Business context and reporting period
Sysco Corporation distributes food and related products to foodservice customers. This unaudited Form 10-Q covers the 13 weeks and 39 weeks ended March 29, 2014, compared with the periods ended March 30, 2013. Although the request labels the period “2013 Q3,” the filing is for fiscal 2014 third quarter.
Key financial results
| Metric | Q3 FY2014 | Q3 FY2013 | 39 weeks FY2014 | 39 weeks FY2013 |
|---|---|---|---|---|
| Sales | $11.28bn | $10.93bn | $34.23bn | $32.81bn |
| Gross profit | $1.99bn | $1.94bn | $6.03bn | $5.92bn |
| Operating income | $332.6m | $337.2m | $1.16bn | $1.20bn |
| Net earnings | $180.9m | $201.4m | $677.4m | $709.4m |
| Diluted EPS | $0.31 | $0.34 | $1.15 | $1.20 |
- Quarterly sales grew 3.2%, while operating income fell 1.4%, net earnings fell 10.2% and diluted EPS declined 8.8%. For the 39-week period, sales rose 4.3%, but operating income declined 3.0%, net earnings 4.5% and diluted EPS 4.2%.
- Gross margin was 17.69% for the quarter versus 17.78% a year earlier, and 17.60% year to date versus 18.06%. Operating margin was 2.9% versus 3.1% for the quarter and 3.4% versus 3.7% year to date.
- Management reported adjusted diluted EPS of $0.38 for Q3, down 5.0%, and $1.26 year to date, down 1.6%. These are non-GAAP measures excluding specified items; they do not replace GAAP results.
- Q3 sales were affected by severe winter weather and low inflation; management said March sales growth improved to 5.5% year over year. Quarterly case volume, including acquisitions, rose about 3.0%; sales from recent acquisitions contributed 0.8% and product-cost inflation was about 0.9%.
Cash flow, balance sheet and liquidity
- For the first 39 weeks, operating cash flow was $848.1m, compared with $759.4m. Capital expenditures were $387.5m versus $373.0m; free cash flow, as defined by Sysco, was $484.3m versus $398.5m.
- Cash and cash equivalents were $341.1m at March 29, 2014. Total assets were $13.14bn and shareholders’ equity $5.23bn. Current assets were $6.64bn and current liabilities $3.94bn.
- Debt carrying value was approximately $3.06bn, up from $2.89bn at June 29, 2013. Commercial paper outstanding was $441.1m at quarter-end. A $1.5bn revolving facility supports U.S. and Canadian commercial paper; Sysco reported no borrowings on its separate $95m uncommitted bank lines.
- Financing cash uses included $497.8m of dividends and $332.4m of treasury-stock purchases. Sysco paid $200m of 4.6% senior notes at maturity during March.
Material changes and management commentary
- Gross profit increased, but grew more slowly than operating expenses year to date. Management cited competition, customer mix shifting toward lower-margin corporate-managed accounts, volume-related costs, acquisitions, and higher delivery and warehouse expenses. Business Transformation initiatives and lower retirement-related costs partly offset these pressures.
- Broadline sales rose 2.7% in Q3 and segment operating income increased 13.3%; the prior-year quarter included a $40.7m multiemployer-pension withdrawal charge. SYGMA sales increased 6.8%, but operating income fell 36.7%, reflecting delivery costs, customer start-up expenses and facility consolidation.
- Sysco recorded a $23.8m increase in its self-insurance reserve during the first 39 weeks. Merger and integration planning costs were $32.4m in Q3 and $36.8m year to date. A $20m contingency accrual was recorded in Q3 for a California investigation concerning delivery drop sites.
- Management estimated unusually severe weather reduced Q3 EPS by $0.01–$0.015. The Q3 effective tax rate was 39.01%, including $6.2m of tax expense associated with a nondeductible penalty estimate in the contingency accrual.
- Operating cash flow improved year over year, helped by working-capital comparisons and significant accruals. Sysco said it expects available operating cash flow, commercial-paper and bank facilities, and capital-market access to meet cash needs for the next 12 months.
Outlook, transactions and risks
- The proposed US Foods merger remained subject to FTC regulatory review. Sysco estimated closing in the first quarter of fiscal 2015. As of April 26, 2014, estimated enterprise value was $8.4bn, including approximately $3.6bn of equity consideration and $4.8bn of US Foods net debt to be assumed or refinanced; amounts could change. Sysco secured a $3.3865bn bridge term-loan facility and expected to issue permanent financing before closing.
- Management forecast approximately $65bn of annual sales for the combined company and at least $600m of annual synergies over three to four years, with $700m–$800m of costs to achieve synergies over three years. These are expectations, not guaranteed outcomes. The merger could require issuing about 87m shares, roughly 13% of post-merger Sysco, and termination under certain conditions could trigger a $300m payment.
- Fiscal 2014 Business Transformation expenses were expected to be $275m–$300m; ERP-related capital spending was expected at $30m–$40m. Sysco expected Broadline cost per case to decline by approximately $0.05 or more in fiscal 2014 and retirement-related expenses to decline by about $85m–$95m from fiscal 2013.
- Risks include merger approval, remedies or failure to realize synergies; increased debt and dilution; competitive pricing and food-cost inflation, particularly meat and dairy; weak consumer demand and severe weather; execution, timing and cost risks in the Business Transformation/ERP program; multiemployer pension exposure; and legal, tax and self-insurance contingencies.
- Sysco estimated up to $90m of potential additional multiemployer-plan withdrawal liability, based largely on older plan data, and cautioned actual exposure could differ materially. It also disclosed $31.2m of letters of credit related to appeals of Canadian tax assessments.
Important facts for investors to verify
- Progress and final regulatory outcome, financing terms, total consideration and dilution for the US Foods merger; test synergy estimates against integration costs and timing.
- Whether sales and locally managed customer growth recover, and whether gross-margin pressure from competition, customer mix and inflation moderates.
- Underlying earnings and cash generation relative to GAAP, including the nature and recurrence of items excluded from management’s adjusted measures.
- Debt, interest-rate exposure, commercial-paper usage and liquidity after any merger financing; assess planned dividends and repurchases alongside those needs.
- Developments in the California drop-site investigation, tax appeals, self-insurance estimates and multiemployer pension liabilities.
- Business Transformation and ERP deployment progress, spending, timing and realized cost savings.