Sysco Corporation

Good morning and welcome to Cisco's second quarter fiscal 2022 conference call. As a reminder, today's call is being recorded. We will begin with opening remarks and introductions. I would now like to turn the call over to Kevin Kim, Vice President of Investor Relations. Please go ahead.

Hello and welcome to Cisco's second quarter fiscal 2022 earnings call. On today's call, we have Kevin Hurkin, our President and Chief Executive Officer, and Erin 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 July 3, 2021, 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 is included at the end of the presentation slides and can be found in the investor section of our website. 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 Kevin Harkin.

Good morning, everyone, and thank you for joining. I will highlight four topics today during our call. First, our financial results for the quarter. Second, I will provide some color on the current state of our business and the COVID environment. Third, I will detail our continued share gains despite a difficult macro environment. And finally, I will outline our approach to the long game with some highlights of our recipe for growth transformation. I'll then turn it over to Aaron to discuss our financial results in more detail. So let's get started with our financial results displayed on slide four. Earlier this morning, Cisco reported fiscal second quarter results that were fueled by substantial top line momentum and an acceleration of market share gains. Our sales and volume performance success is a testament to our supply chain strength and the advancement of our recipe for growth. Our operating expenses for the period were elevated due to the effects of COVID on our business. And as a result, Our bottom line results were below our expectations this quarter. Key headlines for the quarter include strong sales results and market share gains. We delivered growth of more than 1.2 times the market, which exceeded our expectations for the period. We delivered sales growth of 10.5% versus 2019 and sequential volume improvements throughout the quarter until the Omicron variant impacted our December performance. More on Omicron in a moment. As I mentioned, Operational expenses within our supply chain were above expectations due to the challenges that COVID is presenting to our labor environment and our transportation costs. I will detail this complex operating environment in a moment, but we remain confident these incremental expenses driven by labor costs are near-term challenges that will improve over time. Our strong sales results in elevated operating expenses resulted in an adjusted earnings per share of 57 cents for the quarter. We further advanced our recipe for growth strategy, which we believe will uniquely position Cisco to win in the marketplace for the long term. Cisco's strength of income statement and balance sheet have enabled us to continue advancing our strategy during a difficult operating environment. That strategic and economic reality will enable Cisco to outperform the market for quarters and years to come. Topic two for today, an update on the state of the business. As I mentioned a moment ago, COVID continues to negatively impact supply chains across the globe, and the effect was elevated in Q2 relative to our first quarter. The impact is being felt in product availability shortages from our suppliers and higher than anticipated labor and transportation costs. I would like to further explain some of the labor cost pressures that we are addressing. At Cisco, we have hired thousands of new associates over the past quarter to support the recovery of our industry, which is coming faster and stronger than had been anticipated. We are also winning market share across our business sectors, which adds to our hiring needs. As a result of our hiring and an industry-wide higher rate of associate turnover, we have a higher ratio of new associates in our labor population than we had originally planned. A higher population of less experienced associates has a direct and negative impact on our supply chain productivity. The punchline, is that our tenured associates perform at a much higher rate of productivity than new associates. With that said, we are confident that we can and will move our newer associates up the productivity curve over time. We have also incurred higher-than-planned expenses as COVID-related illnesses accelerated in the quarter and have continued into January. To provide a sense of the magnitude of this disruption, nearly 10% of our U.S. workforce tested positive for COVID during the month of January, and were out for a minimum of several days. To cover these absences, we invested in overtime and supplemental third-party resources to ensure that we properly supported our customers. At Cisco, we cannot let our healthcare, education, hospitality, and important restaurant partners go without food because of these labor challenges caused by COVID. Our customer-centric approach to ensure that we can ship on time and in full will benefit our relationship with our customers for the long term. positively impacting retention and growth. We are confident that our service performance is stronger than the industry as measured by our Net Promoter Score. In fact, our NPS performance versus the market expanded in the quarter. Lastly, as