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Edited Transcript of SYY earnings conference call or presentation 4-Feb-19 3:00pm GMT

Q2 2019 Sysco Corp Earnings Call

HOUSTON Feb 6, 2019 (Thomson StreetEvents) -- Edited Transcript of Sysco Corp earnings conference call or presentation Monday, February 4, 2019 at 3:00:00pm 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

* Andrew Paul Wolf

Loop Capital Markets LLC, Research Division - MD

* 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 - Research Analyst

* Karen Holthouse

Goldman Sachs Group Inc., Research Division - VP

* 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 Second Quarter Fiscal 2018 (sic) [2019] Conference Call. As a reminder, today's call is being recorded. We will begin today's call with opening remarks and an introduction.

I would like to turn the call over to Neil Russell, Vice President of Investor Relations, Communications and Treasurer. You may begin, sir.

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

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Thanks, Natalia, and good morning, everyone. Welcome to Sysco's Second 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 reconciliations 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 would 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, as always, for joining us. I'd like to start this morning with some key themes that drove our results for the quarter, along with some comments on the current macro environment that we're operating in, followed by a discussion of recent organizational changes, then continuing with our U.S. Foodservice Operations business results and concluding with a discussion of our international and other business segments. Joel will then discuss the financial results in more detail.

For the second quarter, we saw improved year-over-year top line results and are continuing to execute on our strategic priorities designed to improve our overall performance. Our focus for the quarter was led by our efforts to enrich the customer's experience of doing business with Sysco and to consistently provide excellent service to help our customers be successful.

We remain committed to achieving our 3-year planned financial objectives, although the manner in which we achieve them may look slightly different from what we originally outlined. Joel will discuss this further in just a few moments.

Our results for the second quarter include: a sales increase of 2.5% to $14.8 billion, gross profit growth of 2.7% to $2.8 billion and adjusted operating expense growth of 2.1%, which delivered an adjusted operating income increase of 4.8% to $603.3 million and an adjusted earnings per share decrease of $0.03 per share to $0.75.

Local case volume was solid within U.S. Broadline operations, growing 3.3%, of which 2.4% was organic. Total case volume within U.S. Broadline grew 2.9%, of which 2% was organic, with local growth outpacing national this quarter. As previously discussed, we expected overall softer volume this quarter due to lapping of the HFM acquisition and the lapping of 2 large national customers.

Looking at broader economic and industry trends. As we think about the key drivers in foodservice and the segments in which we operate, there are a number of factors which are important to the overall macro environment, including consumer confidence and discretionary spending. Even with the recent somewhat volatile financial markets, we continue to see U.S. consumer confidence remaining fairly strong, driven by the solid labor market, with unemployment remaining low at 3.9% as of December, which is normally a good indicator of that higher consumer confidence.

In the restaurant industry, we continue to see sales growth, particularly in same-store sales, while traffic continues to be mixed.

And lastly, from an international economic outlook perspective, it's mixed where we do business. In the U.K., the consumer is still dealing with uncertainty and concerns over Brexit next step. However, this is balanced with some strength in other geographies, and generally speaking, we were seeing decent consumer spending and overall industry trends in the other international markets where we do business.

Turning to the topic of M&A. M&A continues to be an important part of our strategy for growth. Last week, 2 new acquisitions were made public, one in the U.S., Waugh Foods; and one in Ireland, Classic Drinks. While these are examples of smaller transactions, especially compared to the size of total Sysco, these acquisitions are great examples of our M&A strategy. Waugh Foods is a Central Illinois distributor, with the overwhelming majority of its business with independent restaurants. And Classic Drinks is an established specialized wine and spirits distributor, which will further strengthen our existing product portfolio in our Ireland business.

I'd like to now transition to some organizational and leadership changes that we recently announced. In order to drive continued growth and create value for all Sysco stakeholders, we implemented organizational and executive leadership changes, which will further align the company with its customer-first operating model and streamline the business. These changes will help us increase agility, reduce costs and accelerate decision-making across the business by getting closer to our customers and better aligning our resources to support and address their evolving needs.

Additionally, this reorganization results in an approximate 10% reduction in salaried corporate support positions. And while any decision which impacts our associates is a difficult one, this is an essential step to realign the organization and sharpen our focus on the company's key strategies to enable growth.

Now I'd like to transition to our second quarter results by business segment, beginning with U.S. Foodservice Operations. Sales for the second quarter were $10.1 billion, an increase of 4.2%. Gross profit grew 4.5%. Operating expenses grew 4.7%, and operating income increased 4.2%. Inflation during the first 2 months of the quarter remained relatively flat but increased towards the end of the quarter, contributing to the total gross profit dollar growth. Overall gross profit growth was also positively impacted by an increase in case growth, a reduction in spot market usage of inbound freight, continued growth in Sysco brand, which was up 59 basis points in our local segment versus prior year, benefiting from our ongoing category management initiatives and our cutting-edge solutions innovation platform. Our cutting-edge solutions continue to provide value-added products for our customers. We are excited about our next launch of these innovative new products that will be taking place in a couple of weeks, which we also believe could be our best yet.

Also of note, we continue to see an increase in the utilization of our digital ordering platform, which has improved over 50% of local cases ordered. Additionally, we continue to make progress on improving our customer-facing tools, including a refreshed delivery app and improvements to our digital shopping platform.

From an expense perspective, operating expenses grew for the quarter, driven primarily by continued supply chain cost increases in both the warehouse and transportation areas. While we have seen increased costs in these areas in recent quarters, we continue to remain focused on better managing and mitigating these costs. As an example, we continue to focus on specialized recruiting, training and onboarding efforts, and we are starting to see an improvement in retention, especially in the warehouse.

