Sysco Corporation

Good morning, and welcome to Cisco's third quarter fiscal 2021 conference call. As a reminder, today's call is being recorded. We will begin with an opening remarks and introductions. I would like to turn the call over to Neil Russell, Senior Vice President of Corporate Affairs and Chief Communications Officer. Please go ahead.

Good morning, everyone, and welcome to Cisco's third quarter fiscal 2021 earnings call. On today's call, we have Kevin Hurrican, our President and Chief Executive Officer, and Aaron Ault, our Chief Financial Officer. Before we begin, please note that statements made during this presentation, which state the company's or management's intentions, beliefs, expectations, or predictions of the future, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act, and actual results could differ in a material manner. Additional information about factors that could cause results to differ from those in the forward-looking statements is contained in the company's SEC filings. This includes, but is not limited to, risk factors contained in our annual report on Form 10-K for the year ended June 27, 2020, subsequent SEC filings, and in the news release issued earlier this morning. A copy of these materials can be found in the Investors section at cisco.com. Non-GAAP financial measures are included in our comments today and in our presentation slides. The reconciliation of these non-GAAP measures to the corresponding GAAP measures are included at the end of the presentation slides and can also be found in the Investors section of our website. As a reminder, we will be hosting Cisco's Investor Day on May 20th. For today's call, Kevin will start by discussing Cisco's recent performance and will then provide an update on the business environment recovery. He will then turn it over to Aaron, who will discuss Cisco's third quarter financial results. To ensure that we have sufficient time to answer all questions, we'd like to ask each participant to limit their time today to one question and one follow-up. At this time, I'd like to turn the call over to our President and Chief Executive Officer, Kevin Hurrican.

Thank you, Neil. Good morning, everyone, and thank you for joining our call today. I hope that you and your families are staying safe and healthy. I would summarize our third quarter performance with four important points. First, our industry's COVID business recovery is here, and the pace of the recovery is accelerating, especially in our domestic US business. Second, we are making excellent progress in our business transformation to better serve our customers and differentiate from our competition. Third, we are winning market share at the national and local customer level. Fourth, our financial results for the third quarter were strong in light of the market conditions, mostly due to improved sales and disciplined expense management. As we have previously communicated, we can see in our performance data that once restrictions placed upon our customers are eased, our business results quickly improve. We see tremendous pent-up demand in the food away from home sector. Our data confirms that consumers are eager to eat at restaurants as soon as restrictions are reduced. Strong sales results and long wait times are common in restaurants operating within geographies that have limited restrictions. The third quarter can be aptly described as difficult at the beginning and robust at the end. Our January performance was negatively impacted by meaningfully tight restrictions on our customers during the winter COVID lockdown. In February, a substantial winter storm adversely affected our performance in our strongest domestic markets. In contrast, the March sales period exceeded our expectations and bodes well as a strong indicator for the business recovery within our sector. As a result, we exited the third quarter with promising sales trends. The improvement is most notable in the southern third of the United States, where reduced restrictions and warmer weather are generating strong performance results. The results in reopened markets met and then late in the quarter surpassed 2019 levels in the important local independent restaurant sector. These results are a positive harbinger of things to come as the northern regions begin to benefit from easing restrictions that are mostly still in place today. The independent restaurant sector exceeding 2019 sales levels in reopened markets is positive outcome and a rebound timing that is faster than the industry had predicted. In Europe, however, restrictions remain firmly in place. our European countries are experiencing restrictions even stronger than those experienced in the U.S. in April of 2020. Our sales results in Europe reflect those tight restrictions and remain down meaningfully compared to 2019 levels. We remain confident in our ability to succeed in the European markets and expect improvement to begin in the latter half of our fiscal fourth quarter. In addition to the softer European performance, our business in the travel, hospitality, and food service management sectors remain down. Our business penetration in Europe and in food service management pre-COVID