Business context and reporting period
Sysco Corporation distributes food and related products to foodservice customers. This Form 10-Q covers the fiscal third quarter and first 39 weeks ended March 30, 2019, with comparisons to the periods ended March 31, 2018. Although the request metadata says “2018 Q3,” the filing is for fiscal 2019 Q3.
Financial performance
| Metric | 13 weeks ended Mar. 30, 2019 | Year-over-year change | 39 weeks ended Mar. 30, 2019 | Year-over-year change |
|---|---|---|---|---|
| Sales | $14.66 billion | +2.2% | $44.64 billion | +2.8% |
| Gross profit | $2.75 billion | +2.9% | $8.43 billion | +3.2% |
| Operating income | $529.6 million | +9.8% | $1.61 billion | -1.3% |
| Net earnings | $440.1 million | +33.3% | $1.14 billion | +16.0% |
| Diluted EPS | $0.85 | +34.9% | $2.17 | +17.3% |
| Gross margin | 18.8% | 18.6% prior year | 18.9% | 18.8% prior year |
| Operating margin | 3.6% | 3.3% prior year | 3.6% | 3.8% prior year |
Management’s non-GAAP adjusted results, which exclude “Certain Items,” showed Q3 adjusted operating income of $620.2 million (+16.6%), adjusted net earnings of $411.2 million (+15.6%) and adjusted diluted EPS of $0.79 (+17.4%). For the first 39 weeks, adjusted operating income was $1.92 billion (+8.5%), adjusted net earnings $1.28 billion (+10.5%) and adjusted diluted EPS $2.45 (+11.5%).
For the first 39 weeks, operating cash flow was $1.37 billion, up from $1.12 billion; free cash flow, a non-GAAP measure, was $998.7 million versus $765.2 million. Capital additions were $382.9 million. Cash and cash equivalents were $521.6 million at March 30, 2019. Total debt carrying value was approximately $8.7 billion, including $537.2 million of current maturities; shareholders’ equity was $2.36 billion. The current ratio was approximately 1.30, based on reported current assets and liabilities.
Material changes and management commentary
- U.S. Foodservice Operations drove growth: Q3 sales rose 4.1% and operating income 9.9%. Management cited case growth, inflation, category management, Sysco-branded products and cost savings. U.S. Broadline case volume including recent acquisitions increased 2.1% in Q3; organic locally managed customer case volume grew 2.2%.
- International sales fell 1.5% in Q3 and operating income fell 47.9%; for the 39-week period, reported operating income fell 58.4%. Currency translation, France integration and restructuring weighed on reported performance. Adjusted international operating income increased 30.0% in Q3 and 8.1% year to date.
- SYGMA sales declined 4.3% in Q3, while operating income improved to $11.7 million from $4.5 million, supported by margin and expense management.
- Q3 net earnings growth notably benefited from a $95.1 million foreign tax credit and other favorable tax effects. The reported Q3 income tax line was a $9.1 million benefit, compared with $34.8 million expense a year earlier. The effective tax rate was -2.12% for Q3 and 13.98% year to date.
- Management reported restaurant-industry trends as mixed: adverse February weather followed by improving March sales; customer traffic declined despite positive same-store sales. U.S. product-cost inflation was 2.3% in Q3, and a stronger U.S. dollar reduced reported sales growth.
- Operating costs faced pressure from transportation, warehouse and labor costs, hiring and overtime. Management said productivity, cost controls and retention efforts were underway. Transformation initiatives generated accelerating savings in Q3, though related costs remained substantial.
Outlook, risks and unusual items
Management reiterated its fiscal 2020 three-year-plan targets, measured against fiscal 2017: sales growth of 4%–4.5%, adjusted operating income growth of 9%, adjusted diluted EPS of $3.85–$3.95, and adjusted ROIC of 16% for existing businesses. It also cited a target of $650–$700 million adjusted operating income growth versus fiscal 2017. Results may not progress evenly by quarter. A planned sale of Iowa Premium, if completed, is expected to reduce planned operating income by about $25 million and could place adjusted operating income growth at the low end of its target range.
“Certain Items” included transformation, restructuring, severance and facility-closure charges, Brakes-related amortization and integration costs, and prior-year debt-extinguishment and pension-plan items. Q3 2019 restructuring and transformation costs were $72.2 million; acquisition-related costs were $18.4 million. The company acquired Waugh Foods and Classic Drinks, bought the remaining 23% of Iowa Premium, and said it was preparing to sell its Iowa Premium interests. The acquisitions’ overall effect was not material to reported results.
Key risks include Brexit uncertainty and foreign-exchange exposure, continuing disruption and integration challenges in France, competition and customer retention, food and fuel cost volatility, labor availability and cost, execution of transformation initiatives, cybersecurity and technology disruptions, acquisition integration, pension obligations and access to financing. Management stated that it expects operating cash flows and available borrowing and capital-market access to meet anticipated cash needs for the next 12 months. It reported no material change in contractual obligations since June 30, 2018. The filing says legal matters are not expected to have a material adverse effect; management concluded disclosure controls were effective.
Important facts for investors to verify
- Separate underlying operating progress from tax benefits and the impact of excluded “Certain Items”; review the company’s non-GAAP reconciliations.
- Track whether U.S. case growth and gross-margin improvement can offset labor, transportation and warehouse cost pressures.
- Monitor international operations, particularly France integration and restructuring, Brexit developments, and currency effects.
- Assess debt and liquidity in light of commercial paper borrowings: $200 million was outstanding at March 30, 2019, rising to $753.7 million by April 19, 2019. The filing says the U.S. commercial-paper-supporting credit facility had no borrowings at that later date.
- Evaluate execution of the fiscal 2020 targets and the timing and financial effect of the planned Iowa Premium sale.