UNITED STATES SECURITIES AND EXCHANGE COMMISSION 

Washington, D.C. 20549 

________________ 

Form 10-Q 

 

 

Commission File Number 1-6544 

________________ 

 

Sysco Corporation 

(Exact name of registrant as specified in its charter) 

 

 

 

Registrant’s Telephone Number, Including Area Code: 

(281) 584-1390 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   

Yes ☑    No ☐ 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   

Yes  ☑    No ☐ 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   

Yes ☐     No ☑ 

 

584,569,243  shares of common stock were outstanding as of April 26, 2014.

 

 

 

 

---

 

 

TABLE OF CONTENTS 

 

 

 

 

  

 

 

---

 

PART I – FINANCIAL INFORMATION 

Item 1.  Financial Statements 

Sysco Corporation and its Consolidated Subsidiaries 

CONSOLIDATED BALANCE SHEETS 

(In thousands, except for share data)

 

Note: The June 29, 2013 balance sheet has been derived from the audited financial statements at that date. 

See Notes to Consolidated Financial Statements

 

---

 

Sysco Corporation and its Consolidated Subsidiaries 

CONSOLIDATED RESULTS OF OPERATIONS (Unaudited)  

(In thousands, except for share and per share data)

 

 

See Notes to Consolidated Financial Statements

  

 

---

 

Sysco Corporation and its Consolidated Subsidiaries 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) 

(In thousands)

 

 

See Notes to Consolidated Financial Statements

 

---

 

Sysco Corporation and its Consolidated Subsidiaries 

CONSOLIDATED CASH FLOWS (Unaudited) 

(In thousands)

 

See Notes to Consolidated Financial Statements

 

 

---

 

Sysco Corporation and its Consolidated Subsidiaries  

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 

 

Unless this Form 10-Q indicates otherwise or the context otherwise requires, the terms “we,” “our,” “us,” “Sysco,” or “the company” as used in this Form 10-Q refer to Sysco Corporation together with its consolidated subsidiaries and divisions.

 

 

1.  BASIS OF PRESENTATION

 

The consolidated financial statements have been prepared by the company, without audit, with the exception of the June 29, 2013 consolidated balance sheet which was taken from the audited financial statements included in the company's Fiscal 2013 Annual Report on Form 10-K.  The financial statements include consolidated balance sheets, consolidated results of operations, consolidated statements of comprehensive income and consolidated cash flows. In the opinion of management, all adjustments, which consist of normal recurring adjustments, necessary to present fairly the financial position, results of operations, comprehensive income and cash flows for all periods presented have been made. 

 

Prior year amounts within the consolidated balance sheets have been reclassified to conform to the current year presentation as it relates to the presentation of certain accounts payable and accrued expenses.  Prior year amounts within the consolidated results of operations have been reclassified to conform to the current year presentation as it relates to the classification of certain amounts within cost of sales and operating expenses.  The impact of these reclassifications was immaterial to the prior year period.    

 

These financial statements should be read in conjunction with the audited financial statements and notes thereto included in the company's fiscal 2013 Annual Report on Form 10-K.   Certain footnote disclosures included in annual financial statements prepared in accordance with generally accepted accounting principles (GAAP) have been condensed or omitted pursuant to applicable rules and regulations for interim financial statements.

 

A review of the financial information herein has been made by Ernst & Young LLP, independent registered public accounting firm, in accordance with established professional standards and procedures for such a review.  A Review Report of Independent Registered Public Accounting Firm has been issued by Ernst & Young LLP and is included as Exhibit 15.1 to this Form 10-Q. 

 

 

2.  CHANGES IN ACCOUNTING 

 

Testing Indefinite-Lived Intangible Assets for Impairment

 

In July 2012, the FASB issued ASU 2012-02, “Testing Indefinite-Lived Intangible Assets for Impairment.”  This update amends ASC 350, “Intangibles—Goodwill and Other” to allow entities an option to first assess qualitative factors to determine whether it is necessary to perform the quantitative impairment test.  Under that option, an entity no longer would be required to calculate the fair value of the intangible asset unless the entity determines, based on that qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount.  The amendments in this update were effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012.  Early adoption was permitted.  The adoption of this update in the first quarter of fiscal 2014 did not result in a change to the company’s interim consideration of impairment of indefinite-lived intangible assets.  Sysco does not believe this update will have an impact on its annual testing for impairment of indefinite-lived intangibles in the fourth quarter of fiscal 2014.

 

Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income

 

In February 2013, the FASB issued ASU 2013-02, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.”  This update amends ASC 220, “Comprehensive Income” to require an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net earnings if the amount is being reclassified in its entirety to net earnings.  For other amounts that are not being reclassified in their entirety to net earnings, an entity is required to cross-reference other disclosures that provide additional detail about those amounts.  The amendments in this update were effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2012.   The additional disclosures required by this update are included in Note 9, “Comprehensive Income.”

  

  

 

3.  FAIR VALUE MEASUREMENTS 

 

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (i.e. an exit price).  The accounting guidance includes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value.  The three levels of the fair value hierarchy are as follows: 

---

 

 

Sysco’s policy is to invest in only high-quality investments.  Cash equivalents primarily include time deposits, certificates of deposit, commercial paper, high-quality money market funds and all highly liquid instruments with original maturities of three months or less.   Restricted cash consists of investments in high-quality money market funds.    

 

The following is a description of the valuation methodologies used for assets and liabilities measured at fair value. 

 

The following tables present the company’s assets measured at fair value on a recurring basis as of March 29, 2014,  June 29, 2013 and March 30, 2013:  

 

 

 

 

---

 

 

The carrying values of accounts receivable and accounts payable approximated their respective fair values due to the short‑term maturities of these instruments. The fair value of Sysco’s total debt is estimated based on the quoted market prices for the same or similar issue or on the current rates offered to the company for debt of the same remaining maturities and is considered a Level 2 measurement.  The fair value of total debt approximated $3,286.5 million, $3,207.6 million and $3,281.9 million as of March 29, 2014,  June 29, 2013 and March 30, 2013, respectively. The carrying value of total debt was $3,062.1  million, $2,888.9 million and $2,798.2 million as of March 29, 2014,  June 29, 2013 and March 30, 2013, respectively.

 

 

4.  DERIVATIVE FINANCIAL INSTRUMENTS 

 

Sysco manages its debt portfolio to achieve an overall desired position of fixed and floating rates and may employ interest rate swaps from time to time to achieve this position. The company does not use derivative financial instruments for trading or speculative purposes. 

 

In August 2013, the company entered into an interest rate swap agreement that effectively converted $500.0 million of fixed rate debt maturing in fiscal 2018 to floating rate debt.  In addition, in fiscal 2010, the company entered into an interest rate swap agreement that effectively converted $200.0 million of fixed rate debt maturing in fiscal 2014 to floating rate debt; this swap was settled upon maturity of the senior notes in March 2014.  These transactions were entered into with the goal of reducing overall borrowing cost and increasing floating interest rate exposure.  These transactions were designated as fair value hedges against the changes in fair value of fixed rate debt resulting from changes in interest rates.

 

In January 2014, the company entered into two forward starting swap agreements with notional amounts totaling $2.0 billion. The company designated these derivatives as cash flow hedges of the variability in the expected cash outflows of interest payments on 10-year and 30-year debt due to changes in the benchmark interest rates for debt the company expects to issue in fiscal 2015.  Prior to issuance of the debt, the effective portion of gains and losses on these cash flow hedges is recorded to Other comprehensive income (loss).  Once the interest rate swap agreements are settled upon issuance of the debt, the cumulative gain or loss recorded in Accumulated other comprehensive (loss) income will be amortized through interest expense over the term of the issued debt.    

 

The location and the fair value of derivative instruments in the consolidated balance sheet as of March 29, 2014,  June 29, 2013 and March 30, 2013 are as follows:

 

 

---

 

The location and effect of derivative instruments and related hedged items on the consolidated results of operations for the third quarter of fiscal 2014 and fiscal 2013 presented on a pre-tax basis are as follows:

 

The location and effect of derivative instruments and related hedged items on the consolidated results of operations for the 39-week periods ended March 29, 2014 and March 30, 2013 presented on a pre-tax basis are as follows:

 

 

Hedge ineffectiveness represents the difference between the changes in the fair value of the derivative instruments and the changes in fair value of the fixed rate debt attributable to changes in the benchmark interest rate.  Hedge ineffectiveness is recorded directly in earnings within interest expense and was immaterial for the third quarter of fiscal 2014 and 2013 and the 39-week periods ended March 29, 2014 and March 30, 2013.  The interest rate swaps do not contain credit-risk-related contingent features. 

 

 

5.  DEBT 

 

As of March 29, 2014, Sysco had uncommitted bank lines of credit which provide for unsecured borrowings for working capital of up to $95.0 million, of which none was outstanding.  Such amounts when outstanding are reflected in Notes payable on the consolidated balance sheet.  

 

Sysco and one of its subsidiaries, Sysco International, ULC, have a revolving credit facility supporting the company’s United States (U.S.) and Canadian commercial paper programs.  The facility provides for borrowings in both U.S. and Canadian dollars.  Borrowings by Sysco International, ULC under the agreement are guaranteed by Sysco, and borrowings by Sysco and Sysco International, ULC under the credit agreement are guaranteed by the wholly-owned subsidiaries of Sysco that are guarantors of the company’s senior notes and debentures.   In January 2014, Sysco and Sysco International, ULC, extended and increased the size of the revolving credit facility described above that supports the company’s U.S. and Canadian commercial paper programs.  The facility was increased to $1.5 billion with an expiration date of December 29, 2018, but is subject to further extension.  The other terms and conditions of the extended facility are substantially the same.  As of March 29, 2014, commercial paper issuances outstanding were $441.1 million and were classified as long-term debt, as the company’s commercial paper programs are supported by the long-term revolving credit facility described above. 

 

During the 39-week period ended March 29, 2014, aggregate commercial paper issuances and short-term bank borrowings ranged from zero to approximately $769.5 million. 

 

The company’s Irish subsidiary, Pallas Foods, has a multicurrency revolving credit facility, which provides for capital needs for the company’s European subsidiaries.  In September 2013, the facility was extended and increased to €100.0 million (Euro).  This

---

 

facility provides for unsecured borrowings and expires September 24, 2014, but is subject to extension.  Outstanding borrowings under this facility were €52.0 million (Euro) as of March 29, 2014, reflected in Notes payable on the consolidated balance sheet. 

 

       In December 2013, Sysco secured a commitment for an unsecured bridge facility in the amount of $3.3865 billion in connection with its proposed merger with US Foods, Inc. (US Foods) (discussed further in Note 12, Acquisitions).  In January 2014, this bridge facility commitment was replaced with a $3.3865 billion bridge term loan agreement with multiple lenders.  Sysco may borrow up to $3.386.5 billion in term loans on the closing date of the US Foods acquisition to fund the acquisition, refinance certain indebtedness of US Foods and pay related fees and expenses. The facility expires on March 8, 2015, but is subject to extension if regulatory approvals have not yet been obtained.   Borrowings under the bridge term loan agreement are guaranteed by the same subsidiaries of Sysco that guarantee the company’s revolving credit facility, and in certain circumstances may also be guaranteed by US Foods after closing of the merger.

 

In March 2014, Sysco repaid the 4.6% senior notes totaling $200.0 million at maturity utilizing a combination of cash flow from operations and commercial paper issuances.

 

6.  COMPANY-SPONSORED EMPLOYEE BENEFIT PLANS 

 

In the tables below, the caption “Pension Benefits” includes both the company-sponsored qualified pension plan and the Supplemental Executive Retirement Plan.  The components of net company-sponsored benefit cost for the third quarter of fiscal 2014 and fiscal 2013 are as follows:    

 

 

The components of net company-sponsored benefit cost for the 39-week periods ended March 29, 2014 and March 30, 2013 are as follows:

 

 

 

Sysco’s contributions to its company-sponsored defined benefit plans were  $18.5 million and $17.5 million during the 39-week periods ended March 29, 2014 and March 30, 2013, respectively. 

 

 

7.  MULTIEMPLOYER EMPLOYEE BENEFIT PLANS 

 

Sysco contributes to several multiemployer defined benefit pension plans in the U.S. and Canada based on obligations arising under collective bargaining agreements covering union-represented employees. Sysco does not directly manage these multiemployer plans, which are generally managed by boards of trustees, half of whom are appointed by the unions and the other half by Sysco and the other employers contributing to the plan.   

