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SYY > SEC Filings for SYY > Form 10-K on 27-Aug-2013All Recent SEC Filings

Show all filings for SYSCO CORP

Form 10-K for SYSCO CORP


27-Aug-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

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 our fiscal 2013 comparisons to fiscal 2012 exclude the impact from Business Transformation Project costs, multiemployer pension plan charges, severance charges, executive retirement plans restructuring, a one-time acquisition related charge and facility closure charges. Collectively, these are referred to as Excluded Charges. Our fiscal 2012 comparisons to fiscal 2011 exclude the impact from Business Transformation Project costs, multiemployer pension plan charges, severance charges, corporate-owned life insurance (COLI) policies and certain tax benefits. More information on the rationale for 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 operations are primarily located throughout the United States, Bahamas, Canada, Ireland and Northern 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 and Canada 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 48% of the total dollars spent on food purchases made at the consumer level in the United States.

Industry sources estimate the total foodservice market in the United States experienced a real sales increase of approximately 1.3% in calendar year 2012 and a decline of 0.1% in calendar year 2011. Real sales changes do not include the impact of inflation or deflation.

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

Fiscal 2013 was a year in which we progressed with our Business Transformation Project while facing a challenging business and economic environment. The foodservice industry has not fully participated in the overall economic recovery primarily due to constrained consumer spending for food-away-from-home. Our results of operations reflect these challenges as well as expenses related to our Business Transformation Project, payroll costs, charges from the withdrawal from multiemployer pension plans and increased fuel expense. We believe our sales growth and expense management on a cost per cases basis was acceptable, however gross profit did not grow as we planned due partially to competitive pressures and a shift in customer mix. 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. We acquired 14 companies during fiscal 2013, which represents annualized sales in excess of $1 billion. We expect these acquisitions will contribute to our sales growth, enhance our international market presence and product assortment.

Comparison of results from fiscal 2013 to fiscal 2012:

Sales increased 4.8%, or $2.0 billion to $44.4 billion.

Operating income decreased 12.3%, or $232.2 million, to $1.7 billion.

Adjusted operating income decreased 1.7%, or $36.4 million, to $2.1 billion.

Net earnings decreased 11.5%, or $129.2 million, to $1.0 billion.

Adjusted net earnings increased 0.1%, or $1.4 million, to $1.3 billion.

Basic earnings per share in fiscal 2013 was $1.68, a 12.0% decrease from the comparable prior year period amount of $1.91 per share. Diluted earnings per share in fiscal 2013 was $1.67, a 12.1% decrease from the comparable prior year period amount of $1.90 per share.

Adjusted diluted earnings per share was $2.14 in fiscal 2013, a 0.5% decrease from the comparable prior year amount of $2.15 per share.

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. Consumer confidence has improved since 2008, however it remains below its historical highs. We believe that the consumer is currently concerned about lingering unemployment levels and lack of growth in personal income. 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. While these trends can be cyclical in nature, greater consumer confidence will be required to reverse the trend. 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. Non-traditional competitors are becoming more of a factor in terms of competition within our industry, and consumer spending trends are gradually shifting more to fresh, natural and sustainably-produced products. 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.

Our gross margin performance has been influenced by multiple factors. Our sales growth in fiscal 2013 was greater with our large regional and national customers. Gross margin from these types of customers is generally lower than our independent restaurant customers. If sales from our independent restaurant customers do not grow at the same rate or a greater rate than sales from these large regional and national customers, our gross margins may decline. Additional pressure exists on our gross margin from competitive pricing pressures. Low growth in the foodservice market is contributing to increased competition which is in turn pressuring gross profits. We expect this pricing pressure will likely continue. Inflation can be a factor that contributes to gross margin pressure; however, inflation rates remained relatively stable throughout fiscal 2013 at a rate between 2.0% to 2.5%. Inflation was present in certain product categories such as poultry and meat, but was not significant in the majority of our product categories. 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.

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 in fiscal 2014 will be similar to the costs incurred in fiscal 2013. Operating expenses have also increased due to provisions related to multiemployer pension plan withdrawals. These pension plan provisions 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 lower costs in the selling and information technology areas due to initiatives from our Business Transformation Project. Fuel costs have increased due to both increases diesel prices and gallon usage.

