $300 million of spent. We are now in the second tranche and we are very pleased with the progress we are making there. Still lots of work to do, we are still adjusted at the very beginning in that process also.

Integrated delivery, really kind of code name for optimizing our warehouse and delivery operations Ken alluded in his comments to the effort to reduce our miles driven, and that took a lot of work, but is going very well in the initial stages.

And finally, I would mention our demand, the work we are doing in demand around the customer and understanding better what our customers needs are and making sure that we have the service offerings that match up to those needs. So those are the major initiatives Jason.

Jason Whitmer - Cleveland Research Company

And when you look specifically at your sales drivers, is there anything beyond the core business reviews and the customer contact reps, things that you could identify over the medium-term or over the long-term that you are looking to really try to drive our performance versus the industry that can be tangible for us to measure you on?

Rick Schnieders

Well I think mostly it’s more of the same -- so the business reviews, business development, making sure we are following through our nose, but every one of these initiatives that I just mentioned are directly designed to grow our sales. So I would say that all of them will contribute to sales growth in to the short terms and in to the longer term. Ken, do you want to add anything?

Ken Spitler

No, I think that covers it, Rick. I think we are just beginning in the demand side to do some pricing work. It’s in the very early stages, but we are very excited about it at this point. Not ready to talk about it yet, but in some tests.

Jason Whitmer - Cleveland Research Company

Good. Thank you.

Operator

And we’ll take our next question from Mark Husson of HSBC.

Mark Husson - HSBC

Yeah. Good morning. I just wanted to know if you could be a little bit more granular on some of the costs that are sort of floating around. I think you mentioned pension costs, but also bonus accruals in the past, and in the fourth quarter last year you told us what the bonuses were and how that swung year-over-year. It also mentioned fuel costs year, and maybe you could just talk about trends there and also pension costs for the coming year? And finally depreciation which seems to be growing rather slowly, can you just talk about why?

Rick Schnieders

Sure, and Mark, I will turn it over to Bill DeLaney to respond to your question.

Bill DeLaney

Okay, Mark, let me break it down a little bit. I think as far as the fuel costs, we have higher fuel cost this year than last year. A good portion of that, but it's not overly significant, it’s pretty much in line with our increases and some of that is pricing. We did buy in last year, which today we are pretty happy with that decision. We have a contract in place through the end of December. So our costs are up, but they are not up dramatically. There is little bit of mileage increase there as well, but overall we still imagine the fuel costs pretty low at this point.

What I am going to try to do is connect maybe the other, some of the other items that you mentioned here in two different ways. I mentioned in my comments that if you bundled these items, there are five major items that we’ve spoken to at various points throughout the year. Pension Stock comp, the company-owned life insurance cash funds and value gains, and then offsetting that to some extent, those have been primarily favorable, and some of those have been fairly large favorable swings.

And we also brought our constituents or investors up to speed throughout the year in terms of the investments that we have made in both strategy initiatives and also acknowledge the fact that last year, in the year where the company didn’t perform to its historical standards, we didn’t pay out bonuses here in at the corporate offices. We’ve got a big swing there, so what I was trying to put across there my comments -- suppose if you put all that and net it all out, and when I am saying you should have saved, but you were prone to do that they essentially offset for both quarter and for the year.

Now, in the third quarter we did give you a little selective guidance there because we were looking at a very large unfavorable swing on the bonus accrual side which was more than what it had been earlier in the first three quarters of the year. So I can tell you that the bonus accruals came in pretty much in the range that we discussed in the call last quarter and in the 10-Q. The one thing that came little more favorable than we would have been able to project, because you can’t project these things was the -- obviously the stock market was very strong and that resulted in some favorable gains in our cash undervalue with the company in the life insurance. So, we've come through it all. We probably picked about a penny versus where we thought we would have been, when we were talking about a quarter ago.

Mark Husson - HSBC

Penny for the quarter?

Bill DeLaney

Penny for the quarter. Not over last year, but versus where our mindset was when we were talking to you at the end of the third quarter.

Mark Husson - HSBC

Okay. Since you are going to sort of -- if this businesses was normal than fiscal '08 and also could you just talk about depreciation which only grew at 5%?

