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Edited Transcript of SYY earnings conference call or presentation 6-May-19 2:00pm GMT

Q3 2019 Sysco Corp Earnings Call

HOUSTON May 10, 2019 (Thomson StreetEvents) -- Edited Transcript of Sysco Corp earnings conference call or presentation Monday, May 6, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Joel T. Grade

Sysco Corporation - Executive VP & CFO

* Neil A. Russell

Sysco Corporation - VP of IR, Communications and T&E and Treasurer

* Thomas L. Bené

Sysco Corporation - Chairman of the board, President & CEO

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Conference Call Participants

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* Ajay Kumar Jain

Pivotal Research Group LLC - Co-Head of Consumer Sector Research & Senior Analyst of Supermarkets, Drug Stores &Food Distribution

* Andrew Paul Wolf

Loop Capital Markets LLC, Research Division - MD

* Christopher Mandeville

Jefferies LLC, Research Division - Equity Analyst

* Edward Joseph Kelly

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* John Edward Heinbockel

Guggenheim Securities, LLC, Research Division - Analyst

* John William Ivankoe

JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst

* Judah C. Frommer

Crédit Suisse AG, Research Division - Senior Analyst

* Karen Fiona Short

Barclays Bank PLC, Research Division - Research Analyst

* Kelly Ann Bania

BMO Capital Markets Equity Research - Director & Equity Analyst

* Marisa Sullivan

BofA Merrill Lynch, Research Division - Research Analyst

* Robert William Summers

The Buckingham Research Group Incorporated - Research Analyst

* Vincent J. Sinisi

Morgan Stanley, Research Division - VP

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Presentation

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Operator [1]

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Good morning, and welcome to Sysco's Third Quarter Fiscal Year 2019 Conference Call. As a reminder, today's call is being recorded. We will begin today's call with opening remarks and introductions.

I would like to turn the call over to Neil Russell, Vice President of Investor Relations, Communications and Treasurer. Please go ahead.

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Neil A. Russell, Sysco Corporation - VP of IR, Communications and T&E and Treasurer [2]

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Good morning everyone, and welcome to Sysco's' Third Quarter Fiscal 2019 Earnings Call. Joining me in Houston today are Tom Bené, our Chairman, President and Chief Executive Officer; and Joel Grade, our Chief Financial Officer.

Before we begin, please note that statements made during this presentation that state the company's or management's intentions, beliefs, expectations or predictions of the future are forward-looking statements within the meaning of the Private Securities Litigation Reform Act, and actual results could differ in a material manner. Additional information about factors that could cause results to differ from those in the forward-looking statements is contained in the company's SEC filings. This includes, but is not limited to, risk factors contained in our annual report on Form 10-K for the year ended June 30, 2018, subsequent SEC filings and in the news release issued earlier this morning. A copy of these materials can be found in the Investors section at sysco.com or via Sysco's IR app.

Non-GAAP financial measures are included in our comments today and in our presentation slides. The reconciliation of these non-GAAP measures to the corresponding GAAP measures are included at the end of the presentation slides and can also be found in the Investors section of our website. (Operator Instructions)

At this time, I'd like to turn the call over to our Chairman, President and Chief Executive Officer, Tom Bené.

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [3]

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Good morning everyone, and thank you all for joining us. I'd like to start off this morning with an overview of our third quarter performance and a discussion around our business segments and the key highlights for the quarter. Following that, Joel will cover the financial results in further detail.

Overall, we are pleased with our overall operating and financial performance for the third quarter. We delivered improved year-over-year growth, in line with our expectations, and managed costs well, including the ongoing cost savings associated with our business transformation initiatives. The improved pace of performance for the second half of fiscal 2019 we previously spoke of is, in fact, taking shape. And while we still have work to do, we remain confident in our ability to deliver our adjusted operating income growth target and now expect that to be at the low end of the $650 million to $700 million range. Joel and I will both elaborate on this further.

From a total Sysco perspective, our third quarter results include increased sales of 2.2% to $14.7 billion; gross profit growth of 2.9%; and adjusted operating expense decrease of 0.4%, which translated into an adjusted operating income increase of 16.6% to $620 million; and an adjusted earnings per share increase of 17.4% to $0.79.

Turning to U.S. restaurant industry data. The overall sales trends remain mixed. According to Black Box and KNAPP-TRACK, we saw some choppiness throughout the quarter as March data was generally positive compared to February, in part due to weather, which negatively impacted February sales. Additionally, same-store sales were positive for the quarter, although traffic once again declined. However, even with this recent choppy industry performance, the overall macro trends remained generally favorable for our customers, as illustrated by continued low unemployment, which was at 3.8% for March, and strong GDP growth for the first quarter at 3.2%.

Economic growth in the international markets in which we operate was mostly positive. This includes modest growth in the foodservice sector, although we continue to see the impacts of Brexit on our U.K. business due to uncertainty and low consumer confidence. In Canada, the consumer confidence index continues to rise with March seeing the third consecutive monthly increase with Technomic forecasting the Canadian foodservice industry to grow 0.6% in real terms or 4.1% on a nominal basis for calendar year 2019. Additionally, we've continued to see reasonable overall trends in the other international markets where we do business.

As we discussed last quarter, we anticipated seeing an increased benefit from our transformation initiatives beginning in the second half of this year, and we began to see those benefits show up this quarter. Overall, our results included a bit softer top line than expected, offset by good overall expense management, which delivered solid operating profit performance that was in line with our expectations. Examples of initiatives that are driving benefits from an expense management perspective include our field finance transformation and the corporate office administrative restructuring which we implemented last quarter.

