Strategy
We intend to continue to expand our market share and grow earnings through strategies which include:
• Sales growth: We intend to grow sales by gaining an increased share of products purchased by existing customers, development of new customers, the use of foldouts (new operating companies created in established markets previously served by other Sysco operating companies), investment in new technologies and a disciplined acquisition program. Our business review program, which is designed to help our customers grow their business, and the size and expertise of our sales force are key factors in maintaining and growing sales.

• Lowering Procurement Costs: We intend to lower our cost of goods sold by leveraging Sysco's purchasing power and procurement expertise and capitalizing on an end-to-end view of our supply chain. Our National Supply Chain initiative is focused on lowering inventory, inbound freight, product costs, operating costs, working capital requirements and future facility expansion needs at our operating companies while providing greater value to our suppliers and customers. A component of our National Supply Chain initiative is the use of redistribution centers (RDCs) which aggregate inventory demand to optimize the supply chain activities for certain products for all Sysco broadline operating companies in a geographic region. We currently have two RDCs located in Virginia and Florida and have purchased the land for a third RDC in Indiana.

• Productivity Gains: We intend to optimize warehouse and delivery activities across the corporation and manage energy consumption to achieve a more efficient delivery of products to our customers.

• Enhanced Technology Platform: During fiscal 2009, we commenced the design of an enterprise-wide project to implement an integrated software system to support the majority of our business processes. The goal of the project is to create a new technology platform that simplifies and standardizes our business model, which we believe will improve the efficiency and effectiveness of our operations.

We will continue to use our strategies to leverage our market leadership position to continuously improve how we buy, handle and market products for our customers. Our primary focus is on growing and optimizing the core foodservice distribution business in North America; however, we will continue to explore and identify opportunities to grow our global capabilities in other markets. As a part of our ongoing strategic analysis, we regularly evaluate business opportunities, including potential acquisitions and sales of assets and businesses.
Results of Operations
The following table sets forth the components of our consolidated results of operations expressed as a percentage of sales for the periods indicated:

                                               2009        2008        2007
              Sales                            100.0 %     100.0 %     100.0 %
              Cost of sales                     80.9        80.8        80.7

              Gross margin                      19.1        19.2        19.3
              Operating expenses                14.0        14.2        14.4

              Operating income                   5.1         5.0         4.9
              Interest expense                   0.3         0.3         0.3
              Other income, net                 (0.0 )      (0.1 )      (0.0 )

              Earnings before income taxes       4.8         4.8         4.6
              Income taxes                       1.9         1.8         1.7

              Net earnings                       2.9 %       3.0 %       2.9 %

The following table sets forth the change in the components of our consolidated results of operations expressed as a percentage increase or decrease over the prior year:

                                                    2009        2008
                  Sales                             (1.8 )%      7.1 %
                  Cost of sales                     (1.7 )       7.2

                  Gross margin                      (2.2 )       6.5
                  Operating expenses                (2.8 )       5.3

                  Operating income                  (0.4 )      10.0
                  Interest expense                   4.3         6.2
                  Other income, net                (34.8 )      29.3

                  Earnings before income taxes      (1.1 )      10.5
                  Income taxes                       4.3        10.5

                  Net earnings                      (4.5 )%     10.5 %


                  Basic earnings per share          (3.3 )%     13.0 %
                  Diluted earnings per share        (2.2 )      13.1

                  Average shares outstanding        (1.8 )      (2.0 )
                  Diluted shares outstanding        (2.4 )      (2.5 )

