Sysco Corporation — Form 10-Q Summary
Reporting period: Fiscal second quarter and first 26 weeks ended December 28, 2013. The quarter comprised 13 weeks. Financial statements are unaudited; year-to-date comparisons are against the 26 weeks ended December 29, 2012.
Business context and financial performance
Sysco distributes food and related products to foodservice customers. Its reportable segments are Broadline and SYGMA. Results reflected a challenging, slow-growth market, competitive pricing, severe weather and a shortened holiday shopping season.
| Metric | 13 weeks ended Dec. 28, 2013 | Change year over year | 26 weeks ended Dec. 28, 2013 | Change year over year |
|---|---|---|---|---|
| Sales | $11.24 billion | +4.1% | $22.95 billion | +4.9% |
| Gross profit | $1.965 billion | +0.7% | $4.030 billion | +1.2% |
| Operating income | $351.8 million | -8.1% | $830.0 million | -3.7% |
| Net earnings | $210.8 million | -4.8% | $496.4 million | -2.3% |
| Diluted EPS | $0.36 | -5.3% | $0.84 | -2.3% |
Gross margin declined to 17.5% from 18.1% in the quarter and to 17.6% from 18.2% year to date. Operating margin was 3.1% versus 3.6% in the quarter and 3.6% versus 3.9% year to date. Management attributed margin pressure to competition and a higher proportion of sales to lower-margin regional and national customers. Adjusted, non-GAAP diluted EPS was $0.47 for the quarter and $1.02 year to date; Sysco cautions that adjusted measures should be considered alongside GAAP results.
Quarterly sales growth included case-volume growth, recent acquisitions and product-cost inflation. Case volumes including acquisitions grew about 4.3% in the quarter and 4.2% year to date; excluding acquisitions, growth was 2.7% and 2.2%, respectively. Acquisitions contributed 1.9% to consolidated sales growth in both periods. Management said sales growth slowed late in the quarter and remained slower early in the third quarter amid weather disruption and weaker restaurant traffic.
Cash flow, debt and liquidity
- Year-to-date cash from operations was $458.2 million, versus $386.8 million a year earlier. Capital expenditures were $270.4 million, versus $261.6 million; reported free cash flow, a non-GAAP measure, was $211.2 million, versus $128.4 million.
- At December 28, 2013, cash and cash equivalents were $449.9 million; current assets were $6.52 billion and current liabilities $3.75 billion. Total debt was $3.206 billion, including $204.2 million of current maturities. Debt increased from $2.889 billion at June 29, 2013.
- Year-to-date financing included $304.5 million of net bank and commercial-paper borrowings, $266.6 million of treasury-stock purchases and $328.3 million of dividends paid. Dividends declared were $0.29 per share for the quarter.
- Sysco reported $400 million of commercial paper outstanding at quarter-end, supported by revolving credit facilities. After quarter-end, it increased and extended its U.S./Canadian revolving facility to $1.5 billion through December 2018.
Material changes and management commentary
- Despite higher sales, gross profit grew more slowly than revenue and operating income fell. Management cited lower gross-margin growth, acquired-operation and volume-related costs, and a $23.8 million increase in the self-insurance reserve estimate. Favorable expense management, lower business-transformation costs and lower retirement-related costs partly offset these factors.
- Broadline sales rose 3.4% in the quarter and 4.4% year to date, while operating income declined 3.2% and 0.5%, respectively. SYGMA sales increased 8.8% and 8.0%, but operating income fell 24.0% and 27.3%, respectively, reflecting delivery costs, lower fuel surcharges, new-customer startup costs and facility-consolidation preparation.
- Management expects fiscal 2014 retirement-related expenses to decline by $75–$85 million versus fiscal 2013, including the prior-year restructuring charges; excluding $21 million of those charges, the anticipated decline is $50–$60 million. Business Transformation Project expenses are expected to be $300–$350 million for fiscal 2014, with management leaning toward the lower end. Sysco expects to meet or exceed its goal of reducing Broadline cost per case by about $0.05 for the fiscal year, but does not expect to sustain the current rate of improvement.
- No full-year revenue or earnings guidance is provided. Management said it expects sufficient liquidity for the next 12 months from operating cash flow, credit facilities and capital-market access.
Merger, outlook and risks
Sysco agreed to acquire US Foods for approximately $3.5 billion of equity consideration ($3.0 billion in Sysco stock and $500 million in cash) and to assume or refinance about $4.7 billion of US Foods net debt, for stated enterprise value of approximately $8.2 billion. The transaction remained subject to regulatory review; management expected a six-to-nine-month review and targeted closing in the first quarter of fiscal 2015. The filing estimated combined annual sales of about $65 billion and at least $600 million of annual synergies over three to four years, with $700–$800 million of costs to achieve those synergies over three years. These are estimates, not assured outcomes. Sysco obtained a $3.3865 billion bridge financing commitment and said it expects permanent financing before closing. The transaction would issue about 87 million Sysco shares, approximately 13% of the post-merger company. Certain termination circumstances could require a $300 million payment.
- Integration, regulatory remedies, customer or supplier losses, execution costs and the expected increase in indebtedness could reduce merger benefits or adversely affect liquidity, credit ratings and results. Rating agencies had placed Sysco on watch for a potential downgrade.
- Sysco estimated potential withdrawal liabilities for certain underfunded multiemployer pension plans of up to $90 million; the estimate relies largely on older plan information and could differ materially. Recorded liabilities for completed withdrawals were approximately $1.5 million.
- Sysco was cooperating with a California investigation concerning alleged violations relating to delivery drop sites; fines or injunctive relief were possible, and financial exposure could not be estimated.
- Other risks include ongoing margin and consumer-demand pressure, fuel and interest-rate exposure, execution of the Business Transformation Project and ERP rollout, and the possibility that merger or transformation costs exceed expectations. Sysco had fixed-price diesel commitments of about $163.2 million through January 2015.
Most important facts for investors to verify
- Whether sales and case-volume growth persist, particularly with locally managed customers, and whether gross-margin compression continues.
- Progress and final regulatory terms for the US Foods transaction, financing structure, total debt assumed or refinanced, termination-fee exposure and achievable net synergies after integration costs.
- Whether operating cash flow and free cash flow remain sufficient to fund capital spending, dividends, repurchases and increased debt service.
- Developments in the California drop-site inquiry and multiemployer pension funding or withdrawal liabilities.
- Delivery of management’s fiscal 2014 expectations for retirement-cost reductions, Business Transformation spending and Broadline cost-per-case improvement.