Business context and reporting period
Sysco Corporation distributes food and related products to foodservice customers. This Form 10-Q covers the 13 weeks ended September 26, 2015 (fiscal 2016 first quarter); comparisons are with the 13 weeks ended September 27, 2014.
Financial results and position
- Sales: $12.563 billion, up 0.9% year over year. Growth from volume and acquisitions was partly offset by deflation and a 2.0% adverse foreign-exchange impact.
- Profit and margins: Gross profit was $2.238 billion, up 2.3%; gross margin rose to 17.81% from 17.59%. Operating income increased 6.0% to $493.5 million, with operating margin of 3.9% versus 3.7%. GAAP net earnings fell 12.3% to $244.4 million; diluted EPS was $0.41 versus $0.47. Adjusted net earnings rose 0.9% to $311.7 million and adjusted diluted EPS was $0.52 in both periods.
- Cash flow: Operating cash flow was negative $261.5 million, versus positive $62.6 million a year earlier; free cash flow was negative $381.2 million versus negative $55.1 million. Capital expenditures were $121.2 million. Management attributed the cash-flow decline mainly to merger-termination payments and lower accrued expenses, including incentive payments.
- Liquidity and debt: Quarter-end cash was $388.3 million and total debt was approximately $3.0 billion. Commercial paper outstanding was $717.5 million at quarter end; as of October 24, $484.0 million was outstanding and none was drawn on the supporting credit facility. Management said operating cash flow and access to commercial-paper and capital markets should meet anticipated requirements for the next 12 months.
- Other metrics: The effective tax rate was 35.98% versus 36.18%. Dividends declared were $0.30 per share versus $0.29. Cash paid for acquisitions was $83.6 million.
Material changes versus the prior comparable period
- Interest expense rose $96.0 million, principally because Sysco redeemed $5.05 billion of notes issued to finance the proposed US Foods merger. The redemption generated an $86.5 million loss on extinguishment of debt; related financing costs included in interest expense totaled $94.8 million.
- The proposed US Foods merger was terminated in June 2015. Management said it did not anticipate further merger-termination costs; first-quarter costs were $9.8 million, compared with $40.5 million of merger and integration-planning costs in the prior-year quarter.
- U.S. Broadline case volumes, including acquisitions, increased 3.4%, with locally managed customer case growth up 2.0%. Sysco-wide product-cost deflation was 0.2%, compared with 4.9% inflation a year earlier. Foreign-currency translation reduced sales growth by 2.0%.
- Segment performance was mixed: Broadline sales rose 0.6% and operating income 5.9%; SYGMA sales fell 6.2% while operating income increased 1.4%; Other-segment operating income declined 29.7%, largely due to startup and early-stage operating costs.
- Cash and current liabilities fell sharply from June 27, 2015, principally reflecting redemption of the merger-related notes and use of cash and commercial-paper proceeds. Sysco also released $168.3 million of restricted cash by using letters of credit for self-insurance security.
Outlook, commentary and risks
- Management cited strong case-volume growth and improved gross-margin performance despite deflation, competitive pricing pressure and foreign-exchange headwinds. It expected deflation and currency translation to remain factors in the following months.
- New three-year targets included at least $400 million of operating-income improvement by fiscal 2018, with 20%–30% targeted in fiscal 2016, and fiscal 2018 diluted EPS of $2.40–$2.50. Sysco also targeted a four-day improvement in working capital and planned a $3.0 billion share-buyback program over two years.
- After quarter end, Sysco issued $2.0 billion of senior notes on September 28, 2015, with maturities in 2020, 2025 and 2045. Proceeds were intended to fund a $1.5 billion accelerated share repurchase, repay about $500 million of commercial paper and support general corporate purposes. By October 24, 32.3 million shares had been delivered under the repurchase; final share settlement remained subject to the agreement’s terms. Management estimated a fiscal 2016 EPS benefit of approximately $0.03–$0.04, partly offset by higher interest expense.
- Principal disclosed risks include continued deflation, competitive margin pressure, foreign-exchange movements, fuel-price volatility, economic and customer-demand conditions, labor availability, technology and cybersecurity disruption, pension obligations, and access to capital. Sysco reported various legal proceedings but did not expect their resolution to materially adversely affect consolidated results or financial position; outcomes remain uncertain.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of the reported earnings decline reflects the one-time debt-redemption costs, and how do GAAP results reconcile to management’s adjusted measures?
- Whether negative first-quarter operating and free cash flow reverses with normal seasonality, and how working capital and merger-related cash payments trend.
- Whether volume growth, especially in Broadline and locally managed customers, offsets deflation, foreign-exchange pressure and competitive pricing.
- Progress toward the fiscal 2016–2018 operating-income, EPS and working-capital targets, and the assumptions behind those targets.
- The final cost, share count and financing impact of the accelerated repurchase, alongside debt levels and interest expense after the September 2015 note issuance.