Rick Schnieders

Yeah, I think that’s really -- the major point we are trying to make here is that we expect going in to the New Year that the pension expenses really the only one I consider today, and tell you with any certainty and that that will be very modestly favorable, we believe in '08.

The stock comp, that'll vary somewhat; our options will be to the end of this year or later in the year, so we may have some quarterly fluctuation of a modest amount. But generally and not knowing what the market is going to do, we don’t really attribute much of our outlook in terms of what's going to happen in those lines.

Certainly, we would expect even [Santa Claus] to be much closer in magnitude with '08 versus '07. And quite frankly on the strategy, as we operationalize more of it and put more if it in to our various corporate departments and we are really not in a position to track that, where we have in the past, and it’s pretty much become more of our corporate overhead, as well as what we are trying to do operationally.

Depreciation Mark, I may have to do a little more work on that. We’ll come back to you and talk about it in the K and at the Analyst Meeting, but we have spent aggressively over the last couple of years on several very good projects in the CapEx line and I think at this point we just haven't seen the acceleration that’s come from that. I don’t have any particular insights, Kirk do you have anything you want to add on deprecation?

Kirk Drummond

No. I really don't. The only thing I could say is that we are making longer-term investments. That the assets are going to be longer-term, which would lower your depreciation.

Mark Husson - HSBC

Yeah. Because some of the early spending on the RDC was software writing, which presumably was written off very aggressively, very early.

Kirk Drummond

Yes. But then the others, a fair amount is buildings and then the buildings as we go forward with that facility expansion pulled out things like that. Those have got much longer lives.

Mark Husson - HSBC

Thank you very much.

Rick Schnieders

Thank you, Mark.

Operator

And we'll take our next question from Meredith Adler of Lehman Brothers.

Sean Roberts - Lehman Brothers

It’s actually Sean Roberts for Meredith today. I am just looking at your real sales growth line over the past several quarters. How do you feel with that indexes versus the industry? And I guess what in particular gives you comfort that that can accelerate next year?

Rick Schnieders

Well again I'll ask my colleagues to pitch in here, but in terms of real sales growth, when we look at what's going on in the industry today we feel comfortable that we continue to outpace the industry and take share from our competitors. So we are very comfortable with that.

The other thing that we have talked about for a number of quarters now, is sort of that illusory number of inflation and frankly it's one that moves around, it can move around very, very rapidly, so we are focusing on nominal, topline sales growth, ex-major acquisitions and just making sure that we leverage that nominal -- that top-line growth.

Kirk Drummond

Yes. I think Sean the only other thing is that, as Ken pointed out in his comments, the inflation environment is a difficult environment to operate in when it gets to 6% and that's challenging for our customer as well as our operating company management team. So I think it's difficult to see the strong real sales growth when you have customers whose purchasing budgets are being impacted by your higher costs. We feel we are doing a pretty good job managing, so there is always going to be some interplay, as Rick points out, between your real growth and when you have higher inflation.

Rick Schnieders

And then what Ken pointed out was the ability of those operating companies, which was absolutely terrific to be able to manage through that. I am sure we took some amount of hit on the gross profit line, but the opening companies did a terrific job managing their expenses beyond any positive impact we may have gotten from the higher inflation. So, we are seeing the operating companies leverage their business very effectively. They are going to continue to leverage their business, and I would expect most of that to come at the expense line.

Sean Roberts - Lehman Brothers

Can you maybe describe that process of passing through the higher cost to customers, and how that might differ between independent versus the chain versus the institutional customers?

Rick Schnieders

Sure, I mean half of our business roughly is a contract basis, half of it is independent side. And on the independent side of our business, we are just working with the customers on a daily basis, sort of negotiating on an item-by-item basis. And so it's a real-time activity that takes place. And so as new pricing, higher or lower comes into play, it takes some amount of time to get that price change into our customer base and into independent customer base. On the contract side of our business, it's pretty cut and dry. For most items, the non-commodity items, prices would change on a monthly basis. For commodity type items, those who are going to generate a bulk of the revenues and the bulk of the purchases, those change on a weekly basis. So, that's kind of on a [real high level], that's the way the mechanism works.

Sean Roberts - Lehman Brothers

And they have full transparency into your cost on the contract business or…?