As it relates to acquisitions, in April, we acquired J&M Wholesale Meats and Imperio Foods, 2 smaller central California distributors. J&M Meat is a foodservice distributor that specializes in key Center of the Plate products, and Imperio Foods carries dry, canned good products, which both are complementary to our existing Broadline business in the central California area. They also provide Sysco with the opportunity to further extend our reach to the important Hispanic customer segment. We will begin to see the impact to our business in the fourth quarter from both of these acquisitions.

Additionally, in the quarter, we made the decision to sell our Iowa Premium cattle processing business. While our 3-year plan forecast included positive operating income for this business, we believe the divestiture of this business is in alignment with our strategic priorities and allows us to focus on our core strength as a distributor. The transaction will result in the reduction of planned operating income of approximately $25 million and is the reason for us now projecting to achieve the low end of our adjusted operating income growth range.

Now I'd like to transition to our third quarter results by business segment, beginning with U.S. Foodservice Operations. Sales for the third quarter were $10.1 billion, an increase of 4.1%. Gross profit grew 5.1%, including an improvement in gross margin of 18 basis points. Adjusted operating expenses grew 2.3%, and adjusted operating income increased 10%. Total case volume within U.S. Broadline grew modestly at 2.1% for the quarter, of which 1.3% was organic. However, we delivered relatively solid growth in our local business as local case growth was up 3.1%, of which 2.2% was organic.

We are pleased with the gross profit growth we delivered for the quarter, which was impacted by a number of factors, including continued positive momentum from category management as we continue to deepen our relationships with our strategic supplier partners; year-over-year favorability from the impact of inbound freight; and continued growth in our Sysco-branded products, which increased by 28 basis points with our local customers this quarter. In addition, the inflation rate for the quarter was 2.3% in U.S. Broadline, up nearly a point from the second quarter of this fiscal year.

Technology continues to be one of our fundamental enablers of growth as we transform our business to serve our customers in ways that best meet their needs. We are continuing to provide new capabilities and tools to enable an improved experience of doing business with Sysco, including new ordering tools, which has driven our e-commerce ordering utilization to more than 53% with our local customers.

From a cost perspective, within U.S. Foodservice Operations, our expense management was solid as adjusted operating expenses were 2.3% for the quarter. While we continue to see supply chain cost challenges in the warehouse and transportation areas, we are seeing positive momentum from our recruiting, onboarding and retention initiatives. These challenges were partially offset by continued improvements seen as a result of our routing optimization initiatives and ongoing process improvements. Furthermore, our finance transformation and Smart Spending initiative have also provided benefits in the quarter.

Moving on to International Foodservice Operations for the quarter. Sales decreased 1.5%, gross profit decreased 3.1%, adjusted operating expenses decreased by 5.8% and adjusted operating income grew 30%. We saw solid overall performance in Canada with strong top line growth and solid gross profit dollar growth of more than 5%, driven in part by an inflation rate of 2.6%, along with strong expense management, partially benefiting from our ongoing regionalization efforts which are progressing well.

In Europe, we continue to have mixed results. The U.K. continues to feel the effects of Brexit uncertainty, causing depressed consumer confidence. However, our Brakes U.K. business continues to stabilize operationally as a result of our multiyear initiatives to transform the business.

In France, social unrest continues to impact tourism and consequently food-away-from-home consumption. Our sales performance during the third quarter was adversely impacted by this unrest and by some operational challenges associated with integrating Brake France and Davigel into Sysco France. That said, the overall integration and supply chain transformation continues to be on track to deliver the long-term benefits that are part of our multiyear plan.

As for our business in Latin America, we continue to see growth opportunities in this region, both with our chain restaurant customers and with our expansion of Cash & Carry locations to complement our Broadline footprint in both Costa Rica and Panama.

Moving on to SYGMA, we continue to make disciplined choices in an effort to deliver improved profitability. In Q3, we saw expected softness in the top line due to transitioned customers while seeing gross margin increased by 28 basis points year-over-year. Solid expense management drove adjusted operating expenses down 7.1% versus prior year, resulting in significantly improved operating performance. In an effort to improve overall profitability in this important segment of the business, we will continue to take a very disciplined approach to growth as we move forward.

Lastly, in our other business segment, we recently announced the restructuring of Guest Supply. As the industry landscape evolves, we are focusing on optimizing our business model and creating a more focused and agile organization to better meet the changing needs of our customers. The new operating structure has created 3 distinct business units under the parent company, Guest Worldwide. The business units include Gilchrist & Soames, our amenity manufacturing unit; Manchester Mills, one of the world's leading textile producers; and Guest Supply, which serves the world's top hotel chains and independent properties in over 100 countries as a full-spectrum distribution solution provider.

In summary, we continue to feel good about the fundamentals of our business. Our customer and operational strategies are firmly aligned around enriching our customers' experience in doing business with Sysco, and we remain focused on engaging our 67,000 dedicated associates around the world to deliver against our financial objectives associated with our 3-year plan.

Let me now turn the call over to Joel Grade, our Chief Financial Officer.

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [4]

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Thank you, Tom, and good morning, everyone. I'd like to provide you with additional financial details surrounding our performance for the quarter. As Tom mentioned earlier, we saw improved year-over-year results for the third quarter. Although we saw some softness in the top line, our earnings reflect solid expense management and strong adjusted operating income growth, which are in line with what we previously stated, and our results of our enterprise-wide transformational initiatives. These initiatives, which are designed to streamline efficiencies and allow us to reinvest in the business to facilitate continued growth, include our Finance Transformation Roadmap, Smart Spending and the Canadian Regionalization initiative.