Moving on to our International Foodservice Operations for the quarter. Sales increased 0.8%. Gross profit decreased 1.6%. Adjusted operating expenses decreased by 2.6%, and adjusted operating income grew 5.1%. International segment, from a top line perspective, we saw improved performance in Canada with strong sales growth year-over-year despite some softness in Alberta. In the U.K., top line performance for the quarter was impacted by continued uncertainty surrounding Brexit, and our business in France was impacted by the yellow vest protests during the critical holiday time frame.

From a cost perspective in our International segment, we had some supply chain challenges in the U.K. as we onboarded several new customers to the business. In Ireland, the team continues to execute strongly against our integration initiatives, and as a result, synergies in the merger of Brakes Ireland and Pallas are ahead of schedule. Our integration of Brake France and Davigel into Sysco France is not only progressing well, but we launched our new Sysco France brand to the French market last week at the SIRHA World Hospitality and Food Service Event in Lyon. This is an important step to building on our position as a leading European foodservice provider.

As we've also discussed, in Europe, we have accelerated the investments we are making related to our long-term strategic growth plans, which are designed to enrich the customer experience and position us well in these markets. Joel will discuss this point further in a moment and its impact to our certain items this quarter.

Moving on to SYGMA. Performance for the quarter was down as we continue to optimize our business in this industry segment and we remain focused on improving our overall operational performance. We expect to see continued softness in the top line as we make disciplined choices in an effort to improve profitability for the long term.

And lastly, in our other business segment, Guest Supply had strong top line performance during the quarter with increased sales of 8.3% and increased gross profit of 5.2%. Though costs continue to be a challenge due to the continued impact of tariffs, product availability and the increased cost of shipping products to our customers. Overall, we are pleased with our performance in the hospitality segment and remain excited about the long-term potential of this business.

In summary, overall the fundamentals in our industry and in our business remain solid. We plan to continue to deliver against our strategic priorities to provide an improved customer experience, excellent customer service and strong operating performance. And finally, I'd like to thank our dedicated associates across the company for all of their efforts to make Sysco a distributor of choice for our customers and a leader in the foodservice industry.

Now I'll 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. Good morning, everyone. I'd like to provide you with additional financial details surrounding our performance for the quarter. As Tom noted, for the second quarter, for total Sysco, sales were $14.8 billion, an increase of 2.5% compared to the same period last year. Changes in foreign exchange rates decreased sales by 0.7%. Gross profit in the second quarter increased 2.7%, and gross margin increased 4 basis points.

During the quarter, particularly in December, in our U.S. Broadline business, we experienced 1.4% inflation driven by a few categories, primarily frozen potato, meat, paper and produce.

Adjusted operating expenses for total Sysco were up 2.1% for the quarter. With regard to the leverage of operating expense growth to gross profit dollar growth, our performance was in line with our expectations. While we did improve performance compared to the first quarter this fiscal year, we remain focused on improving this trend in the third quarter, in the second half of the year and for the remainder of the 3-year plan.

Total adjusted operating income was $603.3 million in the quarter, an increase of 4.8% compared to the same period last year. Changes in foreign exchange rates decreased adjusted operating income by 48 basis points.

We have previously discussed the transformative initiatives that we have in place, which will allow us to continue to grow our business and capitalize on our strong fundamentals. As we continue to evolve as a company, we are placing further emphasis on the holistic assessment of our work in order to effectively centralize and standardize our business, including by leveraging technology and strengthening Sysco overall.

We will continue to focus on strong implementation and execution while accelerating some of this work, all of which provides us with the confidence to achieve our financial objectives. As a reminder, we are expecting to see increased cost savings benefit from these initiatives in the second half of this fiscal year.

Some of these initiatives include: first, our finance transformation road map. This important work is about modernizing our global financial platform, starting mostly within our U.S. operations. We are centralizing activities, automating work and working with offshore partners where the transactional work can be done more efficiently and cost effectively. Changes have begun and we expect to see the benefits in the second half of this fiscal year.

The second area of focus is our smart spending initiatives. Here, we take a detailed and accelerated view of indirect spending categories to identify and execute on cost reductions in these areas. Again, we anticipate benefits being realized in the second half of the fiscal year.

In our Canadian regionalization, this work is about optimizing the leadership and overall structure of our Canadian business, which historically has been highly decentralized. We have good opportunities here and feel great about the progress we have made thus far.

And finally, regarding overall administrative expenses. We continue to aggressively look for new and innovative ways to drive costs out of the business, which align with our transformative efforts to drive growth, areas that are not only in line with our 3-year plan objectives but also either accelerate some initiatives or are incremental to the original plan. An example would be the changes we discussed earlier regarding the new streamlined organizational and business unit structure.

Turning to earnings per share. Our adjusted EPS for the quarter decreased $0.03 to $0.75 per share. Our EPS results this quarter were impacted by our tax rates. As a reminder, in the second quarter of fiscal 2018, we saw a retroactive benefit back to the beginning of our fiscal year in FY '18 due to the adoption of reduced tax rates in the U.S. While U.S. tax rates are lower in fiscal 2019 as compared to fiscal 2018, the retroactive benefit created a larger benefit in the second quarter of our fiscal 2018 as compared to the second quarter of fiscal 2019.

Our EPS results this quarter were also impacted by increased interest expense, which was higher than the same period last year due to variable rate changes and less stock option exercises than the prior year. I'd also like to remind you that we anticipate our effective tax rate for this fiscal year to be 25%.

