Sysco Corporation — Form 10-Q summary
Business context and reporting period
Sysco distributes food and related products to foodservice customers. This unaudited filing covers the 13-week quarter and 26-week year-to-date period ended December 27, 2014, in fiscal 2015; comparisons are with the periods ended December 28, 2013. Amounts below are U.S. dollars.
Financial results and liquidity
| Metric | 13 weeks | 26 weeks |
|---|---|---|
| Sales | $12.09 billion, up 7.6% | $24.53 billion, up 6.9% |
| Gross profit | $2.09 billion, up 6.1% | $4.27 billion, up 6.0% |
| Gross margin | 17.25%, down 23 basis points | 17.42%, down 14 basis points |
| Operating income | $315.4 million, down 10.3% | $781.1 million, down 5.9% |
| Net earnings | $158.0 million, down 25.1% | $436.8 million, down 12.0% |
| Diluted EPS | $0.27, versus $0.36 | $0.73, versus $0.84 |
| Adjusted diluted EPS (non-GAAP) | $0.41, up 5.1% | $0.93, up 5.7% |
Management’s adjusted measures exclude specified items, including merger planning and financing costs; they are supplemental and not substitutes for GAAP results. Quarterly adjusted operating income was $396.3 million, up 3.1%; year-to-date adjusted operating income was $905.3 million, up 4.7%.
Sales growth reflected product-cost inflation, volume growth and recent acquisitions. Management estimated product-cost inflation at 6.0% for the quarter and 5.4% year to date, mainly from meat and dairy. Quarterly case volumes, including acquisitions, rose 3.6%. Foreign exchange reduced sales growth by 0.9% in the quarter and 0.7% year to date. Operating expenses rose faster than sales, and gross margin narrowed. Higher pay-related costs, merger expenses and significantly higher interest expense weighed on GAAP earnings.
Year-to-date operating cash flow was $452.4 million, versus $458.2 million. Capital expenditures were $298.1 million, and free cash flow, a non-GAAP measure, was $156.5 million versus $211.2 million. Cash dividends paid were $340.7 million. At December 27, cash and cash equivalents were $4.91 billion; total debt was approximately $7.6 billion, compared with $2.8 billion at June 28, 2014. Current assets were $11.46 billion and current liabilities $4.29 billion. The cash balance was substantially increased by merger financing proceeds not yet deployed.
Material changes versus prior period
- The October 2014 issuance of $5 billion of senior notes to finance the proposed US Foods transaction sharply increased debt and interest expense. Net interest expense rose $47.3 million in the quarter and $47.7 million year to date; management identified much of the increase as merger-related financing costs.
- Quarterly and year-to-date GAAP earnings declined, while management’s adjusted earnings measures increased. Merger and integration planning costs were $78.0 million in the quarter and $118.5 million year to date.
- Operating cash flow was nearly flat year over year, but free cash flow declined 25.9%, reflecting increased capital spending, lower asset-sale proceeds, merger-related cash costs and a $50 million pension contribution.
- Broadline sales increased 8.3% in the quarter and 7.7% year to date; SYGMA operating income fell 23.6% and 30.2%, respectively. Corporate expenses and adjustments increased to $308.5 million for the quarter and $572.3 million year to date.
Outlook, management commentary, risks and unusual items
The proposed US Foods merger remained subject to FTC review. Sysco proposed selling 11 US Foods distribution centers to Performance Food Group for $850 million, but the FTC had not accepted the proposed remedy as of the filing. Under certain conditions, termination could require a $300 million payment. Merger completion would also entail issuing approximately 87 million Sysco shares to US Foods owners.
Management estimated annual operating synergies of at least $600 million after four years, with operating synergies expected to begin in the second year after closing. It estimated approximately $115 million of annual interest savings and $150 million of cash tax savings from acquired net operating losses, expected in the first year after closing. Estimated integration expenses were $700–$800 million and incremental integration capital spending $300–$400 million over four years. Management expected the deal to be accretive in the second year after closing, excluding integration costs and deal-related amortization. These are forward-looking estimates, not guaranteed outcomes.
The notes carry a mandatory redemption feature: if the merger has not closed by October 8, 2015, or the agreement is terminated on or before that date, Sysco must redeem the notes at 101% of principal plus accrued interest. Management expected approximately $80 million of additional interest expense over the remainder of fiscal 2015, assuming the notes were not redeemed.
Management described foodservice demand as gradually improving but expected industry growth to remain modest. Competitive pricing and inflation may pressure margins; management cited driver shortages and rising payroll costs. If diesel prices remained at then-current levels, it estimated fuel expense could decline approximately $15 million in the second half of fiscal 2015, partly offset by lower fuel surcharges. It expected fiscal-year Broadline cost per case to increase approximately $0.05–$0.10 versus fiscal 2014. No comprehensive earnings guidance was provided in the filing.
Other items and exposures include estimated potential multiemployer pension withdrawal liability of up to $90 million, which management said could materially differ due to dated plan information; approximately $30 million of letters of credit posted in a Canadian tax dispute, with up to $111.3 million of additional cash payment or letters of credit potentially required to pursue appeals; and $49.1 million of gross unrecognized tax benefits plus $37.9 million of accrued interest. Management said ongoing legal proceedings were not expected to have a material adverse effect, while noting outcomes remain uncertain.
Important facts for investors to verify
- FTC review status, acceptability and scope of the proposed divestiture remedy, deal timing, termination-payment triggers and mandatory note-redemption consequences.
- Actual merger consideration, debt assumed or refinanced, shares issued, realized synergies, integration costs and capital spending versus management estimates.
- Underlying volume and organic sales trends versus inflation, acquisitions and currency effects, alongside gross-margin and Broadline cost-per-case trends.
- Cash conversion and free cash flow after working-capital needs, pension contributions, capital expenditures, dividends and merger-related payments.
- Debt, interest expense, liquidity and refinancing needs after deployment of the $5 billion note proceeds, including the 2015 note maturity.
- Developments in multiemployer pension exposure, the Canadian tax assessments and other tax or legal contingencies.