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SYY > SEC Filings for SYY > Form 10-Q on 7-May-2013All Recent SEC Filings

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Form 10-Q for SYSCO CORP


7-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This discussion should be read in conjunction with our consolidated financial statements as of June 30, 2012, and the fiscal year then ended, and Management's Discussion and Analysis of Financial Condition and Results of Operations, both contained in our Annual Report on Form 10-K for the fiscal year ended June 30, 2012.

Our discussion below of our results includes certain non-GAAP financial measures that we believe provide important perspective with respect to underlying business trends. Any non-GAAP financial measure will be denoted as an adjusted measure and excludes the impact from executive retirement plans restructuring, multiemployer pension plan charges, severance charges, facility closure charges and Business Transformation Project costs. Collectively, these are referred to as Excluded Charges. More information on the rationale of the use of these measures and reconciliations to GAAP numbers can be found under "Non-GAAP Reconciliations."

Overview

Sysco distributes food and related products to restaurants, healthcare and educational facilities, lodging establishments and other foodservice customers. Our primary operations are located throughout the United States, Canada and Ireland and include broadline companies (which include our custom-cut meat operations), SYGMA (our chain restaurant distribution subsidiary), specialty produce companies, hotel supply operations, a company that distributes specialty imported products and a company that distributes to international customers.

We consider our primary market to be the foodservice market in the United States, Canada and Ireland and estimate that we serve about 18% of this approximately $235 billion annual market. According to industry sources, the foodservice, or food?away?from-home, market represents approximately 46% of the total dollars spent on food purchases made at the consumer level in the United States.

General economic conditions and consumer confidence can affect the frequency of purchases and amounts spent by consumers for food-away-from-home and, in turn, can impact our customers and our sales. We believe the current general economic conditions, including pressure on consumer disposable income, have contributed to a decline in the foodservice market. Historically, we have grown at a faster rate than the overall industry and believe we have continued to grow our market share in this fragmented industry.

Highlights

We have faced a challenging business and economic environment thus far in fiscal 2013 and these challenges became more pronounced in our fiscal third quarter. We believe our results were negatively impacted by the consumers' hesitation to spend on food-away-from-home due to multiple factors including increased tax rates, tax refund delays, periods of higher gasoline prices, high unemployment and unfavorable weather in certain geographies that we service. Our sales growth was impacted as a result. Our earnings declined primarily due to expenses related to our Business Transformation Project and a charge from the withdrawal from a multiemployer pension plan. Additionally, for the third quarter of fiscal 2013, we do not believe we consistently executed our business plan across the organization. We will remain focused on the execution of our business plan and initiatives from our Business Transformation project, with the goal for these items to contribute to the long-term success of our customers and in turn, growth in our earnings.

Comparisons of results from the third quarter of fiscal 2013 to the third quarter of fiscal 2012:

Sales increased 4.0%, or $0.4 billion, to $10.9 billion.

Operating income decreased 23.2%, or $101.6 million, to $337.2 million.

Adjusted operating income decreased 4.4%, or $21.8 million, to $470.5 million.

Net earnings decreased 22.4%, or $58.1 million, to $201.4 million.

Adjusted net earnings decreased 1.4%, or $4.1 million, to $289.1 million.

Basic and diluted earnings per share in the third quarter of fiscal 2013 were $0.34, a 22.7% decrease from the comparable prior year period amount of $0.44 per share.

Adjusted diluted earnings per share were $0.49 in the third quarter of fiscal 2013 and $0.50 in the third quarter of fiscal 2012, or a decrease of 2.0%.

Comparisons of results from the first 39 weeks of fiscal 2013 to the first 39 weeks of fiscal 2012:

Sales increased 4.7%, or $1.5 billion, to $32.8 billion.

Operating income decreased 12.8%, or $176.5 million, to $1.2 billion.

Adjusted operating income increased 0.5%, or $8.1 million, to $1.5 billion.

Net earnings decreased 12.7%, or $102.9 million, to $709.4 million.

Adjusted net earnings increased 1.9%, or $16.9 million, to $914.3 million.


Basic earnings per share in the first 39 weeks of fiscal 2013 was $1.21, a 12.3% decrease from the comparable prior year period amount of $1.38 per share. Diluted earnings per share in the first 39 weeks of fiscal 2013 was $1.20, a 13.0% decrease from the comparable prior year period amount of $1.38 per share.

