Sysco Corporation

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

Good morning, everybody, and welcome to Cisco's Third Quarter Fiscal 2022 Earnings Call. On today's call, we have Kevin Hurkin, our President and Chief Executive Officer, Aaron Ault, our CFO, and Neil Russell, our SVP of Corporate Affairs and Chief Communications 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 meanings of the Private Security 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 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 Herkins.

Good morning, everyone. Thank you for joining our call. Our financial performance this quarter exceeded our internal expectations, driven by strong top-line performance, accelerating market share gains, solid gross margin management, and improvement in our operations expenses. Earlier today, we raised our four-year guidance, and Aaron will walk you through the details in just a few moments. Our strong performance for the quarter demonstrates our focus on the customer and the advancement of our recipe for growth strategy. Simply put, we are winning in the marketplace. The best measure of the success is the continued market share gains that we are delivering. Our performance versus the market accelerated in the quarter, and we solidly exceeded our fiscal 2022 goal of growing 1.2 times the market. I will highlight three topics during our call today. First, I will touch on our financial results. I'll discuss the state of the current operating environment. And finally, I will highlight progress from a 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 number four. Our third quarter results were fueled by strong top-line performance across the U.S. and international segments and progress made in lowering operating expenses as a percentage of sales. As a result, our profit results were ahead of our internal expectations this quarter. While our operational expenses remain elevated versus our historical standards, we have begun making progress in improving our productivity. We will continue to make progress in the coming quarters. Key headlines this quarter include market share gains that significantly exceeded our 1.2 times the market growth target, significant volume improvements, with U.S. Broadline volume up approximately 19% versus the same period in fiscal year 2021, and our USFS business delivering volume growth versus 2019 in total. This also included another quarter of profitable growth coming from our international segment. Our expense structure is improving. As I mentioned, we still have work to do in order to return to our standard of excellence, but we have begun making progress. Importantly, our snapback investments were reduced by more than 50% versus the prior quarter. Our strong sales results and continued progress in improving operating expenses drove solid profit growth. We delivered adjusted earnings per share of 71 cents for the quarter. We achieved these results while meaningfully advancing our recipe for growth strategy. This included successfully closing on the coastal company's transaction during the quarter. further expanding our industry-leading produce business that has high growth at attractive margins. Topic two for today, an update on the current environment. The third quarter started with COVID-related disruptions from the Omicron variant. Recall that the negative impact from Omicron started in late November and the effects were felt through February. Cisco delivered a strong quarter of growth despite the headwind from Omicron. Two factors played to our favor. a strong market rebound in late February and into March, and Cisco winning market share throughout the entire quarter. Combined, these factors enabled both our US and international businesses to deliver volumes greater than our internal forecast for the period. As I mentioned a moment ago, volume in our US food service operations exceeded pre-COVID-19 levels for the quarter. The positive momentum was strong across geographies, as well as across different customer types. With that said, we expect additional momentum over time from improved international volume as the recovery in the food-away-from-home market strengthens internationally. At Cisco, we have two business sectors that remain heavily impacted by COVID, business and industry, which includes customers such as office cafeterias, and travel and hospitality, which is heavily impacted by conferences and large group catering events. We anticipate both segments making progress this summer and into the fall. For example, many major employers have begun returning to the office, and recent reports from airline and hotel CEOs have cited steadily improving bookings for this summer. An advantage of Cisco is that we are fully diversified across the food away from home business. While high cost of fuel is being felt by our customers, we have not experienced a reduction of consumer demand. The fact that we cover all restaurant types up and down the price point spectrum provides us some protection in an unpredictable economy. Additionally, the pricing relationship between food at home and food away from home is favorable to Cisco versus historical relationships, as you can see on slide six in our presentation. With that said, we remain concerned about the long-term effect of