Sysco Corporation

quarter fiscal year 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, everyone, and welcome to Cisco's fourth quarter fiscal year 2022 earnings call. On today's call, we have Kevin Herkin, our President and Chief Executive Officer, Aaron Ault, our Chief Financial Officer, 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 meaning 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 investor 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 also 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 Hurkin.

Good morning, and thank you for joining our call. Q4 marked another quarter of positive top and bottom line performance at Cisco. The quarter capped off strong financial performance in fiscal 2022 as we grew annual sales by 33.8% to over $68 billion. For the year, Cisco grew our business more than 1.3 times the industry. This result exceeded our goal for the year, and the second half of the year performance was even stronger than the first. The outperformance in the U.S. helped drive over 17 billion of total company sales growth for the year. Consistent with our focus on profitable growth, we grew adjusted EPS by 133.8%. Our team generated these results while advancing our recipe for growth strategy, improving our balance sheet, and delivering compelling shareholder returns. I will highlight two topics during our call today. I will share progress we have made as a company over the past year that displays Cisco's unique position of strength in the market. Second, I will convey why we are confident in our trajectory for profitable growth in fiscal 23. Before I get started, let me acknowledge that we are closely monitoring macroeconomic pressures that are impacting consumer confidence across the globe, such as spikes in gas prices, food inflation, and rising interest rates. Despite these external factors, Cisco is prepared to deliver significant market share gains and profitable growth this coming year. So let's get started with our unique position of strength and a bit more about who we are, displayed on slides five and six. I am often asked to describe Cisco. Simply put, Cisco is 50% a food supply chain company and 50% a food sales and marketing company. To be successful as a leader at Cisco and to be successful in this business, you need to be equally capable of leading in both arenas, supply chain and sales. Over the past two and a half years, we have developed a strategy called our Recipe for Growth that is advancing our capabilities in supply chain and sales. We are transforming Cisco by building new capabilities that will further enable our position as the global leader in food distribution. Let me first highlight the 50% of Cisco that is our food supply chain by summarizing some of our biggest accomplishments of the past year. Throughout the year, we have led the industry from an OTIF perspective. For those not in logistics, that stands for on time and in full. This past year was the most challenging OTIF year on record in our industry. During those challenging conditions, Cisco was able to be better in stock and better able to ship on time versus those that we compete against. As a result, we won substantial new business and provided stronger than industry average service levels to our existing customers. We're deeply committed to returning to and exceeding our historical OTIF levels over the coming quarters and years. We fully converted our supply chain to a full six-day service week, Simultaneously, we converted the majority of our U.S. frontline associates to a four-day work schedule, enabling improved work-life balance for our associates. The six-day work model for our large network of DCs will enable Cisco to grow profitably for years to come by better leveraging our physical assets. The transition to the six-day model was a big lift, and I want to thank our associates and our customers for their partnership in the transition. The 6-day model will ensure industry-leading OTIF results for years to come. We launched our Cisco Driver Academy, opening our first training location and began building out a nationwide infrastructure that will be complete by the end of this calendar year. The Driver Academy is helping Cisco address a shortage of skilled drivers, and our academy will increase the number of skilled drivers at Cisco and will deliver increased lifetime earnings potential for the associates selected to participate. We have piloted and are scaling new picking methods at our warehouses that will improve the experience of our delivery drivers. In addition, we are providing our drivers with advanced material handling equipment that reduces the physicality of their day. These actions will improve the experience of our drivers, enabling improved productivity, improved retention, and increased customer service. Lastly, we have built out a distributed order management system, or DOMS for short, that will enable omnichannel fulfillment at Cisco in fiscal 23. We have decoupled the front end of our network, sales, from the back end of our network, operations, through this project. No longer will a customer need to order just from their local site's inventory assortment. We are opening up our vast network of inventory to our customers through the DOMS implementation, while also improving the productivity of our working capital through this industry-leading project. We will be launching