I'd like to take a minute now to talk about why we had a large amount of certain items this quarter. We continue making investments in our business related to our strategic plans designed to position us for long-term growth. Our certain items in the second quarter are primarily related to these initiatives, including the integration of our businesses in France and Ireland, European multi-temperature investments, our finance transformation road map and Canadian regionalization. The largest of the certain items is related to the restructuring of our France business, which included significant severance. As we've discussed with the France restructuring, we are integrating our Brake France and Davigel businesses into Sysco France. The merger of these 2 businesses will position us well for continued success in the French marketplace, and we expect to see benefit from this initiative in our France business beginning in fiscal 2020. Additionally, as we have stated, we anticipate seeing benefit from our finance transformation road map and Canadian regionalization initiatives in the second half of this fiscal year.

Now turning to cash flow. Cash flow from operations was $917.8 million for the first 26 weeks of fiscal 2019, which was $15.4 million lower compared to the prior year period. Free cash flow for the first 26 weeks of fiscal 2019 was $700.9 million, which is $22.4 million higher compared to the prior year. The improvement in free cash flow was due primarily to continued improvements in payables and receivables. As a reminder, in the second quarter of fiscal 2018, we deferred cash tax payments due to flood relief associated with Hurricane Harvey, so this is impacting our year-over-year comparison.

Net capital expenditures totaled $216.9 million for the first 26 weeks of fiscal 2019, which was $37.8 million lower compared to the prior year period.

In summary, we saw improved results for the second quarter, and we remain focused on supporting our customers and executing our business initiatives to achieve our objectives. At this point, we are halfway through our 3-year plan and have increased adjusted operating income by $241 million. We are committed to achieving our goals. And as always, we are committed to performing consistently on a high level to achieve customer satisfaction and solidify our industry-leading position.

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 the line of Karen Short with Barclays.

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Karen Fiona Short, Barclays Bank PLC, Research Division - Research Analyst [2]

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I just like to clarify a couple of things. So as we look at the percent of savings coming from gross profit dollars versus OpEx, it does seem that it will be much more skewed to OpEx now with these layoffs. Can you maybe just give an update on how to think about that?

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

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Yes. So I would say it's somewhat more than kind of -- I wouldn't call it dramatically more. But again, just -- if you think about the first path of the 3-year plan, for the most part, we've had relatively flat levels of inflation; certainly, some of the challenges we've had in supply chain. So I guess I would just say that some of the -- there's a bit more emphasis on some of the administrative cost reductions. But again, as we've seen a little bit of inflation returning and certainly because -- obviously, continue to work to mitigate some of the challenges on the supply chain side. Again, I would say, somewhat more focused, but again, I wouldn't say we're really dramatically shifting, as we talked about earlier.

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

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And Karen, I might just add. I mean, I think if you think about it as we really have 2 big buckets. You had gross profit and you had costs. And what we've really been talking about and what we've been sharing is that our supply chain costs have been higher over the last few quarters, so we're having to balance that still on the cost side. So it's kind of cost and gross profits isn't the big shift, it's really more between some of the cost buckets that we're really focusing on.

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Karen Fiona Short, Barclays Bank PLC, Research Division - Research Analyst [5]

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Okay. But just for modeling purposes, to clarify, when I look at the corporate number, it's fair to say that, that only included the benefit of the corporate -- or the supply chain -- supply shared services for 1 month out of the 3 in the quarter, right? So going forward, as we model corporate, that number should be quite a bit lower?

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

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Yes. So it would not have included any of that at this point. So there will be some impact on corporate expenses moving forward, yes.

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Karen Fiona Short, Barclays Bank PLC, Research Division - Research Analyst [7]

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Okay. And then just my follow-up is I was curious if local organic case growth internally was in line with plan. And I know you said the kind of quarter was in general, but I'm only asking because you actually got no longer have a slide highlighting case growth, and you guys have kind of had that slide in the past. So any color on that would be great.

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [8]

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Let's look back at that slide, I'm not sure about that. But as far as the local case growth, I think we feel really good about the case growth. I think there was a little bit of choppiness in the quarter. It kind of came back a little stronger towards the end, which is we feel good about. But I would say it was maybe a little less than we had planned but not dramatically different.

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Operator [9]

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

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John Edward Heinbockel, Guggenheim Securities, LLC, Research Division - Analyst [10]

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Tom, maybe a quick question. Could you maybe walk through some of the changes you made here on the organizational side? Because it may sound more operational. So what happened in terms of chain of command -- span of control, layers of management? How do you go to market differently because of this? And how do you guard against any adverse impact on your customer?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [11]

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Great question, John. Thanks. So let's start with the changes we made were, in fact, around kind of streamlining the business. And we think about spans and layers was the key focus. Very focused on corporate, and so when you think about impact to our customers or to our selling organization or to our growth plans, little to none. I mean, that's not where the focus was. This is really about how do we kind of improve the agility of this organization, our ability to make decisions more quickly, and so was heavily focused on corporate office. And as you probably saw or heard, there was a couple of changes with my leadership team. So the headline here is mostly kind of the spans and layers exercise in areas where we felt like we could remove some costs and maybe some redundancy and candidly, get us more focused on the key priorities we've got and that we've outlined to you all. From a leadership perspective, there were a couple of changes that are probably worth highlighting. One is that we have gone through some work within our technology area. We've got kind of an innovation technology group and we've got a core traditional technology group. And we're looking at how we bring those 2 organizations closer together. And we've been doing some work around that, and as we continue that work, we will continue to make some adjustments. And so what you saw there was a change taking place within the kind of traditional IT area. The great news for us is we've got a deep bench here. We feel very good about the team we've got and the work we're doing, and so I don't think you should expect and we certainly don't expect to miss a beat with our technology efforts.

