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 Ireland and other markets. This unaudited filing covers the 13 weeks ended October 2, 2010, the first quarter of fiscal 2011; comparisons are with the 13 weeks ended September 26, 2009. Management stated that the financial statements include normal recurring adjustments and were reviewed by Ernst & Young LLP.
Financial performance and liquidity
- Sales: $9.751 billion, up 7.4% year over year. Management attributed growth to improving case volumes, estimated product-cost inflation of 3.3%, acquisitions (0.6% favorable impact), and foreign exchange (0.5% favorable impact).
- Profit and margins: Gross profit was $1.831 billion, up 4.8%; gross margin declined to 18.78% from 19.24%. Operating income rose 1.8% to $506.2 million, while operating margin fell to 5.2% from 5.5%. Net earnings decreased 8.3% to $299.1 million; diluted EPS was $0.51 versus $0.55. The effective tax rate increased to 37.28% from 29.93%.
- Cash flow: Operating cash flow was $226.8 million versus $41.6 million. Investing activities used $147.4 million, including $142.9 million of capital expenditures; financing activities used $224.1 million, including $116.7 million of share repurchases and $146.9 million of dividends. Cash and cash equivalents declined $137.1 million during the quarter to $448.4 million.
- Balance sheet and debt: At October 2, 2010, cash was $448.4 million, current assets were $5.289 billion, and current liabilities were $3.146 billion. Total debt carrying value was approximately $2.495 billion, including $2.487 billion of long-term debt and $7.8 million of current maturities. No commercial paper was outstanding; Sysco had a $1.0 billion revolving facility and $95 million of uncommitted bank lines, with none drawn under the latter at quarter-end.
- Capital returns: The quarterly dividend declared was $0.25 per share, up from $0.24. Sysco repurchased 4.0 million shares for $116.7 million during the quarter; a new authorization for 20 million shares was approved in August 2010.
Material changes versus the prior-year quarter
- Sales and operating income grew, but operating income grew more slowly than sales and net earnings and EPS declined. Higher operating expenses and a higher effective tax rate contributed.
- Gross margin percentage contracted amid strategic pricing, elevated inflation in dairy, meat, and seafood (reported at 8% to 11%), and a greater mix of higher-volume SYGMA business.
- Operating cash flow increased substantially from the prior-year quarter, primarily because the prior-year period included $316 million paid in connection with the IRS settlement. Fiscal 2011 first-quarter cash taxes paid were $35.2 million, compared with $334.8 million a year earlier.
- Broadline sales rose 6.6% and segment operating income rose 5.3%. SYGMA sales rose 14.7%, with operating income increasing from $5.8 million to $14.6 million. Corporate expenses increased to $71.0 million from $43.3 million.
Outlook, management commentary, and risks
- Management described the economic recovery as slow and consumer confidence and disposable income as pressured. It noted that sales trends had turned positive in the third quarter of fiscal 2010 and remained positive in this quarter, but gave no specific financial guidance.
- The Business Transformation Project had completed its design phase and was in system-building and testing. A pilot was anticipated in the second half of fiscal 2011, with implementation across most Broadline and SYGMA companies anticipated by fiscal 2013. Management expects long-term benefits but said costs will exceed benefits in early implementation, including fiscal 2011.
- Management said cash from operations, capital-market access, and credit facilities should meet anticipated cash needs. Sysco reported that approximately 81% of long-term debt was at fixed interest rates, including swaps that convert $450 million of fixed-rate debt to floating rates.
- Tax matters: The IRS settlement requires payments of $212 million in each of fiscal 2011 and 2012; management said it believes resources are sufficient. Unrecognized tax benefits were $84.1 million and accrued interest liabilities were $28.3 million; the filing did not estimate the reasonably possible range of changes in unrecognized benefits.
- Pensions and contingencies: Management expects contributions to underfunded multi-employer plans to increase. Estimated potential withdrawal liability was as much as $190 million, based largely on plan valuations dated December 31, 2008; $6.3 million was recorded for plans from which Sysco had already withdrawn. Management said pending legal proceedings were not expected to have a material adverse effect.
- Other exposures: COLI policy gains were $13.5 million versus $21.2 million a year earlier and can cause earnings volatility. Diesel fuel commitments totaled approximately $80 million through October 2011, covering an estimated 30% to 35% of fuel needs for contracted periods. Management cited economic weakness, inflation or deflation, fuel prices, transformation execution, leverage and interest rates, supply interruption, and pension funding as risks.
Important facts for investors to verify
- Whether case-volume gains and sales growth continue, and how much comes from pricing, inflation, acquisitions, foreign exchange, and underlying demand.
- Whether Sysco can protect gross margins against strategic pricing and elevated category-specific food inflation while controlling labor, pension, and corporate costs.
- The sustainability of operating cash flow after working-capital movements and tax-payment timing, including the remaining IRS settlement installments.
- Actual costs, timing, and benefits of the Business Transformation Project relative to the stated implementation expectations.
- Updated funding and withdrawal-liability estimates for multi-employer pension plans, and changes in tax contingencies and COLI-related gains or losses.
- Share repurchases and dividends relative to cash generation, debt levels, and capital requirements.