our first flight soon with plans to expand and scale in 23 and beyond. Our supply chain mission at Cisco is clear. Enable profitable growth by delivering the industry's leading assortment of products delivered on time and in full at a delivery frequency that meets or exceeds our customers' expectations. Our supply chain greatly enhanced our capabilities to deliver on that mission in fiscal 22. Now I would like to highlight the progress that we've made in the other 50% of our company's key work focus, food sales and marketing. We live our foodie credentials every day with over 7,500 sales consultants and hundreds of culinary partners and product specialists across the globe. I dare say there are a few, if any, that know more about food and food trends than our culinary teams. Our sales associates have the highest customer satisfaction scores in the industry. with NPS overall satisfaction rates a full point higher than their competitors. Please see chart seven. Our sales consultants are experts in everything from building menus with our customers, identifying and introducing new food trends, and importantly, partnering with our customers to help save them money. From a product perspective, we have the broadest assortment of food in the industry, and we have expanded that assortment strength with the recent acquisitions of Greco, Paragon Foods, and the Coastal Companies. Our product assortment is second to none, and we offer fair and appropriate prices to our customers. Like I summarized with our supply chain, I would like to highlight some of the progress that we have made over the past year in regards to food sales and marketing. We implemented an intelligent, data-driven pricing system to improve our ability to be what we call right on price at the customer item level. We built and scaled a customer personalization engine, which provides our customers with unique offers that meet their specific needs. We upgraded and improved our digital shopping platform. We improved search navigation. We made it even easier to reorder common essentials. And we introduced product recommendation engines that increase customer basket size. We improved what we call team-based selling, better leveraging our sales teams across Broadline and our collection of specialty businesses. Lastly, we can measure success over the past year in several ways. I'd highlight two. Firstly, during the great resignation, our sales consultant retention in fiscal 2022 exceeded our historical average. RSEs love the new tools that we have built, and they have deeply embraced our recipe for growth. And secondly, we successfully grew more than 1.3 times the industry in 2022. This result exceeded our goal for the year. And the second half of the year performance was even stronger than the first. Our customers are rewarding us with more of their business because of the relationships they have with our sales teams and because of the new tools and services that we have deployed in food sales and marketing. Defining excellence in food sales and distribution, that is Cisco. We are confident that we have the size, scale, and expertise to be the leader in these two arenas. bringing innovation to our customers every day. Topic two for today, I'd like to discuss the current economic climate and our view for the upcoming year. We are closely monitoring macroeconomic pressures and data points related to food inflation, gas prices, and consumer confidence. There is no doubt that end consumers have a lot on their minds these days. We think it's important to remember the resilience of our industry, and how we have adapted over the past few years. We submit respectfully that food away from home has proven to be resilient, and quite frankly, essential. Over the last two and a half years, our industry has dealt with challenge after challenge, with three major waves of COVID, double-digit inflation, and innovation in Ukraine impacting the food supply. Despite these challenges, we have delivered profitable growth. We have learned to operate in an abnormal environment and we are prepared to navigate another dynamic year ahead. While we anticipate that recent macroeconomic headwinds may create less robust industry-wide growth rate in 23 than we had originally planned, we are prepared to generate sales growth of at least 10% in 2023. Erin will address guidance in more detail in a moment. There are several reasons why we believe we will deliver on our financial targets. First, as the industry leader, we are fully diversified. covering every corner of the food away from home market. We serve restaurants up and down the price point spectrum and across all restaurant types. We deliver food to healthcare and education facilities that are less prone to recession. We deliver to travel and recreation facilities into many office buildings. These last two sectors continue to rebound and will provide a source of growth in the coming year. Additionally, we still have big opportunities to grow in the restaurant space. Even if foot traffic is more muted than originally forecasted by Technomic, remember that we serve roughly 50% of the total restaurant door locations, and we have roughly 30% share of wallet with existing customers. Cisco can still grow our business even if the market growth is less compelling. And given the strict shutdowns internationally in 2022, we have strong growth potential year