The other thing is there were some -- think about this administration area. We had a role that was a kind of administrative role. It was a combination of a lot of other things that as a company, we've tucked under that role over the last couple of years. Think about CSR. Think about even some of our communications work. And so we felt like there was an opportunity here to streamline that work and that organization. And so we obviously replaced the important part of that role, which was the Chief Legal Officer, and we promoted a talented woman named Eve McFadden here at Sysco, who's now our new Chief Legal Officer and Corporate Secretary. And so, again, really no impact there, I think, from an overall business perspective or certainly from any of our customers or our strategic focus. And so those were probably the largest changes that are worth highlighting.

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [12]

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Yes. And if I can just add one thing and just reiterate some of what Tom said. None of these were cost changes that were in any way inconsistent. We're not taking cost-outs that are actually supportive of growth. So I think that's really an important point here that there's work being done to streamline and tighten the connection between our customers and ourselves, but there is certainly nothing done that's going to impact growth.

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John Edward Heinbockel, Guggenheim Securities, LLC, Research Division - Analyst [13]

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And one last thing. If you -- as you look at the step-up in inflation, right, you saw in December, it's not clear if that's going to continue, but let's assume it does. How do you feel about pass-through right now, right, relative to all the other cost pressures your customers are seeing maybe compared to the past? Do you think you can pass it through as you have in the past? Or maybe it's a little more challenging?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [14]

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Yes. I don't think we've seen really a big change there. Look, as we've always said, too much inflation is hard to pass through, but as long as it remains at kind of this modest level, I think we still feel very good about our ability to do that. Clearly, we've got lots of tools in our tool belt here, including Sysco brand, which we continue to talk a lot about, but it's driving really good performance. I think it was 59 basis points we talked about this quarter. And again, we've kind of seen that ongoing benefit that we get from Sysco brand. And that helps our customers a lot. It generally provides them some value, and obviously, it's good for us as well.

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Operator [15]

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

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Vincent J. Sinisi, Morgan Stanley, Research Division - VP [16]

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Just wanted to follow up on the headcount reductions. Can you just kind of give us maybe a little bit more color on how does that fit into kind of the grand scheme of the cost-cutting initiatives, especially as we go through the next couple of years here? Is it fair to say that, that's kind of the largest bucket among them? And other ones that might be worth noting in terms of progress?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [17]

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Let me start out and let Joel talk here, too. And I think it's important you go back to the things we've been consistently talking about. So certainly, cost is an important part of us delivering the 3-year plan. And as we've continued to talk, I mean, the balance of that cost may be slightly different than we initially had talked about primarily between the supply chain area because that area has been increasing and the administrative cost side. But this recent action is really about maintaining the focus that we talked about on cost broadly. Yes, it was focused on administrative side of this, but I wouldn't say that this is a large part of the overall. You think about the plans we had over the 3 years, all these areas need to work together, and this is just one piece of that, that overall puzzle in addition to the big buckets that Joel also has mentioned numerous times. So with that, I'll let Joel kind of build on that.

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

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Yes. I think the only thing I'd add, Vinnie, and this is we've talked about the fact that we've had some of these initiatives that we have that were -- some were multiyear in scope, and in some cases, some benefits are being able to be accelerated on those. And then in some cases, there are also things that we looked at that were outside of the main scope of those, and this would be one of those things. And so in other words, as we sort of thought about some of the things we've talked about at our overall cost discussions, this would be one of those things that would be incremental to that. And so -- anyway, that's the way I would think about it. And again, just -- again, as a reminder, there's obviously still a very large part of this benefit that we're looking to get from our gross profit dollar growth as well. So I mean, I still consider this is as a very balanced approach, which is some -- just some further acceleration of these things, I think some of these things that -- like this that were incremental to the additional plans that we laid out.

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Vincent J. Sinisi, Morgan Stanley, Research Division - VP [19]

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Okay. That's helpful, guys. And then maybe just a quick follow-up. Tom, I think you said in your prepared remarks that you had a reduction in spot market usage. Can you guys just give us a quick update on transportation freight costs, kind of where you are on a sequential basis and how you're able to be better managing through?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [20]

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Yes. The thing about that comment was very specific to inbound freight. And if you think about a year ago when we really hit -- I think in this quarter had a big increase in that spot market utilization because of the tight market hit and everyone was scrambling, we got -- like probably everybody, we got kind of pushed to the spot market. We've just done, as we talked for the last really 4 quarters, a much better job of managing that. And so as we went into this year, it's that overlap that I'm really referring to that was down. So I think we talked about this last quarter. I'd say the inbound freight is kind of at a new normal. It's higher than it was certainly a year ago, kind of spread out over a year. But year-over-year for the quarter, we saw some benefit just because that's when we took the biggest impact last year.

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Operator [21]

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

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Judah C. Frommer, Crédit Suisse AG, Research Division - Research Analyst [22]

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Maybe, first, just on the independent case growth commentary. I think it's been a while that you've been talking about same-store sales being flattish to positive and traffic being more mixed. And kind of at what point do you get concerned about the trajectory of that independent business? And can you talk about those very small 1- and 2-store independents versus the chains that you've been talking about more recently?

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

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Yes. I think we continue to feel good about the mix of our business. We've talked, over the last couple of quarters, about the -- this kind of regional chains or this kind of micro chains are growing, and that continues. And I think we still feel good about our position there because of the value proposition that we have for those customers. When you think about the true independents, the ones you're talking about, these kind of 1- and 2-unit kind of operators, look, we continue to see, as we said, decent growth there. Now it is very much driven by the outlet and the type of business that they're running and the experience they're providing, but generally speaking, we still feel good about that. So I think there -- and as you've heard us talk a lot, and I won't overdo it on the -- this market is still very fragmented. So the acquisitions are a good example even -- while Waugh is a fairly small acquisition relative to Sysco's size, it's a great example of where there are a lot of really good regional distributors out there who are still doing good business and are a good fit. And so those guys are heavily independent driven, and it's a great example of how we can leverage some great work and a great organization that they have with Sysco and the capabilities we bring. So long way of saying, look, I think we still feel really good about our position, our growth and certainly our prospects given the marketplace that we operate in.