For the third quarter of fiscal 2019, total Sysco sales grew 2.2%. Foreign exchange rates negatively affected total Sysco sales by approximately 1.1%. In our U.S. Broadline business, we experienced 2.3% inflation driven by a few categories, including the frozen potato, poultry and meat categories, and we are managing this modest increase in inflation well. Gross profit in third quarter increased 2.9%. And gross margin increased 14 basis points, while adjusted operating expenses decreased by 0.4%, resulting in strong adjusted operating income growth of 16.6% to $620 million. Changes in foreign exchange rates decreased adjusted operating income by 34 basis points. Although it will vary from quarter-to-quarter, we are focused on maintaining the 150 basis point gap between gross profit dollars and operating expense dollars that we committed to as part of our 3-year plan in order to achieve our adjusted operating income growth target.

Turning to earnings per share. Our adjusted earnings per share for the quarter increased $0.12 to $0.79 per share. Our EPS results this quarter were impacted by our strong operating income, adjusted tax rate, foreign exchange impact and stock option exercises.

I would now like to discuss our tax rate for the quarter. The GAAP effective tax rate of negative 2% for the third quarter of fiscal 2019 is primarily attributable to the determination made during the quarter to recognize the favorable impact of $95 million of foreign tax credits generated as a result of distribution to Sysco from our foreign operations at the end of fiscal 2018. Our adjusted tax rate for the quarter was 21%. Looking to our fourth quarter, we would expect our effective tax rate to be in the 23% to 25% range.

Now turning to cash flow. Cash flow from operations was $1.4 billion for the first 39 weeks of fiscal 2019, which is $244 million higher compared to the prior year period. Free cash flow for the first 39 weeks of fiscal 2019 was $1 billion, which was $233 million higher compared to the prior year. The improvement in free cash flow was primarily due to last year's pension contribution, partially offset by cash taxes and the impact to working capital from an increase in days sales outstanding.

Net capital expenditures totaled $367 million for the first 39 weeks of fiscal 2019, which was $10.8 million higher compared to the prior year period. For the full year fiscal 2019, we now expect a capital expenditure forecast of approximately 1.1% of sales, down slightly from our previously stated 1.2%. That said, there are no changes to the prioritized order of capital allocation, which is as follows: investing in the business, consistently growing our dividend, participating in M&A and a balanced approach to share buybacks and paying down debt.

As Tom mentioned earlier, with the anticipated sale of Iowa Premium, we expect to achieve our target at the low end, the $650 million to $700 million range, as a result of our planned operating income being decreased by $25 million.

In summary, we saw improved year-over-year results for the third quarter led by continued momentum from improved underlying business performance, solid local case growth and good cost management. That said, we have more work to do in order to achieve the financial objectives of our 3-year plan, although we remain confident in our ability to achieve these objectives. We are committed to serving our customers and delivering at a high level of execution in all areas of our business that will improve our financial performance in both the near and long term.

Operator, we are now ready for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question is from Christopher Mandeville from Jefferies.

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Christopher Mandeville, Jefferies LLC, Research Division - Equity Analyst [2]

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Can you speak to the gross margin improvement in the quarter and maybe help us understand those referenced impacts by order of magnitude? And then Tom or Joel, as it relates to private label penetration, it was again expansion, but it was one of the lower rates we've seen in recent quarters. So maybe you could kind of help us understand that as to whether or not it was an anomaly and we can return back to that 50 to 60 bps of expansion going forward? Or any color would be appreciated.

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [3]

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Yes. Sure, Chris. This is Joel. I'll start. I think the way I would think about that, again, it's really a balance across some of the levers, I would say. But I mean, certainly, our continued opportunities in our Sysco Brand certainly are a strong driver as well as continued category management efforts where we continue to – again obviously it's not what it was 5 years ago where we had this giant year-over-year jump, but the reality is we continue to enhance our relationships with our suppliers and continue to drive category management as well across our -- again our business. And so I think those are a couple of the areas that certainly are driving -- again, I know you're asking about the margin percentage. But again, I'm really talking about what we think about most, and that is our gross profit dollars.

We obviously also had some favorable benefits of some inflation. Inflation in our world, clearly, is something that ultimately -- certainly in the moderate range it's at to date, is a good driver of opportunities, again to move -- to continue to push cost of goods through to our customers, and so that's certainly beneficial in terms of the dollars and gross profit. And I would say it's not necessarily at the levels that that's detrimental, really. The comments that I think we made, it's just we're managing these cost of goods inflation well, and I think that's really, really to the fact that this is -- yes, there's a ton of inflation, really, in our wheelhouse in terms of where this thing functions best. So I would really say those are some of the main drivers of what we're looking at here and just in general some of the tools that you've you heard about in the past in terms of, again, the revenue management's continue to help us to drive the -- with our margins in a positive way.

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [4]

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Hey, Chris. This is Tom. Just maybe 2 other things that I'd reinforce as well is we did get some positive year-over-year benefit on the inbound freight side, which, as we've talked in the past, does impact gross margin. And then to your specific question around Sysco Brand, we look at 28 basis point improvement as a very positive number still. As long as that continues to move in the right direction, that's a reflection for us of a couple of things. One, our customers still are reacting positively to all Sysco Brand; and two, we continue to bring innovative ideas and solutions to the market. So we actually view that to be a solid number. While it might be a little less than the growth than you've seen in a couple other quarters, it's still a really good number.

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Christopher Mandeville, Jefferies LLC, Research Division - Equity Analyst [5]

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Okay. And then just my final question would be, as you brought it up, Joel, inflation. What should we be expecting in the coming quarter? And if there's a willingness, would you guys be able to disclose organic case growth quarter-to-date?

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [6]

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Yes. And so I mean, I think the -- just on your question on inflation, I mean, I think certainly our forecast is to continue to see, I would say, moderate levels of inflation as we move forward certainly over the next couple of quarters. There's nothing that jumps out necessarily that would be really significant in terms of the overall inflation numbers. So I would say to expect certainly additional moderate levels of inflation over the next couple of quarters. Organic case growth, I think that was part of the U.S. Foodservice Ops. 2.2% was the overall number that was organic.