 

Based upon the information available from plan administrators, management believes that several of these multiemployer plans are underfunded.  In addition, pension-related legislation in the U.S. requires underfunded pension plans to improve their funding

---

 

ratios within prescribed intervals based on the level of their underfunding.  As a result, Sysco expects its contributions to these plans to increase in the future.  In addition, if a U.S. multiemployer defined benefit plan fails to satisfy certain minimum funding requirements, the Internal Revenue Service may impose a nondeductible excise tax of  5% on the amount of the accumulated funding deficiency for those employers contributing to the fund.   

 

Withdrawal Activity 

 

Sysco has voluntarily withdrawn from various multiemployer pension plans.  Total withdrawal liability provisions recorded were $1.5 million in the first 39 weeks of fiscal 2014 and $43.2 million in the first 39 weeks of fiscal 2013.  As of March 29, 2014,  June 29, 2013, and March 30, 2013, Sysco had approximately $1.5 million, $40.7 million and $54.8 million, respectively, in liabilities recorded related to certain multiemployer defined benefit plans for which Sysco’s voluntary withdrawal had already occurred.   Recorded withdrawal liabilities are estimated at the time of withdrawal based on the most recently available valuation and participant data for the respective plans; amounts are subsequently adjusted to the period of payment to reflect any changes to these estimates.  If any of these plans were to undergo a mass withdrawal, as defined by the Pension Benefit Guaranty Corporation, within the two plan years following the plan year in which we completely withdraw from that plan, Sysco could have additional liability.  The company does not currently believe any mass withdrawals are probable to occur in the applicable two-plan year time frame relating to the plans from which Sysco has voluntarily withdrawn. 

 

Potential Withdrawal Liability 

 

Under current law regarding multiemployer defined benefit plans, a plan’s termination, Sysco’s voluntary withdrawal, or the mass withdrawal of all contributing employers from any underfunded multiemployer defined benefit plan would require Sysco to make payments to the plan for Sysco’s proportionate share of the multiemployer plan’s unfunded vested liabilities.  Generally, Sysco does not have the greatest share of liability among the participants in any of the plans in which it participates.  Sysco believes that one of the above-mentioned events is reasonably possible for certain plans in which it participates and estimates its share of withdrawal liability for these plans could have been as much  as $90.0 million as of March 29, 2014.  This estimate excludes plans for which Sysco has recorded withdrawal liabilities or where the likelihood of the above-mentioned events is deemed remote.  This estimate is based on the information available from plan administrators, the majority of which had a valuation date of December 31, 2012. As the valuation date for most of these plans was December 31, 2012, the company’s estimate reflects the condition of the financial markets as of that date.  Due to the lack of current information, management believes Sysco’s current share of the withdrawal liability could materially differ from this estimate. 

 

8.  EARNINGS PER SHARE 

 

The following table sets forth the computation of basic and diluted earnings per share:

 

The number of options that were not included in the diluted earnings per share calculation because the effect would have been anti-dilutive was approximately 2,800,000 and 10,800,000 for the third quarter of fiscal 2014 and fiscal 2013, respectively.  The number of options that were not included in the diluted earnings per share calculation because the effect would have been anti-dilutive was approximately  2,000,000 and 24,200,000 for the first 39 weeks of fiscal 2014 and 2013, respectively.

 

 

---

 

9.  COMPREHENSIVE INCOME

 

Comprehensive income is net earnings plus certain other items that are recorded directly to shareholders’ equity, such as foreign currency translation adjustment, amounts related to cash flow hedging arrangements and certain amounts related to pension and other postretirement plans.  Comprehensive income was $110.4 million and $186.4 million for the third quarter of fiscal 2014 and fiscal 2013, respectively.  Comprehensive income was $607.4 million and $751.5 million for the first 39 weeks of fiscal 2014 and fiscal 2013 respectively.

 

A summary of the components of other comprehensive income (loss) and the related tax effects for each of the periods presented is as follows: 

 

 

 

---

 

 

 

 

 

 

 

 

 

---

 

The following tables provide a summary of the changes in accumulated other comprehensive (loss) income for the periods presented:

 

 

 

 

 

 

10.  SHARE-BASED COMPENSATION  

 

Sysco provides compensation benefits to employees and non-employee directors under several share-based payment arrangements including various employee stock incentive plans, the Employees’ Stock Purchase Plan, and various non‑employee director plans. 

 

Stock Incentive Plans 

 

Sysco’s 2013 Long-term Incentive Plan (2013 Plan) was adopted in November 2013 and reserved up to 55,600,000 shares of Sysco common stock for share-based awards to employees, non-employee directors and key advisors.  Of the 55,600,000 authorized shares, 45,000,000 were new shares approved with the 2013 Plan and 10,600,000 were from remaining shares authorized and available for grant under the amended 2007 Stock Incentive Plan (2007 Plan) as of the date of the approval of the 2013 Plan.  No further grants will be made from the 2007 Plan.  Of the 55,600,000 authorized shares, the full 55,600,000 shares may be issued as options or stock appreciation rights and up to 17,500,000 shares may be issued as restricted stock, restricted stock units or other types of stock-based awards.  The contractual life of options granted under the 2013 Plan will be no greater than ten years, as compared to a maximum contractual life of seven years for options granted under the 2007 Plan.

 

In the first 39 weeks of fiscal 2014, options to purchase 5,575,645 shares were granted to employees.  The fair value of each option award is estimated as of the date of grant using a Black-Scholes option pricing model. The weighted average grant-date fair value per share of options granted during the first 39 weeks of fiscal 2014 was $4.64. 

 

In the first 39 weeks of fiscal 2014, 1,314,813 restricted stock units were granted to employees.  Based on the jurisdiction in which the employee resides, some of these restricted stock units were granted with forfeitable dividend equivalents. The fair value of each restricted stock unit award granted with a dividend equivalent is based on the company’s stock price as of the date of grant. For restricted stock unit awards granted without dividend equivalents, the fair value was reduced by the present value of expected dividends during the vesting period. The weighted average grant-date fair value per share of restricted stock units granted during the first 39 weeks of fiscal 2014 was $33.39. 

 

In the first 39 weeks of fiscal 2014, restricted awards in the amount of 43,119 were granted to non-employee directors from the 2009 Non-Employee Directors Stock Plan.  The non-employee directors may elect to receive these awards in restricted stock shares

---

 

that will vest at the end of the award’s stated vesting period or as deferred units which convert into shares of Sysco common stock upon a date selected by the non-employee director that is subsequent to the award’s stated vesting date.  The fair value of the restricted awards is based on the company’s stock price as of the date of grant.  The weighted average grant-date fair value per share of restricted awards granted during the first 39 weeks of fiscal 2014 was $33.40.

 

Under the 2009 Non-Employee Directors Stock Plan, non-employee directors may elect to receive up to 100% of their annual directors’ fees in Sysco common stock on either an annual or deferred basis.  Sysco provides a matching grant of 50% of the number of shares received for the stock election subject to certain limitations.  In the first 39 weeks of fiscal 2014, 24,565 shares with a weighted average grant date fair value of $34.59 were issued for these elections in the form of fully vested common stock or deferred units.

 

Employees' Stock Purchase Plan 

 

Plan participants purchased 997,017 shares of Sysco common stock under the Sysco Employees’ Stock Purchase Plan during the first 39 weeks of fiscal 2014. 

 

The weighted average fair value per share of employee stock purchase rights issued pursuant to the Employees' Stock Purchase Plan was $5.09 during the first 39 weeks of fiscal 2014. The fair value of the stock purchase rights is estimated as the difference between the stock price and the employee purchase price. 

 

All Share-Based Payment Arrangements 

 

The total share-based compensation cost that has been recognized in results of operations was $60.9 million and $56.7 million for the first 39 weeks of fiscal 2014 and fiscal 2013, respectively. 

 

As of March 29, 2014, there was $76.5 million of total unrecognized compensation cost related to share-based compensation arrangements.  This cost is expected to be recognized over a weighted-average period of 2.5  years.

 

 

11.  INCOME TAXES 

 

Uncertain Tax Positions 

 

As of March 29, 2014, the gross amount of unrecognized tax benefits was $92.3 million and the gross amount of liability for accrued interest related to unrecognized tax benefits was $33.6 million. It is reasonably possible that the amount of the unrecognized tax benefits with respect to certain of the company’s unrecognized tax positions will increase or decrease in the next twelve months either because Sysco prevails on positions that were being challenged upon audit or because the company agrees to their disallowance.  Items that may cause changes to unrecognized tax benefits primarily include the consideration of various filing requirements in numerous states and the allocation of income and expense between tax jurisdictions.  At this time, an estimate of the range of the reasonably possible change cannot be made. 

 

 Effective Tax Rates 

 

The effective tax rate for the third quarter of fiscal 2014 of 39.01% was negatively impacted by the recording of $6.2 million of tax expense related to a non-deductible penalty that the company has estimated within a contingency accrual.  This negative impact was partially offset by the recognition of $1.0 million of tax benefit related to disqualifying dispositions of Sysco stock pursuant to share-based compensation arrangements.  Indefinitely reinvested earnings taxed at foreign statutory rates less than our domestic tax rate also had the impact of reducing the effective tax rate. 

 

The effective tax rate for the third quarter of fiscal 2013 of 34.26% was favorably impacted by the recording of $4.6 million of domestic tax benefit related to a foreign tax payment and $4.5 million of tax benefit related to disqualifying dispositions of Sysco stock pursuant to share-based compensation arrangements.  Indefinitely reinvested earnings taxed at foreign statutory rates less than our domestic tax rate also had the impact of reducing the effective tax rate. 

 

The effective tax rate for the first 39 weeks of fiscal 2014 of 36.99% was negatively impacted by the recording of $6.2 million of tax expense related to a non-deductible penalty that the company has estimated within a contingency accrual.  This negative impact was partially offset by the recording of $4.7 million of tax benefit related to disqualifying dispositions of Sysco stock pursuant to share-based compensation arrangements.  Indefinitely reinvested earnings taxed at foreign statutory rates less than our domestic tax rate also had the impact of reducing the effective tax rate. 

 

The effective tax rate of 36.03% for the first 39 weeks of fiscal 2013 was favorably impacted by the recording of $7.1 million of tax benefit related to disqualifying dispositions of Sysco stock pursuant to share-based compensation arrangements and the recording

---

 

of $4.6 million of domestic tax benefit related to a foreign tax payment.  Indefinitely reinvested earnings taxed at foreign statutory rates less than our domestic tax rate also had the impact of reducing the effective tax rate. 

 

Other 

 

The determination of the company’s provision for income taxes requires significant judgment, the use of estimates and the interpretation and application of complex tax laws. The company’s provision for income taxes reflects a combination of income earned and taxed in the various U.S. federal and state, as well as foreign, jurisdictions. Jurisdictional tax law changes, increases or decreases in permanent differences between book and tax items, accruals or adjustments of accruals for unrecognized tax benefits or valuation allowances, and the company’s change in the mix of earnings from these taxing jurisdictions all affect the overall effective tax rate.    

 

 

12.  ACQUISITIONS 

 

During the first 39 weeks of fiscal 2014, in the aggregate, the company paid cash of $40.5 million for acquisitions made during fiscal 2014.  Acquisitions in the first 39 weeks of fiscal 2014 were immaterial, individually and in the aggregate, to the consolidated financial statements. 

 

Certain acquisitions involve contingent consideration typically payable over periods up to five years only in the event that certain operating results are attained.  As of March 29, 2014, aggregate contingent consideration amounts outstanding relating to completed acquisitions were $92.9  million, of which $25.3 million could result in the recording of additional goodwill when paid and $57.1 million was recorded as earnout liabilities as of March 29, 2014.

