Sysco Earnings Call Insights: Gross Margin Pressure, Operating Expense Leverage

On Monday, Sysco Corporation (NYSE:SYY) reported its third quarter earnings and discussed the following topics in its earnings conference call. Here’s what you need to know.

Gross Margin Pressure

Michael Kelter – Goldman Sachs & Co.: I wanted to ask about the gross margin pressure. Is there a way that you might be able to tease out how much of that is from food inflation versus competitive pressures versus mix shift to lower margin business and kind of I guess as a second part of that is if the current food cost environment holds, meaning the basket is probably going to be down a bit next year based on the spot market, will GM rebound in fiscal ’13?

William J. DeLaney – President and CEO: Obviously, I think you know it’s enough – well enough now to know that I probably can’t answer with the kind of precisions you’d love for me to answer with, but let me try to – as I would say to you that it’s clearly coming from multiple places. I’d say you’ve got first and foremost you’ve got our customers who are feeling a lot of pressure to continue to create traffic in their establishments and that’s where you see this difference in inflation whether inflation at the restaurant is we believe running 2% or 3% and our is about 5% to 7% so far this year. So, there is that kind of challenge that you work through there with your customer each and every day. There is certainly the typical type of competitive pressure that goes along with that. There is – no, that’s not to sell, there is also on the buy where I think we have opportunities there to continue or find ways to work more effectively with our suppliers and that type of thing to in terms of how we purchase the product. Then, I think the third thing; I think this is little more clear this quarter is, there is us in us in terms of our mindset and our approach to pricing and trying to strike the right balance between being responsive to our customers and writing appropriate margin and that type of thing. So it comes from all three, the reality from where I sit, that makes this quarter a little different than the first half of year is, I just feel like we didn’t do as good a job on the margin line in terms of what we can control and what we can influence in the short-term. I would just use an example and I’m not putting a pencil to this, but I think we’re in an environment today, if you just listened already, I just said and look at everything that you all look at. The environment today I don’t think is an environment where anytime soon we are going to see margins turnaround and necessarily grow. I do think there is opportunity to mitigate that pressure and if we just had maybe half of the erosion that we saw on the margin line, maybe even just two thirds of it. I think the tone of my comments and the tone of the release would have been a little different, where our earnings would’ve been good to, maybe not great, but they would have been very acceptable quarter from our perspective. I think we’re in a mode right now where our job is to continue to certainly be sensitive to our customers, work closer with our suppliers, but we’ve got to do a better job managing margin and I think from a messaging standpoint, when you’re selling a box of food, a daily average box costs $30, $35, but some of the boxes in the area where we are seeing the most inflation, poultry, meat, those boxes because cost $45 and $55, it’s very – I don’t think it is practical to expect that that is going to be passed along in a short period of time on a proportionate basis, but I certainly think it is appropriate to expect us to do a better job managing the pricing on that and that’s obviously what we are working at.

A Closer Look: Sysco Earnings Cheat Sheet>>

Michael Kelter – Goldman Sachs & Co.: You mentioned you actually referenced in your opening remarks several initiatives to improve gross margin, could you maybe to the extent that you are able give us an idea of what kind of things are thinking about and if there are any one or two that we should have our eye on?

William J. DeLaney – President and CEO: I think it should be hard for you to have your eye on it, but I think the things we have our eye on is there is certain things that we do in terms of how we approach pricing and where we might make exceptions and that type of thing and how we work with customers and suppliers that we just need to be more consistent throughout the organization. So, it’s not one or two things, it’s several things that go into how we price with both our large contract customers and also with our street customers, how we buy product, how we manage their process internally and where we are really alluding to theirs. We have opportunity to execute better and in particular more consistently throughout the company and just make some better decisions there. So, I can’t give you a lot of granularity for obvious reasons, but I can tell there is opportunity there.

Michael Kelter – Goldman Sachs & Co.: Lastly, maybe if you could talk a bit about the cadence of sales in the quarter. I hate to slice things so finely, but the changing casual dining sales trajectory in intra-quarter, this particular quarter, was pretty significant, where you had a decent January, February and then a weaker March and April. So, curious if you can give us any color as to what you saw for the quarter?