elevated inflation, and we are taking strong actions to manage the situation. We are actively working to improve cost of goods sold inbound to Cisco so that we can pass along value to our customers. We are aggressively pursuing Cisco brand penetration opportunities as we know that Cisco products save our customers money. We're also working aggressively with our customers to help them with their menu design and therefore helping these customers find alternatives to step around highly inflationary items in subcategories. We're also helping them to have confidence in their menu pricing strategies. This work helps Cisco earn trust and respect with our large customer base. In regards to our supply chain, I'd like to report the conditions are improving. Applicant flow to open positions has increased, and our talent acquisition team has helped us make progress in improving our staffing health. As a result, we have been able to reduce associate overtime and improve our service levels to our customers over the past quarter. Our NBS, or Net Promoter Score, results this quarter improved and continue to lead versus the market. It is still a very dynamic environment, but the size and scale advantages of Cisco are enabling us to succeed in a turbulent environment. Topic three for today, I'll provide select highlights of our recipe for growth progress. Last quarter, I provided an update on two of our growth initiatives, Cisco Your Way and our Italian Cuisine platform. These two initiatives continue to progress well, driving profitable growth for the company. We expanded Cisco Your Way to additional neighborhoods in the quarter, and the recently added locations are performing consistent with the strong results from our pilot locations. Today, I'd like to provide an update on two additional topics, our supply chain transformation and progress that we are making in consultative sales. As I mentioned, our supply chain health has improved over the past quarter as applicant flow to our open jobs has improved, and we're beginning to make progress in operations productivity. Improving the efficiency of our supply chain is a top priority for our entire leadership team. To ensure that we succeed at a higher level in the future, we're making substantial commitments to improve our associate experience within operations. A great example is our Driver Academy, which is now up and running in full swing. We've graduated our first class of drivers and we have opened additional academy locations. We expect to be nationwide with this capability by the end of the calendar year. The Driver Academy will enable us to provide upward career path mobility for our warehouse associates and improve associate retention in this critical driver role. Our graduates are able to increase their career earnings potential by upscaling and becoming certified drivers. At Cisco, we have a leading in competitive driver wage, and we are making the certification process easier, removing the barriers and costs to becoming certified. This action will open the door for more of our associates to advance their careers. The Driver Academy is a win-win-win for our associates, for Cisco, and for our customers. Additionally, over the past quarter, we have converted our operations from an industry-traditional five-day workweek to a full six-day delivery model. This might sound like a small endeavor, but the reality is quite the opposite. We made the change to a full six-day model for the following reasons. The change is better for our associates. Why? We have converted our associates from a standard five-day schedule to a more work-life-friendly four-day workweek. This will improve associate retention over time. The six-day workweek increases the efficiency of our operations by further utilizing our physical assets, enabling us to better sweat the assets of our trucks and buildings. The model increases our weekly throughput and also provides us more flex capacity on each and every day, enabling us to better handle fluctuations of demand. These changes to our supply chain will help make Cisco an even more preferred employer and that will enable us to serve our customers. As important as having an efficient and flexible supply chain, we are continuing to advance the capabilities of our industry-leading sales teams. Our sales associates have the highest customer satisfaction scores in the industry, and we want to increase that competitive advantage. We have worked hard over the past year to bring stronger digital tools to the selling process to enable the success of our sales team. I want to be very clear that these digital tools do not reduce the importance or quantity of our sales staff. These tools are intended to assist our sales teams with their consultative selling process. Our technology team has built a system that provides each sales rep with a next best action to be presented to our customers. For some customers, this may be a conversion from a national brand product to a Cisco brand item, saving them money. For other customers, this may be the introduction of a promotional offer for a category perhaps they've not traditionally purchased from Cisco, like produce. For others, still, the tool can identify items that a customer used to buy but are no longer placing in their shopping basket with