 

In the second quarter of fiscal 2014, the company announced an agreement to merge with US Foods.  US Foods is a leading foodservice distributor in the U.S. that markets and distributes fresh, frozen and dry food and non-food products to more than 200,000 foodservice customers including independently owned single location restaurants, regional and national chain restaurants, healthcare and educational institutions, hotels and motels, government and military organizations and retail locations.  Following completion of the proposed merger, the combined company will continue to be named Sysco and headquartered in Houston, Texas.  As of the time the merger agreement was announced in December 2013, Sysco agreed to pay approximately $3.5 billion for the equity of US Foods, comprised of $3 billion of Sysco common stock and $500 million of cash.  As part of the transaction, Sysco will also assume or refinance US Foods’ net debt, which was approximately $4.7 billion as of September 28, 2013, bringing the total enterprise value to $8.2 billion at the time of the merger announcement.  As of April 26, 2014, the merger consideration is estimated as follows:  approximately $3.6 billion for the equity of US Foods, comprised of $3.1 billion of Sysco common stock valued using the seven day average through April 25, 2014, and $500 million of cash.  US Foods' net debt to be assumed or refinanced was approximately $4.8 billion as of December 28, 2013, bringing the total enterprise value to $8.4 billion as of April 26, 2014.  The value of Sysco’s common stock and the amount of US Foods’ net debt will fluctuate.  As such, the components of the transaction and total enterprise value noted above will not be finalized until the merger is consummated.  Sysco has secured a fully committed bridge financing that could be used for funding a portion of the purchase price.  After completion of the transaction, the equity holders of US Foods will own approximately 87 million shares, or roughly 13% of Sysco.  A representative from each of US Foods’ two majority shareholders will join Sysco’s Board of Directors upon closing.  This merger is currently pending a regulatory review process by the Federal Trade Commission.  The company estimates the merger will close in the first quarter of fiscal 2015.  Under certain conditions, including lack of regulatory approval, Sysco would be obligated to pay $300 million to the owners of US Foods if the merger was cancelled.   

 

 

13.  COMMITMENTS AND CONTINGENCIES 

 

Legal Proceedings 

 

Sysco is engaged in various legal proceedings which have arisen, but have not been fully adjudicated.  The likelihood of loss for these legal proceedings, based on definitions within contingency accounting literature, ranges from remote to reasonably possible to probable.  When probable, the losses have been accrued.  Based on estimates of the range of potential losses associated with these matters, management does not believe the ultimate resolution of these proceedings, either individually or in the aggregate, will have a material adverse effect upon the consolidated financial position or results of operations of the company.  However, the final results of legal proceedings cannot be predicted with certainty and if the company failed to prevail in one or more of these legal matters, and the associated realized losses were to exceed the company’s current estimates of the range of potential losses, the company’s consolidated financial position or results of operations could be materially adversely affected in future periods. 

 

During the first quarter of fiscal 2014, Sysco was made aware of certain alleged violations of California law relating to its use of remote storage units in the delivery of products.  These are commonly referred to as drop sites.  Sysco is cooperating fully with the investigation being conducted by authorities in California, but could be subject to penalties and injunctive relief.  In the third quarter of fiscal 2014, Sysco has recorded a contingency accrual of $20 million which represents its current estimate of the potential liability related to this investigation.    

 

---

 

 

Fuel Commitments 

 

Sysco routinely enters into forward purchase commitments for a portion of its projected diesel fuel requirements.  As of March 29, 2014, outstanding forward diesel fuel purchase commitments totaled approximately $159.1 million at a fixed price through May 2015. 

 

Other Commitments 

 

Sysco has committed to aggregate product purchases for resale in order to benefit from a centralized approach to purchasing.  A majority of these agreements expire within one year;  however, certain agreements have terms through fiscal 2018.  These agreements commit the company to a minimum volume at various pricing terms, including fixed pricing, variable pricing or a combination thereof.  Minimum amounts committed to as of March 29, 2014 totaled approximately $2,449.3 million.

 

 

14.  BUSINESS SEGMENT INFORMATION 

 

The company has aggregated its operating companies into a number of segments, of which only Broadline and SYGMA are reportable segments as defined in the accounting literature related to disclosures about segments of an enterprise.  The Broadline reportable segment is an aggregation of the company’s U.S., Canadian, Caribbean and European Broadline segments.  Broadline operating companies distribute a full line of food products and a wide variety of non-food products to both traditional and chain restaurant customers, hospitals, schools, hotels, industrial caterers and other venues where foodservice products are served.  These companies also provide custom-cut meat operations.  SYGMA operating companies distribute a full line of food products and a wide variety of non-food products to certain chain restaurant customer locations.  "Other" financial information is attributable to the company's other operating segments, including the company's specialty produce and lodging industry segments, a company that distributes specialty imported products,   a company that distributes to international customers and the company’s Sysco Ventures platform, a suite of technology solutions that help support the business needs of Sysco’s customers.   

 

The accounting policies for the segments are the same as those disclosed by Sysco for its consolidated financial statements.  Intersegment sales represent specialty produce and imported specialty products distributed by the Broadline and SYGMA operating companies. Management evaluates the performance of each of the operating segments based on its respective operating income results.  Corporate expenses and adjustments generally include all expenses of the corporate office and Sysco’s shared service center.  These also include all share-based compensation costs and expenses related to the company’s Business Transformation Project. 

 

---

 

The following tables set forth certain financial information for Sysco’s business segments:

 

 

 

 

---

 

 

15.  SUPPLEMENTAL GUARANTOR INFORMATION – SUBSIDIARY GUARANTEES 

 

On January 19, 2011, the wholly-owned U.S. Broadline subsidiaries of Sysco Corporation entered into full and unconditional guarantees of all outstanding senior notes and debentures of Sysco Corporation.   Borrowings under the company’s revolving credit facility supporting the company’s U.S. and Canadian commercial paper programs and the company’s US Foods acquisition bridge facility are also covered under these guarantees.  As of March 29, 2014, Sysco had a total of $2,966.1 million in senior notes, debentures and commercial paper outstanding that was covered by these guarantees.  All subsidiary guarantors are 100%-owned by the parent company, all guarantees are full and unconditional and all guarantees are joint and several, except that the guarantee of any subsidiary guarantor with respect to a series of senior notes or debentures may be released under certain customary circumstances.  If we exercise our defeasance option with respect to the senior notes or debentures of any series, then any subsidiary guarantor effectively will be released with respect to that series.  Further, each subsidiary guarantee will remain in full force and effect until the earliest to occur of the date, if any, on which (1) the applicable subsidiary guarantor shall consolidate with or merge into Sysco Corporation or any successor of Sysco Corporation and (2) Sysco Corporation or any successor of Sysco Corporation consolidates with or merges into the applicable subsidiary guarantor. 

 

The following condensed consolidating financial statements present separately the financial position, comprehensive income and cash flows of the parent issuer (Sysco Corporation), the guarantors (the majority of the company’s U.S. Broadline subsidiaries), and all other non‑guarantor subsidiaries of Sysco (Other Non-Guarantor Subsidiaries) on a combined basis with eliminating entries.

 

 

 

 

---

 

 

 

 

 

 

 

 

 

---

 

 

 

 

 

 

 

 

 

---

 

 

 

 

 

 

---

 

 

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 29, 2013, 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 29, 2013. 

 

Our discussion below of our results includes certain non-GAAP financial measures that we believe provide important perspective with respect to underlying business trends.  Other than free cash flow, any non-GAAP financial measure will be denoted as adjusted measures and exclude the impact from executive retirement plans restructuring, multiemployer pension withdrawals, severance charges, merger and integration costs associated with our pending US Foods, Inc. (US Foods) merger, change in estimate for self-insurance costs, charges from an estimate of a contingency accrual, facility closure charges and amortization of US Foods financing costs, collectively defined as (Certain Items).  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 (U.S.), Bahamas, Canada, Republic of 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, a company that distributes to international customers and our Sysco Ventures platform, our suite of technology solutions that help support the business needs of our customers. 

 

Highlights    

 

The market environment in the first 39 weeks of fiscal 2014 was challenging for many of our customers.  The third quarter was also impacted by unusually severe winter weather throughout much of the country, particularly in the months of January and February.  While our sales growth was modest in the third quarter of fiscal 2014 due to severe weather and lower levels of inflation, our sales growth in March was more robust than the prior two months and on a year-over-year basis due to improved weather and growth in our locally-managed customers.  Competitive pricing pressures and changes in customer mix resulted in lower levels of gross profit growth for the first 39 weeks of fiscal 2014;  however, our third quarter gross profit grew at a faster pace compared to the first half of fiscal 2014.  We believe these third quarter gross profit improvements are attributable to more consistent margin management practices, strengthening local trends, and the low level of inflation we experienced during much of the quarter.  Our expense management performance was favorable overall despite cost pressures in our delivery and warehouse areas.  Our improvements largely resulted from our Business Transformation initiatives, which helped drive our Broadline cost per case lower than in the first 39 weeks of fiscal 2013 and the third quarter of fiscal 2013.    

  

Comparisons of results from the third quarter of fiscal 2014 to the third quarter of fiscal 2013: 

 

 

Comparisons of results from the first 39 weeks of fiscal 2014 to the first 39 weeks of fiscal 2013: 

 

---

 

 

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

 

In the second quarter of fiscal 2014, we announced an agreement to merge with US Foods.  This merger is currently pending a regulatory review process.

 

  

 

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.  Consumers continue to spend their disposable income in an increasingly disciplined manner.  We believe these conditions have 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 U.S. is expected to be modest over the long-term.  We believe these industry trends reinforce the need for us to transform our business to reduce our overall cost structure and provide greater value to our customers. 

 

Our gross margin performance has been influenced by multiple factors.  The modest level of growth in the foodservice market has created additional competitive pricing pressures which is in turn negatively impacting gross profits. Sales to our locally-managed customers, including independent restaurant customers, have not grown at the same rate as sales to our corporate-managed customers.  Gross margin from our corporate-managed customers is generally lower than other types of customers.  Our locally-managed customers comprise a significant portion of our overall volumes and an even greater percentage of profitability because of the high level of value added services we typically provide to this customer group.  As a result, our gross margins have declined.  We have implemented several short-term action steps and longer term strategic initiatives to accelerate both our locally-managed sales and mitigate ongoing gross margin pressures.  Inflation can be a factor that contributes to gross margin pressure; however, inflation rates have remained relatively stable over the past year.  Recently, we have seen increasing inflation in the meat and dairy categories which represent approximately 30% of our annual sales.  There are some indications that inflation may increase in future months particularly with these “center of plate” items.  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 be difficult to pass on to our customers and inflation 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 2013, stemming from higher case volumes, some of which is attributable to our acquired operations, partially offset by lower business transformation expenses and benefits from business transformation initiatives.  We have experienced a decrease in pay-related expenses in the selling and information technology areas due to initiatives from our Business Transformation Project.  Other areas of pay-related expense have increased primarily from acquired companies and within delivery areas of our business.  Our retirement-related expenses consist primarily of costs from our company-sponsored qualified pension plan (Retirement Plan), our Supplemental Executive Retirement Plan (SERP) and our defined contribution plan.  Our Retirement Plan was substantially frozen and the SERP was completely frozen in fiscal 2013, and our defined contribution plan was enhanced with greater benefits.  The net impact of these actions is a reduction in retirement-related costs for fiscal 2014 as compared to fiscal 2013.  We have incurred additional costs in connection with the proposed merger with US Foods announced in the second quarter of fiscal 2014 primarily from integration planning and due diligence costs.  We anticipate incurring additional costs as we begin planning for integration of the two companies as well as other financing costs incurred in connection with the proposed merger.  The proposed merger is undergoing regulatory review by the Federal Trade Commission and we estimate the merger will close in the first quarter of fiscal 2015. 