Rick Schnieders

Well, sure, because they know what their markets are as they are fee structure, so they see the cost, sure.

Operator

And we'll take our next questions from Steve Chick of J.P. Morgan.

Steve Chick - J.P. Morgan

Hi, thanks. Good quarter.

Rick Schnieders

Thank you.

Steve Chick - J.P. Morgan

Bill, I don't know if you have this handy, but your prepaid expenses jumped a bit in this quarter. In fact, it looks like by most of what I've seen -- looking back in the past I think it doubled what it was in the third quarter. Do you happen to know why that is?

Rick Schnieders

Yes, I do. We'll talk more about it in the K Steve, but we do have a litigation accrual out there that we are involved in a product liability claim that we believe we are very, very well insured for, but it's progressed to the point when we set up both in accrued expense and a prepaid for roughly the same amount, and that's the proper accounting. So basically, we've added close to about $50 million to the accrued expenses and $50 million to the prepaid, another line to account for that, but there is no P&L impact.

Steve Chick - J.P. Morgan

Great, okay. Good. There is no cash impact, I guess.

Rick Schnieders

Correct. This is totally non-cash, non-P&L at this point.

Steve Chick - J.P. Morgan

Okay, great. And then to clarify, now I understand you want to get at the unusual -- the operating expense items or so forth. Did you say that the net favorable impact was a penny for all of the items or was that just for the quarter?

Rick Schnieders

Okay. Let me be real clear on this. What we said is on the year-over-year that they largely offset if you look at all of the items. Going back to the third quarter when we gave some selective guidance on the bonuses, we did that because it was much larger now than it had been and to be honest with you, probably at that time if we were to have provided this, which we wouldn't and didn't, we probably would have thought that we would have a hard time for it to be breakeven in the fourth quarter. With the stock market being strong, it turned out that the cash surrender value came in much better than what we thought, which allowed it to basically offset for the fourth quarter. So, I don't mind the COLI gave us about a penny for the quarter.

Steve Chick - J.P. Morgan

Okay.

Rick Schnieders

Versus a year ago.

Kirk Drummond

But Steve, the total of those major items did a balance off for the quarter.

Rick Schnieders

Yeah, it is important as they are roughly offsetting for the quarter and for the year, it's just add -- if you go back 90 days. I don't know that we would have thought that we'd have offset. But again, we're only talking a penny. But since you're asking that's the situation.

Steve Chick - J.P. Morgan

Okay, that's helpful. And then last, for the business reviews, did you say what you did complete for the year and down and how many you plan going into 2008?

Kirk Drummond

No, we didn't. I haven't collected that data as of yet, but I'm sure it's in the 40,000 and we expect that to go slightly going to 2008.

Rick Schnieders

I think one of the underlying things we've seen there Steve, is that this is, we've been doing this long enough now. That's truly become pretty much -- and accepted best business practices that's what we do and we'll continue to track them internally, but we're probably not going to talk quite as much about the aggregate numbers going forward.

Steve Chick - J.P. Morgan

Okay, alright, thank you.

Rick Schnieders

Thank you, Steve.

Operator

And we'll take our next question from Ajay Jain of UBS.

Ajay Jain - UBS

Rick, I know you've got a policy of not commenting on the beyond going financial impacts from the RDC but with the second facility coming on stream this year. How do you feel about the year-over-year comparisons? Or the benefits that you're seeing now for the North East, RDC now have to offset the depreciation expense and pre-opening expense that you are going to expect to hit the P&L from the second distribution center in Florida?

Rick Schnieders

Yeah, Ajay thank you, the real -- going back now for a year for four quarters because, we already see a stuff so now inter-twined with the business itself, the operating companies, we're not commenting partly because again it becomes very difficult as most of the benefits accrue at the operating companies. So, we don't comment on the specifics of the RDC itself. However, I'll just go back to what I did say earlier and that is that we are at, full ramp, the operation is running very, very smoothly, we are very pleased with it and we are going forward with the forward RDC at this point and it's on schedule, it's going very, very well.

Ajay Jain - UBS

Okay. And can you also confirm what the increase was in headcount for marketing associates and customer contact personnel both for the quarter and for the year?

Kirk Drummond

5% for the year.

Ajay Jain - UBS

Okay. And for the quarter?