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Judah C. Frommer, Crédit Suisse AG, Research Division - Research Analyst [24]

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Okay. Great. And then maybe just quickly, if we kind of rewind to Q1, I would say there was some combination of warehouse labor pressure and flattish inflation causing some consternation on your part that hitting the midpoint of 2020 guidance would be tougher against that backdrop. Would you say that we fast-forward to Q2 and kind of the exit rates there, that was kind of the offset in operating expense and inflation kind of re-ramping that, you do feel better about those 2020 targets than you did 3.5 months ago?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [25]

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Well, I think we felt good about the 2020 targets all along. So I think what we've talked about is some shifting of how we might deliver that. But we have consistently said we feel good about our ability to deliver this 3-year plan and we still feel very comfortable about that.

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [26]

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Yes, Judah, I think we just -- we've called out a couple of things that we've said are causing us to continue to accelerate some other things because we're certainly not just sitting on our laurels and saying inflation is low and supply chain is high. But obviously, we're going after some of that stuff. But I think we've been pretty consistent in expressing our confidence in achieving our targets.

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Operator [27]

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Your next question is from the line of Marisa Sullivan with Bank of America.

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Marisa Sullivan, BofA Merrill Lynch, Research Division - Research Analyst [28]

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I wanted to ask about cost savings. As some of the initiatives that you've talked about kind of roll in and kick in, in the back half, do you think that you'll get back to that longer-term 150 basis point gap between gross profit dollar and OpEx growth in 3Q? Or is that more of a -- will that take more time to get you back to that long-term level?

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [29]

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Hey, Marisa, this is Joel. So the way I would think about that, obviously, we don't give that type of quarterly guidance, but what I would say is that, again, as we continue to express confidence in our -- achieving our 3-year targets and as mathematically would be necessary in order to get back to or exceed that rate over the next 6 quarters, I would think about it that way. Again, we've talked about the fact that our second half this fiscal year, we believe, we'll ramp in some of those areas, including that gap. So again, I'm not giving specific guidance. I would just tell you that we continue to express our confidence, and I'm going to say mathematically, that would certainly have to be the case over the course of those 6 quarters.

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Marisa Sullivan, BofA Merrill Lynch, Research Division - Research Analyst [30]

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Got you. And then on the corporate reductions that you announced this morning. When did they kick in? How quickly did they roll on to the P&L? And is there more room to go? Do you have to kind of find more incremental pockets to get to maybe back to that mid- to higher end of the EBIT improvement range?

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [31]

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Why don't I start here? I mean, so I think the question when does it start to kick in, that will be in the third quarter. And so you'll start to see some of those benefits hit in Q3 and, again, over the second half of the fiscal year. I guess the other thing I would say, and again, certainly, Tom can chime in here, we're always continually looking for ways to do this. Again, we often get asked, "Hey, we've got these sort of key initiatives we've laid out. Are there other things you're doing?" And then, again, that's our job to always look for different opportunities. And so we'll certainly continue to do that, but hopefully, that gives you some clarity on the timing.

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

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Yes, Marisa, I think that's well said. I think this -- anytime you take an action like this, it's difficult for the associates involved and we take that very seriously here. But I think at the same time, it is our responsibility to be constantly looking for ways to optimize this business and improve the overall experience our customers have with doing business with us. And we're going to continue to do that as an organization, and we'll have to -- time will tell whether or not some of those things need to be accelerated or not, but we feel really good about the plans we have in place right now.

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [33]

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Yes. And I think the only thing I'd just -- again, not to sound like a broken record here, but again, these are not -- again, we're not taking costs out of things that are actually facilitating growth in our company. And so I think that's just the really important -- we continue to invest in this company. We continue to ensure that we're investing in the right places to grow. And we also continue to look for opportunities to streamline. I just think it's important to make sure that message is loud and clear.

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Operator [34]

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

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Kelly Ann Bania, BMO Capital Markets Equity Research - Director & Equity Analyst [35]

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Just going back to the workforce reduction. I guess 2 questions. One, can you just talk about the size of the impact of that on a dollar standpoint on an annualized basis? And then I just -- I guess to clarify, was this always part of the 3-year plan? Or was there any change into the size of the structure of it? Or was it just pulled forward in terms of timing relative to your original expectations?

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

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Kelly, thanks for the question. Yes. So no, this -- first of all, a couple of things on that. We haven't actually given the dollar amount, the dollar magnitude of that. We did talk about certain -- 10% of the positions in corporate support, but we have not given that dollar amount. The question -- and so, again, as I mentioned in my remarks, this -- I would characterize this as one of those things that are incremental to some of the stuff that we actually talked about as part of our plan. This would fall in one of those categories we often get the question, "Hey, what else are you guys doing?" This would be one of those things. And so this would not have fallen into one of the things we talked about specifically in our Investor Day or key initiatives that we often talk about.

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Kelly Ann Bania, BMO Capital Markets Equity Research - Director & Equity Analyst [37]

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Okay, perfect. And then in terms of the inflation, it sounded like that started really in the latter part of the quarter. Just curious if that has continued into January and what maybe you're expecting for the back half in terms of inflation in your plan.