is creating a lingering delay in the full recovery of our business results in comparison to select other distributors. We are confident that these sectors will recover, but their recovery will be at a slower pace than our core restaurant sector. As a result, when these geographies and segments more fully recover, it will add strength and sustainability of Cisco's recovery, giving us fuel to grow in quarters and years to come. All told, we delivered a sales decrease of 13.7% for the quarter. While sales were down compared to 2020, our results reflect an improvement over our second quarter decline of 23%, which is another clear signal that the industry is recovering. The most compelling outcome of the fiscal third quarter is that the local independent restaurant sector was performing well above our expectations as we exited the quarter, with many restaurant partners running sales increases compared to 2019. While our third quarter fiscal results were down compared to the prior year, I am pleased to report that we once again delivered a profitable quarter, delivering $437 million of adjusted EBITDA. Cisco is doing more than anyone in the food service distribution industry to ensure the success of restaurants and prepare for the return of food service demand, which can be seen in our overall market share growth throughout the quarter. Cisco gained overall market share versus the rest of the industry, reflecting the progress of our recent investments. Our sales teams are actively engaged with new customers and helping existing customers maximize their business during this recovery period. We continue to win business at the national and contract sales level. We have now posted over 1.8 billion of net new wins since the start of the pandemic, with another strong quarter of new contracts signed. I've said on prior calls, the contracts we are writing are at historic profit margins. We are winning the new business due to our supply chain and our service capabilities. In addition to the national contract sales wins, we onboarded more new local customers than ever before during the third quarter. Fueled by our restaurants rising program and our new sales associate compensation model, A recent industry report confirmed that the number of local restaurants was down approximately 10% to 2019 levels due to permanent closures. The 10% closure is better than most experts had predicted for the industry. After posting the strongest quarter ever of new local customer wins at Cisco, you can see on slide six that we are now serving 10% more local customers than we did in fiscal 2019. The fact that we have increased the number of customers that we serve during this pandemic bodes well for our future top line growth when the industry is fully recovered. Our increased customer count positions us well to take market share as the business returns to the food away from home sector in our fiscal 2022 and beyond. As we discussed on our last call, we began making several strategic investments in preparation for the business recovery. These investments increased throughout the fiscal third quarter and will continue in our fourth quarter. We have focused our investments on our customers, our people, our inventory, our technology, and our community. These investments have helped position Cisco ahead of the curve for the return of food service demand. Our investments in our customers, including our Restaurants Rising campaign, make it easier for restaurants to succeed and strengthen their business for the future. During this uncertain business environment, we have made it easier for our customers to do business with Cisco by waiving delivery minimums on regularly scheduled delivery days. We are making investments in our people, including increasing our efforts to proactively staff in advance of the business recovery curve to ensure we have the right number of people in the right locations at the right time to be able to ship on time and in full to our customers. At Cisco, we expect to hire over 6,000 associates in the second half of our fiscal year. We have a full court press on hiring warehouse selectors and drivers. Throughout our industry, drivers are indeed in short supply and hiring is a challenge. We are pulling every lever to ensure we meet our hiring targets. While this hiring investment will increase our operational expenses in the short term, over the long term, it will help ensure that Cisco is able to maximize their share gains during the business recovery. We are also making investments in inventory to properly position our warehouses to support customer demand. Currently, Cisco has inventory on hand and on order in a combined amount that is greater than our inventory position before the COVID crisis began. Our ability to ship product on time and in full during the upcoming period of volume recovery is a core element of what makes Cisco the strongest broad-line distributor in the industry. Due to our strong balance sheet, we are uniquely positioned to be able to make investments in inventory to ensure we can accelerate growth faster than the overall recovery. We are seeing pressure and constraints in the supply chain as select suppliers struggle with