Sysco Corporation (10-Q): Quarter ended December 31, 2011
Business context and reporting period. Sysco distributes food and related products to foodservice customers across the United States, Canada and Ireland. The filing covers the 13-week second quarter and first 26 weeks of fiscal 2012, compared with the corresponding periods ended January 1, 2011. The interim statements are unaudited; management says they include normal recurring adjustments. Sysco estimated it served about 17.5% of a roughly $225 billion U.S. and Canadian foodservice market.
Financial performance
| Metric | 13 weeks ended Dec. 31, 2011 | Year-over-year change | 26 weeks ended Dec. 31, 2011 | Year-over-year change |
|---|---|---|---|---|
| Sales | $10.244 billion | +9.2% | $20.831 billion | +8.9% |
| Gross profit | $1.846 billion | +4.8% | $3.793 billion | +5.1% |
| Gross margin | 18.02% | 18.77% prior year | 18.21% | 18.85% prior year |
| Operating income | $427.0 million | −2.3% | $936.3 million | −0.7% |
| Net earnings | $250.1 million | −3.1% | $552.8 million | −0.8% |
| Diluted EPS | $0.43 | −2.3% | $0.94 | −1.1% |
- Second-quarter gross margin declined 75 basis points; the 26-week margin declined 64 basis points. Management attributed the pressure mainly to high product-cost inflation that Sysco could not fully pass through without harming customer business.
- Adjusted, non-GAAP results excluding Business Transformation Project costs and COLI adjustments showed second-quarter operating income up 2.5%, net earnings up 3.3% and diluted EPS of $0.46, up 2.2%. For the first 26 weeks, adjusted operating income rose 4.4%, net earnings 6.2% and diluted EPS was $1.02, up 7.4%. These measures are not substitutes for GAAP results.
- Estimated product-cost inflation was 6.3% in the quarter and 6.8% for the half-year. Case volumes, including recent acquisitions, grew about 3.6% and 2.6%, respectively; excluding those acquisitions, growth was about 2.8% and 2.0%. Holiday-period conditions improved volume trends late in the quarter.
- Broadline sales rose 9.6% in the quarter and operating income 4.5%; SYGMA sales rose 6.9% while operating income fell 7.4%. Comparisons reflect revised prior-year segment presentation after changes to cost allocations and segment classification.
Cash flow, balance sheet and capital
- For the first 26 weeks, operating cash flow was $538.5 million versus $282.6 million a year earlier. Investing cash use was $487.8 million, including $433.9 million of capital expenditures and $36.8 million for acquisitions. Financing cash use was $341.4 million. Cash declined $303.2 million to $336.5 million.
- Management attributed much of the operating-cash-flow increase to redemption of approximately $75 million of COLI policies, improved working-capital management and timing of accruals. Inventory rose and accounts payable declined during the period; the filing describes seasonal and payment-timing effects.
- At December 31, cash was $336.5 million; restricted cash was $132.0 million. Total debt carrying value was approximately $2.858 billion, up from $2.669 billion at July 2, 2011. Current maturities of long-term debt were $205.9 million. About 70% of debt was fixed-rate, including swaps. The filing estimates debt fair value at $3.331 billion.
- A new $1.0 billion revolving credit facility supports U.S. and Canadian commercial paper programs and runs to December 2016, subject to extension. Commercial paper outstanding was $375 million at quarter-end and $275 million on January 28, 2012. A $200 million note due June 2012 was intended to be refinanced with commercial paper, notes or a combination.
- Sysco repurchased 10.0 million shares for $272.3 million in the half-year and paid $307.1 million in dividends. Management expected repurchases in the second half of fiscal 2012 to be substantially lower than in the first half. The quarterly dividend declared was $0.27 per share.
Outlook, commentary and risks
- Management described a challenging market, citing economic pressure on consumer spending, uneven consumer confidence, elevated food inflation and higher operating expenses. Sysco said it was generally able to pass on modest inflation but not the unusually high increases while preserving gross margin.
- Fiscal 2012 capital expenditures were estimated at $700–$750 million; $433.9 million had been spent in the first half. The estimate was reduced because construction timing for a third regional distribution center changed.
- Fiscal 2012 Business Transformation Project expenses were estimated at $230–$250 million, with related capital expenditures of $125–$145 million. Management said costs would exceed benefits in fiscal 2012. A second pilot began early in the third quarter; deployment timing depended on assessing its results. The project carries implementation, cost-effectiveness and systems risks.
- Fuel costs, excluding recoveries through surcharges, were expected to increase about $30–$40 million for fiscal 2012 versus fiscal 2011, assuming fuel prices did not rise significantly. Management expected fuel surcharges to offset most of that increase. Forward diesel commitments were about $95.9 million through December 2012, covering an estimated 30%–35% of fuel needs for contracted periods.
- Sysco expected sufficient operating cash flow and access to credit and capital markets for anticipated cash needs. It also expected to pay the remaining $106 million of fiscal 2012 IRS settlement installments during the third and fourth quarters; $106 million had been paid in the first half.
- Multiemployer pension plans were believed to be underfunded, and Sysco expected future contributions to rise. Estimated potential withdrawal liability on most participating plans was as much as $220 million, based largely on older plan valuations; a further $46.9 million was already recorded for plans from which Sysco had withdrawn.
- Unrecognized tax benefits were $72.5 million and accrued interest liabilities were $35.2 million. Management could not estimate the reasonably possible range of changes in unrecognized tax benefits. Legal proceedings were not expected by management to have a material adverse effect, although outcomes could differ from estimates.
- Sysco redeemed approximately $75 million of COLI policies and substituted corporate-owned real estate held in a rabbi trust. The assets are not SERP plan assets and remain available to creditors in a bankruptcy or insolvency. Management had shifted COLI investments toward low-risk fixed-income assets to reduce earnings volatility.
Important facts for investors to verify
- Whether case-volume growth continues and whether Sysco can recover higher food costs without further gross-margin deterioration.
- Actual Business Transformation Project spending, pilot results, rollout schedule, capitalized costs and eventual realized savings.
- Cash-flow quality, including the effects of COLI redemption, working-capital timing and tax payments.
- Fuel prices and the extent to which surcharges offset fuel-cost increases; review the commitments and their market-price exposure.
- Updated multiemployer pension funding and withdrawal-liability information, tax-position developments and the June 2012 note refinancing.
- Share repurchases, debt levels and liquidity against the company’s capital-spending and dividend commitments.