Executives
Rick Schnieders - Chairman, CEO
Ken Spitler - President, COO
Bill DeLaney - CFO
Kirk Drummond – SVP Finance, Treasurer
Neil Russell - IR
Analysts
John Heinbockel - Goldman Sachs
Ajay Jain - UBS
Meredith Adler - Lehman Brothers
Jason Whitmer - Cleveland Research Company
Greg Badishkanian - Citigroup
Mark Husson - HSBC
Steve Chick – JP Morgan
Alec Patterson - RCM
Andrew Wolf - BB&T Capital Markets
Bill Leach - Neuberger Berman, LLC
Christopher Routhe - Piper Jaffray & Co.
SYSCO Corporation (SYY) F1Q08 Earnings Call November 5, 2007 10:00 AM ET
Operator
Welcome to today's SYSCO Corporation first quarter fiscal year 2008 earnings 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 call over to Mr. Rick Schnieders, SYSCO's Chairman and Chief Executive Officer. Please go ahead, sir.
Rick Schnieders
Thank you, operator and good morning to everyone. Thank you for joining us to discuss SYSCO's first quarter fiscal 2008 financial results. With me in Houston and speaking on today's call are Ken Spitler, President and Chief Operating Officer; and Bill Delaney, Chief Financial Officer.
But first, let me turn it over to our newly appointed Assistant Vice President of Investor Relations, Neil Russell.
Neil Russell
Thanks Rick, and good morning everyone. Before we being, please note that 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 in a material manner.
Additional information concerning factors that could cause actual results to differ in a material manner from those in the forward-looking statements is contained in the company's SEC filings, including, but not limited to risk factors contained in the company's annual report on Form 10-K for the year ended June 30, 2007 and in the company's press release issued earlier this morning.
I want to point out a couple of changes to our reporting. The income statement and the press release include a couple of additional line items. First, we added a line item to show gross margin dollars. Second, we added a line item to show operating income. Although both measure can be calculated from our previous reports, we decided to formally shown the line items going forward. Please understand that all comparisons given during the call refer to changes between the first quarter of fiscal 2008 and the first quarter of fiscal 2007, unless otherwise noted. Also, all comments about earnings per share refer to diluted earnings per share unless otherwise noted.
With that out of the way, I will turn it back over to our Chairman and Chief Executive Officer, Rick Schnieders.
Rick Schnieders
Thank you, Neil. Let me start by saying we had another solid quarter, delivering sales growth of 8.5%, and leveraging that into 16.2% earnings per share growth. We are encouraged by the fact that this is the fourth consecutive quarter where earnings per share growth has exceeded 15%.
We are pleased with how the new fiscal year has begun. We continue to take share in a difficult business environment, with high inflation continuing throughout the second quarter. We are executing our strategic business initiatives, and we are gaining traction from these initiatives across our operations. As we have communicated in the past, our initiatives are long term in nature, and take time to fully implement.
A key component of our strategy is to invest in our future, to find better and more efficient ways to serve our customers and drive profitable growth. We are always trying to help our customers grow, which positions us to participate in their success.
Now I would like to turn the call over to Ken, who will talk about how our operations performed in the first quarter.
Ken Spitler
Thanks, Rick. Overall I am pleased with our performance in the quarter. Sales growth was in line with our expectations, and operating income increased by about 16%. Our operating companies performed well. Similar to last quarter, our internal measure of product cost inflation remained higher than normal, averaging just under 6%. Our operating companies continued to manage their business very well in that challenging environment. Our ability to grow gross profit dollars faster than operating expenses was key to our results.
Something I said last quarter still holds true: while our operating companies performed well under the current conditions, we believe a modest inflationary environment over time is best for SYSCO and our customers. We experienced low gross margins as a percent of sales this quarter, which is not unusual during times of high inflation and inversely, inflation favorably impacted operating expenses as a percent of sales. This combined with effective cost management by our operating companies helped drive our growth in operating income.
Last quarter I shared a few metrics that helped drive the business. This quarter, I will expand on one of those topics: miles driven. We are continually managing the miles driven in order to provide quality service to our customers and to minimize fuel expense. As a result of increasingly impactful initiatives such as XY routing and designated delivery days, the number of miles driven increased only about 1% in the quarter.
In summary, I am pleased with our operating results, and we are committed to continuous improvement going forward. Now Bill will review the financial results.
Bill DeLaney
Thank you, Ken. As Rick and Ken have just discussed, our first quarter financial results were strong. Earnings per share grew approximately 16% in the quarter, primarily driven by sales growth of 8.5%, and operating margin expansion of 31 basis points. Gross margin dollars grew 7.3%, while operating expenses increased only 4.7%.
These results include a $16 million decrease in share-based compensation year over year. We moved the grant date for incentive stock options from the first quarter to the second quarter of the fiscal year, and we expect the benefit created by this timing change to be partially reversed during the second quarter.
The first quarter results however, were negatively impacted by a $9.4 million charge for an anticipated accelerated future contribution to one of the company's multi-employer pension plans.
Cash flow from operations increased about $19 million, or approximately 11% in the first quarter to $192 million, primarily driven by our growth in net earnings. As we noted in the press release, capital expenditures were $132 million during the first quarter, which is in line with our business plan. Such investment even in challenging times is necessary if we are to achieve our long-term goals.