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

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Yes. I would say, Kelly, at this point, that has continued. And I think our expectation is that would call modest levels of inflation here over the next couple of quarters.

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Kelly Ann Bania, BMO Capital Markets Equity Research - Director & Equity Analyst [39]

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Okay, great. And maybe just a bigger picture one then. As you look at your competitive set, obviously, the big 3 have about 1/3 of the share. But just curious what you're seeing from that other 2/3 and those regional distributors. You talked about some of them performing well with independents or catering to the independents well. But are you seeing any changes in behavior or strategy with those group of distributors that we don't really get to hear from on a regular basis?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [40]

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Hey, Kelly, this is Tom. No, I don't think we really -- I mean, it remains very competitive, obviously, out there. And when we -- we've talked about this a fair amount, but as you know, the big -- kind of the public 3, while that's very visible to everyone, there are very good and very capable regional distributors in this business and many of them. But there are some fairly large ones as well on a regional basis that we all compete with. And I would say that they have always been good competition and they continue to be, but I don't think we've seen anything kind of new or different from them or just dramatically changed. So highly competitive, but there are certainly a lot of good companies out there in this industry.

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Operator [41]

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Your next question is from the line of Karen Holthouse with Goldman Sachs.

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Karen Holthouse, Goldman Sachs Group Inc., Research Division - VP [42]

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Just on the inflation commentary. So it was pretty flat in the first 2 months, and then you ended up a little bit ahead of 1% for the quarter, really, just driven by December. Would that -- just the math would imply that you were running north of 4% probably in December? Is that the right way to think about it? And is that how to think about a run rate into the third quarter? Or were there really some parts of that, that you would view as more temporary?

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [43]

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Yes. So Karen, it's Joel. We -- first of all, I'd say we were slightly inflationary or -- again, over the first couple of months, so I wouldn't say we're flat. And 4 -- that was -- the math rack doesn't apply 4% over December, so it certainly implied some acceleration in December. As I mentioned the -- some of that inflation, again -- I'd say it's carried over into the third quarter. And we anticipate, again, modest levels of inflation as we head into the second half of the year, but I would not anticipate 4% inflation heading into the second half of the year.

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Operator [44]

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Your next question is from the line of John Ivankoe with JPMorgan.

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John William Ivankoe, JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst [45]

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First, I wanted to get back to some of the prepared remarks about the industry, which I think were -- discussing the expectation of same-store sales growth but traffic being mixed. Can you elaborate on what sectors that you're seeing in terms of -- that aren't participating in this overall economic growth and maybe how you're positioning towards the better sectors and less towards the slower or even negative sectors, might be changing over the next couple of years? And then I'll have a follow-up as well.

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

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Sure. I mean, if you think about -- we've talked a lot about the various sectors over the years. And if you think about the restaurants obviously being the largest segment of this industry and of the market, let's start there. But I think we talk about the traffic and the spend, it's highly variable. So if you think about it from a NPD perspective, the total traffic during the last -- during this last time frame was basically up slightly and the spend was up about 3%. QSR was driving the majority of that. Mid-scale, they call mid-scale dining, traffic was down about 2% and spend was up about 1%. And then casual was also -- traffic was down and the spend was up. So it's kind of mixed if you think about the various segments within restaurant.

As we've also talked a lot about, though, we participate in lots of different segments. We continue to see growth opportunities in places like health care and, certainly, education. Retail sector continues to be a growing foodservice segment. And so there continues to be lots of areas of growth out there. And we've also talked and it's been a focus for us for a few years now but it continues to be is the ethnic segments within restaurants continue to see growth. And depending on -- that's somewhat maybe more -- a little more geographic based, but we see solid growth in certain ethnic segments as well.

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John William Ivankoe, JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst [47]

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Okay, helpful. I wanted to see if there was maybe a change of tone in any way regarding your comments, and it sounds like it's more consistent. The next question, if I can sneak another one in before the final one, digital ordering now at 50% of local case growth order. That would suggest maybe you were at some type of a tipping point. Obviously, the marketing associates are doing less ordering and they're doing a lot more servicing or adding value to their customers. Could you remind us whether we're now at the point where the level of marketing associates is relatively stable despite the expectation of local case growth? Or maybe we can get to a point where the best marketing associates can serve more clients and just be more overall profit additive to the corporation.

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [48]

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Sure, John. It's a good question. So we've actually been over 50% for a few quarters now, but we have kind of hit this -- it is a -- I think it's an important question because it's a good percentage of our business that is online. And remember, this is the local business we're talking about. Our national or contract business, a lot -- higher portion of that is actually done online or through things like EDI. But within this local segment, about this same time a year ago, we also talked about we were adding some marketing associates. We've kind of gotten through that addition, and we felt like that was really important at the time because we had now had some tools available to us that were enabling us to target where those resources could go. Think about that as where we had some bigger maybe share gaps or share opportunities. And once we have identified that, we wanted to make sure we were focused there. As we think about it today, given that percentage of ordering, given some of the additional tools we continue to provide our customers and our organization, I do think we're at a place where we're somewhat stable from a selling resource perspective. We are seeing larger territories. We think that's a good thing, but we aren't looking at this as a way to dramatically reduce or change our selling resources. We continue to believe they're a very, very important part of our model. And we know from our customer feedback that they are highly valued. So it's really about continuing to give them more tools to help them be more effective and, obviously, more consultative but also making sure that our customers have the opportunity to do business with us the way they want to, which has been also our focus in our model.