Adjusted diluted earnings per share were $1.55 in the first 39 weeks of fiscal 2013 and $1.52 in the first 39 weeks of fiscal 2012, or an increase of 2.0%.

See "Non-GAAP Reconciliations" for an explanation of these non-GAAP financial measures.

Trends and Strategy

Trends

General economic conditions and consumer confidence can affect the frequency of purchases and amounts spent by consumers for food-away-from-home and, in turn, can impact our customers and our sales. We believe that the consumer is currently concerned about the recent increase in taxes and the potential for more increases, tax refund delays, periods of higher gasoline prices, lingering high unemployment rates and other fiscal issues. We believe these items and other current general economic conditions, have negatively impacted consumer confidence and contributed to a slow rate of recovery in the foodservice market. According to industry sources, real sales growth for the total foodservice market in the United States is expected to be modest over the long-term. We believe these industry trends reinforce the need for us to transform our business so that we can be in a position to provide greater value to our customers and reduce our overall cost structure.

We experienced levels of high product cost inflation during the first three quarters of fiscal 2012; however, inflation rates declined to a range of 2% to 3% in the fourth quarter of fiscal 2012 and the first 39 weeks of fiscal 2013.
As a result, gross margin pressure has eased somewhat with these more modest inflation amounts which are beneficial to us and our customers. While we cannot predict whether inflation will continue at current levels, periods of high inflation, either overall or in certain product categories, can have a negative impact on us and our customers, as high food costs can reduce consumer spending in the food-away-from-home market, and may negatively impact our sales, gross profit, operating income and earnings. Additional pressure exists on our gross margin from competitive pricing pressures. Low industry growth is contributing to increased competition which is in turn pressuring gross profits. Our sales growth in fiscal 2013 has been greater with our large regional and national customers. Gross margin from these types of customers is generally lower than other types of customers. If sales from our independent restaurant customers does not grow at the same rate as these large regional and national customers, our gross margins may decline.

We have experienced higher operating expenses this fiscal year as compared to fiscal 2012. Our Business Transformation Project has been a primary contributor to this increase. This project is a key part of our strategy to control costs and grow our market share over the long-term. This project includes an integrated software system that went into deployment in August 2012, resulting in increased deployment expenses and software amortization. In fiscal 2012, we were still building and testing our software and therefore had a greater amount of capitalized costs. We believe expenses related to the project will increase in fiscal 2013 as compared to fiscal 2012 due to amortization of the software asset and increased deployment costs.

Operating expenses have also increased due to higher fuel costs and provisions related to multiemployer pension plan withdrawals. These generally occur when a collective bargaining agreement is being renewed. Pay-related expenses have increased primarily from acquired companies and within delivery areas of our business, however these have been partially offset by improvements in the selling and information technology areas due to initiatives from our Business Transformation Project. Net company-sponsored pension costs were lower in the first 39 weeks of fiscal 2013 as compared to fiscal 2012. At the end of fiscal 2012, we decided to freeze future benefit accruals under the company-sponsored qualified pension plan (Retirement Plan) as of December 31, 2012 for all United States-based salaried and non-union hourly employees. Effective January 1, 2013, these employees were eligible for additional contributions under an enhanced, defined contribution plan. Pension costs will decrease in fiscal 2013 primarily due to this plan freeze. Absent the Retirement Plan freeze discussed above, net company-sponsored pension costs would have increased $106.9 million in fiscal 2013, or $26.7 million per quarter. Our expenses related to our defined contribution plan, which are included within pay-related expenses, will increase in fiscal 2013 and will more than offset our reduced pension costs. In November 2012, we approved a plan to restructure our executive nonqualified retirement program, including the Supplemental Executive Retirement Plan (SERP), by freezing benefits. We believe this restructuring more closely aligns our executive plans with our non-executive plans. As a result of this restructuring, we incurred $5.4 million in charges in the third quarter of fiscal 2013 and $17.6 million in the first 39 weeks of fiscal 2013, primarily from the accelerated vesting of benefits within the executive deferred compensation plan. We expect to incur an additional $3.4 million in charges in the fourth quarter of fiscal 2013 from increased costs that resulted from vesting participant benefits in the SERP concurrent with the plan to freeze benefits and from other executive retirement program changes. Over the long-term, we believe the changes to all of these retirement programs will result in reduced volatility of retirement-related expenses and a reduction in total retirement-related expenses.