 

Strategy

 

We are focused on optimizing our core broadline business in the U.S., Bahamas, Canada, Republic of Ireland and Northern 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:

 

---

 

The five strategies above are designed to drive sustainable profitable growth, increase asset optimization and free cash flow and increase operating margins.  Consistent with these three objectives, in the second quarter of fiscal 2014, we announced an agreement to merge with US Foods.  US Foods is a leading foodservice distributor in the U.S. that markets and distributes fresh, frozen and dry food and non-food products to more than 200,000 foodservice customers including independently owned single location restaurants, regional and national chain restaurants, healthcare and educational institutions, hotels and motels, government and military organizations and retail locations.  Following the completion of the proposed merger, the combined company will continue to be named Sysco and headquartered in Houston, Texas. At closing, Sysco is expected to have annual sales of approximately $65 billion and with successful integration, we believe at least $600 million in estimated annual synergies can be obtained in the combined company over a three to four year time period.  Expenses to achieve synergies are estimated to be $700 million to $800 million to occur over a three year time frame once the acquisition has closed.  We anticipate some level of capital expenditures primarily for internal use software and other computer equipment; however, amounts have not been estimated at this time.  As of the time the merger agreement was announced in December 2013, Sysco agreed to pay approximately $3.5 billion for the equity of US Foods, comprised of $3 billion of Sysco common stock and $500 million of cash.  As part of the transaction, Sysco will also assume or refinance US Foods’ net debt, which was approximately $4.7 billion as of September 28, 2013, bringing the total enterprise value to $8.2 billion at the time of the merger announcement.  As of April 26, 2014, the merger consideration is estimated as follows:  approximately $3.6 billion for the equity of US Foods, comprised of $3.1 billion of Sysco common stock valued using the seven day average through April 25, 2014 and $500 million of cash. US Foods' net debt to be assumed or refinanced was approximately $4.8 billion as of December 28, 2013, bringing the total enterprise value to $8.4 billion as of April 26, 2014.  The value of Sysco’s common stock and the amount of US Foods’ net debt will fluctuate.  As such, the components of the transaction and total enterprise value noted above will not be finalized until the merger is consummated.  We have secured a fully committed bridge financing and expect to issue permanent financing prior to closing.  After completion of the transaction, the equity holders of US Foods will own approximately 87 million shares, or roughly 13%, of Sysco.  A representative from each of US Foods’ two majority shareholders will join Sysco’s Board of Directors upon closing.  This merger is currently pending a regulatory review process by the Federal Trade Commission, which will likely take between three to six months.  We expect the transaction to close in the first quarter of fiscal 2015.  Under certain conditions, including lack of regulatory approval, Sysco would be obligated to pay $300 million to the owners of US Foods if the merger were cancelled that would be recognized as an expense.

Business Transformation Project 

 

Our multi-year Business Transformation Project consists of several initiatives including:

 

 

With respect to our ERP system, we successfully installed a major scheduled update to the system and have deployed the system to eight locations as of March 29, 2014 and two additional locations through April 2014.  We are continuing to define a larger scale deployment schedule.  We have experienced greater capitalization of costs in fiscal 2014 as compared to fiscal 2013 incurred to develop system improvements and believe our capital spending for fiscal 2014 will be in the range of $30 million to $40 million.  We believe our total business transformation expenses will be in the range of $275 million to $300 million for fiscal 2014.    Our business transformation expenses are decreasing due to lower employee costs that were attributed to our Business Transformation Project due to a change in allocation for employees that are not dedicated full time to the project.  Only full time employee costs are included in fiscal 2014 while fiscal 2013 included all employee costs.  Additional contributors to the decreases include an increased level of capitalization on amounts spent for system improvements and reduced level of spend with consultants in fiscal 2014. 

 

We are seeking to lower our operating cost structure through various initiatives.  These include efforts 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 continue to benefit fiscal 2014.  Our ongoing initiatives include items in our delivery and warehouse operations such as route optimization, warehouse and delivery scorecards to track performance and enhance accountability, consolidated procurement of parts and forklift equipment and optimizing our fleet.

 

We also seek to lower our product costs through various initiatives such as our category management initiative.  This initiative is designed to lower our total product costs and to align our product assortment with customer demand.  We are using market data and customer insights to make changes to our product assortment while building strategic partnerships with our suppliers to grow our sales and our suppliers’ sales.  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.  By the end of fiscal year 2014, we expect to have launched all of the categories in the pilot and wave one categories and the majority of our wave two categories.  These represent approximately $5

---

 

billion to $7 billion in annual spend and approximately one-third of the total addressable spend.  We continue to believe this initiative will provide benefits to our customers and savings for us over the next few years.    

 

 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:

 

 

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:

 

 

 

 

Sales 

 

Sales were 3.2% higher in the third quarter and 4.3% higher in the first 39 weeks of fiscal 2014 than in the comparable period of the prior year.  Sales for third quarter of fiscal 2014 increased as a result of case volume growth, product cost inflation and the resulting increase in selling prices.  Sales for the first 39 weeks of fiscal 2014 increased as a result of sales from acquisitions that occurred within the last 12 months, case volume growth and product cost inflation and the resulting increase in selling prices.  The third quarter was also impacted by unusually severe winter weather throughout much of the country particularly in the months of January and February.  However, our sales growth in March was more robust than the prior two months and on a year-over-year basis

---

 

at 5.5% due to improved weather and growth in our locally-managed customers.  Our sales growth in the first 39 weeks of fiscal 2014 was greater with our corporate-managed customers as compared to sales growth with our locally-managed customers.  We believe our locally-managed customer growth has been negatively influenced by market conditions including the impact of lower consumer spend; however, our sales growth with our locally-managed customers was slightly less than our corporate-managed customers in the third quarter consistent with the improvements experienced in March.  Case volumes including acquisitions within the last 12 months grew approximately 3.0% in the third quarter and 3.8% in the first 39 weeks of fiscal 2014.  Case volumes excluding acquisitions within the last 12 months grew approximately 2.3% in the third quarter and first 39 weeks of fiscal 2014.  Our case volumes represent our results from our Broadline and SYGMA segments combined.  Sales from acquisitions within the last 12 months favorably impacted sales by 0.8% in the third quarter and 1.6% in the first 39 weeks of fiscal 2014.  Changes in product costs, an internal measure of inflation or deflation, were estimated as inflation of 0.9% during the third quarter and 1.3% for the first 39 weeks of fiscal 2014.  Recently, we have seen increasing inflation in the meat and dairy categories which represent approximately 30% of our annual sales.   There are some indications that inflation may increase in future months particularly with these “center of plate” items.  The exchange rates used to translate our foreign sales into U.S. dollars negatively impacted sales by 0.9% in the third quarter of fiscal 2014 and 0.6% in first 39 weeks of fiscal 2014. 

 

 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 table sets 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:

 

 

 

 

 

Operating income for the third quarter and first 39 weeks of fiscal 2014 was lower than the comparable periods of fiscal 2013 primarily from a lower rate of growth in our gross profit, expenses attributable to volume growth, including payroll, expenses from our acquired operations, increased delivery and warehouse costs and higher corporate expenses.  These were partially offset by lower sales organization costs, lower retirement-related expenses and decreased Business Transformation Project expenses.  Adjusted operating income for the third quarter was slightly higher than the third quarter of fiscal 2013.  Adjusted operating income for the first 39 weeks of fiscal 2014 was lower than the first 39 weeks of fiscal 2013 primarily from a lower rate of growth in our gross profits, expenses attributable to volume growth, including payroll, expenses from our acquired operations, increased delivery and warehouse

---

 

costs and higher corporate expenses.  These were partially offset by lower sales organization costs, lower retirement-related expenses and decreased Business Transformation Project expenses.  As a percentage of sales, we experienced favorable expense management partially from benefits from our business transformation initiatives.      

 

Gross profit dollars increased in the third quarter and first 39 weeks of fiscal 2014 as compared to the third quarter and first 39 weeks of fiscal 2013 primarily due to increased sales volumes.  Gross margin, which is gross profit as a percentage of sales, was 17.69% in the third quarter of fiscal 2014, a decline of 9 basis points from the gross margin of 17.78% in the third quarter of fiscal 2013.  Gross margin was 17.60% in the first 39 weeks of fiscal 2014, a decline of 46 basis points from the gross margin of 18.06% in the first 39 weeks of fiscal 2013.  This decline in gross margin was partially the result of increased competition resulting from a slow-growth market; however, our third quarter gross profit grew at a faster pace compared to the first half of fiscal 2014.  We believe these third quarter gross profit improvements are attributable to more consistent margin management practices, strengthening local trends, and the low level of inflation we experienced during much of the quarter.  Increased sales to lower margin corporate-managed customers also contributed to the decline in the first 39 weeks of fiscal 2014.  Our locally-managed customers comprise a significant portion of our overall volumes and an even greater percentage of profitability because of the high level of value added services we typically provide to this customer group.  If sales from our locally-managed customers do not grow at the same rate as sales from these corporate-managed customers, our gross margins may continue to decline.  Inflation can be a factor that contributes to gross margin pressure; however, inflation rates have remained relatively stable over the past year.  There are some indications that inflation may increase in future months. 

 

Operating expenses for the third quarter and first 39 weeks of fiscal 2014 increased 3.5%, or $56.8 million, and 2.9%, or $136.8 million, over the comparable prior year periods, respectively.  Adjusted operating expenses for the third quarter and the first 39 weeks of fiscal 2014 increased 3.3%, or $51.2 million, and 2.6% or $123.0 million, in the first 39 weeks of fiscal 2014 over the comparable prior year period, respectively.  These increases were primarily due to expenses attributable to volume growth, expenses from our acquired operations, increased delivery and warehouse costs and higher corporate expenses.  These were partially offset by lower sales organization costs, lower retirement-related expenses and decreased Business Transformation Project expenses.  We also experienced increased depreciation and amortization expense in both periods.  We believe favorable expense management, partially from our Business Transformation initiatives, helped to keep our operating expense increases from being greater.  Sysco’s results of operating expenses are impacted by Certain Items which are expenses that can be non-recurring or not a part of our everyday operations.  While the nature of these certain items can vary from period the period, the year over year change in these items was not a significant driver to the results of our third quarter and first 39 weeks.  See more information on the rationale of the use of these measures and reconciliations to GAAP numbers can be found under “Non-GAAP Reconciliations.” 

 

Operating Expenses Impacting Adjusted Operating Income

 

Pay-related expenses, excluding labor costs associated with our Business Transformation Project, US Foods integration planning and retirement-related expenses, increased by $28.3 million in the third quarter and $8.5 million in the first 39 weeks of fiscal 2014 over the comparable prior year periods.  The increases experienced were primarily due to costs from companies acquired in the last 12 months as well as increased delivery and warehouse compensation, partially attributable to case growth.  Pay-related costs have also increased at our corporate office as certain employee costs attributed to our Business Transformation Project in fiscal 2013 are no longer attributed to the Business Transformation Project in fiscal 2014 due to a change in allocation methodology.  In fiscal 2013, we allocated internal associates based upon estimates of the percentage of time they spent on the project.  In fiscal 2014, only associates that that are dedicated full time to the project are included in Business Transformation Project costs.  Benefits from our Business Transformation initiatives have helped in lowering the rate of growth in these expenses particularly in our sales area for both the third quarter and first 39 weeks of fiscal 2014.  During fiscal 2013, we streamlined our sales management organization and modified marketing associate compensation plans.  The first 39 weeks was also impacted by a reduction in pay in the information technology area, resulting from the restructuring of this department in fiscal 2013, which reduced headcount in this area.  Lower provisions for management incentive plans also contributed to the decline in pay-related expenses for the first 39 weeks of fiscal 2014.   

 

Depreciation and amortization expense increased by $7.5 million in the third quarter and $29.1 million in the first 39 weeks of fiscal 2014 over the comparable prior year periods.  The increase in amortization expenses related to our Business Transformation Project is described below.  The remaining increase of $4.4 million in the third quarter and $20.0 million in the first 39 weeks of fiscal 2014 was primarily related to amortization of acquisition-related intangibles and depreciation on assets that were not placed in service in the third quarter and first 39 weeks of fiscal 2013 that were in service in the third quarter and first 39 weeks of fiscal 2014. 

 

Our retirement-related expenses consist primarily of costs from our Retirement Plan, SERP and our defined contribution plan.  As a part of our Business Transformation initiatives, our Retirement Plan was substantially frozen and the SERP was completely frozen in fiscal 2013, and our defined contribution plan was enhanced with greater benefits.  The net impact in the third quarter of fiscal 2014 of our retirement-related expenses as compared to the third quarter of fiscal 2013 was a decrease of $31.2 million, consisting of a $30.9 million decrease in our net company-sponsored pension costs and approximately $0.3 million for other costs.   The net impact in the first 39 weeks of fiscal 2014 of our retirement-related expenses as compared to the first 39 weeks of fiscal 2013 was a decrease of $58.8 million, consisting of a $102.6 million decrease in our net company-sponsored pension costs and approximately $5.1 million for other costs, partially offset by $48.9 million increased costs from the defined contribution plan. We expect our retirement-related

---

 

expenses in fiscal 2014 as compared to fiscal 2013 will decrease approximately $85 million to $95 million from reduced pension expenses, partially offset by increased defined contribution plan expenses.  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 $21 million of restructuring charges taken in fiscal 2013 and the charges estimated for fiscal 2014, the decrease in fiscal 2014 is expected to be approximately $65 million to $75 million. 