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [7]

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But you're asking year-to-date, right, Chris? And that's...

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Christopher Mandeville, Jefferies LLC, Research Division - Equity Analyst [8]

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Quarter-to-date.

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [9]

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Oh, quarter-to-date numbers. Okay.

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Christopher Mandeville, Jefferies LLC, Research Division - Equity Analyst [10]

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Yes. Just to try and strip some of the noise from weather and what have you and maybe expect the calendar shift for Easter as well.

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [11]

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Yes. So I will say this, so when we talk about there is local -- our local case volume for the quarter, that was the question I was answering, was 2.2%, it was organic. Total case volume organic was 1.3%, just Broadline.

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Christopher Mandeville, Jefferies LLC, Research Division - Equity Analyst [12]

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But is there any real comment for April?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [13]

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Not really. I mean we continue to -- we're -- I think we feel good about the continued momentum of the business, and I don't view anything necessarily -- Easter, there was a bit of an Easter shift but not a big shift given the timing of when it fell last year in the quarter versus this year.

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Operator [14]

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Your next question comes from the line of Edward Kelly from Wells Fargo.

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Edward Joseph Kelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [15]

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Yes. I want to start with OpEx, and I was hoping that you could give us a little bit of help here. I mean obviously you had a big quarter from a cost perspective. Maybe just dig in a little bit more related to the drivers, and I'm asking this question because I think a lot of the accelerated efforts that you guys have been talking about weren't supposed to be at a full run rate this quarter. So I'm just trying to figure out how we think about OpEx going forward. And then as part of this, Q4's comparison looks pretty hard and I think you had at a workers' comp benefit last year that you have to lap. Can you get to that 1.5% spread in Q4?

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [16]

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Well, I'll start. And I mean, I think a couple of things I would say to that. Number one, and I'll maybe take the last point first. The 1.5 point spread obviously and I think I even said in my prepared comments, is something that we looked at over the course of a 3-year plan. It doesn't mean that necessarily every quarter is going to look the same. Some actually will be higher. Some actually possibly will be lower as obviously we've seen both here. I think the way I would look at it, though, I mean, again, as we did signal, we did anticipate some improved performance in the second half of the year.

Obviously, as some of these benefits start to kick in from our Finance Technology Roadmap, Smart Spending, work in the Canada Regionalization, some of the other administrative cross work that we did around some of our corporate office transitions. I think the -- again, we feel good about our -- those things kicking in, as we've said, in the second half of this year as we head into next year as well. I would also call out just, again, overall, our operating performance continues to be pretty strong in the expense line that's a case of actually, we had some -- a little bit of a fuel headwind this particular quarter. It was about $0.03 a case. So I mean, we had -- I think the question is do we expect this to continue in these areas? I do.

To your point, there are some headwinds that we're anticipating that we're going to be up against in the fourth quarter. But certainly, as we've talked about here for a little while, we certainly anticipated our leverage from the second half of the year will be better than the first half, and I think we certainly start to see that.

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Edward Joseph Kelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [17]

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Okay. And then just a follow-up on CapEx. So the CapEx guidance is down a bit. Can you just talk a bit about what's driving that? I don't know if Iowa Premium has anything to do with it. And how sustainable a rate of sort of 1.1% would be going forward?

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [18]

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Well, I mean, again, the way I would look at that, I mean, number one, it's not that off from our forecast. But I mean, the reality of it is we spend our CapEx and make our investments based truly, truly on the needs of the business. There has been naturally no change in terms of our perspective on our capital- llocation priorities. That will always start with investing in our business. We're obviously very committed in doing that. We've got a lot of change programs and things transitioning in our organization that will continue to require investments.

I would just tell you that, from a timing perspective, some of those things happened. Again, things do move around in the business in some ways, so some of that's probably due to timing as much as anything, but I would definitely not take away that there are some change in terms of the way we're looking at forecasting our CapEx. We just -- again, we just adjust spending in investment in terms of the needs of the business.

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Operator [19]

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Your next question comes from the line of Karen Short from Barclays.

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Karen Fiona Short, Barclays Bank PLC, Research Division - Research Analyst [20]

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First thing I just want to ask was in terms of the composition of the -- now, I guess, the kind of $650 million. Is there any change to the breakout between gross profit and then the Supply Chain versus the admin?

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [21]

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No, Karen. So there's not. I would just -- the only shift and all was related to the anticipated sale of business. But no, there is no bucketing difference, if you will.

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Karen Fiona Short, Barclays Bank PLC, Research Division - Research Analyst [22]

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Okay. And then the same question I just want to ask. I know you obviously mentioned, and you have been mentioning, positive same-store sales but traffic weakness. So I was just wondering if you could talk a little bit about trends with traffic and I guess same-store sales on a true like mom-and-pops local basis in terms of the independents versus kind of the micro change? Any patterns or differences you could point to there?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [23]

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Yes. Karen, this is Tom. I mean look I think we have seen certainly some choppiness this quarter in particular, and I think there are probably a bunch of different things driving that. But it depends, really, on what source you look at. I mean NPD would call out that while overall spend is up, traffic is up in some areas as well and down in others. And Black Box and KNAPP-TRACK, they're probably more -- a little more consistent in they've called traffic down, really, across most of the segments. So I think it's driven by everything from some weather choppiness in Q3 -- our Q3 and mostly in February, and then I think, again, kind of consumer efforts during that time. The small chains seemed to be doing a little bit better, so that's going to be your kind of micro change.

And then the pure independents, at least in this quarter according to NPD, tend to be a little bit softer, but I wouldn't say from our perspective we have seen necessarily any major difference in trend line that we've experienced over the last couple of quarters. So we continue to feel like this independent growth that we've had in that sector is doing well, and we continue to feel pretty confident in our ability to continue to grow and take share in that space.