meeting increased demand levels. This is known as the supply chain bullwhip effect as market conditions rebound. At Cisco, we have seen this constraint coming and have been partnering with our top suppliers for more than 90 days to pre-position inventory at our warehouses. We view this as an opportunity to grow our business and take additional market share. We are continuing our strategic investments in our technology to improve the customer experience. Our technology platform is being meaningfully improved so that we can better serve our customers. We're making it easier for our customers to order products through our Cisco Shop platform, and we're implementing a best-in-class pricing software. We will discuss both of these topics in detail at our Investor Day. Lastly, our corporate social responsibility initiatives and 2025 goals are progressing well. Our industry-leading CSR efforts are setting the standard for care and progress across three pillars of people, product, and planet. We are making great strides on this very important work as evidenced by our recent announcement with cargo, which is a critical partnership, along with the National Fish and Wildlife Foundation to improve sustainable grazing practices across one million acres of grassland. This effort helps to improve soil health, promote biodiversity, and increase carbon storage and safeguard the livelihoods of ranchers and the communities in which we serve. This progress is also good for our business, as our customers can buy Cisco product with confidence, knowing the environmental and social benefits we bring to their table. At Cisco, we are working to maximize our opportunity to recover faster than the industry. We have an opportunity to gain market share given our financial strength and our compelling business transformation. We are prepared to do more than any other food service distributor in the industry to ensure the success of our customers, and our customers' success will generate business growth for Cisco. I would like to invite everyone to our May 20th Investor Day. At that important meeting, we will provide you with the details of our strategic growth plan and how that plan will deliver compelling financial results. Please plan to join us virtually on May 20th, and Neil will provide you with the details and logistics. I want to give a heartfelt thanks to all of our Cisco associates who continue to help our customers grow and succeed in this challenging environment. I am proud of their dedication during this dynamic operating environment. I'll now turn the call over to Erin Ault, who will discuss our third quarter results along with additional financial details. Aaron, over to you. Thank you, Kevin, and good morning. Improving sales trends, a profitable quarter, and strong cash flow, those are our key headlines. Our fiscal third quarter presented us with the beginning of a restaurant recovery in the United States, countered by continued business disruption in the international and food service management parts of our portfolio. As a result, we balanced five financial priorities, tactical investments in inventory, team, and equipment to get ahead of the business recovery, strategic investments in capabilities and technologies to advance the transformation, careful cost control to mitigate the impact of the COVID environment on our bottom line, purposeful reduction of our indebtedness, and, of course, continued return of capital to shareholders through our dividend payments, totaling $689 million so far this fiscal year. As Kevin called out, we were delighted to see the improving sales trends and the progress on profit, and I will speak more in the income statement shortly. I would like to start today with an emphasis on the strong position we are in as we move up the recovery curve and how that strength is impacting our view of the cash flow and the balance sheet. Recall at the end of the second quarter, we had $5.8 billion of cash. During the third quarter, we generated positive cash from operations of $543 million, offset by $83 million of net capital investment, leaving us with incremental positive free cash flow for the third quarter of $460 million. Working capital was a source of cash for us in the quarter, even though we invested heavily in inventory, and as Kevin pointed out, we ended the third quarter with inventory on hand and inventory on order exceeding pre-COVID levels. And we benefited from a significant increase in payables at quarter end. We saw rising normal course receivables balances as our customers started purchasing more. But we also made excellent progress on obtaining timely payment from our customers on both pre-COVID and post-COVID bills. For the nine-month period, even in the face of COVID-19, Cisco generated an impressive $1.2 billion in free cash flow. This strong cash flow is approximately $300 million better than we had forecast earlier this year, driven by the combination of higher sales and profit, working capital benefit, and lower capex than forecast back in the first quarter. All in, we ended the third quarter with $4.9 billion of cash on hand. We expect that the fourth quarter will bring continued progress on the EBITDA