My last point of discussion will be the income tax rate. The effective tax rate for the first quarter of fiscal 2008 was 38.1%, a decrease of about 60 basis points from the same time last year. The decrease in the effective tax rate was primarily due to the net tax benefit resulting from the combination of two items.
We recorded a tax benefit for a net operating loss carryforward related to state taxes, which was partially offset by a tax provision for a foreign tax contingency. The net impact of these two items was a net benefit of about $5 million, which reduced the overall effective tax rate. While difficult to predict, we do not foresee this favorable variance continuing over the balance of the year.
In summary, we are pleased with our financial results for the quarter, and encouraged by our overall performance for the past year. We remain focused both on contributing to the ongoing success for our customers, and achieving SYSCO's long term financial objectives.
With that operator, we will now take questions.
Question-and-Answer Session
Operator
Your first question comes from John Heinbockel - Goldman Sachs.
John Heinbockel - Goldman Sachs
Rick, can you talk about the macro environment a little bit? Are you seeing any real tangible sign of a purchasing slowdown by your customers? Or is that happening and you are simply picking up enough share to offset that?
Secondly, do you see your customers consolidating vendors or suppliers at a faster rate here than they were six months ago or a year ago?
Rick Schnieders
Thanks for the question, John and in fact, I think it is fair to say while not having terrific industry numbers, we don't see a lot of growth out there. However to your point exactly, we are watching the pieces, the new items that we are selling customers out there, and we feel very good about that.
To the second part of your question about consolidation, it is pretty hard for us to determine whether there is any consolidation, other than whether they are using fewer distributors; other than the fact that we are gaining share in this challenging marketplace.
John Heinbockel - Goldman Sachs
How much is drop size growing roughly, this quarter or last quarter? Do you have a sense of that?
Rick Schnieders
Yes, average drop size, those numbers we have shared before are running about where they have been the last three years, which is in the range of 3% to 4% in the average drop size.
John Heinbockel - Goldman Sachs
That has been fairly consistent. There hasn't been a pickup or a slowdown really of late, say the last couple quarters?
Rick Schnieders
No, and as Ken alluded to last quarter and this quarter, we continue to work with our customers to get those additional items, but also to make sure that we are routing our trucks properly, getting the right number of cases on the truck and where we can, to do some consolidation to get our average pieces up. That is frankly working very well.
John Heinbockel - Goldman Sachs
Finally, the gross margin impact from inflation looked to be a little lighter this quarter versus last. Is that more a timing of passthrough of your costs? Is it more that? Or is the centralized procurement benefit picking up sequentially?
Rick Schnieders
John, we haven't done any sort of statistical analysis on that difference. I think the difference is not significant, the difference between the impact of inflation on gross margins last quarter and this quarter. We are still, as Ken alluded to in his comments, we are still pressure on gross margins related to the inflation. On the other hand, we are picking that up at the expense line, but even more than that, I think an indication of those operating companies and how hard they are working to control their costs, we are seeing the real pickup at the expense line, which is exactly where we expected and where we have to see it.
John Heinbockel - Goldman Sachs
The procurement benefits are picking up gradually, correct? There hasn't been any big step-up of late?
Rick Schnieders
That is right.
Operator
Your next question comes from Ajay Jain - UBS.
Ajay Jain - UBS
I think there have been a couple of instances, I think it was last year and also in fiscal '06 as well where you had some calendar shifts for accruals related to pension expense, and I was just wondering if you could talk about what the basis is for these timing adjustments on your actuarial assumptions?
Bill DeLaney
The change we are talking about this morning is on our stock comp expense, not on the pension. In the past, I believe the issues on pension have been more or less annually, year-over-year, and a lot of that is driven by the discount rate that we are required to use to discount back the projected benefit obligations. The change we are talking about today is on stock comp.
That was a conscious decision. We didn't put it all in the release because it is kind of cumbersome. The long and the short of it is it is primarily for administrative reasons, it just was becoming increasingly difficult to process the options, get them in front of our comp committee, and find a time that we could issue them outside of a black-out period, that would work for everyone. In the interest of being more accurate and optimizing the time window, we pushed the grant date back from September to November.
In fact, we will be going to the comp committee with our recommendations this week, and there will be a final meeting next week, and those grants will be approved as deemed by the committee next week. So that is really all it is. It is more of administrative change. As I have said here, we would expect a good portion at least of that benefit to reverse in the second quarter.
Ajay Jain - UBS
As relates to the stock compensation, you did mention that some of that, based on the change in the grant date, that benefit will reverse itself this quarter. Can you give any more specificity and quantify how you see the comparisons in Q2, and also what your outlook is on an annualized basis for options expense for the full year?
Bill DeLaney
It is one of those great questions that you would need to be a soothsayer to give you a precise answer. We haven't even gotten them approved yet. It is dependent on how many are approved and the mix of the people that are involved in that package and a lot of other things. So I think as far as I will go with you today is we would expect a portion of it to partially reverse in the second quarter, and I think we'd be in a better position by the end of the second quarter, perhaps when we release earnings, to give you a little better view going forward.