Our retirement-related expenses consist primarily of costs from our company-sponsored qualified pension plan (Retirement Plan), our Supplement Executive Retirement Plan (SERP) and our defined contribution plan. The net impact in fiscal 2013 of our retirement-related expenses as compared to fiscal 2012 was an increase of $31.3 million. At the end of fiscal 2012, we decided to freeze future benefit accruals under the Retirement Plan as of December 31, 2012 for all United States-based (U.S.-based) salaried and non-union hourly employees. Effective January 1, 2013, these employees were eligible for additional contributions under an enhanced, defined contribution plan. Absent the Retirement Plan freeze discussed above, net company-sponsored pension costs would have increased $106.9 million in fiscal 2013, however because of the freeze the costs decreased as compared to fiscal 2012. Our expenses related to our defined contribution plan increased in fiscal 2013. During fiscal 2013, we approved a plan to restructure our executive nonqualified retirement program, including the 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 $21.0 million in charges in fiscal 2013. We expect our retirement-related expenses will decrease in the range of $75 million to $85 million in fiscal 2014 as compared to fiscal 2013. A greater portion of the decrease will occur in the second half of fiscal 2014 due to operation of our enhanced, defined contribution plan for a one-year period. Excluding the $21.0 million restructuring charge in fiscal 2013, the decrease is expected to be $50 million to $60 million in fiscal 2014. 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.

We expect gross margin pressure to persist in fiscal 2014; however, we intend to achieve sales case growth and to reduce costs per case to improve our earnings performance trends in fiscal 2014 as compared to fiscal 2013.


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: Our primary focus is to help our customers succeed. We believe that by building on our current competitive advantages, we will be able to further differentiate our offering to customers. Our competitive advantages include our sales force of over 7,000 marketing associates; our diversified product base, which includes quality-assured Sysco brand products; the suite of services we provide to our customers such as business reviews and menu analysis; and our wide geographic presence in the United States and Canada. In addition, we have a portfolio of businesses spanning broadline, specialty meat, chain restaurant distribution, specialty produce, hotel amenities, specialty import and export which serves our customers' needs across a wide array of business segments. Through our Sysco Ventures platform, we are developing a suite of technology solutions that help support the administrative needs of our customers. We believe this strategy of enriching the experience of doing business with Sysco will increase customer retention and profitably accelerate sales growth with both existing and new customers.

Continuously improve productivity in all areas of our business: Our multi-year Business Transformation Project is designed to improve productivity and reduce costs. An integrated software system is included in this project and will support a majority of our business processes to further streamline our operations and reduce costs. These systems are commonly referred to as Enterprise Resource Planning (ERP) systems. We view the technology as an important enabler of this project; however the larger outcome of this project will be from transformed processes that standardize portions of our operations. This includes a shared business service center to centrally manage certain back-office functions that are currently performed at a majority of our operating companies. This project includes other components to lower our cost structure through improved productivity without impacting our service to our customers. We continue to optimize warehouse and delivery activities across the corporation to achieve a more efficient delivery of products to our customers and we seek to improve sales productivity and lower general and administrative costs. We also have a product cost reduction and category management initiative to use market data and customer insights to make changes to product pricing and product assortment.

Expand our portfolio of products and services by initiating a customer-centric innovation program: We continually explore opportunities to provide new and improved products, technologies and services to our customers.

Explore, assess and pursue new businesses and markets: This strategy is focused on identifying opportunities to expand the core business through growth in new international markets and in adjacent areas that complement our core foodservice distribution business. As a part of our ongoing strategic analysis, we regularly evaluate business opportunities, including potential acquisitions and sales of assets and businesses.

Develop and effectively integrate a comprehensive, enterprise-wide talent management process: Our ability to drive results and grow our business is directly linked to having the best talent in the industry. We are committed to the continued enhancement of our talent management programs in terms of how we recruit, select, train and develop our associates throughout Sysco as well as succession planning. Our ultimate objective is to provide our associates with outstanding opportunities for professional growth and career development.

Business Transformation Project

Our multi-year Business Transformation Project consists of:

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;

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

several other initiatives.