I mentioned, Omicron negatively impacted our top line performance starting the weekend after Thanksgiving. Our business in Europe was impacted first with the reintroduction of major restrictions on our customers Our sales and volume performances in December were impacted by those restrictions, most notably in the UK, France, and Canada. For example, restaurants in the majority of Canada began closing for on-premise dining at the end of the second quarter, with restrictions slowly starting to ease in February. These types of restrictions impact our customers' performance and ordering patterns. As a result, we expect the top-line impact from Omicron to continue into the third quarter. The speed of the return to pre-Omicron volume levels is uncertain, but we are seeing signs of progress in Europe as restrictions have begun easing. I would like to highlight again that Cisco sequentially improved sales and volume performance every month compared to 2019 levels until the impact of Omicron began being felt Thanksgiving weekend, and we are confident that we will get back to that growth pattern as Omicron recedes. Topic three, let's turn to our market share performance highlighted on slide five. Despite the challenges presented by Omicron at the end of the quarter, as you can see on slide five, Cisco delivered exceptional growth versus the market in the second quarter. As a result, we are now confident we will exceed our 1.2 times the market growth target for the full fiscal year. Our performance versus the market expanded this quarter. Furthermore, looking back over the last three quarters, we are beginning to pull ahead of the industry. The next slide from NPD shows how, over the last two years, we have consistently increased the percentage of customers that purchase exclusively from Cisco. This compares to the dotted line that shows the percentage of customers not yet buying from Cisco. You can see that the dotted line is steadily declining. These slides are just two more proof points that our team is winning in the marketplace and that our strategy is working. Lastly, topic four. I will highlight examples in our business transformation and how that progress will enable consistent, profitable growth. Today, I will give an update on two of our growth initiatives, Cisco Your Way and our Italian Cuisine program. As a reminder, Cisco Your Way is a new service model that we are piloting to better serve what we call restaurant-dense neighborhoods. Through this program, we are providing our customers with enhanced levels of service and sales support, We are very pleased with the success of the pilot locations and we will be expanding the program to net new neighborhoods in the spring of 2022. In addition to Cisco YearWay, I would like to provide an update on our Italian cuisine platform work. As a reminder, Italian is one of the largest cuisine segments and Cisco historically under-penetrated with this important customer segment. We did not have an optimal assortment and we lacked the go-to-market selling strategy to win. Our GRECO acquisition has changed that capability in a meaningful way. First off, GRECO is off to a great start and is exceeding our year one top and bottom line expectations. We are really pleased with the GRECO business and the great work that they are doing. As importantly, we are leveraging the GRECO product assortment and selling prowess and bringing the best selling items to Cisco houses across the country. More on that in due course. Winning in the specialty sectors, like Italian, is a priority for our recipe for growth strategy. Turning to slide seven, in summary for the quarter, we are winning as a company in the marketplace. We are growing our business with new and existing customers. Our year-to-date growth is exceeding our 1.2 times the industry target for the year and is being driven by our supply chain strength and our recipe for growth strategy. We also returned over 650 million of cash to our shareholders during the quarter. We are confident that the impact of our initiatives will grow over time, enabling us to consistently outperform the market at large. As I wrap up my prepared remarks, I want to thank all of our associates at Cisco. These past two years have been challenging. We continue to lead the industry from a service perspective and make deliveries to our customers regardless of the COVID conditions. I am proud of our sales, operations, and global support center teams for the persistence and customer focus that they have displayed. I really want to thank them for their tenacity, and I'll use another word, endurance. I am honored to serve these associates and work by their side. I would also like to welcome the recently appointed members of our board of directors, Ali Dibaj, Joe Golder, and Allison Kenny-Paul. Together, they bring deep industry experience, a modern skills inventory, including finance, consumer, and digital and strategy capabilities. Our three new board members will be extremely valuable to Cisco in our transformation for years to come. I'll now turn it over to Aaron, who will provide additional financial details before we open it up for questions. Thank you, Kevin. Good morning. Here are our second quarter fiscal 2022 financial headlines, as seen on slide nine. Sales growth of 41.2% compared to last year, also up 10.5% versus fiscal 