Cisco. Our sales consultants are then prompted with offers and suggestions to specifically enable success against those use cases. The goal of this work is to increase the productivity of the customer visit. This work positively impacted our performance versus the market in Q3, which was our strongest volume growth quarter versus the market for the year. Slide seven in our presentation makes the clear case of our progress in becoming a growth company. Lastly, our working commitments in corporate social responsibility, or CSR, were recently recognized by Sustainalytics and Just Capital. This recognition is due in no small part to our recent announcement of a science-based climate goal that is aligned with SBTI. As the leader in our industry, we are proud to be the first and only U.S. food service distributor with a science-based climate goal. Research from the World Economic Forum suggests that companies who make progress in these important areas drive improved TSR over time compared to their peers. To ensure that we walk the walk, our board is prepared to incorporate ESG as a part of our executive compensation program beginning next year. The work we are doing is the right thing to do, and we strongly believe that it is also good for our business and our investors. Turning to slide eight, in summary for the quarter, Cisco is winning, leading the industry, and accelerating growth. We are growing our business with new and existing customers. Our supply chain is performing better than the industry at large, and we are driving strategic initiatives to further increase that strength advantage. Our continued transformation investments are enhancing our commercial selling capabilities, and we are investing in our associates. The improved profitability in the quarter is encouraging, but there is more work to be done as our teams focus on our recipe for growth strategy and improving operations productivity. I'll now turn it over to Aaron, who will provide additional financial details before we open it up for questions. Thank you, Kevin, and good morning. We are upbeat on our business, and we have several notable headlines for our third quarter, as seen on slide 10. Sales growth of almost 43% compared to the prior year, which is also up more than 15% versus 2019, reflecting resilient demand and sequential improvements month over month. We recorded more than $3 billion in gross profits, The highest gross profit in absolute dollar term is for any quarter at Cisco ever as we continue significant efforts to optimize our assortment and COGS while effectively managing our product cost inflation. Our investments in Snapback operating costs dropped in the quarter by more than half from $73 million in Q2 to $35 million in Q3. As promised, The impact of our workforce transition on productivity improved. Incremental training and overtime is estimated to have cost us approximately $30 million in the third quarter, down from approximately $40 million in the second quarter, and we expect further improvements as we head into Q4. As an aside, I would note that the actions we're taking around productivity are actually serving to accelerate our supply chain transformation as part of the recipe for growth. We invested $48 million of operating expense against our strategic investments, creating momentum with our commercial capabilities. All in, adjusted operating income more than doubled, and adjusted EBITDA increased almost 73% compared to last year. With those headlines on the table, I'm going to provide some details on the financials for the quarter and some thoughts on our outlook. Third quarter sales were $16.9 billion. an increase of 42.9% from fiscal 2021 and a 15.3% increase from fiscal 2019. In the United States, sales in our largest segment, U.S. food service, were up dramatically by 43.6% versus fiscal 2021 and up 18.8% versus fiscal 2019. Local case volume within the U.S. broadening operations, a subset of U.S. food service, increased 14.1% while total case volume within U.S. operations increased 18.8% compared to last year. Sigma sales were up 13.5% versus fiscal 2021 and up 16.8% versus fiscal 2019. International sales were up 64.5% versus fiscal 2021 and up approximately 3% versus fiscal 2019. Sales trends accelerated nicely in our international segment with lower Omicron cases and as government-related restrictions on our customers eased in the quarter. Foreign exchange rates had a negative impact of 0.7% on Cisco sales results. Let me pause here and call out one point of progress for the year-to-date period. We are really pleased with the profit contribution and improvements coming from international. In the last nine months, the business has delivered an adjusted operating income swing of $265 million year-over-year. Inflation continued to be a factor during the quarter at approximately 16% in our U.S. broad-ended business. We have been able to actively manage the impact of product inflation, and those efforts will continue. Gross profit for the enterprise was above $3 billion in the third quarter, an increase of 42% versus fiscal 2021, an increase of 9.4% versus fiscal 2019. The increase in gross profit was driven by year-over-year improvements in volume versus fiscal 2021, and compared to the same quarter in both fiscal 2021 and fiscal 2019, increases