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Karen Fiona Short, Barclays Bank PLC, Research Division - Research Analyst [24]

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Okay. And then just last housekeeping. Corporate came in, on a dollar basis, a lot higher than I would have expected given the layoffs that you'd announced. I don't know if that's just an allocation issue or what because I would have thought on a dollar basis, it would have been quite a bit down sequentially in year-over-year.

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [25]

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Are you talking about -- you're talking about the last -- kind of the specifically corporate layoffs -- you're talking in total administrative costs?

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Karen Fiona Short, Barclays Bank PLC, Research Division - Research Analyst [26]

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Yes.

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [27]

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Obviously, there are a lot of things that are part of our Financing Technology Roadmap that are very much fueled focused. And so in fact, one of the things we talked about in the first half of the year is that there were -- again, why don't we feel comfortable about this because there have been notifications in a sizeable number of field personnel. And so I would tell you I think the majority of what you're seeing is pretty -- is probably even more fueled focused than corporate, but it is balanced between the 2.

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Operator [28]

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Your next question comes from the line of Andrew Wolf from Loop Capital Markets.

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Andrew Paul Wolf, Loop Capital Markets LLC, Research Division - MD [29]

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Wanted to follow up on the cadence of sales question that people asked about. You guys said January was strong on a good weather comparison. February, not good. Should we take away from that sort of March and April have somewhat normalized? I think people are trying to get -- we're obviously trying to get a sense of whether the industry has slowed or not in your view, sort of on a normalized basis.

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [30]

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Yes. I think we would say that that's -- we feel like there's certainly things since the weather impacts and the early part of the quarter things have stabilized.

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Andrew Paul Wolf, Loop Capital Markets LLC, Research Division - MD [31]

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And I know you gave us -- I may have missed this, but I heard a Technomics forecast for Canada. Do you have one for the U.S. that you might be able to share with us?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [32]

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As you know, Technomic kind of gets out ahead of it, and they do it by quarter kind of by -- sorry, by subsegment. I may have that information, let me see if I -- if I have it, I can get it to you. We may need to get back to you on that, but we generally do have that information.

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Andrew Paul Wolf, Loop Capital Markets LLC, Research Division - MD [33]

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Okay. And I just had one other question unrelated to sales. So in the -- you took a $35 million charge that was related to a change in the business technology strategy. So could you expand a little upon that, what the change is in your business technology strategy?

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [34]

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So just -- can you clarify -- can you ask that question one more time, Andy?

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Andrew Paul Wolf, Loop Capital Markets LLC, Research Division - MD [35]

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Of the $72 million charges you excluded out of operating expense, $35 million was allocated for what you called a change in business technology strategy. Is that basically going to the cloud? And could you expand on, so we could understand it a little bit better.

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [36]

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Yes. There's some of that. It's also kind of a variety of things. I mean there was actually an accelerated depreciation we took in Europe that was really also due to a technology change. So I think there's been a few things that -- again, and that number is also accelerated our G&A a little bit. But I would say there's one thing that it -- that fell into. There are a number of things that are just parts of our technology strategy that are included in that number, and there's not necessarily one big thing there. And there's not -- one thing I would -- I guess maybe the takeaway would not be that we've somehow have a significant change in technology because we do not. There's just a variety of things going on.

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Andrew Paul Wolf, Loop Capital Markets LLC, Research Division - MD [37]

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That was what I was trying to get to, so appreciate it.

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [38]

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Yes, yes.

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [39]

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Yes. Think of it as more specifically around finance transformation, which has a technology component of it, and then the European work we've been doing where we have an ERP in France that we've been updating. And so those are the 2 main drivers of it.

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Operator [40]

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Your next question comes from the line of Marisa Sullivan from Bank of America Merrill Lynch.

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Marisa Sullivan, BofA Merrill Lynch, Research Division - Research Analyst [41]

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Great. I just wanted to touch on fuel quickly. You called that there was a slight headwind in the third quarter. Well, how should we think about fuel in the fourth quarter as it impacts your expense?

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [42]

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Yes. So Marisa, I would anticipate some of those continued headwinds as we head into the fourth quarter and probably a little bit and as we head into next year as well.

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Marisa Sullivan, BofA Merrill Lynch, Research Division - Research Analyst [43]

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Got you. And I haven't heard you guys talk about category management in a while on your calls. But I'm wondering was there anything you guys are doing differently in the third quarter that kind of made it a greater impact? Anything that you're planning for the fourth quarter as we should think about gross margin in CatMan?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [44]

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Hey, Marisa. It's Tom. No. I wouldn't say anything unique. I think what we're just trying to highlight is we continue to -- it's an ongoing process. It has been now for years, and we're starting to do some deeper work with some of our more strategic supplier partners and think about them more as some potentially long-term benefits as we begin to partner more deeply with some suppliers.

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Marisa Sullivan, BofA Merrill Lynch, Research Division - Research Analyst [45]

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Got you. And are you seeing any impacts or any customer feedback on category management? Are they liking what you're doing? Or is it -- are they having to adjust to assortment changes?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [46]

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No. I think we're at a point now where it's early, early days, so call it a few years ago now. I think we -- because we were changing some suppliers in some areas or products, that was creating some choppiness, but we actually continue to have a very good feedback from our customers around the work we're doing in CatMan. Obviously, if it drives cost benefit for them, they're very excited about that. And as I mentioned, we are getting more focused on strategic partnerships so that we can have more consistent supply for the long term. So generally it was very positive.

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Operator [47]

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Your next question comes from the line of Judah Frommer from Crédit Suisse.