over year from our international division. Simply put, we intend to win share, profitably in fiscal 23. Second, regarding inflation, we continue to work with our customers to pass through the majority of product cost inflation. Interestingly, the relative price of eating out has been less impacted by inflation than the cost of food at the grocery store, as seen on slides 8 and 9. When coupled with people's desire to eat out, we believe that restaurants will once again prove resilient. Our investments in food sales and marketing capabilities through our recipe for growth strategy will deliver increased value in the coming year. The topics I highlighted on this call today, coupled with new programs like Cisco Your Way and Cisco Perks, will drive increased market share growth. Once again, we plan to grow faster than the overall industry, with a target in fiscal 23 of growing 1.35 times the industry. This trend will put us on the trajectory needed to deliver our end of fiscal year 24 target of growing 1.5 times the industry. We are increasingly confident in our longer term guidance provided in May of 2021 at our investor day. In addition to ensuring that we drive compelling market share growth, Erin, our entire leadership team, and I will be focused on productivity improvement and structural cost out. We are proud of the progress that we have made in reducing structural costs over the past year and we will be relentlessly focused on improving operations efficiency in fiscal 23. Lastly, we are excited to welcome Paulo Peraboom as the newly appointed leader of our international operations. Paulo has an extensive track record of driving transformation and building high-performing customer-focused teams across multiple geographies. This includes over 30 years of experience across seven countries, all in the food business. Our international team had a strong year of improvement in 22, and we are increasingly confident in our future. Apollo will take the momentum we are building to the next level. I'd now like to turn it over to Aaron, who will provide additional financial details. Aaron, over to you. Thank you, Kevin, and good morning. The Cisco team delivered strong financial results for the fourth quarter and the full financial year, giving us many reasons to be upbeat about our business. Let's talk about some of the highlights. We achieved an all-time record for quarterly and annual sales at Cisco, landing at $19 billion for the quarter and almost $69 billion for the year. For the fourth quarter, our enterprise sales grew 17.5%, with U.S. food service growing at 16.4% and international growing at 30%. At the enterprise level, adjusting out the extra week in Q4 of fiscal year 21, our sales growth was even higher. at 26.5%. With respect to volume, U.S. broad line volume increased 5.4% on a 13 to 13 week comparison basis. We made $3.5 billion in adjusted gross profit for the quarter and $12.4 billion for the year, up almost 20% versus last year for the fourth quarter and up 32.5% for the year. Adjusted gross margin improved to 18.4% in the fourth quarter, with the rate rising from last quarter and up 33 basis points to Q4 fiscal 21, even with the impact of incremental inflation. GP dollars per case grew in all four segments versus prior year, marking the fourth consecutive quarter of such growth. We continued to pass along product inflation, which was around 15% in the US in the fourth quarter, while passing along part of our operating cost inflation. Our SNAP Act operating costs dropped to $29 million in Q4. Productivity gaps, however, were a continuing factor as, on the one hand, we returned to employment levels higher than fiscal 19, but on the other, we invested to cover overtime to address growing demand and lower productivity of the new staff. We invested $67 million of operating expenses for the recipe for growth in the quarter, with supply chain investments ramping up significantly. Overall adjusted operating expenses were $2.6 billion for the quarter, or 13.8% of our sales. Operating leverage improved by 55 basis points for the quarter and 117 basis points for the year. Adjusted operating income increased by 45% versus last year to $877 million in the quarter, also exceeding our pre-COVID Q4 2019 results, an excellent sign of progress. Operating income for the year was $2.6 billion. We are particularly pleased with the progress of our U.S. food service segment, which delivered record operating income for the quarter, and with the continued sequential progress of our international operations, which once again made progress in the direction of pre-COVID profitability. At the enterprise level, we continue to have the highest EBITDA margin in the industry. Adjusted EBITDA surpassed $1 billion for the first time ever in a quarter at Cisco, and we delivered $3.3 billion of adjusted EBITDA for the year, notwithstanding COVID, Omicron, inflation, the invasion of Ukraine, and high fuel prices. Adjusted earnings per share increased to $1.15, which is an all-time high for the fourth quarter or any quarter, for that matter, at Cisco. In regards to the balance sheet, we paid down $450 million of debt as it came due in Q4. We ended the year at 2.9 times net debt to adjusted EBITDA. And during the fiscal year, we returned $1.5 billion to shareholders through $500 million of share repurchase, completed in the fourth quarter, and $959 