Sysco Corporation (10-Q) — Quarter Ended April 2, 2011
Period clarification: The supplied filing is for the 13-week third quarter and 39 weeks year-to-date of fiscal 2011; it does not cover 2010 Q3. Sysco distributes food and related products to foodservice customers, primarily in the United States and Canada. Financial statements are unaudited; management states normal recurring adjustments were made.
Financial performance
| Metric | Q3: 13 weeks | Year to date: 39 weeks |
|---|---|---|
| Sales | $9.762 billion, up 9.1% | $28.898 billion, up 7.4% |
| Gross margin | $1.811 billion; 18.6% of sales, versus 18.8% | $5.384 billion; 18.6% of sales, versus 19.1% |
| Operating income | $427.5 million, down 1.1%; 4.4% margin versus 4.8% | $1.371 billion, down 1.5%; 4.7% margin versus 5.2% |
| Net earnings | $258.5 million, up 4.4% | $815.7 million, down 3.1% |
| Diluted EPS | $0.44, up 4.8% | $1.39, down 2.1% |
Cash flow and balance sheet: Year-to-date cash from operations was $665.8 million, versus $476.5 million; capital expenditures were $454.1 million. Cash declined to $385.7 million from $585.4 million at fiscal year-end. At April 2, current assets were $5.439 billion and current liabilities $3.136 billion. Total debt carrying value was $2.673 billion, up from $2.481 billion at July 3, 2010; debt fair value was estimated at $2.874 billion. Shareholders’ equity was $4.207 billion.
Year-to-date investing cash outflow was $435.5 million and financing cash outflow $449.1 million. Sysco repurchased 10 million shares for $291.6 million and paid $445.4 million in dividends. Its $1.0 billion revolving credit facility supports commercial paper; $186 million of commercial paper and $2.3 million of bank-line borrowings were outstanding at quarter-end.
Changes and operating drivers
- Revenue growth reflected higher selling prices from product-cost inflation, improving case volumes, acquisitions (0.6% contribution) and favorable currency translation. Estimated product-cost inflation was 5.1% in Q3 and 4.2% year to date, compared with deflation in the prior-year periods.
- Gross margin dollars rose, but more slowly than sales. Margin percentage fell amid high inflation in selected categories and strategic pricing intended to build volume and market share. Faster growth in lower-margin SYGMA also affected year-to-date mix.
- Operating expenses rose 10.6% in Q3 and 7.5% year to date, driven by pay-related costs, pension expense, fuel costs and multi-employer pension withdrawal provisions. A $36.1 million Q3 withdrawal charge reduced EPS by approximately $0.04.
- Q3 net earnings increased despite lower operating income, helped by a lower effective tax rate and higher other income. Year-to-date net earnings declined, partly reflecting a higher effective tax rate than the prior year, which included a one-time IRS-settlement-related tax benefit.
- By segment, Q3 sales grew 8.9% in Broadline and 9.8% in SYGMA; operating income rose 3.2% and 24.8%, respectively. Custom-cut meat operations were moved into Broadline reporting, and prior periods were reclassified.
Outlook, risks and unusual items
- No formal revenue or earnings guidance is provided. Management says the slow economic recovery, weak consumer confidence and high food inflation make conditions challenging; prolonged inflation could pressure demand, sales and margins.
- Management expects fiscal 2011 capital expenditures of $625–650 million. The Business Transformation Project is expected to require approximately $900 million in total cash outlay; $210 million was spent in the first 39 weeks. Broader rollout is expected to begin in fiscal 2012 and reach most Broadline and SYGMA companies by the end of fiscal 2013. Management expects project costs to exceed benefits during early implementation and estimates Q4 project expenses $15–25 million above the prior-year quarter.
- Assuming fuel prices do not rise significantly, management expects Q4 fuel costs, before surcharges, to increase approximately $15–20 million versus the prior-year quarter, with higher surcharges expected to offset a substantial portion. Forward fuel commitments totaled about $71 million through February 2012, covering an estimated 30–35% of fuel needs for contracted periods.
- Sysco estimates potential withdrawal liability on multi-employer pension plans of up to $200 million, based on older plan data and excluding liabilities already recorded. Recorded liabilities were approximately $42.4 million. Management expects future required contributions to underfunded plans may increase. Legal proceedings are not expected by management to have a material adverse effect.
- The IRS settlement requires $212 million of payments in fiscal 2011 and $212 million in fiscal 2012; $159 million of the fiscal 2011 amount had been paid by quarter-end. Unrecognized tax benefits were $75.4 million, with $33.8 million of accrued interest; the reasonably possible change could not be estimated.
- Other potential volatility includes COLI investment-related gains, which were $29.5 million year to date, and company-sponsored pension costs. In April, after quarter-end, Sysco adopted an involuntary severance plan, with liabilities expected primarily from future transformation-related severance.
Most important facts for investors to verify
- Whether volume growth and strategic pricing can offset food-cost inflation without further deterioration in gross margin.
- The timing, total cost, implementation risks and expected benefits of the Business Transformation Project.
- Actual multi-employer pension exposure, required contributions and any further withdrawal charges.
- Cash generation and working-capital needs, including remaining IRS settlement payments, capital spending, dividends and debt levels.
- Fuel-price assumptions and the degree to which surcharges and forward contracts offset higher fuel costs.