But I will tell you this, in the Q as we're drafting it today, we don't really expect this year-over-year change to be material.
Ajay Jain - UBS
I seem to recall last year that the share repurchase activity was a little bit front end loaded. I was just wondering if you could confirm what the level of share buybacks were in the latest quarter?
Bill DeLaney
It was back end loaded I believe last year. It is just the reverse this year. We picked it up quite a bit, and Kirk is sitting right here. Do you have a number, Kirk?
Kirk Drummond
Actually, we evened it out a little bit for the first quarter. I want to say it is about 187 million, I think, in the first quarter.
Bill DeLaney
So we have been pretty aggressive buying back this quarter.
Ajay Jain - UBS
Can you confirm the number?
Bill DeLaney
It is roughly 190 million this quarter, versus about 65 million for the first quarter last year.
Operator
Your next question comes from Meredith Adler with Lehman Brothers.
Meredith Adler - Lehman Brothers
I would like to go back a little bit to just Ajay's question about pension, because I didn't really understand what was in the press release about something about potential acceleration. What exactly have you done, and what do you anticipate needing to do?
Bill DeLaney
As we have disclosed, I think pretty consistently, we participate in several different multi-employer pension plans, which are essentially plans that our union employees are participants in and we contribute to those plans. We have one such plan that in fact, in the past we disclosed that there is some underfunding issues in the aggregate; not in each of those plans but in the aggregate.
One of those plans, we have become more aware of in recent times, and in particular in the last month, that their underfunding situation is much more acute. In fact, even though we haven't been directly notified, we have reason to believe through third parties that we will probably need to make an accelerated contribution here at some point in the relatively near future. So with that information, we went ahead with the best information available to us, and took a charge for about $10 million.
Meredith Adler - Lehman Brothers
I would like to go back a little bit to the first set of questions about the macro environment. If you look at the public restaurant chains, they are clearly suffering tremendously. It is unclear whether that is all because of food inflation but a lot of that seems to be just about the consumer economy.
I was wondering whether you have any commentary on independent private restaurants, whether you are seeing similar kinds of issues? You said that growth has not been very strong. Do you see slowdowns in new units? Do you see people closing down?
I think some people are very gloomy about the restaurant business, and I was wondering if you could comment. And then also, to what extent is higher food inflation cause either consumers or restaurants to buy less product?
Rick Schnieders
Meredith, I will start and say that I think that the consumer confidence is not good at this point, causing this lack of real growth in the industry overall. You see it in the retail sectors in general, I believe.
In terms of specific numbers, new operations opening, restaurants closing, independent restaurants closing, that information would lag us, but anecdotally, we don't see restaurants closing en masse.
I would point out to you that over the last few years, as you know, we have done a better job of stratifying customers and understanding our customer base better and I would also say today that based on that, we have a stronger core group of customers, and those customers tend to be in business for very long periods of time; ten years, 15 years, 20 years. That is kind of the heart of our business, and even, they have been through tough times before, 1990, 1991, we'll all go through tough times together in the future.
Fortunately, our base of customers tends to be those that are going to hang on, they understand the restaurant business well, and we see less churn in our customers today than we did three, four, five years ago, because we were diligent about identifying that stratified customer group that we have out there.
Meredith Adler - Lehman Brothers
Do you have any perspective on where food inflation will go for the remainder of this calendar year, and maybe into the first quarter of next year?
Rick Schnieders
Well, again, we would have to be calling on the soothsayers. We are beginning to see just recently a little bit of softening in some categories; dairy, for instance which really needed to soften up. I am sure you have followed that Argentina has been out of the wheat market here for the last ten months or so, and on Friday they announced they were coming back into the market. Wheat prices at commodity level are down just a bit month over month. So we don't want to get too far out in front of ourselves here, but we think there may be a little bit of softening of inflation over the next few months now.
Operator
Your next question comes from Jason Whitmer - Cleveland Research.
Jason Whitmer - Cleveland Research
Rick, I know you talked a lot about anecdotal impact of business reviews. I was curious if you guys have done any quantitative impact on the impact you have had on independent restaurant profitability, something where you are really helping them drive either better top line sales, or more importantly, help their profitability with their menu development, or things of that nature, if you have really been trying to track that as a big success point for your business?
Rick Schnieders
I think at some level, a certain number of customers will share their profitability with our operating companies and with our marketing associates. Again, very anecdotally, we do get positive feedback from our customers, and I have got some stories that I could tell, and I am sure most of the folks in this room have stories, where we have had a particularly strong relationship with a customer, we have helped them enormously and their business has grown.
So you know, absolutely, I think that is happening out there. We have operating companies where we have done a number of business reviews with the same customer and at some point, the only way we are going to continue to grow with that customer is to help them grow their business.
I think anecdotally, you know, we don't have any statistics on this, but anecdotally we do have customers where we have provided significant assistance to them and their business as a result has grown, and they would honor that. I think they would say that that is true.
Jason Whitmer - Cleveland Research
I think when we met a little over a month ago in Boston, there was a sourcing summit that you guys held internally to try to really reconfigure or reset the bar on sourcing. What are some of the best wins and changes coming out of that over the six weeks or so?