Sales
Sales for fiscal 2009 were 1.8% less than fiscal 2008. Product cost inflation and the resulting increase in selling prices had a significant impact on sales levels in fiscal 2009. Estimated product cost increases, an internal measure of inflation, were approximately 4.7% during fiscal 2009. The changes in the exchange rates used to translate our foreign sales into U.S. dollars negatively impacted sales by 1.2% compared to fiscal 2008. Non-comparable acquisitions offset the rate of sales decline by 0.2% for fiscal 2009.
Sales for fiscal 2008 were 7.1% greater than fiscal 2007. Product cost inflation and the resulting increase in selling prices had a significant impact on sales levels in fiscal 2008. Estimated product cost increases, an internal measure of inflation, were approximately 6.0% during fiscal 2008. The changes in the exchange rates used to translate our foreign sales into U.S. dollars increased sales by 1.0% compared to fiscal 2007. Non-comparable acquisitions contributed 0.1% to the overall sales growth rate for fiscal 2008.
Our sequential quarterly sales trend has demonstrated a continuing decline throughout fiscal 2008 and 2009 from a positive 8.5% in the first quarter of fiscal 2008 to a negative 6.6% in the fourth quarter of fiscal 2009. We believe the deteriorating economic conditions, which are placing pressure on consumer disposable income, are contributing to a decline in real volume in the foodservice market and, in turn, have contributed to a reduction in our sales. We believe we will continue to experience a difficult economic environment into fiscal 2010. Thus far in fiscal 2010, we have experienced moderate deflation. Both of these conditions will make it challenging to grow sales in fiscal 2010; however, if underlying economic conditions improve during fiscal 2010, we believe our trend of sequential quarterly sales decline may reverse.
We believe that our continued focus on the use of business reviews and business development activities, investment in customer contact personnel and the efforts of our marketing associates and sales support personnel are key drivers to strengthening customer relationships and growing sales with new and existing customers. We also believe these activities help our customers in this difficult economic environment.
Operating Income
Cost of sales primarily includes product costs, net of vendor consideration and in-bound freight. Operating expenses include the costs of facilities, product handling, delivery, selling and general and administrative activities.
Operating income decreased 0.4% in fiscal 2009 from fiscal 2008 to $1,872,211,000, or 5.1% of sales. Operating income declined primarily due to a decline in sales, partially offset by a decline in operating expenses. Gross margin dollars decreased 2.2% in fiscal 2009 as compared to fiscal 2008, and operating expenses decreased 2.8% in fiscal 2009.
Operating income increased 10.0% in fiscal 2008 over fiscal 2007 to $1,879,949,000, or 5.0% of sales. Operating income increased primarily due to an increase in sales, partially offset by an increase in operating expenses. Gross margin dollars increased 6.5% in fiscal 2008 as compared to fiscal 2007, and operating expenses increased 5.3% in fiscal 2008.

Beginning in the fourth quarter of fiscal 2007, Sysco began experiencing high levels of product cost increases in numerous product categories. These increases persisted throughout fiscal 2008 at levels approximating 6.0% and rose even higher to 7.6% in the first 26 weeks of fiscal 2009. The level of product cost increases began moderating during the third quarter of fiscal 2009 and was 0.5% in the fourth quarter of fiscal 2009. Generally, Sysco attempts to pass increased costs to its customers; however, because of contractual and competitive reasons, we are not able to pass along all of the product cost increases immediately. Prolonged periods of high inflation, such as those we have recently experienced, have a negative impact on our customers, as high food costs and fuel costs can reduce consumer spending in the food-prepared-away-from home market. As a result, these factors may negatively impact our sales, gross margins and earnings. We may also be negatively impacted by periods of prolonged product cost deflation because we make a significant portion of our sales at prices that are based on the cost of products we sell plus a percentage markup. As a result, our profit levels may be negatively impacted during periods of product cost deflation, even though our gross profit percentage may remain relatively constant.
We believe the operating expense performance for fiscal 2009 compared to fiscal 2008 was aided by operating efficiencies and lower payroll expense related to reduced headcount and lower incentive compensation. The positive impact of these expense reductions was partially offset by the combined effect of increased losses on the adjustment of the carrying value of corporate-owned life insurance policies to their cash surrender values and an increase in the provision for losses on receivables. In addition, our fuel costs increased during fiscal 2009 compared to fiscal 2008.
Operating expenses in fiscal 2008 compared to fiscal 2007 were negatively impacted by the combined impact of losses on the adjustment of the carrying value of corporate-owned life insurance policies to their cash surrender values and increased provisions related to multi-employer pension plans. The negative impact of these expense increases was partially offset by lower share-based compensation expense and lower company-sponsored pension expenses. In addition, our fuel costs increased during fiscal 2008 compared to fiscal 2007. We increased our use of fuel surcharges to offset a portion of these increased costs, thereby partially reducing the impact to operating income.
We adjust the carrying values of our corporate-owned life insurance policies to their cash surrender values on an ongoing basis. The cash surrender values of these policies are largely based on the values of underlying investments, which include publicly traded securities. As a result, the cash surrender values of these policies will fluctuate with changes in the market value of such securities. The performance in the financial markets resulted in losses for these policies of $43,812,000 in fiscal 2009, losses of $8,718,000 in fiscal 2008 and gains of $23,922,000 in fiscal 2007. The performance of the financial markets will continue to influence the cash surrender values of our corporate-owned life insurance policies, which could cause volatility in operating income, net earnings and earnings per share.
The provision for losses on receivables included within operating expenses increased by $42,454,000 in fiscal 2009 over fiscal 2008. The current economic conditions and related decrease in consumer demand combined with tightening credit markets have impacted the liquidity of some of our customers, resulting in an increase in delinquent payments on accounts receivable. Customer accounts written off, net of recoveries, were $71,877,000, or 0.20% of sales, $32,367,000, or 0.09% of sales, and $26,010,000 or 0.07% of sales, for fiscal 2009, 2008 and 2007, respectively. The increase in our provision for losses on receivables is related to customer accounts across our customer base without concentration in any specific location. We continue to monitor our customer account balances and our credit policies and believe continued strong credit practices will be necessary to avoid significant increases in our provision for losses on receivables. However, if the difficult economic environment persists, we expect to continue to experience higher levels of provision for losses on receivables and higher levels of write-offs, such as those experienced in fiscal 2009, in fiscal 2010.
Pay-related expenses decreased by $192,086,000 in fiscal 2009 from fiscal 2008. The reduction was due to a combination of reduced headcount and lower incentive compensation. Headcount declines occurred due to both productivity improvements and workforce reductions commensurate with lower sales. The criteria for paying annual bonuses to our corporate officers and certain portions of operating company management bonuses are tied to overall company performance. The overall company performance criteria for payment of such bonuses for fiscal 2009 were not met; therefore corporate executive officers will not receive bonuses for fiscal 2009 and operating company management bonuses are at lower levels for fiscal 2009 as compared to fiscal 2008.
Sysco's fuel costs increased by $33,154,000 in fiscal 2009 over fiscal 2008 primarily due to increased contracted diesel prices. Our fuel costs increased by $34,023,000 in fiscal 2008 over fiscal 2007 due to increased market diesel prices. Sysco's costs per gallon increased 18.6% in fiscal 2009 over fiscal 2008 and 18.7% in fiscal 2008 over fiscal 2007. Sysco's activities to manage increased fuel costs include reducing miles driven by our trucks through improved routing techniques, improving fleet utilization by adjusting idling time and maximum speeds and using fuel surcharges. Fuel surcharges were approximately $5,000,000 higher in fiscal 2009 over fiscal 2008 and $27,000,000 higher in fiscal 2008 than in fiscal 2007. Usage of these surcharges was greater in the second half of fiscal 2008 and first half of fiscal 2009, due to sustained, increased market diesel prices during that period. Fuel surcharges are reflected within sales and gross margins.