Rick Schnieders

I don't think we know that number, we could get it, but it's a little early to collect all that data from the operating companies. But if it is 5% and it's probably a good number for next year.

Ajay Jain - UBS

Okay, great, thank you very much.

Rick Schnieders

Thank you, Ajay.

Operator

(Operator Instructions) And we'll go next to John Heinbockel of Goldman Sachs.

John Heinbockel - Goldman Sachs

A couple of things, for long-term goals what's the time table for that, is that five years or something different?

Rick Schnieders

Well, I don't know, we've talked about specifics, but I would say it's three to five years but it kind of ongoing, we are thinking about it as ongoing, but yeah, three or five years.

John Heinbockel - Goldman Sachs

There will be the seven to nine normalize inflation is probably what around three?

Rick Schnieders

We think in terms of two and half.

John Heinbockel - Goldman Sachs

Okay. You’re sort of thinking 4% to 6% real growth on average over that time period?

Rick Schnieders

Sure, however the numbers workout, but yeah, we were really focusing on that nominal, that topline nominal growth excluding major acquisitions.

John Heinbockel - Goldman Sachs

How would that -- does that tie in roughly to, I know we’ve talked about this in the past, and how much of the strategic initiative savings get reinvested, and how much go to the bottom line? Does that sort of tie in to a 50:50 splitter or something different?

Rick Schnieders

Well, we really haven't talked about those numbers, and I will tell you that I don’t know that we know those numbers yet. There is still work to be done, but we are going to share some of those strategically, share some of those savings strategically to help our customers grow our business, grow particular categories and some will come to the bottom line.

John Heinbockel - Goldman Sachs

Alright, and on gross for the quarter, you know, I thought the number was very good considering inflation and also the drop in corporate brand penetration? Are you seeing now a fairly, I don’t know, if you have a number, but from the strategic sourcing initiative, does that now ramping up -- in dollar terms at a fairly good rate. Was it much better than the third quarter ramping up at that level or not quite?

Rick Schnieders

Well I think it is ramping up, John. We don’t have any numbers at this point in terms of the overall impact, but the first spend, the first pilot project, six categories was $300 million, the second tranche is about $1.3 billion. We are doing some initial work on the third tranche, and so, again, if we add the $300 million and the $1.3 billion you are still at a fairly small number versus in comparison to the total purchases.

John Heinbockel - Goldman Sachs

But you guys, do have a -- can you track every quarter the amounts you are saving on sourcing, a dollar amount?

Rick Schnieders

Okay, we can do, we track it.

John Heinbockel - Goldman Sachs

Okay, and it sort of increasing pretty consistently on a sequential basis or are we seeing some do we see a jump in the fourth versus the third or not really?

Rick Schnieders

No, I mean, I wouldn’t want to get into that level of detail, John and leave the extraordinary. I think that, frankly at this point we don't know and the numbers we really don’t want to get into.

Bill DeLaney

John, this is Bill, I mean, as Ken mentioned, these hundreds of metrics we look at, many of those are along these lines and it’s very detailed and they move around and it’s a process as we’ve described from the beginning. So it’s not quite as scientific as something I want it to be.

John Heinbockel - Goldman Sachs

Alright, and then finally, I guess, it sounds like you are not in demand for your customers, we are not seeing any real weakening there in light of what's happening with inflation and the economy in general, that’s held up pretty well?

Rick Schnieders

Yeah, I think the demand is at most customer type. It is very, very level and we don’t see a significant change at this point.

John Heinbockel - Goldman Sachs

Okay. Thanks.

Rick Schnieders

Thank you, John.

Operator

And we'll take our next question from Alex Patterson of RPM.

Alex Patterson - RPM

Yes, thank you. Just following up on John's questions about the nominal sales target implicit about a 5% to 6% real growth rate, is that comfort level sort of inflation ignorance, I mean, in other words are you really expecting real growth to re-accelerate to that, or do you really need to get inflation down to the 2% to 3% level to attain that?

Rick Schnieders

Well, again our target is for nominal which would include the inflation and the real sales growth, and as we've said several times over the past year or two is that, because of all the things that move within those numbers, we are really focusing less on inflation at this point and looking at the nominal sales growth, because ultimately that's what we have to leverage to grow those earnings.