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Judah C. Frommer, Crédit Suisse AG, Research Division - Senior Analyst [48]

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Maybe, first, just on the changes to guidance related to Iowa Premium. I think you said the entire kind of reduction guidance is due to Iowa Premium. But if we're stripping $25 million out obviously, that's not necessarily the low end. So when you say the low end, are you saying $650 million to $675 million effectively?

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [49]

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Yes. No. I think -- here is the way I would think about that, Judah. I think what we've talked about really, our previous guidance was really around the midpoint of the range. And so if you do $650 million to $700 million, that will be $675 million. Really, we're talking about here is a $25 million related to Iowa Premium. And yes, that is the only adjustment to our guidance at this point. We should take it from that midpoint down to the lower end of the range.

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Judah C. Frommer, Crédit Suisse AG, Research Division - Senior Analyst [50]

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Okay. That's helpful. And switching gears. I thought you said that freight was a tailwind on the inbound side in Q3. Is that right? Are you telling us that you're actually getting a benefit there or that it was less of a headwind year-over-year? And any commentary around kind of the freight situation and driver shortages and ability to retain drivers lately would be helpful.

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [51]

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Sure. Just remember, we had separate a couple of things here. So inbound is our gross margin, and I did mention that we had some year-over-year positive impact to that. Again, a year ago, we were still dealing with quite a few challenges that related to inbound freight. So I would think about it as it has gotten better. We're not feeling that kind of impact, and there was a piece of that gross margin improvement that was driven by that this year. As it relates to outbound, we continue to have -- certainly be managing that I think better than we were a year ago as well, but we still have challenges from a transportation perspective, although albeit I think the work that we're doing around recruiting and retention is much improved, and we are seeing positive impacts across our operations versus a year ago in that regard.

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [52]

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Yes. Judah, just one thing I would just add to that. I think I would characterize the inbound freight as less of a headwind and not necessarily a benefit. In other words, we've -- there were some level of resetting in the overall structure that happened, and -- but relative to Tom's point to where we're at last year, we're really up against some real major challenges. We have less of a headwind this year, the way I think about that.

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Operator [53]

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Your next question comes from the line of John Heinbockel from Guggenheim Securities.

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John Edward Heinbockel, Guggenheim Securities, LLC, Research Division - Analyst [54]

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So, Tom, maybe 18 months ago, you guys selectively added MAs in a few markets. So how are they performing? And then if you think about the opportunity on the share side, is there an opportunity today to go out and redirect some of the cost savings into more MA hiring to try to drive more share? Or is that not productive?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [55]

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John, thanks for the question. So I would say, first of all, we felt really good about the work we did around MAs a little over a year ago. And if you recall, when we talk about it back then, what we have really focused on was a few tools that enabled us to do a better job of understanding where the biggest opportunities were and then applying those resources to those specific geographies or areas. And so we continue to believe that, that targeted approach is the right approach.

And as I think about it over time, it's -- so it's not as much just about adding MAs for the sake of adding MAs. It's about adding them where we now know we have the biggest opportunity to succeed, and so we'll continue to selectively do that. And we're candidly all the time evaluating our territories and each of our opportunity areas, and that may yet encourage us to shift in certain areas versus others, but I would say just outright adding a bunch of more MAs for the sake of that is not really our strategy.

We continue to see our territory size get a little bit larger as we are able to provide the marketing associates with more tools and support. We talk a lot about the tools and support that we offer our customers on that side of the business, and we continue to do, I think, a really nice job of building up those capabilities, whether that be things like menu planning analysis for our business review process where we have our chefs engaged. So I think we're continuing to focus those total resources on the local side of the business, not just the marketing associate, but leveraging the MAs to bring these other kind of tools and capabilities that we've built behind them to the market.

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John Edward Heinbockel, Guggenheim Securities, LLC, Research Division - Analyst [56]

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And then have you guys started to give thought to when you provide the next plan, right, what's the time frame for that? And is the idea another 3-year plan or sort of shift to a year-by-year outlook?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [57]

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Yes. I don't think we -- we haven't made a call on that yet, John. And so we're -- I think we're still working through ourselves what's the best approach, and so I'd say kind of more to come. We'll certainly talk with you all when we're in a place we want to do that.

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Operator [58]

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(Operator Instructions) Your next question comes from the line of Ajay Jain from Pivotal Research Group.

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Ajay Kumar Jain, Pivotal Research Group LLC - Co-Head of Consumer Sector Research & Senior Analyst of Supermarkets, Drug Stores &Food Distribution [59]

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Yes. I know you guys don't typically comment on case growth internationally. And, Tom, you did mention in the prepared comments that top line in Canada is really strong, and then you also talked about some of the challenges in France and the U.K. But is there any way you can give some directional commentary about organic case growth internationally, specifically for Canada, the U.K. and the rest of Europe, sequentially and year-over-year?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [60]

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Honestly, Ajay, I think part of the challenge for us in this area is the way we are still, I would say, managing through that transition. The cases that we talked about in the U.S. and the consistency that we can provide you guys does not exist in that business yet. And so potentially, over time, we might be in a place to do that. But today, the way we still account for the sales and the way we think about the cases or the pounds or the units that we sell in different parts of the world are not on account of our inconsistent basis.

But what I did say, and I will reinforce here, we did have strong top line growth in Canada. And what we said in Europe is, look, we had a couple of things going on in Europe that are impacting us. Certainly, the U.K. and everything with Brexit has created some choppiness over there. Our sales are positive. It's just that they are not growing at the rate we would like them to or would want them to at this point. And then in France, look, I think we all thought the unrest that was going on, the social unrest in France would have by now certainly cleared, and it just has not. And while that's not a huge impact because it's a big country, there's certainly still some things going on there that are creating issues for our customers and therefore us getting products to them.