Ken Spitler
Yes. That was just a reset meeting to make sure that we were doing the best we could. Some of the learnings that we had out of that were how we rolled it out to the operating companies. We were a little slow getting that out to them, so we have refined that process, and we are quicker to market with the rollout. That was probably the most significant learning that we had out of it. There was a lot of just that sort of thing that we did.
Jason Whitmer - Cleveland Research
Last question, Rick, there was a chart a couple years ago, I remember seeing it very frequently, in terms of the number of operating companies that had an operating margin above 6%, above 7%, something to that effect. I think if I recall, almost two-thirds of them were above 6%. Has that changed materially over the last couple years, into something like sourcing or RDC, or whatever else you have in your strategic road map does that change the earnings power potential of any of the operating companies?
Rick Schnieders
Well, I think it does, Jason, but maybe even more important that that is it is all those things together, but it's also just the ability of that management team or those management teams that were not at 7%, that were at 2% or 3%, their ability over time to kind of get their arms around the business, and manage the net margins of the business upwards. I think it has changed, but as you will also recall, I am sure, is that those operating companies that were toward the lower end of that graph generally tended to be the newer operating companies, because they were acquisitioned.
Time is really a big factor for all of us. We talk about how it is taking time for us to institute and install these initiatives. That is absolutely true. Same thing with an operating company. It just takes time to get your arms around all the moving parts to drive your earnings higher. That chart in terms of the shape of it would not be significantly different. The newer companies we have today are toward the lower end, and those that are more mature generally tend to be better, at the higher end of the chart.
Operator
For our next question we will go to Greg Badishkanian - Citigroup.
Greg Badishkanian - Citigroup
Following up on food inflation, it sounds like it is sort of a neutral impact to your bottom line, in terms of EBIT dollars, is that right?
Rick Schnieders
I think that is right. I think that is absolutely right. The bigger concern that we have and Bill has said this for a while, is that as high inflation goes on for too long, the real impact is to our customers' business, and consumer confidence level and causing the consumer rather than eating out three or four times a week, to eat out two or three times a week. That is by far the biggest impact to our business.
Greg Badishkanian - Citigroup
When you look at your independent customers, are they doing a better or worse job relative to the large chains, in terms of passing on those price increases to their end user?
Rick Schnieders
Well, I think the truth of the matter is that some are doing better, and some are not doing so well. We don't have any real statistics on that. But I will also say that we have worked hard in business reviews, and more broadly to help our customers understand the importance of adjusting their pricing in this market. I think we put out a marketing piece a month ago, Ken, to kind of emphasize that very point.
Ken Spitler
We do see that our independent customers are a little more nimble with the ability to change their menu, and change their menu pricing than the chains are.
Bill DeLaney
With that said, it you are a pizzeria and your dairy costs go up 25% or 50%, it is kind of hard to pass along real quick.
Greg Badishkanian - Citigroup
Moving over to acquisitions, are you seeing multiples coming down and companies looking to sell?
Rick Schnieders
Well, it is a bifurcated market out there. I think you have seen the big public deals, and the extravagant multiples that they have been able to command. On the other hand, we today continue to work the largest list of smaller acquisitions that we have ever had an opportunity to work. I think as in anything, there are opportunities, there will be opportunities at the larger end, the larger acquisitions. I think that the multiples will get more realistic over time. But we continue to look at every possible new partnership that we possibly can. We are still very actively engaged in assessing the acquisition market.
Greg Badishkanian - Citigroup
Sometimes it takes time for the sellers to reconcile that, the take out multiples have come down, and so have you seen that over the past few months, or do you think it will take a little more time for the take out multiples to come down some?
Ken Spitler
What we are seeing, there is still a fairly high expectation out there that we think will take a little while longer to mitigate itself.
Bill DeLaney
I think the other thing is some of these folks have to decide whether they are really sellers or not. There's being a seller, at a multiple of 12, 13 and there is being a seller at a lower multiple. I am sure within their own organizations they're having those discussions.
Operator
Your next question comes from Mark Husson - HSBC.
Mark Husson - HSBC
I want to ask a question about gas prices, and about the overall structure of your distribution system. When you think about regional distribution centers, what kind of stress testing did you do in thinking about $3 a gallon, $4 a gallon, $5 a gallon, and does an RDC have a much better gallon burn profile, if you like, than the previous sort of structure in the Northeast?
Rick Schnieders
Well, I think where we see it is when you look at sort of the piece number. You want to look at it right down to the case level Mark, and so absolutely, and the RDCs allow us to keep the trucks fuller. The inbound trucks fuller into the RDC, the outbound trucks to the operating companies. So there is a huge benefit there, particularly longer term, as we move more and more inbound freight through those RDCs. It is a big environmental positive environmental impact, and a big impact in terms of the cost.
The other thing that is happening that we feel very good about is that we are shipping more product by rail into the RDCs than we anticipated. As you might expect, I mean, on a per case basis, the rail is about one-half what truck is. So there are a number of opportunities, in terms of optimizing the costs, the fuel costs if you will, as well as the environmental impact that we have. So we are going to have a smaller carbon footprint going forward.
Mark Husson - HSBC
I am assuming the [inaudible] do the same thing.