Bill DeLaney

I think again it's important to impress upon everyone and I think John just asked his question. These are goals that we've targeted for ourselves over the longer-term whether you say three to five years as Rick pointed out. So one of the things we are trying not to do is to get into a quarterly component of each delta here. Because they move around we've gone back and as I'm sure you all having look at the growth in the industry over the last several years and we looked what Sysco has done in those environments. And based on industry history and in our performance in different environments, we thought that this would be a more realistic goal to set over the next three to four years.

Alex Patterson - RPM

I mean I asked you because really the metric is more important than the nominal sales number as your gross profit dollar growth, as the vehicle to leveraging your operating expense and hitting your bottom-line targets. So I guess what I’m wondering is, are these nominal sales growth targets, really sort of getting towards a gross profit dollars growth target, in sort of a backhanded way?

Bill DeLaney

I don't think so and I think that the thing that we learn every year and every day in this business is, if there is gross profit, there is expense and we believe that these are realistic growth goals for us to manage the business around. For example, if you take a look at this quarter, if we just look at it kind of line-by-line we would say, well our margins were up but our expenses were unusually low versus the prior year.

So, which is the most relevant? Well, I think the most relevant is in an inflationary environment, our operating margins improved by about four times of the point, and even that's a little bit more than what we would ask you to expect going forward, but I don't know that I would necessarily agree that the gross profit is the defining line. I think the way we are looking at it, as you got sales line, then you've got operating margin line, and when you get to that operating margin line, we expect to expand that over time to leverage those earnings, and a lot of things that are into this product mix, customer mix, and then these types of environment that we are working in today.

Rick Schnieders

But we do expect most of their gain as we've suggested previously. Most of the gain will come at the expense line and we are working hard to make sure that we are -- our systems are in place to drive our expense ratios down.

Alex Patterson - RPM

Yes, okay. Well okay. Thanks. The shipping and handling for the year was that up or less than the rate of sales?

Rick Schnieders

Yes.

Ken Spitler

Yes.

Bill DeLaney

Yes. But in comparison it absolutely was.

Alex Patterson - RPM

Okay, great, thank you.

Rick Schnieders

Thank you.

Operator

We will take our next question from Andrew Wolf of BB&T.

Andrew Wolf - BB&T Capital Markets

Good morning, congratulations on a nice quarter. And obviously in the quarter for everything you are saying in the numbers, how they flushed out to the bottom-line, you manage in the quarter nicely against inflation and obviously in the systems and everything like that. But Rick, I mean, let me just speak out what my view of the world is and I would like you to answer that, if this inflation stays high it's just can't be anything but tougher for your customers, and vice versa.

I mean if [Gerry] stops inflating 20% and comes back down, that will be good and if it stays up at 20%, I just don’t frankly see how it helps them. Either their bottom-line gets contracted or they try to pass it through and restaurant prices go up. Could you just sort of -- I mean you folks have a view internally on how you're looking forward -- your sort of, what's sweet spot for inflation and as what investors should think about in that regard?

Rick Schnieders

I think a sweet spot for inflation is roughly that 2% to 2.5% number, that is kind of the traditional number. We operate better in that environment. We think that our customers do also. But I will tell you Andy that we work very, very hard with our customers to help them manage through this difficult time. So things like -- we will help them do pricing on their menus to make sure they are staying up with the cost that they are experiencing, that they are putting that into their menu costing. We help them find alternative products to introduce to their patrons, is either a special item or on their menus.

We have fairly sophisticated menu printing and reprinting services that we provide for our customers also. And so I think the other things is, when you start talking about the industry as a whole, it's kind of like averages and it becomes very difficult. We have many, many operators who are terrific in managing in these difficult times. They up their promotional spending. They draw customers into their restaurant. They manage their menu appropriately and they manage their menu pricing appropriately. So, I think there is a core of customers, they are here today and will be here in ten years who will go through these more difficult times and be very, very successful going through them. So, what we can help is that we just help those customers, help our customers in these more difficult times.

Ken Spitler

But as I said, Andy, this is Ken. As I said in my opening comments, we don't think that level of inflation is good for our customers or us. We would like to see it less than that six down in the 2, 2.5 to 3.