We deployed our ERP system to three additional locations in fiscal 2013 and experienced 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 for improvement to certain components of the system that we want to address before we continue deploying to additional locations. These improvements include simplifying certain processes to improve response times and reduce system loads. We believe that this will improve system stability and result in improved ability to scale the system as we move forward. While these


improvements are being made, we will continue implementing individual modules such as our human resource module and continue with other Business Transformation initiatives. We intend to deploy the system to one additional location around the end of this calendar year. If our updates are successful, we anticipate that further deployment will resume early in calendar 2014. Our deployment schedule will be further defined at that time.

Our cost transformation initiative seeks to lower our cost structure by $300 million to $350 million annually by fiscal 2015. These include initiatives to increase our productivity in the warehouse and delivery activities including fleet management and maintenance activities. It also involves improving sales productivity and reducing general and administrative expenses, partially through aligning compensation and benefit plans. Efforts from our cost transformation initiatives in fiscal 2013 spanned many areas of operations. We completed the implementation of maintenance management tools in our United States Broadline (U.S. Broadline) companies. 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 which is expected to be complete by the third quarter of fiscal 2014. Also, in our U.S. Broadline companies we began centralizing field finance work to our shared services center. We believe this transition will be complete by December 2013. We have begun implementing enhancements to our routing technology and processes to improve delivery efficiencies and expect this initiative to be complete by fiscal 2015. 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 and category management initiative is designed to lower our total product costs by $250 million to $300 million annually by fiscal 2015 and to align our product assortment with current customer demand. We are using market data and customer insights to make changes to our product assortment while building strategic partnerships with our suppliers. We believe there are opportunities to more effectively provide the products that our customers want, commit to greater volumes with our suppliers and create mutual benefits for all parties. We believe that procuring greater quantities with select vendors will result in reduced prices for our product purchases. In fiscal 2013, our product cost reduction and category management initiative was active in reducing SKUs in our inventory and increasing participation in our centralized purchasing initiative. We are in the process of piloting four product categories in our category management initiative and have received encouraging acceptance rates from our customers of our new assortment of products. Our suppliers have engaged in the process and appreciate building strategic partnerships that include customer insights into current trends and product innovations..

Expenses related to the Business Transformation Project were $330.5 million in fiscal 2013 or $0.36 per share, $193.1 million in fiscal 2012 or $0.21 per share and $102.6 million in fiscal 2011 or $0.11 per share. The increase in costs in 2013 was largely attributable to deployment costs and software amortization, which began in August 2012. Software amortization totaled $76.8 million in 2013. The increase in costs in 2012 was due to increased project spending, reduced capitalization of expenditures and expenses due to the ramp up of our shared services center. We anticipate that project expenses for fiscal 2014 will be similar to fiscal 2013. Despite the increase in expense, our cash outlay for our Business Transformation Project, which excludes non-cash software amortization, decreased approximately $48 million as compared to fiscal 2012.

Our goal for our Business Transformation Project is to generate approximately $550 million to $650 million in annual benefits to be achieved by fiscal 2015. In fiscal 2013, we believe we exceeded our goal of realizing approximately 25% of the total benefit. In fiscal 2014, we believe we can obtain approximately 50% to 70% of the total targeted benefit. If we are successful in obtaining these benefits in fiscal 2014, some of the trends in gross profits and operating expenses noted above could be favorably impacted.

Our original goal was to grow our diluted earnings per share to $2.50 to $2.75 by fiscal 2015. Despite the success of our Business Transformation Project, our diluted earnings per share has not grown as originally anticipated due to the difficult economic environment and the general operating performance of our underlying business that did not meet our expectations. We no longer believe we will achieve our original goal of producing diluted earnings per share to $2.50 to $2.75 by fiscal 2015.