William J. DeLaney – President and CEO: We don’t typically comment on cadence of growth month-to-month. Obviously, we read a lot of what you all write and we have a sense for what you are saying, which is, I believe the industry view is that things did slow down in terms of growth in March and April. As we talked last quarter, it is back-ended weighted quarter for us, March is always going to drive our number. So, anytime you got a bigger denominator, I think sometimes that will affect the growth rates as well, but certainly the things that helped in January and February, were the calendar, I believe we had – I think the holiday helped us here early on in the quarter. In the scheme of the overall numbers, that’s not that big a deal. I think weather was probably the biggest thing and we have kind of whining about weather, but at least on this call we are at least acknowledging that it clearly helped the industry and it helped us from the standpoint I think in some of your more metropolitan markets in the north. We saw and felt better volumes. I will quickly add and I’m not whining about it, as I said, we were hurt in areas where you would expect winter to be beneficial, so the big ski areas in Colorado and Utah, and in Florida. We did not do as well in those areas and so I’m not going to say it netted out, but it wasn’t a totally positive thing from weather standpoint. So, I’m not trying to dodge your question too much here, but we saw good growth in first couple of months. It continued maybe at somewhat of lower rate, but I’d have to tell you, the biggest thing I think we’re beginning to see, and we don’t comment on this on a month-by-month basis either is, I think the rate of inflation is subsiding and that’s going to affect the top line as well. Hopefully, over time, it will subside to a level where it’s more in sync with what our customers can absorb.

Operating Expense Leverage

Ajay Jain – Cantor Fitzgerald: My first question is just on the operating expense leverage, which I think was somewhat commendable, but you clearly benefited from the cycling of last year’s charge for multiemployer pension expense. I just wanted to ask if there were any other factors that you can talk about behind the cost savings and whether or not any of the SG&A improvement has spillover effect into the fourth quarter?

William J. DeLaney – President and CEO: I think we did some good things on the expense line. We tried to call out the things that I would characterize as nonrecurring or unusual. So, the business transformation expense because of where we are in the timeline was a little less than what we originally thought and we did have the credit last year. The point I made was that, at the operating company level, our cost per case was down slightly which is a big deal to manage your cost per case flat to down is something we’re always trying to do and at times we do it better than other times. So, I think if you go and look at our first half of the year, certainly we have margin pressure. The first quarter we didn’t see the type of volume growth we would have like to see in that. We did do better in that area in the second quarter, but we had opportunities just on execution in terms of the expense side in the business and I just felt that our folks did a better job managing the expense throughout the Company in all facets, SG&A and operations. So, I think we just executed better on that line and that’s a line we’re going to have to continue to address both structurally as well as just day-to-day management to mitigate the margin pressures that we can’t totally overcome.

Ajay Jain – Cantor Fitzgerald: Can you confirm if there was a significant payroll or headcount driven benefit this way this quarter?

William J. DeLaney – President and CEO: I’ll let Chris take that one.

R. Chris Kreidler – EVP and CFO: Really nothing to be called out Ajay.

Ajay Jain – Cantor Fitzgerald: As far as the change in the outlook for pension expense, Chris can you confirm what’s behind the updated guidance and if that’s on the multiemployer side or presumably with your corporate sponsored pension plan?

R. Chris Kreidler – EVP and CFO: I may not be understanding the questions. We actually did change our pension guidance. It’s been the same all year. Was there a different question?

Ajay Jain – Cantor Fitzgerald: No. I’m sorry I was just – I was going off of your presentation materials. I though the pension expense was indicated to be $25 million lower than fiscal ’11.

R. Chris Kreidler – EVP and CFO: Yeah, and that’s been the case. For the year, we said it would be down about $28 million, roughly about $7 million per quarter and that’s been consistent during the year. That’s one of those items you set in the beginning and it pretty much is set for the year. So, I was just calling out that on a year-over-year basis that is lower and it’s one of the reasons why the cost is lower.

Ajay Jain – Cantor Fitzgerald: Sorry, my bad. Finally I understand that you were able to eke out some gross profit dollars growth this last quarter, but assuming that you are going to market now with a more aggressive pricing structure, the gross margin impact seems to be increasing each quarter so even as inflation seem to be moderating, do you have any color about the gross margin outlook for the current quarter in June, I mean could the impact be more than the 100 basis points from Q3?

William J. DeLaney – President and CEO: The only color I have, Ajay, is we need to improve as I said a couple of times now. So I certainly hope not and as I mentioned in my prepared comments it’s an area of keen focus here so, and we need to bring that number back. As I said to Michael, at this level of inflation, I don’t know that’s realistic that we can totally reversible it, but we certainly need to lessen out that variance.