in GP dollars per case across all segments as we successfully managed increased costs from our product suppliers and acted to optimize our business processes and performance. Of note, the enterprise and U.S. food service both reached all-time highs for Q3 gross profit dollars. Gross margin rate was 17.8% or 18% on an adjusted basis during the quarter, with the adjusted margin rate moving upward as the math was still impacted by inflation. Of course, it is gross profit dollars that counts in an inflationary environment, and gross profit per case increased in all four segments. We are focused on price relevancy, being right on price and are doing the right things to cover our costs while also supporting our customers. Turning back to the enterprise, adjusted operating expense for the quarter came in at $2.5 billion as we delivered progress on our multi-year cost-out program and improved SNAP-VAC costs. As we touched on earlier, and as you can see in slide 15, Operating costs this quarter were impacted by variable costs associated with significantly increased volumes, more than $35 million in one-time and short-term transitory expenses associated with the SNAP Act, $48 million of purposeful investments to further accelerate our recipe for growth initiatives, and lastly, the still-present but improving expense challenges associated with new higher productivity. Despite the dynamic operating environment, We expect additional improvements from SNAP-PAC costs and productivity expenses during the fourth quarter as we balance cost reduction initiatives with continued transformation investments. Together, the SNAP-PAC investments and the productivity-related costs total approximately $65 million of operating expenses this quarter. That's important because the simple math would say that these transitory expenses had a downward impact to our adjusted EPS of approximately 10 cents further proving our point that there is further opportunity for profit improvement in the future for Cisco, as Q3 adjusted EPS without these expenses would have already exceeded 2019 levels. All in, we leveraged our adjusted operating expense structure and delivered expense as a percentage of sales of 14.6%, which is flat from fiscal 2019, and improvement of 119 basis points from the same quarter in fiscal 2021. Finally, for the third quarter of fiscal 2022, adjusted operating income increased $319 million from last year to $575 million. This was primarily driven by a 43% improvement in U.S. food service and continued progress on profitability from international. As Kevin called out, adjusted earnings per share increased an impressive 49 cents to 71 cents for the third quarter. Now let's turn to a discussion of year-to-date cash flow. Cash flow from operations was $746 million on a year-to-date basis. Our company continues to transition from a period when sales, profit, and working capital were all down during COVID to a period of high growth, growing profits, and a focus on making the investments necessary to win the long game. A year ago at this time, we commented that we had a strategy and the balance sheet to invest in the business in support of the recipe for growth, and that is exactly what we are doing. Free cash flow year-to-date was $434 million. EBITDA as a primary source of cash is up $900 million year-over-year in the year-to-date period as our sales increased, but we've not yet quite recovered to fiscal 19 levels. The rising sales... and profitability were enabled by taxable investments in higher inventory levels this year, both in absolute cases on hand as we left the purposeful inventory declines in the management of the COVID period and in dollar value given inflation. And with our rapidly growing sales comes a higher balance in healthy accounts receivable, also a use of cash here to date, which our team continues to manage well, offset in part by higher accounts payable. In the year to date, we've also paid higher interest expense from COVID debt and refinancings, paid higher cash taxes, partly due to prior year refunds and deferrals, and invested more in CapEx in support of the recipe for growth. This year is effectively a transition year from a free cash flow perspective, and we expect that future years will continue to reinforce the significant cash flow generated by Cisco as sales and profit grow and investments in working capital are normalized. Let me emphasize, we are playing to win the long game and are leveraging our balance sheet and cash flow in support of the long-term growth of Cisco. Along those same lines, recall that we began the year with high cash balances and we end the quarter with almost $900 million in cash on hand. Year to date, we've used that cash to invest in the business, spending $312 million on CapEx and paying for acquisitions such as Coastal with cash on hand. Our balance sheet is a key differentiator compared to our competition, and we are better prepared than anyone else in the industry entering a rising interest rate environment. Why? Because we have strong cash generation, a strong investment grade rating, and a manageable debt profile, including some of the lowest rates ever achieved by Cisco in a 30-year tenure issued in December. We remain committed to maintaining a strong investment grade rating and achieving a