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John William Ivankoe, JP Morgan Chase & Co, Research Division - Senior Restaurant Analyst [49]

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Great. And then the final question, the acquisition of wine -- excuse me, of Classic Drinks, which does wine and spirits in Ireland, is that -- that segment, is that a one-off for you? Obviously, the U.S. has, especially even on a per-state basis, had a lot of unique challenges in terms of wine and spirits distribution. But is that a unique-to-Ireland type of business segment for you? Or might there be other types of applications in your geographies around the world in that type of segment?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [50]

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I would say it's a little more unique to Ireland or maybe some parts of Europe. In Ireland, we have a small -- we sold a small amount of wine and spirits. In that market in particular, the competitive set -- wine and spirits is a big part of the competitive set. So the Classic Drinks acquisition really puts us in a great spot to compete more broadly in that overall market. And so I'd say it is a little more unique. They don't have nearly the kind of state-by-state laws that we have here in the U.S., and so it's -- I'd say, at this point, think about it as something that's appropriate for that market but not something that is a strategic shift for Sysco.

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Operator [51]

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

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Edward Joseph Kelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [52]

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I wanted to just start off with a question on gross profit per case. Your gross profit dollars exceeded case growth in U.S. Broadline again after really kind of, I guess, stalling over the last couple of quarters, so obviously encouraging. I would imagine that this is reinflation, normalization of inbound freight, better local mix, I mean, all things that are good for you and the industry, obviously. Is there anything else in here that was driving that? And should we expect that to continue going forward?

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [53]

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Yes, I don't -- Ed, this is Joel. I think the other thing you probably -- I think you summarized it pretty well. The only thing I might add is the -- our brand growth. Again, that's something -- 59 percentage points up again in this -- in our local brand sales this quarter. So I mean, I think that's -- I'd say that's one other area that's certainly strongly impacting that. And so I think you're right. I mean, again, some of the -- a few of the things that you did talk about. Again, to Tom's point, the inbound freight piece was a little bit of an overlap issue, I'd call it, that if you'll recall a year ago, we were talking about was a fairly sizable impact for us. So there's probably some -- a little bit of heavier influence from that. But broadly speaking, I think the mix, the brand, a bit more inflation and, again, some normalizing some of the impacts we had on the inbound freight, I think, is certainly a fair way to look at that.

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Edward Joseph Kelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [54]

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All right. And then just on the OpEx side. The growth in OpEx moderated a bit from Q1 but still reasonably high. Obviously, that's warehouse labor, driver pay. Just thoughts on where you are in terms of having to raise wages on both of those sides. And how are you thinking about the necessity of future wage increases? Just any thoughts on whether things are settling down at all there for you.

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

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I think what's happening is we are kind of at a new level. We talked about it on the inbound side and certainly, I'd say, on some of the internal operating expenses. Having said that, I don't -- so I don't think we're necessarily anticipating any larger significant costs like hourly increases that are going to dramatically change the OpEx going forward. Where we're very focused on is how do we go after some of those big cost buckets that drive the expense. And so for -- in this business, as you well know, there are things like miles driven. There are things like cases per mile. So the efficiencies that we can drive that really impact the costs are the things that we're trying to focus on. And we've got a couple of initiatives that we feel early days are helping us and performing well. We've talked about small delivery vehicles a bit in the past. We think that, that's a mitigating factor in the fact that we can bring in kind of non-CDL drivers in that environment and deliver those cases at a little lower cost per case. So we're trying to do a lot of those things that ultimately help the overall cost, the operating expense, if you will, more broadly on a sustainable basis knowing that we do have higher wage rates than we did in the past and that we'll probably continue to see that going forward. But I don't think it's a new spike that's coming in front of us. I think it's more we've now kind of hit that number and we're now just trying to manage the overall utilization of our headcount and our resources.

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [56]

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And I think if I can add one thing to that also is just the -- again, part of our -- part of the challenge we are having with some of the retention of some of the newly hired associates. And so I think -- which is then driving overtime, which is then driving other things that are lower -- a little bit lower productivity. And so I think somewhere we're also making a significant emphasis on is in terms of hiring, our training, our onboarding processes to ensure that we do have a better retention rate with some of the hiring, both on the driver and the warehouse side. But I think to Tom's point, I agree, I think it's leveled out somewhat but certainly not in a position where we'd say we're past the issue.

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Edward Joseph Kelly, Wells Fargo Securities, LLC, Research Division - Senior Analyst [57]

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Joel, just one quick one for you on the tax rate. When you say the full year tax rate at 25%, I think the adjusted tax rate in the first half is lower than that. How should we think about the back half tax rate? I guess that's what I'm asking you.

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [58]

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Yes. I would just look at the whole -- about a 25% run rate would be the way I would think about that.

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Operator [59]

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Your next question is from the line of Ajay Jain with Pivotal Research.

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Ajay Kumar Jain, Pivotal Research Group LLC - Co-Head of Consumer Sector Research [60]

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On the cost cutting that you've just announced, it sounds like those initiatives are mostly focused on U.S. operations. So I don't know if there's any international component for the headcount reductions. But can you give any additional geographic breakdown on the latest cost-cutting initiatives? And then within the U.S., what's the relative breakdown of the cost cuts between the regional operating companies and corporate?

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [61]

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Sure. So it's Joel. I'll start here. So the discussion we had regarding the cost cuts here was exclusively focused in our U.S. business and really on our corporate office and our corporate support. So I think this was not a -- what I'll call U.S. field related. It was -- again, it was really specifically in our U.S. and corporate support operations. So I think the -- some of the things we did talk about on a few of certain items was related to, again, some of the infrastructure changes we had in bringing our businesses together in France. But what you're specifically asking about is U.S. related only.

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Ajay Kumar Jain, Pivotal Research Group LLC - Co-Head of Consumer Sector Research [62]

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Okay. And I know you didn't want to provide a dollar amount for the cost savings in response to an earlier question. But can you at least confirm what you're expecting for overall restructuring charges that are associated with the layoffs?