So long-winded of saying I think we still feel generally good about those businesses. We would have liked to see a little more top line growth in Europe in this last quarter. That's kind of built into my prepared comments driving that overall numbers, and we feel good about the U.S. numbers and certainly about Canada. We just don't have the information in a way that we feel like it's easily providable to you guys.

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Ajay Kumar Jain, Pivotal Research Group LLC - Co-Head of Consumer Sector Research & Senior Analyst of Supermarkets, Drug Stores &Food Distribution [61]

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Okay. Would it be possible to confirm how much you've allocated for severance in Q3 and year-to-date? I think there was some kind of breakdown provided last quarter for Canada and Europe, but I'm just wondering if there's any update on severance that includes U.S. foodservice. And also wondering if you can give your outlook for severance for Q4.

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [62]

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Ajay, there's volumes to that. I mean they're not GAAP recs. I mean we do have a fair amount of detail that is probably what I would -- the best I'd be able to give you here in terms of spelling that out. Again obviously if you think about the areas and certainly, really, across our business, we've had a little bit of this Finance Technology Roadmap, some of the work we've talked about at corporate here in the U.S. side, this Canada Regionalization, some of the work we've done in freight in terms of those programs, I mean obviously again some of that I think you'll see spelled out in some of our non-GAAP rec, but I think that's by (inaudible) read the best view on that.

And the only thing I would say is, I mean, obviously there is some pretty sizable numbers in there, particularly in the last quarter as it relates to Europe. Obviously, that was -- well, not all inclusive. I would say that was obviously the biggest majority of what's going to come there and at least in that part of the world.

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Ajay Kumar Jain, Pivotal Research Group LLC - Co-Head of Consumer Sector Research & Senior Analyst of Supermarkets, Drug Stores &Food Distribution [63]

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Okay. And in terms of the impact from the recent head count restructuring, will that be more reflected in Q4? Or was the majority of that allocated in Q3?

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [64]

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Yes. I mean I think the majority of that -- again, the majority of that is actually going to be in -- within Q2 but then also here in Q3, so I wouldn't expect -- a lot of that to be reflected in Q4, obviously the benefits we were starting to realize here as we talk about in the second half of the year and as we head into next year.

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Ajay Kumar Jain, Pivotal Research Group LLC - Co-Head of Consumer Sector Research & Senior Analyst of Supermarkets, Drug Stores &Food Distribution [65]

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Okay. I had one final question, if I can. I think you've made some adjustments in the financials for accelerated depreciation year-to-date. I'm not sure if there was any impact in Q3 itself, but I thought at this point, you should have cycled the technology restructuring plan from a few years ago. And maybe I can get some clarification offline. But I thought conceptually, at this point, there shouldn't be any residual impact from the SAP accelerated depreciation unless your year-to-date adjustments are for Europe or unrelated to the previous.

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [66]

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I wouldn't think about it that way. I mean we actually have some D&A, particularly on the D side increase this quarter that was related to, I would call it, accelerated depreciation in Europe for the most part. There are some -- as Tom referenced earlier, there are some of the technology changes we're making over there that, again, allowed us to actually accelerate some depreciation there. And so the majority of the depreciation increase you're seeing is related to some technology transitions in Europe, but it's not related to what you were talking about before in terms of the -- some of SAP write-offs here in the U.S.

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Operator [67]

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Your next question comes from the line of Vincent Sinisi from Morgan Stanley.

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Vincent J. Sinisi, Morgan Stanley, Research Division - VP [68]

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Great. Wanted to just go back to the choppiness in the top line in the domestic business. Obviously, as you said a few times, it seems like more kind of February and weather specifically. But just wondering, was there a lot of variability that you could see by region? Another way of asking was it basically the weather and largely February the way to think of it? Or were there any other factors that just might be worth us knowing?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [69]

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Yes. I would say nothing that was inconsistent with what you just said. I mean I think we just -- when I talked about weather, we saw certain parts of the country where there were more impacts than others. So I would say nothing else beyond that, that we saw.

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Vincent J. Sinisi, Morgan Stanley, Research Division - VP [70]

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Okay. And then just on -- I appreciate the color on the Iowa Premium versus the 3-year plan. But as you had this quarter very nice expense control, just kind of curious more from like a high-level perspective like with the buckets that you're getting more of the kind of cost-cut efforts pulled to date, how much kind of lead time or planning is there with some of the levers that you have to pull? Kind of said another way like kind of how much quarter-by-quarter planning or impact or not, is there any kind of way to think about that?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [71]

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Maybe I'll start and then let Joel chime in. If you think about the way our business operates, we have regular operating expense which is generally built into the businesses that is going to have a pretty consistent cadence depending on volume and our top line being a big driver, right, because a lot of that is driven by cost per unit.

In addition, we talked about big, strategic initiatives like finance transformation, like Canada Regionalization, like Smart Spending that we have planned out, and we believe we have a good view as to when those impacts would be happening. And then we have things like our last quarter when we announced the corporate restructuring that is more of a onetime event where we would see that coming into the business.

So long-winded way of saying it, I think generally speaking, our operating expense moves with our business performance, meaning our volume. And then -- and certainly, the headwinds or tailwinds we see in the business, fuel being a great example of a headwind we're feeling right now, certainly things like driver and warehouse turnover in the past and just the low employment rates driving higher cost of some of those roles in the company. But everything else is generally planned out, and we have visibility to that, except for these one-timers. Does that get at what you're asking?

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Vincent J. Sinisi, Morgan Stanley, Research Division - VP [72]

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Yes. No. That was very helpful.

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Operator [73]

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Your next question comes from the line of John Ivankoe from JPMorgan.