Rick Schnieders
Absolutely, because we are closer to the customer, no question.
Mark Husson - HSBC
You are closer to the customer, but then the inbound freight doesn't look quite as good, presumably.
Rick Schnieders
No actually, the real important thing on the inbound freight is making sure that those inbound trucks, whether they are coming into an RDC or coming into an operating company, making sure that those trucks are full. When you open that back door, it is stacked to the ceiling.
Mark Husson - HSBC
To push it a little bit further, if you had some catastrophe in Venezuela or something and you had to deal with $5 a gallon and you are having a meeting right now, what would be top of the agenda to discuss?
Rick Schnieders
I think we would have to look at expanding fuel surcharges for sure. But the other thing, silver lining in this whole thing, is that we are closer to our customers than our competitors. We do do a better job of routing those inbound trucks, so we are all going to pay essentially the same price for fuel. We just do a better job on a per case basis on moving that product.
Ken Spitler
I can add to that by saying that on the outbound side, we would be looking at reducing miles, and reducing the number of deliveries that we currently make. If you are getting three, then we would go two, if you are getting two, we would go one, that sort of thing. It is all about miles.
Rick Schnieders
And in our discussions so far, because we have been in a fairly high fuel environment here for a while, our discussions with our customers as we have gone to better routing has been quite positive. You know, they understand. They are just like the rest of us. They pull up and fill their cars up. They read the newspapers. So our customers appreciate the spot that we are all in, not just the distributors.
Mark Husson - HSBC
Switching gears, if I could please, just on U.S. Foodservices, this any sort of update, any announcements coming out of that business, any reorganization or any change in behavior?
Rick Schnieders
They are closing one facility in Cincinnati. That is the only public information we've seen so far. We have not seen any strategic move on their part.
Ken Spitler
There are still a lot of rumors, Mark, but we can't put a finger on anything.
Mark Husson - HSBC
The deferred tax benefit, any update on whether or not you are going to be allowed to keep it?
Rick Schnieders
Well, we certainly think we are. We are still in the process Mark, and essentially where we are at now, I don't think it has changed much since we were in Boston, or even since we drafted the K. We have obviously taken a position, the IRS has pushed back, and we are in the appeals process now. I think the next step is probably to get an appeals officer and that is moving along at a fairly deliberate pace. I don't think we're going to have a whole lot more news, at least from what I understand, until the spring, and perhaps later than that.
We could still be a year away from this thing, running its course one way or another. We certainly continue to believe our facts are strong. Obviously at the same time we are now in an appeals process. So we will play it out.
Operator
Your next question comes from Steve Chick – JP Morgan.
Steve Chick - JP Morgan
Are you still on track to increase your sales force by 4% to 5% this year? And do you have the, what the increase was for the current quarter?
Ken Spitler
I do. It is 5.1% on the customer contact people. We are really looking at 4% this year, which is really would make me happy if we could stay in the 4% range. Right now we are at 5.1%.
Steve Chick - JP Morgan
So you are at 5.1%, but you think you might come in at the lower end.
Ken Spitler
I would be happy with 4%.
Steve Chick - JP Morgan
As it relates to that, your sales target of 7% to 9%, I know it is a long-term target; you didn't have it in the press release today. Given the volatility of what's around us and some of the comments on macro, can you confirm post your quarter end that you are still pretty happy with how sales are trending and that the 7% to 9% figure is a pretty good range to continue to think about for this year?
Ken Spitler
Yes, sir.
Steve Chick - JP Morgan
If you could give us an update on the Florida redistribution center and when you expect it to be in operation?
As it relates to that, I had a tough time estimating your depreciation and amortization, which comes in a little below what I would estimate, and I don't know when the RDC comes into play if the D&A starts to kick in on that facility, so if you could speak to that a little bit?
Ken Spitler
I will answer the first part of that as we are right on schedule with it. We are to start ramping up in April as planned.
Bill DeLaney
The way I would look at the other, Steve, is just look at in the context of our overall capital expenditures. We are at the higher end of our range, if you will, in terms of percent of sales. One of the reasons is because of the ramp-up in the Florida RDC. So I don't know that I want to specifically comment on depreciation as it relates to that construction, but I think you should continue to expect us to be in that 625, give or take, zone for CapEx for this year.
Steve Chick - JP Morgan
Well what I am looking at because you're at the high end of the CapEx plan but in the last two quarters the depreciation expense has been growing. It was year over year I think 0.4% this quarter. I have a feeling that some of that might be, in April, does the depreciation start to kick in on the Florida facility when it goes into operation in April?
Bill DeLaney
Yes it is capitalized until it goes in, and then it starts to kick in.
Steve Chick - JP Morgan
Bill, a little bit in the weeds but just on the breakout of your sales, intersegment sales looked like they were flat year over year. We could talk about it offline if you want. Do you have any sense of why that is, or is that impactful?
Bill DeLaney
Can you define intersegment for me, just so I am answering the right question?
Ken Spitler
Intercompany?
Steve Chick - JP Morgan
Intercompany, yes, I am sorry. Your intercompany sales were kind of flat year over year and it usually grows a little higher than that. I don't know if it's the mix of your customer base? We could certainly take it offline.