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:

                               2013       2012       2011
Sales                        100.0  %   100.0  %   100.0  %
Cost of sales                 82.3       81.9       81.2
Gross profit                  17.7       18.1       18.8
Operating expenses            14.0       13.6       13.9
Operating income               3.7        4.5        4.9
Interest expense               0.3        0.3        0.3
Other expense (income), net   (0.0)      (0.0)      (0.0)
Earnings before income taxes   3.4        4.2        4.6
Income taxes                   1.2        1.6        1.7
Net earnings                   2.2  %     2.6  %     2.9  %

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 prior year:

                                      2013         2012
Sales                                4.8  %       7.8  %
Cost of sales                        5.3          8.7
Gross profit                         2.5          3.8
Operating expenses                   7.3          5.9
Operating income                   (12.3)        (2.1)
Interest expense                    13.3         (4.1)
Other expense (income), net        158.2  (1)   (52.4) (1)
Earnings before income taxes       (13.3)        (2.4)
Income taxes                       (16.2)        (1.9)
Net earnings                       (11.5) %      (2.6) %

Basic earnings per share           (12.0) %      (2.6) %
Diluted earnings per share         (12.1)        (3.1)

Average shares outstanding           0.3          0.2
Diluted shares outstanding           0.6          0.1

(1) Other expense (income), net was income of $17.5 million in fiscal 2013, $6.8 million in fiscal 2012 and $14.2 million in fiscal 2011.

Sales

Sales for fiscal 2013 were 4.8% higher than fiscal 2012. Sales for fiscal 2013 increased as a result of product cost inflation and the resulting increase in selling prices, sales from acquisitions that occurred within the last 12 months and case volume growth. Our sales growth in fiscal 2013 was greater with our large regional and national customers as compared to sales growth with our independent restaurant customers. We believe our independent sales growth has been negatively influenced by lower consumer sentiment. Case volumes excluding acquisitions within the last 12 months improved 1.3% in fiscal 2013. Our case volumes represent our results from our Broadline and SYGMA segments only. Sales from acquisitions within the last 12 months favorably impacted sales by 1.5% for fiscal 2013. Our acquisition activity has been greater in fiscal 2013 as compared to fiscal 2012. We estimate the carryover impact into fiscal 2014 will cause sales to increase by approximately 1.0%. We expect to continue the trend of closing acquisitions in fiscal 2014 that will continue to add at least 1.0% in total annualized sales from new acquisitions in fiscal 2014. Changes in product costs, an internal measure of inflation or deflation, were estimated as inflation of 2.2% during fiscal 2013. Case volumes including acquisitions within the last 12 months improved approximately 2.6% in fiscal 2013. The changes in the exchange rates used to translate our foreign sales into U.S. dollars did not have a significant impact on sales when compared to fiscal 2012.

Sales for fiscal 2012 were 7.8% higher than fiscal 2011. Sales for fiscal 2012 increased as a result of product cost inflation, and the resulting increase in selling prices, along with improving case volumes. Changes in product cost, an internal measure of inflation, were approximately 5.5% during fiscal 2012. Case volumes including acquisitions within the last 12 months improved approximately


3.0% during fiscal 2012. Case volumes excluding acquisitions within the last 12 months improved approximately 2.5% during fiscal 2012. Sales from acquisitions in the last 12 months favorably impacted sales by 0.7% for fiscal 2012. The changes in the exchange rates used to translate our foreign sales into U.S. dollars did not have a significant impact on sales when compared to fiscal 2011.

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.

Fiscal 2013 vs. Fiscal 2012

The following table sets forth the change in the components of operating income and adjusted operating income expressed as a percentage increase or decrease over the prior year:

                                                                      Change in
                                           2013           2012         Dollars      % Change
                                                           (In thousands)
Gross profit                           $ 7,867,591    $ 7,676,577     $  191,014       2.5  %
Operating expenses                       6,209,113      5,785,945        423,168       7.3
Operating income                       $ 1,658,478    $ 1,890,632     $ (232,154)    (12.3) %

Gross profit                           $ 7,867,591    $ 7,676,577     $  191,014       2.5  %
Adjusted operating expenses (Non-GAAP)   5,783,854      5,556,468        227,386       4.1
Adjusted operating income (Non-GAAP)   $ 2,083,737    $ 2,120,109     $  (36,372)     (1.7) %

The decrease in operating income in fiscal 2013 as compared to fiscal 2012 was primarily driven by increased expenses, including charges related to our Business Transformation Project and increased pay-related expenses.

Gross profit dollars increased in fiscal 2013 as compared to fiscal 2012 primarily due to increased sales. Gross margin, which is gross profit as a . . .

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