We periodically enter into forward purchase commitments for a portion of our projected monthly diesel fuel requirements. In fiscal 2009, the forward purchase commitments resulted in an estimated $68,000,000 of additional fuel costs as the fixed price contracts were higher than market prices for the contracted volumes. In fiscal 2008, the forward purchase commitments resulted in an estimated $21,000,000 of avoided fuel costs as the fixed price contracts were generally lower than market prices for the contracted volumes. In fiscal 2007, the forward purchase commitments resulted in prices that were comparable to market prices.
As of June 27, 2009, we had forward diesel fuel commitments totaling approximately $64,000,000 through March 2010. In July 2009, we entered additional forward purchase commitments totaling approximately $16,000,000 at a fixed price through June 2010. Together, these contracts will lock in the price of approximately 40% of our fuel purchase needs for fiscal 2010. Our commitments through August 2009 were entered into at prevailing rates from mid-July through mid-August 2008. As a result, these contracts are at fixed prices greater than both the prices incurred during same periods in the previous fiscal year and current market prices. The remainder of our outstanding contracts were entered into at the prevailing rates in March, April and July 2009 and thus the fixed price on these contracts reflects the lower current market price for diesel.
Fuel costs in fiscal 2010, exclusive of any amounts recovered through fuel surcharges, are expected to decrease by approximately $50,000,000 to $80,000,000 as compared to fiscal 2009. Our estimate is based upon the prevailing market prices for diesel in mid-August 2009, the cost committed to in our forward fuel purchase agreements currently in place for fiscal 2010 and estimates of fuel consumption. Actual fuel costs could vary from our estimates if any of these assumptions change, in particular if future fuel prices vary significantly from our current estimates. We continue to evaluate all opportunities to offset potential increases in fuel expense, including the use of fuel surcharges and overall expense management. However, consistent with the lower current market price for diesel, we expect fuel surcharge revenue to be significantly lower in fiscal 2010 as compared to fiscal 2009, declining by as much as $60,000,000.
Share-based compensation cost in fiscal 2009 was $24,620,000 less than in fiscal 2008. Share-based compensation expense decreased $17,335,000 in fiscal 2008 from fiscal 2007. Contributing to the decrease in both years was a reduction in the level of option grants being awarded compared to previous years, resulting in reduced compensation expenses being recognized. Also affecting the decrease in fiscal 2009 was the removal of the previous stock award component from the Management Incentive Plan annual bonus awards beginning with fiscal 2009. As a result, the share-based compensation expense related to the stock award component of the incentive bonuses recorded in previous years was not incurred in fiscal 2009, and overall share-based compensation expense was reduced as compared to the prior year. Beginning in fiscal 2010, we expect to replace the stock award component of the incentive bonuses with annual discretionary grants of restricted equity awards subject to time-based vesting. Share-based compensation expense in fiscal 2010 is expected to increase by $5,000,000 to $15,000,000 relative to fiscal 2009 due primarily to the anticipated discretionary grant of restricted awards in fiscal 2010.
Net company-sponsored pension costs in fiscal 2009 were $22,877,000 higher than fiscal 2008, due primarily to the recognition of actuarial losses from lower returns on assets of Sysco's company-sponsored qualified pension plan (Retirement Plan) during fiscal 2008 and the merging of participants from a multi-employer pension plan the Retirement Plan (see Multi-Employer Pension Plans at "Liquidity and Capital Resources, Other Considerations"), partially offset by a decrease in expense due to an increase in the discount rates used to calculate the plan's liabilities and amendments to our Supplemental Executive Retirement Plan (SERP). Net company-sponsored pension costs decreased $8,754,000 in fiscal 2008 over the prior year, due primarily to the funding status and the projected asset performance of the Retirement Plan at that time. Net company-sponsored pension costs in fiscal 2010 are expected to increase by approximately $37,000,000 over fiscal 2009 due primarily to lower returns on assets of the Retirement Plan during fiscal 2009, partially offset by an increase in the discount rates used to calculate our projected benefit obligation and related pension expense for fiscal 2010.
We recorded provisions related to multi-employer pension plans of $9,585,000 in fiscal 2009, $22,284,000 in fiscal 2008 and $4,700,000 in fiscal 2007. See additional discussion of multi-employer pension plans at "Liquidity and Capital Resources, Other Considerations."
Net Earnings
Net earnings declined 4.5% in fiscal 2009 from fiscal 2008 due primarily to the impact of changes in income taxes discussed below, as well as the factors discussed above. Net earnings increased 10.5% in fiscal 2008 over fiscal 2007 due primarily to the factors discussed above, as well as the impact of changes in income taxes discussed below.
The effective tax rate was 40.37% in fiscal 2009, 38.25% in fiscal 2008 and 38.25% in fiscal 2007.
The effective tax rate for fiscal 2009 was negatively impacted primarily by two factors. First, the company recorded tax adjustments related to federal and state tax contingencies of $31,000,000. Second, the loss of $43,812,000, which had a tax effect of $16,824,000, recorded to adjust the carrying value of corporate-owned life insurance policies to their cash surrender values was non-deductible for income tax purposes and had the impact of increasing the effective tax rate for the period. The effective tax rate for fiscal 2009 was favorably impacted by the reversal of valuation allowances of $7,800,000 previously recorded on Canadian net operating loss deferred tax assets.