 

Expenses related to our Business Transformation Project, inclusive of pay-related and software amortization expense, were $70.7 million in the third quarter of fiscal 2014 and $83.2 million in the third quarter of fiscal 2013, representing a decrease of $12.5 million.  Expenses related to our Business Transformation Project, inclusive of pay-related and software amortization expense, were $197.6 million in the first 39 weeks of fiscal 2014 and $242.3 million in the first 39 weeks of fiscal 2013, representing a decrease of $44.7 million.  The decrease in the third quarter and first 39 weeks of fiscal 2014 resulted from reduction in certain employee costs that were attributed to our Business Transformation Project in fiscal 2013 that are no longer attributed to the Business Transformation Project in fiscal 2014 due to a change in allocation methodology.  In fiscal 2013, we allocated internal associates based upon estimates of the percentage of time they spent on the project.  In fiscal 2014, only associates that that are dedicated full time to the project are included in Business Transformation Project costs.  Additional contributors to the decreases include an increased level of capitalization on amounts spent for system improvements to enhance stability and scalability reduced level of spend with consultants as compared to the comparable period in fiscal 2013.  The decrease in the first 39 weeks was partially offset by an increase in depreciation and amortization expense related to the Business Transformation Project of $9.1 million in the first 39 weeks of fiscal 2014 over the first 39 weeks of fiscal 2013.  Amortization commenced in August of fiscal 2013; therefore, the first 39 weeks of fiscal 2013 only included eight months of amortization expense.  As a result of the lower trend in these expenses, we expect these expenses to be in the range of $275 million to $300 million for fiscal 2014.

 

Operating expense on a cost per case basis for our Broadline companies decreased $0.03 and $0.07 per case as compared to the third quarter and first 39 weeks of fiscal 2013, respectively, primarily from reduced pay-related expenses from our sales and information technology areas and lower retirement-related expenses, partially offset by increased costs from delivery and warehouse pay-related expenses.  We expect to meet or exceed our goal to reduce our Broadline companies cost per case in fiscal 2014 as compared to fiscal 2013 by approximately $0.05 per case.

 

Certain Items within Operating Expenses

 

Sysco’s results of operating expenses are impacted by Certain Items which are expenses that can be non-recurring or not a part of our everyday operations.  See more information on the rationale of the use of these measures and reconciliations to GAAP numbers can be found under “Non-GAAP Reconciliations.”   Our more significant certain items applicable for the third quarter and first 39 weeks of fiscal 2014 include costs in connection with the proposed merger with US Foods and a contingency accrual of $20 million recorded in the third quarter of fiscal 2014.  Also impacting the first 39 weeks of fiscal 2014 was a change in the estimate of our self-insurance reserve.  Our more significant certain items applicable for the third quarter and first 39 weeks of fiscal 2014 related to  withdrawal liabilities from multiemployer pension plans. 

 

We have incurred additional costs in connection with the proposed merger with US Foods announced in the second quarter of fiscal 2014 primarily from integration planning and due diligence costs.  These costs totaled $32.4 million in the third quarter of fiscal 2014 and $36.8 million in the first 39 weeks of fiscal 2014.  We anticipate incurring additional costs as we continue planning for integration of the two companies as well as other financing costs incurred in connection with the proposed merger. 

 

From time to time, we may voluntarily withdraw from multiemployer pension plans to minimize or limit our future exposure to these plans.  In the third quarters of fiscal 2014 and 2013, we recorded provisions of zero and $40.7 million, respectively, related to multiemployer pension plan withdrawals.  In the first 39 weeks of fiscal 2014 and fiscal 2013, we recorded provisions of $1.5 million and $43.2 million, respectively, related to multiemployer pension plan withdrawals.

 

Sysco maintains a self-insurance program covering portions of workers’ compensation, general and vehicle liability and property insurance costs.  The amounts in excess of the self-insured levels are fully insured by third party insurers.  Liabilities associated with these risks are estimated in part by considering historical claims experience, medical cost trends, demographic factors, severity factors and other actuarial assumptions.  In the second quarter of fiscal 2014, based on the historical trends of increased costs primarily attributable to our worker’s compensation claims, we increased our estimates of our self-insurance reserve to a higher point in an estimated range of liability as opposed to our past position at the lower end of the range. This resulted in a charge of $23.8 million in the first 39 weeks of fiscal 2014. 

 

 Net Earnings 

 

Net earnings decreased 10.2% in the third quarter and 4.5% in the first 39 weeks of fiscal 2014 from the comparable periods of the prior year due primarily to the changes in operating income discussed above.  Adjusted net earnings decreased 5.0% and 2.2% during the same periods.    

 

---

 

The effective tax rate for the third quarter of fiscal 2014 of 39.01% was negatively impacted by the recording of $6.2 million of tax expense related to a non-deductible penalty that the company has estimated within a contingency accrual.  This negative impact was partially offset by the recognition of $1.0 million of tax benefit related to disqualifying dispositions of Sysco stock pursuant to share-based compensation arrangements.  Indefinitely reinvested earnings taxed at foreign statutory rates less than our domestic tax rate also had the impact of reducing the effective tax rate. 

 

The effective tax rate for the third quarter of fiscal 2013 of 34.26% was favorably impacted by the recording of $4.6 million of domestic tax benefit related to a foreign tax payment and $4.5 million of tax benefit related to disqualifying dispositions of Sysco stock pursuant to share-based compensation arrangements.  Indefinitely reinvested earnings taxed at foreign statutory rates less than our domestic tax rate also had the impact of reducing the effective tax rate. 

 

The effective tax rate for the first 39 weeks of fiscal 2014 of 36.99% was favorably impacted negatively impacted by the recording of $6.2 million of tax expense related to a non-deductible penalty that the company has estimated within a contingency accrual.   This negative impact was partially offset by the recording of $4.7 million of tax benefit related to disqualifying dispositions of Sysco stock pursuant to share-based compensation arrangements.  Indefinitely reinvested earnings taxed at foreign statutory rates less than our domestic tax rate also had the impact of reducing the effective tax rate.  

 

The effective tax rate of 36.03% for the first 39 weeks of fiscal 2013 was favorably impacted by the recording of $7.1 million of tax benefit related to disqualifying dispositions of Sysco stock pursuant to share-based compensation arrangements and $4.6 million of domestic tax benefit related to a foreign tax payment.  Indefinitely reinvested earnings taxed at foreign statutory rates less than our domestic tax rate also had the impact of reducing the effective tax rate. 

 

Earnings Per Share 

 

Basic and diluted earnings per share in the third quarter of fiscal 2014 were $0.31, an 8.8% decrease from the comparable prior period amount of $0.34 per share.  Adjusted diluted earnings per share in the third quarter of fiscal 2014 were $0.38 a 5.0% decrease from the comparable prior period amount of $0.40 per share.  These results were primarily from the factors discussed above related to net earnings.  We estimate that the impact of the unusually severe weather in January and February in fiscal 2014 reduced our earnings per share results by $0.01 to $0.015 per share.     

 

Basic earnings per share in the first 39 weeks of fiscal 2014 were $1.16, a 4.1% decrease from the comparable prior year period amount of $1.21 per share.  Diluted earnings per share in the first 39 weeks of fiscal 2014 were $1.15, a 4.2% decrease from the comparable prior year period amount of $1.20 per share.  Adjusted diluted earnings per share were $1.26 in the first 39 weeks of fiscal 2014 and $1.28 in the first 39 weeks of fiscal 2013, or a decrease of 1.6%.  These decreases were primarily the result of the factors discussed above related to net earnings.  

 

Non-GAAP Reconciliations 

 

Sysco’s results of operations are impacted by costs from charges from restructuring our executive retirement plans, multiemployer pension charges (MEPP), severance charges, US Foods merger and integration planning costs, change in estimate of self-insurance, charges from an estimate of a contingency accrual, charges from facility closures and  amortization of US Foods financing costs.  Management believes that adjusting its operating expenses, operating income, net earnings and diluted earnings per share to remove the impact of these charges provides an important perspective of underlying business trends and results and provides meaningful supplemental information to both management and investors that is indicative of the performance of the company’s underlying operations and facilitates comparison on a year-over-year basis.   

 

The company uses these non-GAAP measures when evaluating its financial results as well as for internal planning and forecasting purposes.  These financial measures should not be used as a substitute in assessing the company’s results of operations for periods presented.  An analysis of any non-GAAP financial measure should be used in conjunction with results presented in accordance with GAAP.  As a result, in the table below, each period presented is adjusted to remove the costs described above.  In the tables below, individual components of diluted earnings per share may not add to the total presented due to rounding.  Adjusted  diluted earnings per share is calculated using adjusted net earnings divided by diluted shares outstanding. 

 

---

 

Set forth below is a reconciliation of actual operating expenses, operating income, net earnings and diluted earnings per share to adjusted results for these measures for the periods presented:

 

 

 

 

 

---

 

 

 

 

 

---

 

 

Segment Results 

 

We have aggregated our operating companies into a number of segments, of which only Broadline and SYGMA are reportable segments as defined in the accounting literature related to disclosures about segments of an enterprise.  The accounting policies for the segments are the same as those disclosed by Sysco for its consolidated financial statements.  Intersegment sales represent specialty produce and imported specialty products distributed by the Broadline and SYGMA operating companies. 

 

Management evaluates the performance of each of our operating segments based on its respective operating income results.   Corporate expenses and adjustments generally include all expenses of the corporate office and Sysco’s shared service center.  These also include all share-based compensation costs and expenses related to the company’s Business Transformation Project. While a segment’s operating income may be impacted in the short-term by increases or decreases in gross profits, expenses, or a combination thereof, over the long-term each business segment is expected to increase its operating income at a greater rate than sales growth. This is consistent with our long-term goal of leveraging earnings growth at a greater rate than sales growth. 

 

The following table sets forth the operating income of each of our reportable segments and the other segment expressed as a percentage of each segment’s sales for each period reported and should be read in conjunction with Note 14, “Business Segment Information”:

 

The following table sets forth the change in the selected financial data of each of our reportable segments and the other segment expressed as a percentage increase or decrease over the comparable period in the prior year and should be read in conjunction with Note 14, “Business Segment Information”:

 

The following table sets forth sales and operating income of each of our reportable segments, the other segment, and intersegment sales, expressed as a percentage of aggregate segment sales, including intersegment sales, and operating income, respectively.  For purposes of this statistical table, operating income of our segments excludes corporate expenses and adjustments of $289.0 million and $736.5 million in the third quarter and first 39 weeks of fiscal 2014, as compared to $223.2 million and $653.2 million in the third quarter and first 39 weeks of fiscal 2013, that is not charged to our segments.  This information should be read in conjunction with Note 14, “Business Segment Information”:

 

 

 

 

---

 

 

 

 

Broadline Segment 

 

The Broadline reportable segment is an aggregation of the company’s U.S., Canadian, Caribbean and European Broadline segments.  Broadline operating companies distribute a full line of food products and a wide variety of non-food products to both traditional and chain restaurant customers, hospitals, schools, hotels, industrial caterers and other venues where foodservice products are served.  These companies also provide custom-cut meat operations.  Broadline operations have significantly higher operating margins than the rest of Sysco’s operations.  In the first 39 weeks of fiscal 2014, the Broadline operating results represented approximately 81.0% of Sysco’s overall sales and 95.0% of the aggregated operating income of Sysco’s segments, which excludes corporate expenses. 

 

Sales 

 

Sales were 2.7% higher in the third quarter and 3.8% greater in the first 39 weeks of fiscal 2014 than in the comparable period of the prior year.  Sales for the third quarter increased as a result of case volume growth and product cost inflation and the resulting increase in selling prices.  Sales for the first 39 weeks of fiscal 2014 increased as a result of sales from acquisitions that occurred within the last 12 months, case volume growth and product cost inflation and the resulting increase in selling prices.  The third quarter was also impacted by unusually severe winter weather throughout much of the country particularly in the months of January and February.  However, our sales growth in March was more robust than the prior two months and on a year-over-year basis due to improved weather and growth in our locally-managed customers.  Our sales growth in the first 39 weeks of fiscal 2014 was greater with our corporate-managed customers as compared to sales growth with our locally-managed customers.  We believe our locally-managed customer sales growth has been negatively influenced by market conditions including the impact of lower consumer spend; however, our sales growth with our locally-managed customers in the third quarter was slightly less than our corporate-managed customers consistent with the improvements experienced in March.  Sales from acquisitions within the last 12 months favorably impacted sales by 1.0% for the third quarter and 2.0% for the first 39 weeks of fiscal 2014.  Changes in product costs, an internal measure of inflation or deflation, were estimated as inflation of 0.9% for the third quarter and 1.1% for the first 39 weeks of fiscal 2014.  Recently, we have seen increasing inflation in the meat and dairy categories. The exchange rates used to translate our foreign sales into U.S. dollars negatively impacted sales by 1.1% in the third quarter and 0.8% for the first 39 weeks of fiscal 2014. 