Andrew Wolf - BB&T Capital Markets

Thanks. And Rick just last to follow-on, because the way you spoke about, obviously certain operators being much more adept, is there -- could you, averages sort of being if not misleading less than FIFO. Is there any, would you classify or draw any distinctions you have how independent operators, let's say stronger independent operators, which Sysco was I think very well penetrated with, versus your typical chain. Do you think a strong independent had this, is that what you are talking about the independents have?

Rick Schnieders

Yeah, in general, because they have greater flexibility, they can move more quickly than chains can. But frankly chains are pretty good at moving pricing also. So, there are various student management teams in those major chains. But the independents are certainly more fleeted foot, they have got one operation or two operations or five operations and they can kind of adjust to the circumstances that present themselves.

Ken Spitler

We find that the independents are able to move from product to product a lot easier in terms of menuing. So, I think that's an advantage for them. They can roll it out pretty quickly.

Andrew Wolf - BB&T Capital Markets

Thank you.

Operator

We will take our next question from Rick Lodewick of Searock Capital.

Rick Lodewick - Searock Capital

Hi, how are you?

Rick Schnieders

Fine, good morning.

Rick Lodewick - Searock Capital

I just had a couple of quick housekeeping questions. With respect to the tax situation with the government, do you guys have any update on that?

Bill DeLaney

Rick, Bill here. No, we are still in the fairly early stages of the appeal process. We have written our protest, respond to their letter and we have written ours and we are going to work through this thing and probably we will take the better part of the year before we have some type of stronger conclusion on what is going to play out. But we feel very good with our position as we said all along.

Rick Lodewick - Searock Capital

Perfect. And just a quick question. If you disclose or can you disclose the allowance for bad debt that was associated with other receivables. Is that change meaningfully as the percentage of the receivables year-over-year?

Rick Schnieders

Sure, our bad debt numbers this year were very close to last year. We set a record last year, it's a very small percentage of our revenues.

Ken Spitler

We had a good year in terms of what we call right also in this year and now we'll have more detail for you and that in the filings.

Rick Lodewick - Searock Capital

Okay. When is the filing expected to come out?

Ken Spitler

I think it's the 29th of August.

Rick Lodewick - Searock Capital

29th August, okay. And you guys have changed the accounting for the COLI last year and now it's starting to cooperate through it sort of creating this volatile income stream or unpredictable income stream that I think the change was intended to avoid, I mean, if you have any thoughts to going back to the old method of accounting here or what are your thoughts on that?

Ken Spitler

Yeah, I have been thinking about two weeks, the answer is given in this call. And also this is – Rick, the thing is that we misinterpreted an accounting proclamation when we changed to beginning of fiscal 2007. We thought we could go to the cost method which frankly will be a lot easier and we'd make it simpler for you to understand as well.

And it turned out we misunderstood that, so then at the end of the third quarter we went back and restated the impact was not material for the year. It's not even material for the quarter but to your point again, it does create a little bit of volatility more of your attempt than anything else I think as far as of our communication.

So, it's not a big deal which is something smaller scale like pension expenses. So something is going to be volatile and in this case it's going to -- one thing, I think, I can tell you is when you see the equity markets performed well, we should do -- we should get a little bit of benefit and when they don't perform well, we will get hurt a little bit and but the accounting we are using today is the appropriate accounting.

Rick Lodewick - Searock Capital

Thanks.

Ken Spitler

And the only accounting we can use.

Rick Lodewick - Searock Capital

Right, I think I got it. Thank you.

Rick Schnieders

Operator, we will take two more questions, okay.

Operator

Thank you Sir. We will go next to Mark Husson of HSBC.

Mark Husson - HSBC.

Yeah, a bit of follow-up here just one on the general competitive environment. U.S. Foodservice kind of -- just to catch your attention -- has disappeared into the more of some interested private equity people but the EBITDA interest coverage is not much better than one. What do you think that goes to a competitive environment and what is it look like right now, do you see anything upfront?

Kirk Drummond

Well, we have seen much changed it all, a lot of rumors flying around but no real change.

Mark Husson - HSBC.

I guess the second question would be, if we are right and the low EBIT margin is something to do if they have some large chunks upon profitable business and is there any conversations happening that you can talk about, about you might like some of those businesses or no?