The effective tax rate for fiscal 2008 was favorably impacted by tax benefits of approximately $7,700,000 resulting from the recognition of a net operating loss deferred tax asset which arose due to a state tax law change, $8,600,000 related to the reversal of valuation allowances previously recorded on Canadian net operating loss deferred tax assets and $5,500,000 related to the reduction in net Canadian deferred tax liabilities due to a federal tax rate reduction. The effective tax rate for fiscal 2008 was negatively impacted by the recording of tax and interest related to uncertain tax positions, share-based compensation expense and the recognition of losses of $8,718,000, which had a tax effect of $3,348,000, recorded to adjust the carrying value of corporate-owned life insurance policies to their cash surrender values.
The effective tax rate for fiscal 2007 was favorably impacted by the recognition of gains of $23,922,000, which had a tax effect of $9,186,000, recorded to adjust the carrying value of corporate-owned life insurance policies to their cash surrender values. The effective tax rate for fiscal 2007 was negatively impacted by the recognition of tax and interest for tax contingencies.
Sysco's affiliate, Baugh Supply Chain Cooperative (BSCC), is a cooperative taxed under subchapter T of the United States Internal Revenue Code the operation of which has resulted in a deferral of tax payments. The Internal Revenue Service (IRS), in connection with its audits of our 2003 through 2006 federal income tax returns proposed adjustments that would have accelerated amounts that we had previously deferred and would have resulted in the payment of interest on those deferred amounts. Sysco reached a settlement with the IRS on August 21, 2009 to cease paying U.S. federal taxes related to BSCC on a deferred basis, pay the amounts currently recorded within deferred taxes related to BSCC over a three year period and make a one-time payment of $41,000,000, of which approximately $39,000,000 is non-deductible. The settlement addresses the BSCC deferred tax issue as it relates to the IRS audit of our 2003 through 2006 federal income tax returns, and settles the matter for all subsequent periods, including the 2007 and 2008 federal income tax returns already under audit. We . . .