 

Operating Income 

 

Operating income increased by 13.3% in the third quarter and 3.6% in the first 39 weeks of fiscal 2014 over the comparable prior year periods.  Both periods of fiscal 2013 included $40.7 million charge related to the withdrawal from a multiemployer pension plan.  No such significant charge was applicable in the comparable periods of fiscal 2014.  We also experienced growth in our gross profits, increased expenses attributable to volume growth, expenses from our acquired operations, increased delivery and warehouse, partially offset by lower sales organization costs and retirement-related expenses.  As a percentage of sales, we experienced favorable expense management partially from benefits from our business transformation initiatives. 

 

Gross profit dollars increased in the third quarter and first 39 weeks of fiscal 2014 primarily due to increased sales.  Gross profit dollars increased at the same rate as sales for the third quarter but at a lower rate than sales for the first 39 weeks of fiscal 2014.  This lack of growth in gross margin for the third quarter and decline in gross margin for the first 39 weeks of fiscal 2014 was partially the result of increased competition resulting from a slow-growth market.  Increased sales to lower margin corporate-managed customers also contributed to the decline in the first 39 weeks of fiscal 2014.  Our locally-managed customers comprise a significant portion of our overall volumes and an even greater percentage of profitability because of the high level of valued added services we typically provide to this customer group.  If sales from our locally-managed customers do not grow at the same rate as sales from these corporate-managed customers, our gross margins may continue to decline.  Inflation can be a factor that contributes to gross margin pressure; however, inflation rates have remained relatively stable over the past year.  There are some indications that inflation may increase in future months.

   

---

 

Operating expenses for the Broadline segment decreased in the third quarter and increased in the first 39 weeks of fiscal 2014 as compared to the third quarter and first 39 weeks of fiscal 2013.  The decrease in expenses in the third quarter of fiscal 2014 compared to fiscal 2013 is the result of a $40.7 million charge related to the withdrawal from a multiemployer pension plan incurred in the third quarter of fiscal 2013.  No such significant charge was applicable in the comparable periods of fiscal 2014.  Absent this charge, expenses increased primarily from volume growth and acquired operations.  The increase in expenses for the first 39 weeks of fiscal 2014 as compared to the first 39 weeks of fiscal 2013 were driven largely by expenses from acquired operations, expenses attributable to volume growth and increased depreciation and amortization expense.  Pay-related expenses increased primarily from added costs from companies acquired in the last 12 months as well as increased delivery and warehouse compensation, partially attributable to case growth.  Depreciation and amortization increased primarily from assets that were not placed in service in the third quarter and first 39 weeks of fiscal 2014 that were in service in the third quarter and first 39 weeks of fiscal 2014.  These increases were partially offset by reduced sales and information technology pay-related expenses.  Retirement-related costs decreased primarily from the plan freezes that occurred in fiscal 2013.  Our expense on a cost per case basis decreased as compared to the third quarter and first 39 weeks of fiscal 2013 primarily from reduced pay-related expenses from our sales and information technology areas and lower retirement-related expenses, partially offset by increased costs from delivery and warehouse pay-related expenses. 

 

SYGMA Segment 

 

SYGMA operating companies distribute a full line of food products and a wide variety of non-food products to certain chain restaurant customer locations.   

 

Sales 

 

Sales were 6.8% greater in the third quarter and 7.6% greater in the first 39 weeks of fiscal 2014 than in the third quarter and first 39 weeks of fiscal 2013.  The increase was primarily due to new customers.  Other contributors to the increase were product cost inflation and the resulting increase in selling prices and case volume increases from existing customers. 

 

Operating Income 

 

Operating income decreased by 36.7% in the third quarter and 30.6% in the first 39 weeks of fiscal 2014 from the third quarter and first 39 weeks of fiscal 2013.  Gross profit dollars increased 3.6% while operating expenses increased 9.0% in the third quarter of fiscal 2014 over the third quarter of fiscal 2013.  Gross profit dollars increased 2.7% while operating expenses increased 6.9% in the first 39 weeks of fiscal 2014 over the first 39 weeks of fiscal 2013.  Gross profit dollar growth was lower than sales growth primarily due to reduced fuel surcharges.  Operating expenses increased in fiscal 2014 largely due to increased delivery costs including pay-related expenses.  Also contributing to the increase in expense were startup costs related to new customers and expenses incurred for a facility consolidation. 

 

Other Segment 

 

“Other” financial information is attributable to our other operating segments, including our specialty produce and lodging industry products segments, a company that distributes specialty imported products, a company that distributes to international customers and our Sysco Ventures platform, our suite of technology solutions that help support the business needs of our customers.  These operating segments are discussed on an aggregate basis as they do not represent reportable segments under segment accounting literature. 

 

Operating income decreased 8.9% in the third quarter and 4.1% in the first 39 weeks of fiscal 2014 over the third quarter and first 39 weeks of fiscal 2013.  The decrease in operating income was primarily driven by startup costs from our Sysco Ventures operations, partially offset by increased earnings from our specialty produce and lodging industry products segments.  Additionally, retirement-related expenses were greater for these companies for the first 39 weeks of fiscal 2014 as our enhanced defined contribution plan became effective January 1, 2013, and some of these operations were not a part of prior benefit plans.    

 

 

---

 

Liquidity and Capital Resources 

 

Highlights 

 

Comparisons of the cash flows from the first 39 weeks of fiscal 2014 to the first 39 weeks of fiscal 2013:  

 

 

Sources and Uses of Cash 

 

Sysco’s strategic objectives include continuous investment in our business; these investments are funded by a combination of cash from operations and access to capital from financial markets.  Our operations historically have produced significant cash flow.  Cash generated from operations is currently generally allocated to:

 

 

Any remaining cash generated from operations may be invested in high-quality, short-term instruments.  As a part of our ongoing strategic analysis, we regularly evaluate business opportunities, including potential acquisitions and sales of assets and businesses, and our overall capital structure.  Any transactions resulting from these evaluations may materially impact our liquidity, borrowing capacity, leverage ratios and capital availability. In the second quarter of fiscal 2014, we announced an agreement to merge with US Foods.  As of the time the merger agreement was announced in December 2013, Sysco agreed to pay approximately $3.5 billion for the equity of US Foods, comprised of $3 billion of Sysco common stock and $500 million of cash.  As part of the transaction, Sysco will also assume or refinance US Foods’ net debt, which was approximately $4.7 billion as of September 28, 2013, bringing the total enterprise value to $8.2 billion at the time of the merger announcement.  As of April 26, 2014, the merger consideration is estimated as follows:  approximately $3.6 billion for the equity of US Foods, comprised of $3.1 billion of Sysco common stock valued using the seven day average through April 25, 2014 and $500 million of cash.  US Foods' net debt to be assumed or refinanced was approximately $4.8 billion as of December 28, 2013, bringing the total enterprise value to $8.4 billion as of April 26, 2014.  The value of Sysco’s common stock and the amount of US Foods’ net debt will fluctuate.  As such, the components of the transaction and total enterprise value noted above will not be finalized until the merger is consummated.  We have secured a fully committed bridge financing and expect to issue permanent financing prior to closing.  After completion of the transaction, the equity holders of US Foods will own approximately 87 million shares, or roughly 13%, of Sysco.  This merger is currently pending a regulatory review process by the Federal Trade Commission and we estimate the merger will close in the first quarter of fiscal 2015.  Under certain conditions, including lack of regulatory approval, Sysco would be obligated to pay $300 million to the owners of US Foods if the merger were cancelled.

 

We continue to generate substantial cash flows from operations and remain in a strong financial position, however our liquidity and capital resources can be influenced by economic trends and conditions that impact our results of operations.   Uncertain economic conditions and uneven levels of consumer confidence and the resulting pressure on consumer disposable income have lowered our sales growth and impacted our cash flows from operations.  Competitive pressures in a low growth environment have also lowered our gross margins, which in turn have caused our cash flows from operations to decrease.  We believe our mechanisms to manage working capital, such as credit monitoring, optimizing inventory levels and maximizing payment terms with vendors, and our mechanisms to manage the items impacting our gross profits have been sufficient to limit a significant unfavorable impact on our cash flows from operations.  We believe these mechanisms will continue to prevent a significant unfavorable impact on our cash flows from operations.  As of March 29, 2014, we had $341.1 million in cash and cash equivalents, approximately 24% of which was held by our international subsidiaries generated from our earnings from international operations.  If these earnings were transferred among countries or repatriated to the U.S., such amounts may be subject to additional tax obligations; however, we do not currently anticipate the need to relocate this cash.

---

 

 

We believe the following sources will be sufficient to meet our anticipated cash requirements for the next twelve months, while maintaining sufficient liquidity for normal operating purposes:

 

 

Due to our strong financial position, we believe that we will continue to be able to effectively access the commercial paper market and long-term capital markets, if necessary.  We believe our cash flows from operations will improve over the long-term due to benefits from our Business Transformation Project, initiatives to improve our working capital management and cash flows from the operations of US Foods once acquired.

 

Cash Flows 

 

Operating Activities

 

We generated $848.1 million in cash flow from operations in the first 39 weeks of fiscal 2014, as compared to $759.4 million in the first 39 weeks of fiscal 2013.  This increase of $88.7 million, or 11.7%, was largely attributable to a favorable comparison on working capital.   Also contributing to the increase in cash flow from operations were several significant accruals in the first 39 weeks of fiscal 2014 and an increase in non-cash depreciation and amortization.  Partially offsetting these favorable comparisons was a   negative comparison on pension expense and contributions, a negative comparison on multiemployer pension withdrawal provisions and payments and reduced net earnings.

 

Changes in working capital, specifically accounts receivable, inventory and accounts payable, had a favorable comparison of $209.9 million on the comparison of cash flow from operations for the first 39 weeks of fiscal 2014 to the first 39 weeks of fiscal 2013.  Both periods were affected by increases in accounts receivable and inventory resulting from increases in sales as well as a seasonal change in volume and customer mix.  Our sales growth in fiscal 2014 has been greater with our corporate-managed customers and payment terms for these types of customers are traditionally longer than average.  Inventory levels can also increase for these types of customers due to the number of proprietary items these customers often require.  Due to normal seasonal patterns, sales to our corporate-managed customers and school districts represented a larger percentage of our sales at the end of each first 39 week period as compared to the end of each prior fiscal year.  The impact the deterioration in both accounts receivable and inventory turnover from the end of the prior fiscal year was less pronounced in the first 39 weeks of fiscal 2014 than the first 39 weeks of fiscal 2013.  The increases in accounts payable in both periods were affected by the normal trend due to the seasonal change in volume and customer mix and partially offset the deterioration in accounts receivable and inventory turnover.  However, the year-over-year impact of the change in accounts payable is favorable to cash flow from operations due to working capital improvements in accounts payable such as extending invoice payment days.  

 

Included in the change in accrued expenses were several significant accruals unique to the first 39 weeks of fiscal 2014, which contributed $80.2 million to the favorable comparison on cash flow from operations for the first 39 weeks of fiscal 2014 to the first 39 weeks of fiscal 2013.  Partially offsetting the favorable impact of the significant accruals was a negative comparison of $63.3 million on multiemployer withdrawal provisions and payments.  The first 39 weeks of fiscal 2014 included a provision for multiemployer pension withdrawal of $1.5 million and a payment of $40.7 million, which resulted in a decrease to accrued expenses.  The first 39 weeks of fiscal 2013 included a provision for multiemployer pension withdrawal of $43.2 million and a payment of $19.1 million, which resulted in an increase to accrued expenses. 

 

Included in the change in other long-term liabilities was a negative comparison on pension expense and contributions, which contributed $103.6 million to the unfavorable comparison on cash flow from operations for the first 39 weeks of fiscal 2014 to the first 39 weeks of fiscal 2014.  Pension expense was $3.6 million and pension contributions were $18.5 million in the first 39 weeks of fiscal 2014, which resulted in a decrease to other long-term liabilities.  Pension expense was $106.2 million and pension contributions were $17.5 million in the first 39 weeks of fiscal 2013, which resulted in an increase to other long-term liabilities.   