Kirk Drummond

We like all their business, but no there are no conversations going on which we can share with you.

Mark Husson - HSBC.

Okay. I like that last bit. And then, final question is, you had mentioned, I think, in the last analyst meeting that as food retailers are increasingly selling good food and prepared food, there may be some opportunities in that market and maybe also in an Asian cuisine and things like that, would you think look at to try and boost your growth rate or are there some other up-markets out there that you are starting to work with?

Rick Schnieders

I think that's a big one, Mark. The other one that we continually work with, it's a smaller segment. Certainly today it’s this meal assembly business, which is best characterized perhaps by the company Dream Dinners, I don't see [a analog], which is a really good operation and a great customer of ours where consumers can go in and prepare meals for the next two weeks or month or whatever at very reasonable prices, good menus, good ingredients.

So, I think that’s one small sort of trend out there that’s an opportunity for us that we are taking advantage of. But frankly we need to do a better job with the retailer, so I think have gotten better with take-out food and more aggressive with take-out food. We are focusing more heavily into that market.

Mark Husson - HSBC

Okay. Great. Thank you.

Rick Schnieders

Thank you.

Operator

And we’ll take our final question today from Westcott Rochette of Bear Stearns.

Westcott Rochette - Bear Stearns

Thank you very much. Just a question on kind of where you see the inflation environment right now, kind of how we peaked and kind of what your outlook or built in to your outlook, say over the next 6 to 12 months?

Rick Schnieders

Westcott, I would tell you that we are not smart enough to figure out what's going on in the inflation area over the next even few months. As you know, there is a lot of pressure certainly in the corn markets. There was the largest corn crop in history, I believe, plan of this year, but it’s a really difficult thing to predict. So I don’t know, I’ll ask Larry maybe, Larry Pulliam was with us this morning. Larry can give us some updates in regard to what he is seeing in the product categories himself.

Larry Pulliam

Yeah, Rick I would have to agree with you, your assessment on it. Westcott, we track commodity cost in just about every category from all the grains, very last top, fuel packaging and we measure it on ongoing basis. We measure it on year-over-year, and clearly and now you have seen some of these things as well, this last quarter it was just unbelievable. Corn prices, grain, soybean and we really don’t have a good feel of where it’s going to go.

We track it very closely, we monitor it, we see the impact it has on our food products, and as Ken said, we have the capability of having the penetration with our territory sweet customers and MA sub customers, so we can help them to move to certain other products, but we ask, we don't know where it is going to go. We have no idea or don't have a good feeling that it's going to be less in the near future.

Westcott Rochette - Bear Stearns

Thanks. And then….

Ken Spitler

And it seems to be a lot of different things at play, political, some droughts, the field situation. It's a little more complex than I think we’ve faced before, but we are prepared for it and we are prepared the leverage whatever comes at us.

Westcott Rochette - Bear Stearns

And just, in general, I know you guys talked about how different customers are dealing with the inflation. Are you seeing in working with your customers generally increasing product menu in order to deal with it or just kind of absorbing it for the near-term and kind of piecing of where we are in that cycle?

Kirk Drummond

I mean I guess this wouldn't be just a temporary price increase by all accounts. Inflation is kind of on a relatively higher sustained level. So, can you just comment?

Rick Schnieders

We want to work with our customers on a regular basis because these kinds of changes, as we have suggested here this morning, can happen often. They can be pretty volatile, they can go high very quickly. They can go -- the pricing can go lower very quickly.

So what's important for us with those 8,000 sales people that are on the streets is making sure that they have the ability to communicate with those customers, and when they see changes in particular product category, that they help their customers make the appropriate price changes on their menus. It’s the only way they are going to survive. So it's part of the way we work.

Westcott Rochette - Bear Stearns

Okay. Thank you very much guys.

Rick Schnieders

Thank you. And I would like to thank everybody who has been on the call with us this morning. We feel very, very good about the quarter, as you probably heard in the comments today, and we feel very, very good about 2008 and beyond. So again, thank you for your interest, thank you for participating in the call today, and have a good day.

Operator

And that does conclude today's conference call. Thank you for your participation. You may disconnect at this time.

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