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John William Ivankoe, JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst [74]

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I want to follow up on some comments that were made about maybe independent restaurants being a little bit softer in the March quarter, I mean, whether we adjust for weather or not. The context of the question and really what I'm getting at is have you seen a significant rate of openings for independent restaurants, in other words, your addressable customer base maybe over the last 12 months? And considering the amount of labor pressure that independent restaurants are facing and just margins which were, in general, lower than chains, are you actually seeing a pickup in closures on the independent side that's noteworthy even on like a very market-specific basis?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [75]

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John, look, I wouldn't say anything that's unique that's happened there. I mean as you -- we all know, in this industry, you've got a lot of new business coming online all the time, and you also have folks that are closing. I don't -- wouldn't say we have seen any dramatic shift in that area. And as I mentioned, the different data sources have some mixed information, but all of them generally talk about positive spend, dollars being up in that kind of 2.5% to 3.5% range. And then you have traffic generally down, with the exception of NPD, which is showing slight increase in traffic. So I don't think there's anything unique or anything in this quarter that we've seen that is highly different than what we've seen in the past quarters.

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John William Ivankoe, JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst [76]

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And is there anything to note by category or by regional that you're beginning to see? And obviously, you might think there's a lot of questions that are being asked you of whether you think there's a slowdown, and I think the answer, at least as it stands today, is no. But when you look at different categories or different regions, is there anything interesting that you're seeing in the marketplace, a little bit more detail, either positive or negative, that you can basically talk about now that gives us, I guess, somewhat of a forecast of the future from Sysco's perspective as opposed to some of the third-party sources that you use for your data?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [77]

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Not really. I mean there's nothing else that I would tell you that we're seeing that's any different.

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Operator [78]

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Your next question comes from the line of Kelly Bania from BMO Capital.

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Kelly Ann Bania, BMO Capital Markets Equity Research - Director & Equity Analyst [79]

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Just going back to expenses again. It seems like there was a good amount of upside, at least in our model, on the international. Can we think about the performance this quarter? I think it was down about $30 million year-over-year. Is that kind of the right run rate to think about for the next few quarters international? And then maybe can you tie in just the impact of the corporate restructuring on the expense performance this quarter?

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [80]

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Yes. Kelly, I'll start. And I think the answer to that is, I mean, obviously we're continuing to do a lot of work there to streamline, make our operations more efficient. I guess I'd say that there is some run rate consistency there, but what I would also tell you is, I mean, there's -- we just have a lot of moving parts right now in some of our international business. What I would not necessarily tie into, one of the things we've talked about in the past, is the sizable transformation we're doing in France. I think the majority of that benefit really we start to see next year, so I would not tie a lot of that necessarily to that big restructuring that we're doing in our French business.

But I would say generally speaking, I think it's fair to continue to see that as a relative run rate, realizing again we just got a lot of moving parts over there in terms of transformation we're doing. So I guess my answer is generally yes. But again, there's -- just realize things are going to move around quarter-to-quarter based on the amount of stuff we've got moving around in that business.

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Kelly Ann Bania, BMO Capital Markets Equity Research - Director & Equity Analyst [81]

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Okay. That's helpful. And maybe just in terms of the U.S. Broadline business. Can you talk a little bit about some of the specialty meat and produce, some of the categories that aren't necessarily part of the normal case growth? And what kind of trends you're seeing in those other areas of the U.S. business?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [82]

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Sure. This is Tom, Kelly. I think we continue to feel really good about our specialty company strategy. As we've talked for a few years, we know that our customers truly value Broadline, but they also have needs oftentimes that can be better met by some specialty companies, and in our case, meats, seafood, poultry on that side and then the produce with FreshPoint. And so I think we continue to feel really good overall what we bring to the market and the value proposition we have there.

We have been working on ways of even helping our customers make that easier for them to procure our products, both from Sysco and from the Sysco specialty companies, and we're seeing benefits of that as well and so creating the environment where it's easy for them to kind of do business with both of those entities as they need to and as they feel like they want to and so versus feeling maybe like 2 or 3 different companies that they're doing business with, the idea that they could do business with one, Sysco, and get the value out of that. So we continue to believe that's an important part of the market, and we continue to feel really good about the work we're doing there.

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Operator [83]

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Your final question comes from the line of the Bob Summers at Buckingham.

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Robert William Summers, The Buckingham Research Group Incorporated - Research Analyst [84]

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So I just wanted to dig a little deeper into the transportation. Drive and spot rates have been contracting all year. So can you maybe talk about how that flows through in your business, either by talking about the percent of business that you do at the spot rate? Maybe talk about how that spot rate influences contract rates as you may be threatened to move more to the spot market, and then lastly how that impacts what you have to pay your drivers.

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [85]

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Hey, Bob. Again, getting back to this conversation about transportation and cost, the piece you're really referring to is the inbound freight part for us, which does hit our gross margin. And we called out in the prepared comments and we've talked a bit here this morning about that we are seeing some year-over-year improvement benefit there. It's not huge, and it's not something that is a major driver for us. But the market has come down, certainly from where it was a year ago, and obviously everybody benefits from that. We obviously try to minimize the spot market because when that -- that's the one that gets the most out of whack the fastest, and that's what happened a year ago. So we continue to manage that side of our business mostly with contracts. But yes, it certainly is that whole market comes down that affects both sides, the spot and contract side.

And then as it relates to our drivers, as we said, I think we've done a lot of work around both recruiting and retention and the way we're operating our business to improve as much as we can our driver retention. And so we feel better about where we're at than we were a year ago, but it continues to be a challenging part of the business and I think will be as long as the market is the way that it is, meaning unemployment is low and there's a lot of freight on the road. So we feel much better where we are now than we were a year ago, but that doesn't mean that we don't still have ongoing challenges associated with the hiring and retention of drivers.

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Operator [86]

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That concludes today's conference call. You may now disconnect.