Sysco Corporation — Form 10-Q Summary
Business context and reporting period
Sysco distributes food and related products to foodservice customers, primarily in the United States and Canada, with operations also in Europe and elsewhere. The filing covers the 13-week second quarter and 26-week first half of fiscal 2011, both ended January 1, 2011; comparisons are with the corresponding fiscal 2010 periods. The interim financial statements are unaudited and were reviewed by the company’s independent auditor.
Financial performance
| Metric | Q2 FY2011 | Q2 FY2010 | First half FY2011 | First half FY2010 |
|---|---|---|---|---|
| Sales | $9.385 billion | $8.868 billion | $19.136 billion | $17.950 billion |
| Gross margin | $1.742 billion; 18.6% of sales | $1.695 billion; 19.1% | $3.573 billion; 18.7% | $3.442 billion; 19.2% |
| Operating income | $437.0 million; 4.7% of sales | $462.4 million; 5.2% | $943.3 million; 4.9% | $959.7 million; 5.3% |
| Net earnings | $258.2 million | $268.3 million | $557.2 million | $594.6 million |
| Diluted EPS | $0.44 | $0.45 | $0.95 | $1.00 |
- Sales rose 5.8% in the quarter and 6.6% year to date. Management attributed growth chiefly to product-cost inflation and higher selling prices; first-half sales also benefited from improving case volumes. Estimated product-cost inflation was 4.5% in Q2 and 3.9% for the first half.
- Gross margin dollars increased, but more slowly than sales. Gross margin percentage fell 55 basis points in Q2 and 50 basis points year to date. Operating expenses rose 5.9% in both periods, contributing to lower operating income.
- Operating income declined 5.5% in Q2 and 1.7% year to date; net earnings declined 3.8% and 6.3%, respectively. First-half earnings also reflected a higher effective tax rate than the prior year, which included a one-time tax benefit.
- Operating cash flow was $282.6 million for the first half, versus $146.4 million a year earlier. Capital expenditures were $317.4 million, compared with $247.6 million; acquisitions and related payments were $26.5 million. Operating cash flow less capital expenditures was therefore negative $34.8 million.
- At January 1, 2011, cash and cash equivalents were $209.8 million, current assets $4.867 billion, and current liabilities $2.722 billion. Long-term debt was $2.654 billion and current maturities were $7.9 million; total debt carrying value was approximately $2.661 billion. Commercial paper outstanding was $173.2 million, supported by a $1.0 billion revolving facility expiring November 2012. No borrowings were outstanding on $95 million of uncommitted bank lines.
- First-half financing included $285.4 million of treasury-stock purchases and $294.1 million of dividends paid. The company reported $0.51 of dividends declared per share for the first half.
Material changes versus the prior comparable periods
- Inflation shifted from estimated product-cost deflation of 3.4% for the prior-year first half and 3.5% in the prior-year quarter to inflation of 3.9% and 4.5%, respectively. High inflation in dairy, meat and seafood was particularly difficult to pass through without affecting customers.
- Sysco reported that strategic pricing initiatives and faster growth in SYGMA, a lower-margin business than Broadline, also pressured gross margin percentages. Q2 Broadline sales rose 4.7% but operating income fell 5.5%; SYGMA sales rose 13.4% and operating income rose 15.0%.
- First-half pension costs increased to $93.2 million from $63.1 million, while company-sponsored pension contributions were $9.7 million versus $77.7 million. Management said no additional Retirement Plan contributions were currently anticipated in fiscal 2011, following a $140 million contribution in fiscal 2010 that would normally have occurred in fiscal 2011.
- Cash decreased by $375.7 million from fiscal year-end, to $209.8 million. The first half included share repurchases, dividends, capital spending and seasonal working-capital movements.
Outlook, management commentary, risks and unusual items
- Management described the economic recovery and consumer confidence as weak, and said rising food costs, pay-related expenses, pension costs and fuel costs could pressure margins and earnings. It expects pension and fuel costs to remain elevated for the rest of fiscal 2011. No numerical full-year sales or earnings guidance is provided.
- The Business Transformation Project is in testing, with a pilot planned during the remainder of fiscal 2011 and implementation across most Broadline and SYGMA companies anticipated by the end of fiscal 2013. Expected total cash outlay is approximately $900 million; $145 million was spent in the first half. Management expects project expenses in the final 26 weeks of fiscal 2011 to be $25–$45 million higher than in the comparable prior-year period and cautions that costs will exceed benefits in early implementation.
- Sysco estimated that, assuming fuel prices do not rise significantly, fuel costs for the final 26 weeks of fiscal 2011, before fuel-surcharge recoveries, could increase $10–$20 million versus the comparable prior-year period. Forward diesel commitments totaled approximately $80.9 million through January 2012, covering an estimated 30%–35% of fuel needs for contracted periods.
- The IRS settlement requires payments of $212 million in each of fiscal 2011 and fiscal 2012. Sysco paid $106 million in the first half of fiscal 2011 and said it had sufficient cash, operating cash flow and capital access to meet the payments. Unrecognized tax benefits were $87.4 million, with $35.5 million of accrued interest; the company could not estimate the reasonably possible range of changes in those tax positions.
- Several multi-employer pension plans are believed to be underfunded. Sysco estimated potential withdrawal liability of up to $220 million based on available plan valuations, many dated December 2009, and noted that the current amount could differ. It had recorded $6.3 million for plans from which it had already withdrawn.
- COLI policy valuation gains were $23.9 million for the first half and $10.3 million in Q2, benefiting earnings and taxes; management noted that market-driven changes could make these gains volatile. The prior-year first half also included a $29 million one-time tax benefit from the IRS settlement.
- Management said pending legal proceedings were not expected to have a material adverse effect. U.S. Broadline subsidiaries guaranteed Sysco’s outstanding senior notes and debentures on January 19, 2011. The company said its disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether sales growth is translating into improved case volumes and sustainable earnings, rather than primarily higher prices from inflation.
- Whether Sysco can protect gross margins while passing through food-cost inflation and executing strategic pricing initiatives; monitor Broadline and SYGMA mix and margins.
- Cash generation relative to capital spending, dividends, repurchases and the remaining IRS settlement payments; confirm liquidity and borrowing needs as cash balances change.
- Actual Business Transformation Project spending, implementation timing, potential disruptions and realized benefits versus the approximately $900 million estimated cash outlay.
- Changes in fuel and pension costs, forward fuel commitments, and the funding and withdrawal risks of multi-employer pension plans.
- Updates to uncertain tax positions and the potential multi-employer withdrawal liability, noting that the filing says the latter estimate relies substantially on older plan valuations.