   

Investing Activities 

 

Our capital expenditures in the first 39 weeks of fiscal 2014 primarily included facility replacements and expansions, fleet, warehouse equipment and technology.   

 

During the first 39 weeks of fiscal 2014, in the aggregate, we paid cash of $40.5 million for acquisitions made during fiscal 2014. 

 

---

 

Free Cash Flow

 

Free cash flow represents net cash provided from operating activities less purchases of plant and equipment plus proceeds from sales of plant and equipment.  Sysco considers free cash flow to be a non-GAAP liquidity measure that provides useful information to management and investors about the amount of cash generated by the business after the purchases and sales of buildings, fleet, equipment and technology, which may potentially be used to pay for, among other things, strategic uses of cash including dividend payments, share repurchases and acquisitions.  We do not mean to imply that free cash flow is necessarily available for discretionary expenditures, however, as it may be necessary that we use it to make mandatory debt service or other payments.  As a result of increased cash provided by operating activities and increased proceeds from sales of plant and equipment, partially offset by increased capital spending, free cash flow for the first 39 weeks of fiscal 2014 increased 21.5%, or $85.8 million, to $484.3 million as compared to the first 39 weeks of fiscal 2013.  We expect the level of increase for the full fiscal year to be moderate given the strong free cash flow performance we achieved in the fourth quarter of fiscal 2013. 

 

Free cash flow should not be used as a substitute in assessing the company’s liquidity for the periods presented.  An analysis of any non-GAAP financial measure should be used in conjunction with results presented in accordance with GAAP.  In the table that follows, free cash flow for each period presented is reconciled to net cash provided by operating activities. 

 

 

Financing Activities 

 

 Equity Transactions 

 

Proceeds from exercises of share-based compensation awards were $193.9 million in the first 39 weeks of fiscal 2014, as compared to $497.7 million in the first 39 weeks of fiscal 2013.  The decrease in proceeds in the first 39 weeks of fiscal 2014 was due to an decrease in the number of options exercised in this period, as compared to the first 39 weeks of fiscal 2013, specifically in the third quarter.  The level of option exercises, and thus proceeds, will vary from period to period and is largely dependent on movements in our stock price and the time remaining before option grants expire.

 

Shares repurchased during the first 39 weeks of fiscal 2014 were 10,059,000 shares at a cost of $332.4 million, as compared to 10,000,000 shares at a cost of $321.0 million in the first 39 weeks of fiscal 2013.  In August 2013, our Board of Directors approved the repurchase of up to 20,000,000 shares for an aggregate purchase price not to exceed $720 million.  The authorization expires on August 23, 2015.  There were no additional shares repurchased through April 26, 2014, resulting in a remaining authorization by our Board of Directors to repurchase up to 11,655,197 shares, based on the trades made through that date.  Our share repurchase strategy is to purchase enough shares to keep our average shares outstanding relatively constant over time, excluding the impact of the 87 million shares to be issued upon closing of the potential merger with US Foods.  The number of shares we repurchase, if any, in the remainder of fiscal 2014 will be dependent on many factors, including the level of future stock option exercises as well as competing uses for available cash.

 

Dividends paid in the first 39 weeks of fiscal 2014 were $497.8 million, or $0.85 per share, as compared to $482.0 million, or $0.82 per share, in the first 39 weeks of fiscal 2013.  In February 2014, we declared our regular quarterly dividend for the fourth quarter of fiscal 2014 of $0.29 per share, which was paid in April 2014.   

 

Debt Activity and Borrowing Availability 

 

We have uncommitted bank lines of credit, which provide for unsecured borrowings for working capital of up to $95.0 million, of which none was outstanding as of March 29, 2014.  There were no borrowings outstanding as of April 26, 2014.  

 

Sysco and one of its subsidiaries, Sysco International, ULC, have a revolving credit facility supporting the company’s U.S. and Canadian commercial paper programs.  The facility provides for borrowings in both U.S. and Canadian dollars.  Borrowings by Sysco International, ULC under the agreement are guaranteed by Sysco, and borrowings by Sysco and Sysco International, ULC under the credit agreement are guaranteed by the wholly-owned subsidiaries of Sysco that are guarantors of the company’s senior notes and debentures.   In January 2014, Sysco and Sysco International, ULC, extended and increased the size of the revolving credit facility

---

 

described above that supports the company’s U.S. and Canadian commercial paper programs.  The facility was increased to $1.5 billion with an expiration date of December 29, 2018, but is subject to further extension.  The other terms and conditions of the extended facility are substantially the same.    There were $441.1 million of commercial paper issuances outstanding as of March 29, 2014.   As of April 26, 2014, commercial paper issuances outstanding were $641.3 million.  We utilize our commercial paper issuances for normal day-to-day operations which may cause outstanding issuances to vary. 

 

During the 39 week period ended March 29, 2014, aggregate commercial paper issuances and short-term bank borrowings ranged from zero to approximately $769.5 million.  During the first 39 weeks of fiscal 2014 and 2013, our aggregate commercial paper issuances and short-term bank borrowings had a weighted average interest rate of 0.17% and 0.19%, respectively. 

 

The company’s Irish subsidiary, Pallas Foods, has a multicurrency revolving credit facility, which provides for capital needs for the company’s European subsidiaries.  In September 2013, the facility was extended and increased to €100.0 million (Euro).  This facility provides for unsecured borrowings and expires September 24, 2014, but is subject to extension.  Outstanding borrowings under this facility were €52.0 million (Euro) as of March 29, 2014 and April 26, 2014.  

 

In August 2013, we entered into an interest rate swap agreement that effectively converted $500.0 million of fixed rate debt maturing in fiscal 2018 to floating rate debt.  This transaction was entered into with the goal of reducing overall borrowing cost and increasing floating interest rate exposure.  This swap was designated as a fair value hedge against the changes in fair value of fixed rate debt resulting from changes in interest rates. 

 

The following transactions were entered in contemplation of securing financing and hedging interest rate risk relating to our assumption or refinancing of US Foods’ net debt that will occur upon the closing of the proposed merger (discussed further under Trends and Strategy).

 

In December 2013, we secured a commitment for an unsecured bridge facility in the amount of $3.3865 billion in connection with our proposed merger with US Foods.  In January 2014, this bridge facility commitment was replaced with a $3.3865 billion bridge term loan agreement with multiple lenders.  We may borrow up to $3.3865 billion in term loans on the closing date of the US Foods acquisition to fund the acquisition, refinance certain indebtedness of US Foods and pay related fees and expenses. The facility expires on March 8, 2015, but is subject to extension if regulatory approvals have not yet been obtained.   Borrowings under the bridge term loan agreement are guaranteed by the same subsidiaries of Sysco that are guarantee the company’s revolving credit facility, and in certain circumstances may also be guaranteed by US Foods after closing of the merger. As an alternative to using our bridge facility, we intend to issue permanent financing prior to closing of the transaction.    

 

In January 2014, we entered into two forward starting swap agreements with notional amounts totaling $2.0 billion. We designated these derivatives as cash flow hedges of the variability in the expected cash outflows of interest payments on 10-year and 30-year debt forecasted to be issued in fiscal 2015 due to changes in the benchmark interest rates.

 

In January 2014, we extended and increased the size of the revolving credit facility described above that supports our U.S. and Canadian commercial paper programs.  The facility was increased to $1.5 billion with an expiration date of December 29, 2018, but is subject to further extension.  The other terms and conditions of the extended facility are substantially the same. 

 

In March 2014, we repaid the 4.6% senior notes totaling $200.0 million at maturity utilizing a combination of cash flow from operations and commercial paper issuances.

 

Other Considerations

 

Multiemployer Plans

 

As discussed in Note 7, “Multiemployer Employee Benefit Plans,” we contribute to several multiemployer defined benefit pension plans based on obligations arising under collective bargaining agreements covering union-represented employees.   

 

Under certain circumstances, including our voluntary withdrawal or a mass withdrawal of all contributing employers from certain underfunded plans, we would be required to make payments to the plans for our proportionate share of the multiemployer plan’s unfunded vested liabilities.  We believe that one of the above-mentioned events is reasonably possible with certain plans in which we participate and estimate our share of withdrawal liability for these plans could be as much as $90.0 million as of March 29, 2014 and April 26, 2014, based on the latest available information as of each date.   These estimates exclude plans for which we have recorded withdrawal liabilities or where the likelihood of the above-mentioned events is deemed remote.  Due to the lack of current information, we believe our current share of the withdrawal liability could materially differ from this estimate.   

 

As of March 29, 2014, June 29, 2013 and March 30, 2013, Sysco had approximately $1.5 million, $40.7 million and $54.8 million, respectively, in liabilities recorded related to certain multiemployer defined benefit plans for which Sysco’s voluntary withdrawal had already occurred. 

---

 

 

Required contributions to multiemployer plans could increase in the future as these plans strive to improve their funding levels.  In addition, pension-related legislation in the U.S. requires underfunded pension plans to improve their funding ratios within prescribed intervals based on the level of their underfunding.  We believe that any unforeseen requirements to pay such increased contributions, withdrawal liability and excise taxes would be funded through cash flow from operations, borrowing capacity or a combination of these items. 

 

Potential Contingencies Impacting Liquidity

 

In the third quarter of fiscal 2014, we recorded a contingency accrual of $20 million which represents our current estimate of a potential liability related to our legal proceedings. 

 

Certain tax jurisdictions require partial to full payment on audit assessments or the posting of letters of credit in order to proceed to the appeals process.  Sysco has posted approximately $31.2 million in letters of credit, representing a partial payment of the audit assessments, in order to appeal the Canadian Revenue Authority assessments of transfer pricing adjustments relating to our cross border procurement activities through our former purchasing cooperative on our fiscal 2004 and 2005 years.  We are protesting these adjustments through appeals and competent authority.  If assessed on later years under these same positions, we could have to pay cash or post additional letters of credit in order to appeal these further assessments.

 

 

Contractual Obligations 

 

Our Annual Report on Form 10-K for the fiscal year ended June 29, 2013, contains a table that summarizes our obligations and commitments to make contractual future cash payments as of June 29, 2013.  Since June 29, 2013, there have been no material changes to our contractual obligations other than as described below. 

 

The following table sets forth, as of March 29, 2014, certain information concerning our obligations and commitments to make contractual future payments:

 

 

 

 

Critical Accounting Policies and Estimates 

Critical accounting policies and estimates are those that are most important to the portrayal of our financial position and results of operations.  These policies require our most subjective or complex judgments, often employing the use of estimates about the effect of matters that are inherently uncertain.  Sysco’s most critical accounting policies and estimates include those that pertain to the allowance for doubtful accounts receivable, self-insurance programs, pension plans, income taxes, vendor consideration, accounting for business combinations and share-based compensation, which are described in Item 7 of our  Annual Report on Form 10-K for the fiscal year ended June 29, 2013. 

---

 

 

 

Forward-Looking Statements

 

Certain statements made herein that look forward in time or express management’s expectations or beliefs with respect to the occurrence of future events are forward-looking statements under the Private Securities Litigation Reform Act of 1995. They include statements about: 

 

---

 

These statements are based on management’s current expectations and estimates; actual results may differ materially due in part to the risk factors set forth below and those discussed in Part II, Item 1A of this Form 10-Q and our Form 10-Q filed for the second quarter of fiscal 2014, and in Item 1A of our Annual Report on Form 10-K for the fiscal year ended June 29, 2013: 

 

For a more detailed discussion of factors that could cause actual results to differ from those contained in the forward-looking statements, see the risk factors discussion contained in Part II, Item 1A of this Form 10-Q and our Form 10-Q filed for the second quarter of fiscal 2014, and in Item 1A of our Annual Report on Form 10-K for the fiscal year ended June 29, 2013. 

 

 

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk   

 

Our market risks consist of interest rate risk, foreign currency exchange rate risk, fuel price risk and investment risk.  For a discussion on our exposure to market risk, see Part II, Item 7A, “Quantitative and Qualitative Disclosures about Market Risks” in our Annual Report on Form 10-K for the fiscal year ended June 29, 2013.  There have been no significant changes to our market risks since June 29, 2013 except as noted below. 

  

Interest Rate Risk 

 

At March 29, 2014,  there was $441.1 million of commercial paper issuances outstanding.  Total debt as of March 29, 2014 was $3.1 billion, of which approximately 67% was at fixed rates of interest, including the impact of our interest rate swap agreements.   