Strategy

We are focused on optimizing our core broadline business in the United States, Canada and Ireland, while continuing to explore appropriate opportunities to profitably grow our market share and create shareholder value by expanding beyond our core business. Day-to-day, our business decisions are driven by our mission to market and deliver great products to our customers with exceptional service, with the aspirational vision of becoming each of our customers' most valued and trusted business partner. We have identified five strategies to help us achieve our mission and vision:

Profoundly enrich the experience of doing business with Sysco;

Continuously improve productivity in all areas of our business;

Expand our portfolio of products and services by initiating a customer-centric innovation program;

Explore, assess and pursue new businesses and markets; and

Develop and effectively integrate a comprehensive, enterprise-wide talent management process.

Business Transformation Project

Our Business Transformation Project consists of three main components:

the design and deployment of an ERP system to implement an integrated software system to support a majority of our business processes and further streamline our operations;

a cost transformation initiative to lower our cost structure; and

a product cost reduction initiative to use market data and customer insights to make changes to product pricing and product assortment.

We have deployed our ERP system to three additional locations in fiscal 2013 and are experiencing improved functionality in many areas compared to past deployments. Our shared services center, Sysco Business Services, continues to expand and provide a broader array of centralized administrative services. The majority of the system functionality is performing as designed; however, we have identified areas of improvement to certain components of the system that we want to address before we continue deploying to additional locations. These improvements include addressing pricing complexity and inventory management functionality. While these improvements are made, we will continue implementing individual modules such as our human resource module and continue with other Business Transformation initiatives. As we reach solutions to address these system improvements, as is customary, we will review components of our ERP system assets for potential impairment. These assets totaled approximately $400 million at March 30, 2013, and no impairment indicators are currently present. We no longer intend to deploy the complete system to any additional locations in this fiscal year; however, we remain committed to completing the system. We anticipate that deployment will resume around the end of calendar 2013 and our deployment schedule in fiscal 2014 will be reassessed as these improvements are made. During the time frame that we are making system improvements, we are updating master data across the enterprise in advance of our ERP system deployment with the goal of achieving faster deployment in the future. We are also assessing different deployment options that balance the pace of deployment with cost.

Efforts from our cost transformation initiatives in the first 39 weeks of fiscal 2013 spanned many areas of operations. We completed the implementation of maintenance management tools in our United States Broadline (U.S. Broadline) companies. Best practice action plans have been created for our warehouse and delivery areas. A customer relationship management tool has been implemented in our U.S. Broadline companies that will improve sales productivity. We restructured our information technology department and contracted with a third party provider for information technology managed services. For our U.S. Broadline companies, we accelerated the implementation of our human resource module from our ERP system and began centralizing field finance work to our shared services center. We believe both of these activities will be complete by December 2013. Lastly, our retirement programs have been restructured, which we believe will result in reduced volatility of retirement related expenses and a reduction in total retirement related expenses in the long-term.

Our product cost reduction initiative has been active in reducing SKUs in our inventory. We also increased participation in our centralized purchasing initiative. We are piloting product offerings in our category management initiative which utilizes customer insights to make changes to product pricing and product assortment. Shipments under our pilot program will begin in the fourth quarter of fiscal 2013.

Expenses related to the Business Transformation Project were $83.2 million in the third quarter of fiscal 2013 or $0.09 per share and $49.5 million in the third quarter fiscal 2012 or $0.05 per share. Expenses related to the Business Transformation Project were $242.3 million in the first 39 weeks of fiscal 2013 or $0.26 per share and $122.8 million in the first 39 weeks fiscal 2012 or $0.13 per share. This increase for both periods was largely attributable to deployment costs and software amortization, which began in August 2012.
Software amortization totaled $19.3 million and $51.2 million for the third quarter of fiscal 2013 and the first 39 weeks of fiscal 2013, respectively. In fiscal 2012, we were still building and testing our software and therefore had a greater amount of capitalized costs. We anticipate that project expenses for fiscal 2013 will be greater than in fiscal 2012 as a result of software amortization, the ramp up of our shared services center, continuing costs for deployment of the software platform and information technology support


costs. Some of these increased costs will be partially offset by benefits obtained from the project, primarily in reduced headcount; however, the costs will exceed the benefits in fiscal 2013.