net debt to EBITDA target ratio of 2.5 times to 2.75 times. As previously announced, we expect to further reduce indebtedness by paying off the $450 million of debt coming due in June. And reflecting the world in which we all live, we also now have further liquidity and risk protection if we need it. Last week, Cisco announced that we successfully increased our revolver capacity from $2 billion to $3 billion with improved terms. Return of capital to shareholders is also part of our capital allocation framework. In May of 2021, our board approved a 4% increase to our quarterly dividend, reflecting an 8 cent increase annually. And two weeks ago, Cisco's board did it again, effectively announcing another 8 cent annual increase, reinforcing our status as a dividend aristocrat. What we wanted to take away from this is that we are serious about all three parts of our capital allocation strategy. We are investing the future growth of the business. We are maintaining a strong balance sheet, and we are returning surplus capital to shareholders. On this last point, our track record goes back decades. But as you can see on slide 18, over the last seven years, cumulatively, we've returned over $13 million of cash to shareholders. We will remain disciplined with our balanced approach to capital allocation and rewarding our shareholders. Now, before I turn to our positive update to guidance, I should address one set of questions we've been getting up front, the impact of the invasion of Ukraine on our business. As a reminder, Europe represents only about 10% of our net sales. Our European portfolio is geographically distant from Ukraine and focused on Ireland, the UK, France, and Sweden. In the past, our exposure to Russian products was minimal. With respect to product inflation in Europe, while we are seeing costs rise more consistently with what we've seen in the U.S. in the last couple of quarters, we were prepared and have many of the same tools we developed in the U.S. to address the impact of product cost increases in Europe. Oil and the impact of rising gas prices have also been topics of interest. We benefit from having hedged 80% of our forecasted bulk fuel volume through fiscal 2023 in the US and Europe. Let's now turn and look forward. We are upbeat about our business. We have witnessed the resiliency of our business as it has responded to the impact of three significant COVID-19 variants, significant inflation, the invasion of Ukraine, and now rising interest rates. We've made great progress in Q3, and we anticipate further progress in Q4, which is why we are upbeat about our business. We are raising our guidance for adjusted EPS in the second half by 16 cents to be from $1.76 to $1.86. Having delivered 71 cents of adjusted EPS in Q3, this means that we expect Q4 to be in the range of $1.05 to $1.15. On a full year basis, this will equate to adjusted ETFs of $3.16 to $3.26. During our last earnings call, we highlighted that we expected a big Q4, and that's not changed with the results of our resilience Q3 results. Our continued optimism for Q4 includes a continued market recovery, continued market share gains, continued pass-through of inflation costs, improved operating expenses as a percentage of sales, from lower snapback and productivity-related costs, all is partially offset by continued investments in our transformation and working through the workforce transition. Lastly, recall that Q4 of last year included one extra week, which will impact accountability. With that, let me turn the call back to Kevin for closing remarks. Thank you, Aaron. As we conclude, I'd like to provide a brief summary on slide 20. Cisco already is the industry leader from an EBITDA margin perspective. You've heard me say this before, but we are now taking that robust foundation as the market leader in creating a growth company. Our financial performance this quarter reflects three key points. First, our volume grew 18.8% in US Broadline compared to last year, and we significantly exceeded our market share target. Second, we improved operations expenses. reducing snapback costs by more than 50% while continuing our transformation efforts. And third, we generated strong profit performance despite a dynamic operating environment. Turning to slide 21, these recent results are also consistent with our long-term plans. We are generating substantial top-line momentum and accelerating market share gains. Our recipe for growth transformation is creating capabilities at Cisco that will help us profitably grow for the long term and further build on our competitive scale advantages. Cisco's strength of income statement and balance sheet have enabled us to continue advancing our strategy during a difficult operating environment, while also rewarding our long-term shareholders with disciplined dividend growth and share repurchases. Lastly, we are committed to both our long-term financial outlook, which includes significant sales and EPS growth, and returning value to shareholders along the way. There are bright days ahead for Cisco, and I am both excited and proud to be a part of the journey. As always, I'd like to thank all of our Cisco associates for the dedication they display to our customers each and every day. Operator, you can now turn over the line for questions.