2019, leading to our highest Q2 sales ever. Good management of our product cost inflation, recording the highest gross profit in absolute dollar terms for NEQ2 at Cisco. A doubling of adjusted operating income and a 62.9% increase in adjusted EBITDA compared to last year, notwithstanding a cost environment which worsened during the quarter. Continued investment against our long-term recipe for growth, with $44 million of operating expense investments against our strategic investments, creating momentum with our commercial capabilities. Proactive action on the COVID-generated labor and safety environments in which we are operating, with $73 million in transitory snapback operating investments, such as recruiting costs, hiring marketing, vaccination promotion, contract labor, and sign-on and retention bonuses in the quarter. And while the magnitude was greater than we could foresee last quarter, we experienced productivity challenges and much higher overtime costs in the quarter resulting from the pandemic-related workforce transition and our prioritization of customer service. With respect to our capital allocation, we refinanced elements of our long-term debt during the quarter, and we returned $657 million of cash to shareholders. With those headlines on the table, let's turn to some details on the financials for the quarter and some thoughts on our outlook. Second quarter sales were $16.3 billion, an increase of 41.2% from fiscal 2021 and a 10.5% increase from fiscal 2019. In the United States, sales in our largest segment, U.S. Food Service, showed excellent progress, up 45.1% versus fiscal 2021, and up 14% versus fiscal 2019, reflecting the pre-Thanksgiving and pre-Omicron resurgence in volumes and sales. Local case volume within the subset of USFS, our U.S. Broadline operations, increased 17.6%, while total case volume within U.S. broad line operations increased 22.5%. Sigma sales were up 16.5% versus fiscal 2021 and up 15.3% versus fiscal 2019, even with the large customer rationalization we disposed earlier, which we expect will be complete on a comparable basis following Q3. International sales were up 43% versus fiscal 2021 and down approximately 3% versus fiscal 2019, Sales trends were accelerating nicely in our international segment before the onset of Omicron and restrictions in our key international markets, such as the UK. And we are watching post-lockdown trends carefully. Foreign exchange rates had a positive impact of 0.3% on Cisco's sales results. We continue to monitor the impact on our customers and on our business as international restrictions are starting to ease, including in Ireland and the UK. Inflation continued to be a factor during the quarter at approximately 14.6% in our U.S. broad-line business. Gross profit for the enterprise was approximately $3 billion in the second quarter, increasing 37.8% versus the second quarter of fiscal 2021, and also exceeding gross profit in fiscal 2019 by 4%. The increase in gross profit was driven by year-over-year improvements in volume versus fiscal 21, and compared to the same quarter in both fiscal 2021 and fiscal 2019, increases in gross profit dollars per case across all four of our reporting segments as we successfully managed increased costs for our product suppliers while addressing some, but not all, of our increased operating costs. Gross margin rate was 17.7% during the quarter, with the margin rate math impacted by product inflation. Of course, it is gross profit dollars that count in an inflationary environment. Turning back to the enterprise, adjusted operating expense came in at $2.4 billion with a combination of planned and unexpected expense increases from the prior year really driven by four things. First, the increased variable costs associated with significantly increased volumes. Second, as you can see in slide 10, more than $73 million of one-time and short-term transitory expenses associated with the SNAP Act, which we expect to decline in the third quarter. While we have increased wages in select locations, those increases are not material. and have the opportunity to be offset by productivity and cost-out improvements going forward. Third, $44 million of purposeful operating expense investments against our recipe for growth initiatives, like personalization, digital sales tools, and assortment capabilities, which remain on track to be elevated for the rest of the year. And fourth, the productivity expense challenges Kevin referenced earlier, including ramp-up time associated with new higher productivity in our warehouses and trucks, elevated overtime, and third-party labor support in the face of staff absences. I want to emphasize that the management team at Cisco has been aggressive in pursuing the root cause of the cost increases. While the transformation continues unabated, the team has also pushed hard to identify and action incremental profit opportunities and cost reduction initiatives, which should help the company in the back half and beyond as the environment stabilizes. Together, the snapback investments and the transformation costs totaled approximately $116 million, of operating expenses this quarter and negatively impacted our adjusted EPS by approximately 17 cents. All in, we leveraged our adjusted operating expense structure and delivered expense as a percentage of sales of 14.7%, which is flat from