Our total expected annualized benefits of our Business Transformation project are $550 million to $650 million by fiscal 2015. We believe that in fiscal 2013 we can achieve 25% of the total expected annualized benefits. We do not believe that the timing of our technology transformation will significantly change this expectation.

Results of Operations

The following table sets forth the components of our consolidated results of operations expressed as a percentage of sales for the periods indicated:

                            13-Week Period Ended                39-Week Period Ended
                      Mar. 30, 2013      Mar. 31, 2012    Mar. 30, 2013      Mar. 31, 2012

Sales                      100.0  %           100.0  %         100.0  %           100.0  %
Cost of sales               82.5               82.2             82.2               81.9
Gross margin                17.5               17.8             17.8               18.1
Operating expenses          14.4               13.6             14.1               13.7
Operating income             3.1                4.2              3.7                4.4
Interest expense             0.3                0.3              0.3                0.3
Other expense               (0.0)              (0.0)
(income), net                                                   (0.0)              (0.0)
Earnings before              2.8                3.9
income taxes                                                     3.4                4.1
Income taxes                 1.0                1.4              1.2                1.5
Net earnings                 1.8  %             2.5  %           2.2  %             2.6  %

The following table sets forth the change in the components of our consolidated results of operations expressed as a percentage increase or decrease over the comparable period in the prior year:

                              13-Week Period     39-Week Period

Sales                              4.0  %             4.7  %
Cost of sales                      4.4                5.1
Gross margin                       2.1                2.9
Operating expenses                 9.8                8.0
Operating income                 (23.2)             (12.8)
Interest expense                  20.9               13.1
Other expense (income), net       51.7  (1)          39.7  (2)
Earnings before income taxes     (25.8)             (14.3)
Income taxes                     (31.5)             (17.1)
Net earnings                     (22.4) %           (12.7) %

Basic earnings per share         (22.7) %           (12.3) %
Diluted earnings per share       (22.7)             (13.0)

Average shares outstanding         0.6                0.0
Diluted shares outstanding         1.0                0.3

(1) Other expense (income), net was income of $3.4 million in the third quarter of fiscal 2013 and $2.2 million in the third quarter of fiscal 2012.
(2) Other expense (income), net was income of $7.6 million in the first 39 weeks of fiscal 2013 and $5.5 million in the first 39 weeks of fiscal 2012.


Sales

Sales were 4.0% higher in the third quarter and 4.7% higher in the first 39 weeks of fiscal 2013 than in the comparable period of the prior year. Sales for the third quarter and first 39 weeks of fiscal 2013 increased as a result of product cost inflation and the resulting increase in selling prices and sales from acquisitions that occurred within the last 12 months. Sales for the first 39 weeks of fiscal 2013 also increased due to improving case volumes. Our sales growth in fiscal 2013 has been greater with our large regional and national customers. Case volumes excluding acquisitions within the last 12 months declined approximately 0.2% in the third quarter and improved 1.5% in the first 39 weeks of fiscal 2013. Our case volumes represent our results from our Broadline and SYGMA segments only. We believe our sales growth was negatively impacted by the consumers' hesitation to spend on food-away-from-home due to factors such as increased tax rates, tax refund delays, periods of higher gasoline prices, high unemployment and unfavorable weather conditions in certain geographies that we service. We believe most of these factors are cyclical in nature and expect overall conditions to gradually improve. Sales from acquisitions within the last 12 months favorably impacted sales by 1.8% for the third quarter and 1.2% for the first 39 weeks of fiscal 2013. Our acquisition activity has been greater in fiscal 2013 as compared to fiscal 2012. Changes in product costs, an internal measure of inflation or deflation, were estimated as inflation of 2.4% during the third quarter and 2.3% during the first 39 weeks of fiscal 2013. Case volumes including acquisitions within the last 12 months improved approximately 1.7% in the third quarter and 2.5% in the first 39 weeks of fiscal 2013. The exchange rates used to translate our foreign sales into United States dollars favorably impacted sales by 0.1% in the third quarter and did not have a material impact in the first 39 weeks of fiscal 2013 compared to the third quarter and first 39 weeks of fiscal 2012, respectively.

Operating Income

Cost of sales primarily includes our product costs, net of vendor consideration, and includes in-bound freight. Operating expenses include the costs of facilities, product handling, delivery, selling and general and administrative activities. Fuel surcharges are reflected within sales and gross profit; fuel costs are reflected within operating expenses.

