Sysco Corporation (10-Q) — Fiscal 2017 Second Quarter
Reporting period: 13 weeks ended December 31, 2016; comparisons are with the 13 weeks ended December 26, 2015. The filing also reports the first 26 weeks of fiscal 2017. Sysco distributes food and related products, primarily in North America and Europe. The July 2016 acquisition of Brakes Group materially expanded its international operations.
Key financial metrics
| Metric | Q2 FY2017 | Q2 FY2016 | Change |
|---|---|---|---|
| Sales | $13.46 billion | $12.15 billion | +10.7% |
| Gross profit | $2.57 billion | $2.16 billion | +19.2% |
| Operating income | $492.4 million | $432.6 million | +13.8% |
| Net earnings | $275.2 million | $272.4 million | +1.0% |
| Diluted EPS | $0.50 | $0.48 | +4.2% |
| Gross margin | 19.1% | 17.7% | +1.4 percentage points |
| Operating margin | 3.66% | 3.56% | +0.10 percentage points |
Sales excluding Brakes decreased 0.2% in the quarter. GAAP net margin was 2.0%, versus 2.2% a year earlier. Adjusted diluted EPS, a non-GAAP measure, was $0.58, up 20.8%; adjusted EPS excluding Brakes was $0.51, up 7.0%.
- First 26 weeks: Sales were $27.43 billion, up 11.0%; operating income was $1.06 billion, up 14.4%; net earnings were $599.1 million, up 15.9%; diluted EPS was $1.08, up 22.7%. Sales excluding Brakes rose 0.4%.
- Cash flow, first 26 weeks: Operating cash flow was $604.9 million, versus $468.9 million; capital expenditures were $285.7 million; reported free cash flow, a non-GAAP measure, was $330.9 million, versus $231.5 million.
- Liquidity and debt at December 31: Cash and equivalents were $847.3 million; current assets were $8.01 billion and current liabilities $5.05 billion. Total debt was approximately $8.3 billion, versus $7.4 billion at July 2, 2016. About 60% of debt was fixed-rate, including swaps. The company reported $1.0 billion of commercial paper outstanding.
- Shareholder returns: Sysco repurchased 22.7 million shares for $1.2 billion in the first half and paid $343.4 million in dividends. Quarterly dividends declared were $0.33 per share.
Material changes and drivers
- Brakes contributed $1.33 billion of quarterly sales and $31.9 million of net earnings; for the first half it contributed $2.61 billion of sales and $50.7 million of net earnings. These figures do not include the acquisition financing interest attributed separately by Sysco.
- Brakes acquisition cash outlay, net of cash acquired, was approximately $2.9 billion. The preliminary allocation included $1.7 billion of goodwill, none expected to be tax-deductible, and acquired customer-relationship and trade-name intangibles.
- U.S. Foodservice quarterly sales fell 0.5%, while operating income increased 9.0%. Management cited improved gross profit, pricing/category management, local-customer growth, productivity and cost control. Locally managed customer case volume grew 1.6%, partly offset by a 2.0% decline in corporate-managed case volume.
- Quarterly interest expense increased 52.9% to $72.2 million, primarily reflecting higher debt after the acquisition and share repurchases. First-half GAAP interest expense declined year over year because the prior-year period included an $86.5 million loss on extinguishing debt raised for the abandoned US Foods merger.
- Cash declined from $3.92 billion at fiscal year-end, reflecting acquisition spending, share repurchases, dividends and other financing activity. Approximately 73% of period-end cash was held by international subsidiaries; repatriation could trigger additional taxes, though Sysco said it did not anticipate needing to repatriate it.
Outlook, commentary and risks
- Management raised its three-year adjusted operating-income growth target to approximately $600–$650 million by the end of fiscal 2018, from an original $500 million target. The target excludes Brakes; management said most of the increase versus the original goal was expected in fiscal 2018.
- Management expected Brakes to be modestly dilutive in fiscal Q3 and modestly accretive in Q4. It expected Brakes to contribute modest EPS accretion through fiscal 2017, with stronger contribution thereafter; Brakes is seasonally stronger in the first half. These are management expectations, not guarantees.
- Management reported deflation of 1.9% for the second quarter and 2.2% for the first half, concentrated in meat, dairy and produce, and expected deflation to continue at least through fiscal year-end. It cited restaurant traffic declines of 0.5% for the quarter and described industry conditions as soft. Sysco also cautioned that fiscal Q3 comparisons could be challenging.
- Key risks include persistent inflation or deflation, weak customer demand and competition, acquisition integration and financing, elevated debt and capital-market access, Brexit effects on U.K. operations, fuel-cost volatility, technology implementation and cybersecurity, labor constraints, and pension obligations. Fuel commitments and swaps covered approximately 35% of projected needs through the remainder of fiscal 2017 and into fiscal 2018; remaining purchases were exposed to market prices.
- Management stated that legal proceedings were not expected to have a material adverse effect based on current estimates, but noted outcomes cannot be predicted with certainty. Disclosure controls were assessed as effective; Brakes was excluded from the controls assessment under the acquisition-year guidance.
Important facts for investors to verify
- How much reported revenue and earnings growth is attributable to Brakes versus Sysco’s existing operations, and whether Brakes integration and expected synergies are progressing.
- Whether underlying case growth, gross-margin gains and expense discipline persist amid deflation and weak restaurant traffic.
- Debt, interest costs, cash location and availability, and the competing demands of acquisition investment, capital expenditures, dividends and repurchases.
- The assumptions and exclusions in management’s adjusted, non-GAAP measures and fiscal 2018 target, including that the target excludes Brakes.
- Potential currency, Brexit, tax, technology, legal and other contingencies that could affect results or liquidity.