fiscal 2019 and down 145 basis points from fiscal 2021. Our cost-out efforts are meaningfully benefiting our P&L and we continue to assess and execute against new cost-out projects each quarter. Finally, for the second quarter of fiscal 2022, adjusted operating income increased $262 million from last year to $496 million. This was primarily driven by a 45% improvement in U.S. food service and continued progress on profitability from international, partially offset by SGMA. The second quarter SGMA operating loss is driven by higher than expected labor costs, which will be offset in future quarters by specific actions already taken by the SGMA management team. Adjusted earnings per share increased to $0.40 to $0.57 for the second quarter compared to last year. Now let me share a couple of comments on cash flow in the balance sheet. Cash flow from operations was $377 million on a year-to-date basis, driven by our higher income and lower interest, offset by higher tax payments and a significant investment in working capital. Net capex was $175.9 million, somewhat lower than expected given increased lead times on fleet and and equipment. Adjusted free cash flow year-to-date was $201 million. At the end of the second quarter, we had $1.4 billion of cash and cash equivalents on hand. As seen in slide 15, our results this quarter also reflected incremental progress against our capital allocation priorities. This included the further strengthening of our balance sheet by successfully refinancing debt during the quarter at longer maturities and more attractive rates, lowering our adjusted interest expense costs going forward. We also commenced our share repurchase program during the second quarter and repurchased approximately 5.7 million shares for a total of $416 million and an average share price of $72.30. This was in addition to paying our quarterly dividend of $0.47 per share in October. We remain committed to growing our dividend and, as previously communicated, plan to next address decisions around our dividend per share during our fiscal Q4. While our track record goes back decades, as you can see in slide 16, over the last seven years, cumulatively, we have returned over $12 billion of cash to shareholders. Let's turn now to the look forward. Our recipe for growth transformation plan is on track. However, Omicron had a noticeable impact on our December and Q2 results, continuing into January and now February. As a result, We are reaffirming our long-term guidance that for fiscal 2024, Cisco will deliver adjusted EPS growth of at least 30% over our record 2019 EPS of $3.55. We are updating our view of the back half to reflect the realities of the disruption caused by Omicron and the labor environment. We expect to fall below our prior EPS guidance for fiscal year 2022. For the full year, we expect adjusted EPS of approximately $3 to $3.10. This translates to adjusted EPS in the back half of about $1.60 to $1.70. In a typical pre-COVID fiscal year, adjusted EPS for our second half is generally weighted around 40% to Q3 and 60% in Q4 due to normal seasonality of our business. This year, we expect our second half profitability to be weighted even more to the fourth quarter. We expect a stronger Q4 this year relative to Q3 as a result of anticipated volume recovery, lower SNAP-X expenses, improved operating productivity, and specific actions we are taking to offset Omicron. In offering this perspective, we are assuming no further COVID variant disruptions to our operating environment. With that, let me turn the call back over to Kevin for closing remarks. Thank you, Aaron. As we conclude, I'd like to provide a brief summary. This quarter included substantial top line momentum and an acceleration of our market share gains. We are winning in the marketplace and we have confidence that we will continue to win share. With that said, Q2 presented challenges from Omicron on both our top and bottom line. Our sequential volume growth progress stalled post-Thanksgiving and that headwind has continued into January. More importantly, COVID-related staffing disruptions increased our operating expenses for the quarter. As a result, our bottom line results were below our expectations. Second, despite the short-term impact of Omicron on our business, we are confident that we will resume our volume improvement as soon as the variant recedes, and we can see green shoots of progress in February from a volume perspective. As it relates to expenses, we have a management plan to improve our year-to-go operating expenses. We are meaningfully focused on improving associate retention, training, and productivity. These activities are a core competency of Cisco and our experienced field leadership team has a plan to deliver improvement for the remainder of the year. Third, we remain confident in the long-term trajectory at Cisco. And as Aaron stated, we are reaffirming our long-term guidance that includes significant sales and EPS growth. Our recipe for growth transformation is creating capabilities at Cisco that will help us profitably grow for the long term. The customer first solutions we are developing will enable us to grow our share profitably and also enables Cisco to be more efficient. There are bright days ahead for Cisco, and I am proud to be part of the journey. Operator, you can now turn it over for questions.