Bill DeLaney
We might go offline on that one. I don't have an answer on that one.
Operator
Your next question comes from Alec Patterson - RCM.
Alec Patterson - RCM
The sales growth in the other specialty segment has continued to decelerate. I am just wondering how much of a food inflation or deflation may be appearing in that number, maybe just a general comment about it?
Ken Spitler
We got hurt on the produce side and the meat side, on both of those.
Alec Patterson - RCM
Hurt means deflation, or hurt means lost sales?
Rick Schnieders
I think we had lost sales on the meat side, some lost sales due to high prices, so customers somewhat trading down. On the produce side, produce is the most volatile category that we have, so the inflation/deflation swings in produce are so dramatic, that I think what we're seeing in the produce is some deflation, but not universally in other categories of product. So we are still, going back to we are still seeing overall pretty high inflation generally.
Alec Patterson - RCM
Regarding the inflation number, essentially you could read it as if you had the right base numbers, flat sequentially? Is it fair to say that the rate of inflation, the second derivative here is decelerating, and does that allow you to capture more passthrough?
Rick Schnieders
I think if it is kind of a delta question, yes, I certainly think that we have seen a slowing in the rate of inflation. In fact, if you look at the just numbers quarter to quarter, a slight decline in inflation. So going back to our earlier conversation, we might see, based on early information about wheat, dairy, cheese particularly, we might see a softening of that inflation number. But I wouldn't think about it in terms of going back to our normal 2% to 2.5%, or 2.5% to 3% inflation levels.
Bill DeLaney
Not to be negative here. That is a good question and that is a fair answer, obviously, but I think you have got to balance, a very, very slight maybe slowing in deceleration two quarters in a row for our customers, where their costs are up substantially. I would describe our market environment right now as quite challenging as it relates to price.
Alec Patterson - RCM
In other words, there may be a greater capacity for passthrough to be recognized in your gross margin trend, but don't immediately translate lower inflation into accelerated volumes?
Bill DeLaney
I wouldn't translate it into either, that is obviously a prerogative. All I am trying to say here is it's still 6% inflation, or 5.9% or whatever. I don't know that our statistics are that precise, that I would draw a huge conclusion on deceleration. I think it's a very tough environment, we are certainly hopeful that it will start to decelerate. I wouldn't bank on that one right now as we sit here today.
Alec Patterson - RCM
The debt structure, any further thoughts on how you are looking at it going forward? I see in this quarter where basically share repurchase and debt taken on, kind of one for one almost. Is there a fresh set of thinking, maybe a rating agency's point of view on debt structure formulating amongst you all?
Bill DeLaney
We are certainly cognizant and staying in close touch with the rating agencies, and folks that we do our banking with and that type of thing. We continue to review our capital structure. Don't take this the wrong way, the way, I don't think that is one of our primary issues right now internally in terms of that. We are comfortable with where we are. We do see opportunities to take our leverage up but with everything that has been going on with the financial markets the last few months, we are going to take our time here and evaluate what makes sense for us.
Alec Patterson - RCM
I am talking strategically, capital structure-wise, the way you look at it. My understanding is that way you look at your debt capacity is kind of an arcane way of looking at it. I was understanding that maybe it was evolving. Has there been evolving of it?
Bill DeLaney
I didn't know if it was arcane. 1980s approach it has been described as. We continue to look at it strategically if you will and we do think we could take on more leverage, and run the company very, very well. All I was trying to address, at this point in time, it is not a number one priority for us.
Operator
Your next question comes from Andrew Wolf - BB&T Capital Markets.
Andrew Wolf - BB&T Capital Markets
To try to get to your real sales growth in broad line, should we just use the overall product cost inflation, or do you have a more specific number you could share with us?
Bill DeLaney
I would do the math on what we have given you, and you will be in the ballpark.
Andrew Wolf - BB&T Capital Markets
The other thing on the broad line is I noticed that the growth there is good, it's outpacing the corporate growth, but this quarter at least a slight downtick in the MA served sales as a percent of broad line. In a non-inflationary environment it would pretty easy to say, yes the market share is down a little bit internally, or the chains are up. But given that it might be easier to passthrough inflation to chains, and so on, on a case basis, or on a volume basis, could we reach the same conclusion that inside broad line the chain business is doing a little better, growing a little faster than the independent, or is inflation skewing that?
Rick Schnieders
No. I think what you're seeing is we started up a new large customer during the first quarter, and they ramped up pretty rapidly, ramped up very well. It is not a difference in inflation at the chain rate versus the independent rate. It is just the new customer. As we talked about it so many times, Andy, you know those big customers come on in chunks, and the growth in the independent market comes on just in very small increments, so that is all that is.
Andrew Wolf - BB&T Capital Markets
Returning to the fuel side, now that diesel is back up, and some people are predicting it is going to start heading up a lot, I have just done some back of the envelope and I want to run this by you. About 2 to 3 bips of exposure for every $0.10 year-over-year increase in diesel? That is unhedged, using some numbers you guys have put out in the past. Is that in the ballpark? I don't know if you want to comment on it.
Secondly, also, if you have hedged at all when prices were lower, what your hedge ratio might be at this point?
