Business context and reporting period
Sysco distributes food and related products to foodservice customers. This Form 10-Q covers the 13-week and 39-week periods ended March 26, 2016, compared with periods ended March 28, 2015. The request metadata says “2015 Q3,” but the filing is for fiscal 2016 Q3.
Financial performance
| Metric | Q3 FY2016 | Q3 FY2015 | 39 weeks FY2016 | 39 weeks FY2015 |
|---|---|---|---|---|
| Sales | $12.00 billion | $11.75 billion | $36.72 billion | $36.28 billion |
| Gross profit | $2.14 billion | $2.06 billion | $6.54 billion | $6.33 billion |
| Operating income | $377.6 million | $327.3 million | $1.30 billion | $1.11 billion |
| Net earnings | $217.1 million | $177.0 million | $734.0 million | $613.7 million |
| Diluted EPS | $0.38 | $0.30 | $1.26 | $1.03 |
- Q3 sales increased 2.2%; case volume contributed 2.3%, acquisitions 0.9%, and foreign currency reduced growth by 1.0%. For the 39-week period, sales rose 1.2%.
- Q3 gross margin was 17.9%, up 34 basis points; 39-week gross margin was 17.8%, up 35 basis points. Product-cost deflation was 0.4% for Q3 and 0.5% for the 39 weeks.
- Q3 operating income rose 15.4% and net earnings rose 22.7%. Adjusted operating income was $437.6 million (+16.0%) and adjusted net earnings were $261.4 million (+10.0%). Adjusted diluted EPS was $0.46 (+15.0%). For the 39 weeks, adjusted operating income was $1.38 billion (+7.7%), adjusted net earnings $848.5 million (+7.3%), and adjusted diluted EPS $1.46 (+9.8%). These are non-GAAP measures.
- Operating cash flow for the 39 weeks was $989.0 million, versus $860.5 million. Capital expenditures were $360.9 million; free cash flow, as defined by Sysco, was $640.7 million versus $438.6 million.
- At March 26, cash and cash equivalents were $610.8 million. Long-term debt was $4.27 billion and current maturities were $7.2 million; total debt was approximately $4.4 billion, with 71% at fixed rates including swaps. No commercial paper was outstanding at quarter-end. Current assets were $6.96 billion and current liabilities $4.11 billion.
- Dividends declared were $0.31 per share for Q3. Average diluted shares declined 4.7% year over year, aided by the $1.5 billion accelerated share repurchase.
Changes, outlook, risks and unusual items
- Growth reflected stronger case volumes—especially in Broadline—gross profit growth outpacing operating expense growth, and fewer shares outstanding. Foreign-exchange translation weighed on sales and earnings; management cited softness in markets affected by the energy downturn and continued competitive pricing pressure.
- Sysco agreed to acquire Brakes Group for approximately £2.2 billion (about $3.1 billion), including repayment of about $2.3 billion of Brakes debt. Management expected closing in June or July 2016, subject to antitrust approval, and expected the transaction to be immediately accretive. Brakes had nearly $5 billion in revenue in the 12 months ended December 2015. The deal was not yet completed at the filing date.
- After quarter-end, Sysco issued $2.5 billion of notes to help finance Brakes. As of April 23, 2016, total debt was approximately $6.8 billion. If the acquisition did not close by March 31, 2017, or the agreement was terminated by then, $1.0 billion of specified notes would be subject to mandatory redemption at 101% plus accrued interest. The filing warns that financing and integration risks could affect liquidity and debt service.
- Sysco began a workforce productivity plan targeting approximately 1,200 positions by the end of FY2017, with expected severance and related charges of $25–30 million. It also plans to replace SAP ERP at 12 operating companies with its SUS system by FY2017. Management estimated technology-related charges of about $70 million in FY2016 and $130 million in FY2017; Q3 included $42.6 million of write-offs and accelerated depreciation.
- FY2016 priorities include at least $500 million of adjusted operating income growth by FY2018, with 20–30% of that improvement targeted in FY2016; management said it remained on track. It expected deflation to persist through at least FY2016, a normalized tax rate of 36–37% for the remainder of FY2016, and FY2016 capital expenditures of about $500 million. Management estimated the share repurchase would benefit FY2016 EPS by $0.03–$0.04.
- Unusual items affected comparisons: Sysco recorded an $86.5 million loss on extinguishment of debt in FY2016 after redeeming $5.05 billion of notes issued for the abandoned US Foods merger. Q3 also included a $7.7 million tax benefit from favorable resolution of tax contingencies. Legal proceedings were not expected by management to have a material adverse effect, although outcomes remain uncertain.
Important facts for investors to verify
- Whether Brakes received required antitrust approval, closed as anticipated, and generated the expected earnings and integration benefits.
- Post-acquisition debt, interest costs, liquidity and capacity to meet any mandatory redemption obligation if the transaction fails to close.
- Whether case-volume growth and gross-margin gains can persist amid deflation, competition and market-specific demand weakness.
- Actual costs and timing of the technology transition and workforce plan, and whether projected savings materialize.
- How GAAP results compare with management’s adjusted measures, including the effect of merger-related, restructuring, tax and debt-extinguishment items.