line. It is also expected to bring investments in working capital as we continue to invest in inventory and as the payables which provided us with benefits in the third quarter come due in the fourth quarter. As a result, we are forecasting flattish free cash flow for the fourth quarter, leaving us with free cash for the year of approximately $1.1 to $1.2 billion. Given our balance sheet, our strong cash generation, and our optimism for the business recovery, Early in the third quarter, we announced that we were continuing the process of reducing our debt levels. We paid down 1.1 billion on that date, funded by cash on hand, and you will see that change in leverage reflected in our third quarter financials. What you will not yet see in the financials is that subsequent to the end of our third quarter, we repaid an additional 200 million pounds sterling on the outstanding amount of the UK commercial paper program And we will later this week pay off the remaining 100 million pounds sterling balance on that program, which will bring our debt levels down by approximately $1.5 billion since the start of the third quarter and down by $2.3 billion since the start of this fiscal year. Stay tuned for a discussion of our capital allocation strategy at Investor Day. Okay, let's turn to the income statement. Given the interest in the shape of the COVID-19 recovery curve, for the next couple of quarters, we will disclose sales comparisons against both fiscal 2019 and fiscal 2020. Third quarter sales were $11.8 billion, a decrease of 13.7% from the same quarter in fiscal 2020, and a 19.3% decrease from the same quarter in fiscal 2019. But with the important qualification that in the last two weeks of the quarter, we began to lap the onset of the COVID-19 crisis. Indeed, looking at the monthly progression measured against fiscal 19, our sales were down 23% and 14% in January, February, and March, reflecting the impact of COVID across the quarter. February would have been better, but for the impact of the winter storm in the US during the last week of February. We are also disclosing today on a one-time basis that our April sales were approximately 4.4 billion, up 102.1% from prior year, and improving to only down 8.8% from fiscal 2019. Our United States sales in the US food service segment were down 5.3% versus fiscal 2019, and SGMA was up 12% versus fiscal 2019, reflecting the increase in restaurant traffic and orders as the lockdowns eased in the US. we will continue to benefit as BUS reopening advances. In contrast, Europe, Canada, and Latin America regressed in the third quarter as a result of strict lockdowns that are now expected to continue, in some cases, until the end of May, and as a result of slower progress in vaccination. The slower international recovery will continue to impact our fourth quarter results and may carry into the early quarters of fiscal 2022, depending on vaccination progress by country. However, we see good news in the recent reopening taking place in the United Kingdom. Here are a couple of additional metrics. For the quarter, local case volume within U.S. Broadland operations decreased 9.7%, while total case volume within U.S. Broadland operations decreased 14.1%. Foreign exchange rates had a positive impact of 77 basis points on our sales results. As we move down the P&L, gross profit was $2.1 billion in the third quarter, decreasing 17.2% versus same quarter in fiscal 2020. Most of the decline in gross profit was driven by lower volumes due to COVID. However, we did see modest gross margin dilution at the enterprise level of roughly 77 basis points versus the same period in fiscal 2020, as our rate came in just a touch shy of 18%. The primary reason for the gross margin dilution is business mix. Our sales and our generally higher margin European business were down, so lower gross margin at the enterprise. Along the same lines, our sales and our lower margin Sigma business were up, so lower gross margin at the enterprise. We also saw a modest margin dilution in each of the business segments with varying causes from product mix shifts, the timing by market of the interplay between passing along inflation and implementing our transformation initiatives. Adjusted operating expense decreased 14.7 percent to just under $1.9 billion, and we saw a modest improvement of operating expense leverage, even with lower sales to prior year. Our expense profile reflected the counterweights of good cost-out achievement balanced against our investments for the recovery curve and our investments against the transformation agenda. As part of this, we targeted and achieved increased significant cost savings. We are on track to surpass our fiscal 2021 goal of $315 million of cost savings. We expect to drive continued cost savings opportunities to help fuel our future growth agenda, a topic I will discuss more at Investor Day in two weeks. Finally, at the enterprise level, adjusted operating income decreased 32 percent to $256 million. For the third quarter, our non-GAAP tax rate of 14.3 percent was favorably driven by the impact of stock option exercises. Adjusted earnings per share decreased 51.1% to 22 cents for the quarter. I'm