Sysco Corporation — Form 10-Q Summary
Reporting period: The filing covers the 13 and 39 weeks ended March 28, 2015, the third quarter and year-to-date period of fiscal 2015. The request metadata says “2014 Q3,” but the filing itself is for fiscal 2015 Q3. Financial statements are unaudited; the interim financial information was reviewed by Ernst & Young.
Financial performance
| Metric | 13 weeks ended Mar. 28, 2015 | Change vs. prior year | 39 weeks ended Mar. 28, 2015 | Change vs. prior year |
|---|---|---|---|---|
| Sales | $11.75 billion | +4.2% | $36.28 billion | +6.0% |
| Gross profit | $2.06 billion | +3.1% | $6.33 billion | +5.1% |
| Operating income | $327.3 million | -1.6% | $1.11 billion | -4.7% |
| Net earnings | $177.0 million | -2.2% | $613.7 million | -9.4% |
| Diluted EPS | $0.30 | -3.2% | $1.03 | -10.4% |
| Gross margin | 17.52% | -17 basis points | 17.45% | -15 basis points |
- Sales growth reflected product-cost inflation, case-volume growth, and acquisitions; foreign exchange reduced sales growth by 1.3 percentage points in Q3 and 0.9 points year to date. Q3 case volumes grew 2.5%, or 2.2% excluding acquisitions.
- Operating expenses rose 4.1% in Q3 and 7.4% year to date, reflecting higher pay-related costs and merger-related items. Interest expense rose to $69.6 million in Q3 and $177.5 million year to date, largely due to financing for the proposed US Foods transaction.
- Management’s non-GAAP adjusted results were stronger than GAAP results: Q3 adjusted net earnings were $237.6 million (+7.0%) and adjusted diluted EPS was $0.40 (+5.3%); year-to-date adjusted net earnings were $791.0 million (+6.7%) and adjusted diluted EPS was $1.33 (+5.6%). These measures exclude specified items, including merger costs and financing costs.
Cash flow, debt and liquidity
- Year-to-date operating cash flow was $860.5 million, compared with $848.1 million. Capital expenditures were $437.3 million, up from $387.5 million; reported free cash flow was $438.6 million, down 9.4% from $484.3 million.
- Cash and cash equivalents were $5.08 billion at March 28, 2015, versus $413.0 million at fiscal year-end. The increase largely reflects the October 2014 issuance of $5 billion in senior notes for the proposed merger; proceeds remained invested pending use.
- Carrying value of total debt was approximately $7.7 billion, versus $2.8 billion at June 28, 2014. The company reported approximately 76% of debt at fixed rates, including swaps. No commercial paper was outstanding at quarter-end; Pallas Foods had €72 million drawn on its revolving facility.
- Year-to-date financing included $5.0 billion of senior-note proceeds, $188.8 million in cash settlements of hedges, $516.5 million of dividends paid, and no open-market share repurchases. A $300 million note maturity in June 2015 was expected to be repaid with cash on hand.
Material changes and operating trends
- Q3 growth moderated from the first half as inflation slowed to 3.7% from 6.1% in Q2 and currency translation became more unfavorable. Competitive pricing pressure and difficulty passing through food-cost inflation weighed on gross margin.
- Broadline, Sysco’s largest segment, reported Q3 sales growth of 4.7% and operating-income growth of 0.3%. SYGMA sales fell 1.1% and operating income fell 41.1%, citing lost business, facility-related transfers and higher warehouse and delivery costs. Other-segment operating income fell 32.7%.
- Business Transformation Project benefits exceeded the original target of approximately $600 million in annual savings and benefits by fiscal 2015, according to management. ERP deployment is shifting toward an enterprise-wide, module-centric approach.
- The Costa Rica foodservice company in which Sysco acquired a 50% interest was consolidated, with its redeemable noncontrolling interest presented outside permanent equity. Separately, the filing describes a 50% Pacific Star investment acquired in Q4, after the reporting period, to be equity-accounted initially.
Merger, outlook, risks and contingencies
- US Foods merger uncertainty was substantial. The FTC voted to authorize staff to seek a preliminary injunction; the hearing was scheduled for May 5, 2015. Sysco had agreed to sell 11 US Foods distribution centers to Performance Food Group for $850 million if the merger closed. The centers generated $4.6 billion in US Foods’ annual revenue.
- Sysco estimated the transaction’s enterprise value at about $8.5 billion as of March 28, 2015. If completed, US Foods shareholders were expected to receive roughly 87 million Sysco shares, about 13% of the combined company. Either party could terminate after the outside date, subject to extensions; under certain conditions Sysco could owe US Foods a $300 million termination fee.
- If the merger had not closed by October 8, 2015, or were terminated by then, Sysco was required to redeem the $5 billion notes at 101% of principal plus accrued interest. The company estimated a roughly $50 million premium and identified potential additional noncash write-offs, including $184 million of hedge losses and $47 million of debt issuance costs and bond discounts.
- Management projected at least $600 million in annual operating synergies after four years, approximately $115 million in annual interest savings, and about $160 million of first-year cash tax savings. Estimated integration expenses were $700–$800 million and incremental capital spending $300–$400 million over four years. Management expected non-GAAP accretion in the second year after closing, excluding integration costs and deal-related amortization. These projections depend on closing and successful integration.
- For fiscal 2015, management expected North American Broadline cost per case to increase approximately $0.05–$0.10 versus fiscal 2014. If diesel prices remained at then-current levels, it estimated an approximately $8 million Q4 fuel-expense reduction versus the prior year, partly offset by lower fuel surcharges. Management did not provide overall earnings or revenue guidance.
- Multiemployer pension plans were believed to be underfunded; estimated potential withdrawal liability for certain plans was up to $89 million, based largely on older plan valuations and subject to material change. Sysco also had posted about $31 million in letters of credit related to Canadian tax assessments and could need to pay or post up to an additional $74 million to pursue appeals.
- Management said it could not predict the FTC litigation outcome or determine whether merger-related termination charges or cash outlays would be required. Other risks cited include food-cost inflation or deflation, competition, labor availability, foreign exchange, fuel prices, technology/ERP execution, and customer or supplier disruption. Management concluded disclosure controls were effective at a reasonable assurance level.
Important facts for investors to verify
- Outcome and timing of the FTC injunction proceeding, merger closing conditions, termination dates and potential termination fees.
- Whether the proposed divestiture package and any additional remedies satisfy regulators, and how they affect expected merger synergies.
- Use of the $5 billion note proceeds, required redemption terms, and the resulting interest, cash and accounting effects if the merger fails or is delayed.
- Underlying margins and case-volume trends, particularly competitive pricing, inflation pass-through, foreign-exchange effects, and SYGMA performance.
- Progress on merger integration and the Business Transformation Project, including whether stated savings, synergy, cost and capital-spending estimates are achieved.
- Actual free cash flow, debt and liquidity after merger-related spending, pension contributions, dividends and capital expenditures; and developments in pension withdrawal and Canadian tax exposures.