The following tables set forth the change in the components of operating income and adjusted operating income expressed as a percentage increase or decrease over the comparable period in the prior year:

                                           13-Week           13-Week       13-Week Period    13-Week
                                        Period Ended      Period Ended       Change in       Period
                                        Mar. 30, 2013     Mar. 31, 2012       Dollars       % Change
                                                               (In thousands)
Gross profit                            $   1,910,319     $   1,871,616       $   38,703      2.1  %
Operating expenses                          1,573,117         1,432,786          140,331      9.8
Operating income                        $     337,202     $     438,830       $ (101,628)   (23.2) %

Gross profit                            $   1,910,319     $   1,871,616       $   38,703      2.1  %
Adjusted operating expenses (Non-GAAP)      1,439,810         1,379,273           60,537      4.4
Adjusted operating income (Non-GAAP)    $     470,509     $     492,343       $  (21,834)    (4.4) %

                                           39-Week           39-Week       39-Week Period    39-Week
                                        Period Ended      Period Ended       Change in       Period
                                        Mar. 30, 2013     Mar. 31, 2012       Dollars       % Change
                                                               (In thousands)
Gross profit                            $   5,831,429     $   5,664,866       $  166,563      2.9  %
Operating expenses                          4,632,794         4,289,698          343,096      8.0
Operating income                        $   1,198,635     $   1,375,168       $ (176,533)   (12.8) %

Gross profit                            $   5,831,429     $   5,664,866       $  166,563      2.9  %
Adjusted operating expenses (Non-GAAP)      4,312,388         4,153,964          158,424      3.8
Adjusted operating income (Non-GAAP)    $   1,519,041     $   1,510,902       $    8,139      0.5  %

The decrease in operating income for both periods was primarily driven by increased expenses, including a charge from the withdrawal from a multiemployer pension plan and charges related to our Business Transformation Project.


Gross profit dollars increased in the third quarter and first 39 weeks of fiscal 2013 as compared to the third quarter and first 39 weeks of fiscal 2012 primarily due to increased sales. Gross margin, which is gross profit as a percentage of sales, was 17.48% in the third quarter of fiscal 2013, a decline of 34 basis points from the gross margin of 17.82% in the third quarter of fiscal 2012. Gross margin was 17.77% in the first 39 weeks of fiscal 2013, a decline of 31 basis points from the gross margin of 18.08% in the first 39 weeks of fiscal 2012. This decline in gross margin was partially the result of increased growth from large regional and national customers. Gross margin from these types of customers is generally lower than other types of customers. As seen in our results during fiscal 2013, if sales from our independent restaurant customers do not grow at the same rate as these large regional and national customers, our gross margins may decline. Increased competition resulting from a slow-growth market also contributed to the decline in gross margins.

We estimate that Sysco's product cost inflation was 2.4% during the third quarter and 2.3% during the first 39 weeks of fiscal 2013. Based on our product sales mix for the third quarter and the first 39 weeks of fiscal 2013, we were most impacted by higher levels of inflation in the poultry and produce product categories for the third quarter and poultry and meat product categories for the first 39 weeks of fiscal 2013. While we cannot predict whether inflation will occur, prolonged periods of high inflation, either overall or in certain product categories, can have a negative impact on us and our customers, as high food costs can reduce consumer spending in the food-away-from-home market, and may negatively impact our sales, gross profit and earnings.

Operating expenses for the third quarter and first 39 weeks of fiscal 2013 increased 9.8%, or $140.3 million, and 8.0%, or $343.1 million, over the comparable prior year periods, respectively, primarily due to increased expenses and charges related to multiemployer pension plan withdrawals, our Business Transformation Project, pay-related expenses, depreciation and amortization expense and fuel. Adjusted operating expenses increased 4.4% or $60.5 million, in the third quarter of fiscal 2013 over the comparable prior year period. Adjusted operating expenses increased 3.8% or $158.4 million, in the first 39 weeks of fiscal 2013 over the comparable prior year period. The increases in adjusted operating expenses in both periods were primarily due to increased pay-related expenses, depreciation and amortization expense and fuel.

Expenses related to our Business Transformation Project, inclusive of pay-related and software amortization expense, were $83.2 million in the third quarter of fiscal 2013 and $49.5 million in the third quarter of fiscal 2012, representing an increase of $33.8 million. Expenses related to our Business Transformation Project, inclusive of pay-related and software amortization . . .

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