 

In August 2013, we entered into an interest rate swap agreement that effectively converted $500.0 million of fixed rate debt maturing in fiscal 2018 (the fiscal 2018 swap) to floating rate debt.  In addition, prior to fiscal 2014, we entered into an interest rate

---

 

swap agreement that effectively converted $200 million of fixed rate debt maturing in fiscal 2014 (the fiscal 2014 swap) to floating rate debt.  These transactions were entered into with the goal of reducing overall borrowing cost.  The major risks from interest rate derivatives include changes in interest rates affecting the fair value of such instruments, potential increases in interest expense due to market increases in floating interest rates and the creditworthiness of the counterparties in such transactions. These transactions were designated as fair value hedges since the swaps hedge against the changes in fair value of fixed rate debt resulting from changes in interest rates.  

 

The fiscal 2014 swap was settled upon maturity of the senior notes in March 2014.  As of March 29, 2014, the fiscal 2018 swap was recognized as an asset within the consolidated balance sheet at fair value within other assets of $1.7 million.  The fixed interest rate on the hedged debt is 5.25% and the floating interest rate on the swap is six-month LIBOR which resets every six months in arrears. 

 

In January 2014, in contemplation of securing financing and hedging interest rate risk relating to our assumption or refinancing of US Foods Inc.’ net debt that will occur upon closing of the proposed merger (discussed in Note 12, “Acquisitions”), we entered into two forward starting swap agreements with notional amounts totaling $2.0 billion. We designated these derivatives as cash flow hedges of the variability in the expected cash outflows of interest payments on 10-year and 30-year debt expected to be issued in fiscal 2015.  These forward starting swaps were recognized as a liability within the consolidated balance sheet at fair value within accrued expenses of $64.0 million.

 

Fuel Price Risk 

 

Due to the nature of our distribution business, we are exposed to potential volatility in fuel prices.  The price and availability of diesel fuel fluctuates due to changes in production, seasonality and other market factors generally outside of our control.  During both the first 39 weeks of fiscal 2014 and fiscal 2013, fuel costs related to outbound deliveries represented approximately  0.7% of sales.

 

We routinely enter into forward purchase commitments for a portion of our projected monthly diesel fuel requirements. As of March 29, 2014, we had forward diesel fuel commitments totaling approximately $159.1 million through May 2015.  These contracts will lock in the price of approximately  60% to 65% of our fuel purchase needs for the contracted periods at prices lower than the current market price for diesel for the remainder of fiscal 2014.    

 

 

Item 4.  Controls and Procedures

 

Sysco’s management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of March 29, 2014. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding the required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Sysco’s disclosure controls and procedures have been designed to provide reasonable assurance of achieving their objectives. Based on the evaluation of our disclosure controls and procedures as of March 29, 2014, our chief executive officer and chief financial officer concluded that, as of such date, Sysco’s disclosure controls and procedures were effective at the reasonable assurance level. 

 

Sysco is currently deploying an enterprise resource planning system to implement an integrated software system to support a majority of its business processes. Through the third quarter of fiscal 2014, this system has been implemented at eight operating locations and within our shared business services center.  The results of these operations are material enough to Sysco’s total financial results that the implementation of the new system required us to modify our internal controls over financial reporting (as that term is defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act). There were no other changes in our internal control over financial reporting that occurred during the fiscal quarter ended March 29, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 

 

  

 

 

---

 

PART II – OTHER INFORMATION

 

Item 1.  Legal Proceedings 

 

None.

 

Item 1A.  Risk Factors 

 

The information set forth in this report should be read in conjunction with the risk factors set forth below and the risk factors discussed in Item 1A of our Annual Report on Form 10-K for the year ended June 29, 2013.

 

The closing and consummation of the merger with US Foods, Inc. (US Foods) is subject to regulatory approval and the satisfaction of certain conditions, and we cannot predict whether the necessary conditions will be satisfied or waived and the requisite regulatory approvals received.

 

The completion of the merger with US Foods is subject to regulatory approvals, including anti-trust approval, and customary conditions, including, without limitation:

 

 

Sysco and US Foods may fail to secure the requisite approvals in a timely manner or on terms desired or anticipated, and the merger with US Foods may not close in the anticipated time frame, if at all.  Sysco has no control over certain conditions in the merger agreement, and cannot predict whether such conditions will be satisfied or waived. Regulatory authorities may impose conditions on the completion of the merger or require changes to the terms of the transaction. Such conditions or changes may prevent the closing of the merger or cause the merger to be delayed, and delays may cause Sysco to incur additional, potentially burdensome transaction costs. 

 

Sysco and US Foods may be required to accept certain remedies in order to obtain regulatory approval for the merger, and any such remedies could reduce the projected benefits of the merger and negatively impact the combined company.

 

The imposition of remedies as a condition to obtaining regulatory approval for the transaction could limit the revenues of the combined company and negatively impact the combined company. The potential remedies may negatively impact the projected benefits of the proposed merger, along with the business, financial condition and competitiveness of Sysco, as the combined company.  Even if regulatory approval for the merger is obtained, any remedies could result in the total revenues of the combined post-merger entity being less than the combined historical revenues of Sysco and US Foods.

 

Termination of the merger agreement or failure to consummate the merger with US Foods could require Sysco to make a termination payment of $300 million, which could adversely impact Sysco’s stock price and would adversely impact Sysco’s liquidity and financial condition.

 

The merger agreement contains certain termination rights, including the right of either party to terminate the merger agreement if the merger has not occurred by March 8, 2015, subject to extension under certain circumstances.  Furthermore, if the merger agreement is terminated due to a failure to obtain required antitrust approvals, in certain circumstances Sysco will be required to pay US Foods a termination fee of $300 million. The payment of such fee could have an adverse impact on our liquidity and financial condition.  In addition, if the merger agreement is terminated, we may suffer other negative consequences.  Our business may be negatively impacted by our management having focused its attention on acquiring US Foods instead of pursuing other advantageous business opportunities or plans.  Furthermore, we will incur substantial expenses and costs related to the merger, whether or not it is consummated, including legal, accounting and advisory fees.  Also, failure to consummate the merger may result in negative market reactions, and may have an adverse impact on Sysco’s stock price and future financial results.

 

---

 

Business uncertainties during the pendency of the proposed merger may adversely impact our current business operations and relationships with employees, vendors and customers.

 

Prospective suppliers, customers or other third parties may delay or decline to enter into agreements with us as a result of the uncertainties surrounding the proposed merger, and we may also lose current suppliers and customers as a result of these uncertainties.  Furthermore, uncertainties as to the effect of the merger transaction may adversely impact employee morale, and impede our ability to retain key employees.  The loss of key employees could impact our ability to successfully integrate the businesses of Sysco and US Foods and fully realize the anticipated benefits of the merger.

 

The pending merger and our current pre-merger integration planning efforts may divert resources from Sysco’s day-to-day operations and ongoing efforts related to other strategies and initiatives.

 

The pending merger and our current pre-merger integration planning efforts may divert our management’s attention from day-to-day business operations and the execution and pursuit of strategic plans and initiatives, including the initiatives related to our Business Transformation Project, which has and will continue to require a substantial amount of resources. The diversion of management attention from ongoing business operations and strategic efforts could result in performance shortfalls, which could adversely impact Sysco’s business and operations.

 

The integration of the businesses of Sysco and US Foods may be more difficult, costly or time consuming than expected, and the merger may not result in any or all of the anticipated benefits, including cost synergies. 

 

The success of the merger between Sysco and US Foods, including the realization of the anticipated benefits, will depend, in part, on the ability of Sysco, as the combined company, to successfully integrate the businesses of Sysco and US Foods. Failure to effectively integrate the businesses could adversely impact the expected benefits of the merger, including cost synergies stemming from supply chain efficiencies, merchandising activities and overlapping general and administrative functions.  

 

The integration of two large independent companies will be complex, and we will be required to devote significant management attention and incur substantial costs to integrate Sysco’s and US Foods’ business practices, policies, cultures and operations. The integration process could also result in the loss of key employees, and the disruption of each company’s ongoing businesses, which could materially impact the combined company’s future financial results.

 

Furthermore, during the integration planning process and after the closing of the merger, we may encounter additional challenges and difficulties, including those related to, without limitation, managing a larger combined company; streamlining supply chains, consolidating corporate and administrative infrastructures and eliminating overlapping operations; retaining our existing vendors and customers; unanticipated issues in integrating information technology, communications and other systems; and unforeseen and unexpected liabilities related to the merger or US Foods’ business.  Delays encountered in the integration could adversely impact the business, financial condition and operations of the combined company.     

 

We may not be able to retain some of US Foods’ vendors and customers after the proposed merger, which could negatively impact the anticipated benefits of the merger.

 

US Foods’ vendors or customers may have termination rights that are triggered upon completion of the merger, and such vendors or customers may decide to not renew their existing relationship with us, and may instead select one of our competitors.  If we are unable to retain and maintain these vendor and customer relationships, then the business, financial condition and operations of Sysco, as the combined company, could be adversely impacted.

 

Consummation of the merger will require Sysco to incur significant additional indebtedness, which could adversely impact our financial condition and may hinder our ability to obtain additional financing and pursue other business and investment opportunities. 

 

In connection with the merger, Sysco will assume or refinance all of US Foods’ outstanding debt, which was approximately $4.7 billion at the time the merger agreement was signed. The purchase price, as well as any refinancing of US Foods’ indebtedness, is expected to be financed with a combination of new debt and cash on Sysco’s balance sheet.  Sysco has secured fully committed bridge financing. 

 

Incurrence of additional indebtedness could have negative consequences, including increasing our vulnerability to adverse economic and industry conditions, and limiting our ability to obtain additional financing and implement and pursue strategic initiatives and opportunities.  Additionally, if we do not achieve the expected benefits and cost savings from the merger with US Foods, or if the financial performance of Sysco, as the combined company, does not meet current expectations, then our ability to service the debt may be adversely impacted.  Our credit ratings may also be impacted as a result of the incurrence of additional acquisition-related indebtedness.  Currently, certain credit rating agencies have put us on watch for a potential downgrade.

 

---

 

The merger will dilute the ownership interests of Sysco’s existing stockholders.  

 

At the time of the consummation of the proposed merger, Sysco will issue approximately 87 million shares, or roughly 13% of Sysco’s outstanding common stock after the transaction is completed.  As a result, the ownership amounts of Sysco’s pre-merger shareholders will be diluted.  Generally, dilution will impact a shareholder’s ownership percentage and ability to influence voting results, and will influence earnings per share, which may impact stock price.

 

Our liquidity can be negatively impacted by payments required to appeal tax assessments with certain tax jurisdictions.  

 

Certain tax jurisdictions require partial to full payment on audit assessments or the posting of letters of credit in order to proceed to the appeals process.  Sysco has posted approximately $31.2 million in letters of credit in order to appeal the Canadian Revenue Authority assessments of transfer pricing adjustments relating to our cross border procurement activities through our former purchasing cooperative on our fiscal 2004 and 2005 years.   If assessed on later years under these same positions, we could have to pay cash or post additional letters of credit in order to appeal these further assessments.  If significant further payments are required, the Company’s financial condition or cash flows could be adversely affected.    

 

 Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds 

 

We made the following share repurchases during the third quarter of fiscal 2014:

 

 

 

 On November 16, 2011, the Board approved the repurchase of 20,000,000 shares.  In August 2013, our Board of Directors approved the repurchase of up to 20,000,000 shares for an aggregate purchase price not to exceed $720 million.  The authorization expires on August 23, 2015.  Pursuant to the repurchase programs, shares may be acquired in the open market or in privately negotiated transactions at the company’s discretion, subject to market conditions and other factors. 

 

The Board of Directors has authorized us to enter into agreements from time to time to extend our ongoing repurchase program to include repurchases during company announced “blackout periods” of such securities in compliance with Rule 10b5-1 promulgated under the Exchange Act. 

 

Item 3.  Defaults Upon Senior Securities 

 

None 

 

Item 4.  Mine Safety Disclosures 

 

Not applicable 

 

Item 5.  Other Information 

 

None 

 

---

 

Item 6.  Exhibits 

 

The exhibits listed on the Exhibit Index immediately preceding such exhibits, which is incorporated herein by reference, are filed or furnished as a part of this Quarterly Report on Form 10-Q. 

 

  

---

 

SIGNATURES 

 

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.