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [63]

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Yes, Ajay, we haven't given that out. We're not planning to.

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Operator [64]

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Your next question is from the line of Bob Summers with Buckingham.

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Robert William Summers, The Buckingham Research Group Incorporated - Research Analyst [65]

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You talked about volumes being choppy during the quarter but coming back toward the end. But any comment on how January was and any impact from the shutdown?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [66]

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I don't think we saw much of an impact from the shutdown. I think what I'd say is that we feel good about how the quarter has started and we feel like it's delivering on the trajectory that we had hoped.

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Robert William Summers, The Buckingham Research Group Incorporated - Research Analyst [67]

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Okay. And then circling back to the cost saving numbers. When I think about the transformation and the smart spending and having a second half impact, is it fair to say that you're trying to get us to weight that more toward the fourth quarter?

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [68]

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I don't know that we've said that, Bob. I mean, I think we've been pretty consistent in saying that we anticipate improvement in the second half of the year. Having said that, that doesn't mean day 1 in Q3 is like everything happens, and so there is a little bit of a spreading over the third quarter where things kick in, which I guess would then suggest fourth quarter would be a bit stronger. But we've been pretty consistent again as well in the second half. And as these things do happen, again, it's a little bit of a ramp over the course of Q3.

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Robert William Summers, The Buckingham Research Group Incorporated - Research Analyst [69]

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Right. Of course. And then lastly, as I think about all the expense savings that you've articulated and -- are they sufficient enough to drive the expense growth, say, below 2.5%, which will allow you the opportunity to flex that spread up, which, if you think about achieving the plan at some point, you'll have to overachieve on that spread for a couple of quarters to get back on track? Is that fair to hold you to that?

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [70]

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I think it is. And certainly, again, we certainly acknowledge that and, again, certainly continue to look for acceleration of opportunities there. But yes, I think that's fair.

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Operator [71]

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Your final question is from the line of Andrew Wolf with the Loop Capital Markets.

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Andrew Paul Wolf, Loop Capital Markets LLC, Research Division - MD [72]

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So the quarter, the U.S. local case growth, I think it faced the toughest year-ago comparison of this economic cycle, if you will. So given the commentary you just made, Tom, that you like how January is and what you'd said about the macro environment, really, I guess, that you get easier comparisons. It shouldn't be too much of a leap of faith for us to get to model somewhat better case growth than you showed this quarter?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [73]

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Look, I think I'd start with -- and we talked about this prior quarter, we talk about again here. In the second quarter, we had -- we lost some cases from acquisition that we did a year ago, HFM, also a couple of large national customers that we lapped. We have another acquisition that we're going to be lapping that we did last year, a larger one than the ones we've done, that we're going to be lapping kind of in the third quarter. So I would say, my commentary around the start to this quarter is it's in line with what we had hoped and what we expected. And so we feel generally good. Having said that, you guys all know, many of you have lived in the frozen -- where the polar vortex happened a week ago. We saw -- we see always things that come up and happen throughout the quarter that we all have to deal with. And so you see little impacts from things like that as well in certain parts of geographies. So I would just say we feel good about the momentum we've had. We feel like we're on the path that we had hoped for. And I don't think there's anything that would necessarily should change your thoughts, your projections one way or another. I think you should -- the commentary we've given is we feel good about the back half. We feel like we can deliver the incremental upside that we've talked about, primarily driven by a lot of the cost activities, and we're feeling pretty good right now.

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [74]

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The only thing I would add to that, just a slight caveat is just remember, I mean, our third quarter, our March -- March is our big month, in other words. So certainly, a couple -- again, talked about -- as Tom said, some decent trends coming out of this thing. But obviously, our Q3 is made or broken to some extent by March. So just as a reminder of that.

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Andrew Paul Wolf, Loop Capital Markets LLC, Research Division - MD [75]

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Sure. And just to close on product cost inflation and talking about how it inflected and we can see those in the numbers the government reports as well. Just curious, do your systems and management allow for that to be passed through, if possible, almost real-time, number one? And how about competitively? Is there just a normal lag, just a sense that nobody wants to be the first guy that move up prices? Or do these prices get through pretty much -- passed through pretty much as they occur?

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Joel T. Grade, Sysco Corporation - Executive VP & CFO [76]

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I think what I would say to that is that just keep in mind the order of magnitude of these things, too. I mean, what we always talk about is that this industry, with a couple percent inflation, typically has been historically able to pass those things along. And so certainly, we continue to feel good about that. And I think a little bit of a lag on -- if you think about half our business being contracts with some type of cost plus, and there's typically a little bit of lag in terms of when we actually are able to book cost increases and then pass that through. So it's not sort of an immediate thing. And on the local side, again, I would just say in these times of what I'd call modest inflation, I think we generally feel pretty good about our ability to pass those things through. So I don't know -- I wouldn't call us in a place where we've got some rapidly accelerated inflation. I think we're in a pretty good inflation point and certainly feel pretty good about our ability to do so.

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Andrew Paul Wolf, Loop Capital Markets LLC, Research Division - MD [77]

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Okay. And if I could lastly, just on the international gross margin contracting a bit this quarter sort of a trend, is that still mainly driven out of the U.K. with the cost inflation they're getting because of their currency? Or is it more broad based?

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Thomas L. Bené, Sysco Corporation - Chairman of the board, President & CEO [78]

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It's primarily U.K. A little bit also in Mexico, but it's primarily U.K.

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Operator [79]

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Thank you for joining us today. This concludes today's earnings call. You may now disconnect.