Rick Schnieders
The first part of that I think is we would like to maybe take that offline, have you call Neil and we will just verify that. Frankly, I don't think we have that number.
Neil Russell
We haven't really calculated that way, Andy, so we need to look at that.
Andrew Wolf - BB&T Capital Markets
Have you hedged out any of your fuel exposure at this point?
Ken Spitler
Beyond the end of the year, December, not beyond that.
Rick Schnieders
So we have been hedged through this calendar year but those contracts run out at the end of the December, so we have some exposure as we go into the second half of the year.
Andrew Wolf - BB&T Capital Markets
At the current inflation, can you say how much you've hedged out currently that we could sort of subtract out of your exposure?
Neil Russell
It is about two-thirds.
Rick Schnieders
Technically, we don't hedge, we just have contracts forward on things.
Neil Russell
For the accountants in the room.
Operator
Your next question comes from Bill Leech - Neuberger Berman.
Bill Leach - Neuberger Berman
I was a little bit confused about your option guidance. It was $0.15 a share last year, should we just plug in $0.15 this year, just to pick a number?
Rick Schnieders
The option guidance was for the second quarter. We would expect the benefit from the first quarter to reverse partially.
Bill Leach - Neuberger Berman
Annual forecast, should we just assume it's the same as last year?
Rick Schnieders
Assume it's not material, it might be slightly less. It's not material.
Bill Leach - Neuberger Berman
Second quarter last year it was $0.04 a share, which was pretty material, about 10% of your reported earnings.
Rick Schnieders
When I say it's not material, I am talking about the change year over year.
Bill Leach - Neuberger Berman
This year should we put $0.05 or $0.06 in? I know it is a just non-cash item, but it does affect your reported earnings quite a lot.
Rick Schnieders
Whatever expense you used for last year, if you use the same expense for this year, I think you will be within a penny or two.
Bill DeLaney
For the entire year.
Bill Leach - Neuberger Berman
But in the second quarter --
Rick Schnieders
I think it will be on the favorable side. There is a lot of variables we don't have our arms around until these options are granted.
Bill Leach - Neuberger Berman
When you say you are going to have part of the benefit in the first quarter reversed in the second quarter. Does that mean we are going to have a $0.06 charge in the second quarter?
Rick Schnieders
No. It means you might see half of the benefit, $16 million, I will let you guys do the math, it was about a $0.015 at $16 million. I don’t want to use pennies. Let's just use dollars because the taxes get a little interesting here.
Let me take a minute, that is a good question. Let me frame it up a little bit. The reason you have that kind of volatility or one of the reasons from quarter to quarter, in terms of when the grant date is designated is because of the makeup of the folks who get the options. The way the accounting works, I am going to keep this pretty high level, but to the extent that you've got folks that are toward the end of their tenure, and they are vested in our retirement plans and able to retire, the way the accounting venture works, is you have to expense the full amount of value of those options for those folks who tend to be some of your higher paid people, at the time that the grant is given. That is why you see the skewing from one quarter to the next and again, it is unfortunate in terms of the communication side but we just thought administratively it was better to put the grant date out to November this year.
Bill Leach - Neuberger Berman
For the tax rate, should we use 38.3%?
Rick Schnieders
No. I would look at last year's tax rate. I wouldn't use any lower than that. We will keep you posted. This was kind of a one-time benefit here or net benefit as we talked about that the accounting requires you to take that benefit in the quarter, and then it becomes realized. The gross part of this benefit was a state tax law change, so we took it all here in the first quarter. I would look at last year's tax rate. It could be a little bit higher, or a little bit lower.
Operator
Your next question comes from Christopher Routhe - Piper Jaffray.
Christopher Routhe - Piper Jaffray
On the inflation issue again, I don't mean to belabor the point, I know you guys don't like to focus on it, you have been getting a lot of questions on this issue, but I know that 2% to 2.5% is really your sweet spot, that is an inflation level that is probably actually good for your customers. At 6% today, we are obviously a long ways away from that. If you could help frame it for me. If 2% is a positive, 6% is a negative, what is a neutral level? How do you look at that? Do you see us reaching that at some time this year? Thanks.
Bill DeLaney
I think a neutral level is in the 3% range, probably not north of 3%. Again, we would have to have a shaman or soothsayer in here to get us to a good prognostication of what is going to happen. We just don't know.
Rick Schnieders
To your point, we don't like talking a lot about it but we understand these questions are all on point. This is not a normal environment. We understand that we need to speak to it. Frankly, it is something that we try to speak to with as much clarity as we can in terms of how much it impacts sales, gross profit margins and expenses. It is a hard thing to get your arms around. It clearly helps you on your expenses, and it clearly hurts you on your GP percent, and we can debate the sales side of it philosophically. At the end of the day, we are talking about it because it has had an impact on the last couple quarters.
Operator
Your next question comes from Meredith Adler - Lehman Brothers.
Meredith Adler - Lehman Brothers
Back to the question about inflation. Obviously, it has the impact it does, gross profit dollars and expense percent, because you have a fee per case and you pass along the cost of the products. What percentage of your revenues are you passing along the cost and just getting a fee?
