Sysco Corporation — Form 10-Q Summary
Business context and period. Sysco distributes food and related products to foodservice customers in the U.S. and several international markets. This unaudited report covers the 13 weeks ended September 27, 2014, the first quarter of fiscal 2015; comparisons are with the 13 weeks ended September 28, 2013. Amounts below are in U.S. dollars.
Financial performance and liquidity
| Metric | Q1 FY2015 | Prior-year quarter | Change |
|---|---|---|---|
| Sales | $12.445 billion | $11.714 billion | +6.2% |
| Gross profit | $2.189 billion | $2.065 billion | +6.0% |
| Gross margin | 17.59% | 17.63% | Down 4 basis points |
| Operating income | $465.6 million | $478.2 million | −2.6% |
| Net earnings | $278.8 million | $285.6 million | −2.4% |
| Diluted EPS | $0.47 | $0.48 | −2.1% |
| Cash from operations | $62.6 million | $169.2 million | −63.0% |
| Free cash flow, company-defined non-GAAP | −$55.1 million | $44.1 million | Down $99.1 million |
- Operating expenses rose 8.6% to $1.723 billion; operating margin was 3.7%, versus 4.1%. Management reported adjusted operating income of $509.0 million, up 5.9%, and adjusted diluted EPS of $0.52, up 6.1%. These non-GAAP measures exclude specified severance, merger/integration, facility-closure and financing items.
- Sales growth reflected estimated product-cost inflation of 4.9%, case-volume growth of 2.3% including recent acquisitions (2.2% excluding them), and a 0.6% contribution from acquisitions. Foreign exchange reduced sales growth by 0.5%. Management said industry sales gains were driven largely by inflation rather than improving restaurant traffic.
- Cash from operations was pressured by working-capital investment and pension-contribution timing. Sysco contributed $50 million to its qualified pension plan during the quarter. Capital expenditures were $118.8 million; cash paid for acquisitions was $32.1 million.
- At September 27, cash and cash equivalents were $384.9 million; current assets were $7.108 billion and current liabilities $4.536 billion. Total debt carrying value was approximately $3.0 billion, including $2.650 billion of long-term debt and $306.9 million of current maturities. Commercial paper outstanding was $398.6 million.
- Quarterly dividends declared were $0.29 per share. No shares were repurchased under the public program during the quarter.
Material changes and management commentary
- Broadline sales increased 7.1% and operating income 6.8%. SYGMA sales increased 1.2%, but operating income fell 38.3%, reflecting higher warehouse and delivery costs and a $1.3 million facility-closure charge. Consolidated operating income declined in part because corporate expenses and adjustments increased to $263.6 million from $207.4 million.
- Management attributed higher costs to pay-related expenses, including driver shortages, wages and overtime, as well as merger planning. Costs classified as “Certain Items” included $40.5 million of US Foods merger and integration costs in operating expenses. Management anticipated additional planning and financing costs.
- Sysco’s proposed US Foods merger remained subject to FTC review. At October 25, 2014, estimated transaction enterprise value was $8.5 billion, including approximately $3.7 billion of equity consideration and $4.8 billion of US Foods net debt. Closing was not expected before the first quarter of 2015. US Foods shareholders were expected to own approximately 13% of Sysco after closing.
- Management estimated at least $600 million of annual synergies over three to four years after closing, with $700–$800 million of related costs expected over three years. These are estimates, not assurances; the filing says required remedies, integration difficulties or lost customers and vendors could reduce benefits.
- Sysco priced $5 billion of senior notes in September and funded them in October, after quarter-end; the bridge facility was then terminated. The notes have maturities from 2017 to 2044 and coupons from 1.45% to 4.50%. If the merger does not close by October 8, 2015, or is terminated on or before that date, the notes must be redeemed at 101% of principal plus accrued interest. Management expected approximately $125 million of additional interest expense over the remainder of fiscal 2015 and disclosed a $12.5 million debt-issuance-cost write-off in the following quarter.
- The company paid $58.9 million in September to settle a 10-year forward interest-rate swap and paid a further $129.9 million in October to settle a 30-year swap. Losses on the swaps are to be amortized through interest expense over the related debt terms.
- Management described the business environment as challenging, citing restrained consumer spending, competitive pricing pressure, inflation and customer mix. It said category-management benefits supported gross-profit growth and expected remaining category launches by fiscal year-end, with benefits less impactful in the fourth quarter. The company stated that existing operating cash flow and borrowing and capital-market access should meet anticipated cash needs for the next 12 months.
Risks, contingencies and other items
- Sysco estimated potential withdrawal liability for certain underfunded multiemployer pension plans of up to $90 million; management cautioned that the estimate could differ materially because current plan information was limited. Required contributions may increase.
- Sysco had posted approximately $31.2 million in letters of credit related to Canadian transfer-pricing tax assessments and could need to pay cash or post up to an additional $123.1 million to pursue appeals.
- Gross unrecognized tax benefits were $46.7 million, with $36.7 million of accrued related interest. The company could not estimate the reasonably possible range of near-term changes.
- Management said the outcome of ongoing legal proceedings was not expected to materially adversely affect consolidated financial position or results, while noting that losses above current estimates could affect future periods. Part II reports no legal proceedings.
- Sysco identified risks from merger approval and execution, increased indebtedness, food-cost inflation or deflation, competition and margin pressure, labor availability, pension funding, technology/cybersecurity disruptions, and access to financing. Disclosure controls were deemed effective at the reasonable-assurance level; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Progress and conditions of FTC review, merger timing, any required divestitures or other remedies, and exposure to the $300 million termination payment under specified conditions.
- Final merger consideration and assumed/refinanced US Foods debt, which can change, and whether projected synergies and integration costs are realized.
- Post-issuance debt, interest expense, liquidity and the senior-note redemption requirement if the merger fails to close by the stated deadline.
- Whether operating cash flow and free cash flow recover as working capital, pension contributions and merger-related cash costs evolve.
- Case-volume growth, food-cost inflation, gross-margin trends, driver and labor costs, and SYGMA operating performance.
- Developments in multiemployer pension exposure and Canadian tax appeals, including any change to estimated liabilities or required cash/credit support.