going to say a few words on our third quarter results by business segment, starting with U.S. food service operations. Sales were $8 billion, which was a decrease of 12.8% versus the prior year period. In the rapidly evolving environment, the business again acquired a record number of new customers as our sales teams hit the streets and we deployed digital tools. We also saw growth in our national accounts customer base. This business, our biggest business, is moving up the COVID recovery curve rapidly. Within the business, Cisco brand sales for the third quarter decreased 116 basis points to 37.3% of total US cases, driven by customer and product mix shift. With respect to local US case, the Cisco brand sales decreased 234 basis points to 44.5%, which was driven by product mix shift into prepackaged and takeaway-ready products. Regaining Cisco brand sales levels and the healthy margins that come with them will be a focus for fiscal 22 and beyond. First profit for U.S. food service decreased 13.7% to $1.6 billion for the quarter. The segment's adjusted operating expenses decreased 16.1% to $1.1 billion. and adjusted operating income decreased 8.3% to $525 million. Product cost inflation was 3.5% versus prior year, driven by deflationary error categories in fiscal 2020. Moving to the SGMA segment, for the third consecutive quarter, sales increased during the third fiscal quarter to $1.6 billion, a 15.9% increase over fiscal 2020 and a 3% increase over fiscal 2019. driven by the success of national regional quick service restaurants servicing drive-thru traffic. While we are pleased with the team's efforts during COVID, Sigma is our lowest margin segment, and our team is carefully calibrating our efforts in that business, particularly as it relates to negotiating agreements with customers. As a result, starting during our fiscal fourth quarter, we will be taking an opportunity to transition away from a large existing regional customer. The financials of that relationship do not meet our preferred profile, and we will be focusing on freeing up capacity for more profitable customers. Going forward, we will continue to be diligent in our contract review and approval process across the enterprise. Gross profit increased 12.3% to $133 million for the quarter, while gross margin was down 27 basis points compared to the prior year. Adjusted operating expenses increased 11.1% to $121 million, and adjusted operating income increased 24.1% to $13 million, all at Sigma. Moving to the international segment, as I mentioned earlier, our European, Canadian, and Latin American businesses continue to be impacted by COVID lockdowns. The international food service operations segment saw sales of $1.7 billion, a decrease of 31.3%, while gross profit decreased 35.1%, and gross margin decreased 110 basis points. The gross margin decline was a result of country mix, customer mix, and product mix. For the international segment, adjusted operating expenses decreased 15.8%, leading to an adjusted operating loss of $92 million. We are confident that international will be a significant recovery opportunity for our company in fiscal 2022. Our other segment, which includes our guest worldwide business, remains in the COVID recovery starting blocks as hospitality occupancy rates remain low compared to prior year levels. While still in turnaround mode, the business improved its underlying profitability during the third quarter. Additionally, our guest worldwide business signed a substantial new customer contract during the quarter that will be very beneficial for the segment as the travel and hospitality sectors recover. That concludes my prepared remarks on the third quarter. We are not providing further guidance for the fourth quarter other than to observe that we continue to monitor our operating environment carefully. While operational challenges remain for many of our customers, we are seeing excellent demand in our core business in the key markets in the center and the south. And we are seeing green shoots on the coast as markets reopen. Let's be clear, the upswing has begun and we expect continued progress across the largest parts of our portfolio in the fourth fiscal quarter. Our team remains resolutely focused on driving our businesses, aggressively managing the business recovery, and building customer-centric capabilities to accelerate long-term growth. As we did in the third quarter, we will continue to deploy our balance sheet to invest in inventory, technology, and our people to stay ahead of the recovery curve while also reducing our indebtedness. During our investor day in two weeks, Kevin and the executive leadership team will offer more detailed perspective on the business, on our growth plans for fiscal 2022 and beyond, and provide further specifics on our transformation efforts. We will comment on our post-COVID capital allocation strategy, including the breadth and depth of our organic and inorganic investment plans, our plans for further debt reduction, and how we're thinking about continued shareholder returns. We look forward to seeing you participate in that virtual event. Thank you for your attention. Operator, we are now ready for questions.