Rick Schnieders
Meredith, we haven't really disclosed that in the past. Keep in mind, we have fee per case business, but we also have a large of percentage markup basis. We have both types of pricing. That is our challenge even internally, it is not obvious how it impacts you in terms of the percentages. We have both types of business out there. That is a number we haven't shared in the past.
Meredith Adler - Lehman Brothers
Another question I have for you. I know that the procurement opportunity is still just getting off the ground. But what are your plans in terms of sharing that benefit and would it be your anticipation that we would actually be able to see the benefit ourselves in looking at the gross margin, or would the majority of it be passed along?
Rick Schnieders
Well we are still working through to understand how this is all going to shake out, frankly, Meredith. So the answer is we don't know and the other complication is that sourcing is now integrated with everything else that we do. So just identifying a benefit, specifically from sourcing, is very, very difficult to do. We're wrapping all this together, RDC, supply chain work that we are doing, sourcing and other work that we are doing in terms of our strategic initiatives, and to pinpoint where the benefit might show up is very, very difficult at this point in time.
Bill DeLaney
I think to be straight with you, Meredith, I don't think you will be able to see the benefit in terms of our public financial statements, we will continue to account the way we account. As we get deeper into this, through the use of our metrics, also just by having more products, items in the game, if you will, we should be able to better speak and even before we start speaking, to better evaluate internally the progress that we are making on these initiatives.
The summit meeting that Ken was asking about, a lot of that discussion in those meetings was just to make sure internally we're doing as good as we can in terms of execution.
We are still very early on. I know we got into this in the conference up in Boston and there was some confusion or maybe disappointment in our lack of direction, but it is real difficult to sit here today and talk about gross profit expansion when you have got the kind of markets that we're working in right now.
We will continue to look at it internally with some of our metrics, and as we see things and if we think they are appropriate and material and relevant, we will share them with you.
Meredith Adler - Lehman Brothers
Just a couple of clarifications. You mentioned about U.S. Foodservice, that they were closing a facility in Cincinnati. Is that a your market where they have been competing with themselves, so that will sort of open the market up, or is that just something else they are doing?
Ken Spitler
I think it's something else. I don't think that's a market that they have two units in.
Meredith Adler - Lehman Brothers
You talked about you had a very long acquisitions list. And I wasn't sure whether that meant just your own list of opportunities that you are focused on, or is that where you have some reason to believe that the owner is interested in selling, or might be interested in selling?
Rick Schnieders
That is where we have fairly solid information that the owner at least at some level is interested in talking about selling the business. However to Bill's point, sometimes there are those psychological hurdles. Initially they say they want to sell, and then later on they think twice about it and change their mind.
Right now we have got a very active list. Honestly most of those are relatively small. But it is good consolidation, a lot of them will be fold-ins, those are particularly profitable to us. We fold them into an existing facility. So it is a good pipeline out there right now. But they tend to be the smaller opportunities.
Bill DeLaney
The only thing I would add to that is just that what has been going on in these financial markets, I think we are getting more calls from the smaller businesses that might be looking to sell. I think that is somewhat predictable with the uncertainty in the markets. That tends to be somewhat of a reality check for folks.
The larger people, I think they have to go back to the drawing board and strategically look at their businesses, and what they want to do. We wouldn't expect to be seeing a whole lot right there now, and we are not.
Rick Schnieders
As we suggested earlier, two things like government regulation and high fuel prices can be particularly challenging for somebody that is in a small segment of the business. They run a lot of miles. They don't have a broad base of product to put on those trucks. So this is a challenging environment, as you know, and I think that causes some of these folks to think about monetizing what they have built over the years.
Meredith Adler - Lehman Brothers
I have one more question. Have you noticed any marked difference in the business by geography?
Ken Spitler
The Midwest is a little bit softer right now.
Operator
Your final question comes from Steve Chick – JP Morgan.
Steve Chick - JP Morgan
You mentioned a large customer win, I think, within the quarter. Did that start off at the beginning of the quarter, and is that a customer that you won from U.S. Foodservice?
Ken Spitler
It started actually in the fourth quarter, Steve. It has ramped up all the way in the first quarter here. It came from a variety of sources. The business was spread out.
Steve Chick - JP Morgan
Obviously when your Q gets filed, we end up seeing a little more of the profits by segment. I don't know if we have to wait until then or Bill, can you speak to maybe where the profits were? You had a pretty good level of margin expansion this quarter, in operating margin. Once we get the Q, do you have what the corporate overhead pieces might be, just broadly? Where the margin expansion came from by segment, or do we have to wait until the filing?
Bill DeLaney
We are going to file on Thursday. We have spoken to a lot the corporate benefit in terms of the stock comp, and you'll see there is a modest benefit from COLI and pension, and that type of thing. There is some good benefit there and then there is modest leverage at the operating line.
Operator
That does conclude today's question-and-answer session. I would now like to turn the call over to Mr. Rick Schnieders for closing remarks.
Rick Schnieders
I want to thank everybody for participating in the call today, and I also want to thank you for your continuing interest in SYSCO. As you can probably hear from our call today, we are pleased with our current performance and we are also pleased with our direction for the future.
Have a good day, and remember, eat out often at one of your favorite restaurants. Thanks. Bye.
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