million of dividends. Since year end, we have also repurchased additional shares. More on that to come. Cash flow from operations was $1.8 billion, and free cash flow was $1.2 billion for the year. With our focus on driving rising sales and profitability comes rising inventory and a higher balance of healthy accounts receivable, both the use of cash for the year. Our team continues to manage our receivables balance as well, and we also benefited from higher accounts payable. We ended the quarter with approximately $867 million in cash on hand. So let's turn and look forward. In recent months, and indeed at the start of my comments today, I observed that Kevin and I are upbeat about our business, and that view carries through to future quarters for Cisco. The upbeat guidance we are providing is reflective of our ongoing investments and our extensive effort to reposition Cisco as a growth company. As Kevin mentioned earlier, we are well positioned and prepared to operate through another dynamic year and are assessing whether and to what degree a recession will impact the economy and our business. It's worth repeating that we benefit from the scale at which we're operating, our diversification as the industry leader across customer types, product categories and geographies, the discipline enabled by our pricing tool, our strong balance sheet, and demonstrated focus on cost takeout. We have carefully examined Cisco's results during the 08-09 recession, and importantly, we benefit from the fact that our company has just operated through and learned from the business interruption of COVID. Here's the real punchline. We are better positioned today to address macro events than we have ever been before. So with all of that said, during fiscal 23, from a growth algorithm perspective, we expect to grow at least 1.35 times the market, regardless of the economic environment. While it is difficult to be precise in the current macro environment, based on initial estimates of market growth and inflation, we expect top line growth of at least 10% over fiscal year 2022, which will move Cisco above the $75 billion annual sales mark for the first time. Bolton acquisitions will also contribute to our growth. We are expecting mid- to single-digit inflation for the full year on an enterprise basis across all categories, moderating from high single digits in the first quarter on a year-over-year basis to low single digits in Q4. We are not planning for a deflationary environment, though some categories may be individually deflationary. We do expect elevated operating expenses during the year as we continue to deal with a hiring environment that is still recovering, associate tenure-driven productivity issues that we expect to improve over the course of this year, and continued planned investments for our transformation, all as mitigated in part by cost-out efforts. Speaking of cost-out, we delivered significant cost-out in fiscal 2022, helping offset incremental operating expenses this year. We have now exceeded our cumulative cost-out target of $750 million, and we're going back for more, the achievement of which is already included in our EPS growth expectations. All in, we are growing our adjusted EPS with both volume growth and profit improvements contributing to our substantial increases in earnings per share. We are guiding adjusted EPS for fiscal year 23 of $4.09 to $4.39. The midpoint of this range equals a 30% increase in adjusted EPS over fiscal year 2022. It also represents a 20% increase in our adjusted EPS from our previous high point, fiscal 19. Please take note of the fact that even the low end of our adjusted EPS range for fiscal year 23 reflects the highest adjusted EPS achieved at Cisco ever in a year. While I do not intend to debate the definition of recession with economists, the low end of our range reflects a modest recession impacting our year. The midpoint reflects the current operating environment, and the top end reflects a strong economic recovery. The macro environment, our productivity improvement efforts, and the timing of our recipe for growth investments will impact the cadence of our earnings growth, with stronger profit growth expected in the second half. For Q1, we expect adjusted EPS to be at or near our prior first quarter high point from back in 2020. The stronger earnings growth in the second half reflects continued progress with our recipe for growth, progress on productivity initiatives, lapping last year's Omicron-related slowdown, and the fact that Q4 is always our seasonal profit high point. You may recall that in May 2021, we provided long-term guidance for fiscal year 24 to achieve adjusted EPS 30% higher than fiscal 19. The midpoint of our fiscal year 23 guidance, which is 20% above fiscal 19, reflects that we are well on our way to achieving our previous long-term EPS guidance. The midpoint of our guidance also translates to adjusted EBITDA of approximately $4 billion in the year. We are forecasting continued strong cash generation and an increase from 2022 levels driven by profit increases offset by investments in working capital as AR grows with our sales and we continue to support our strategy with tactical investments in inventory. Our capital allocation strategy remains the same going forward. Invest in the business, including through M&A. Maintain our strong investment grade rating and continue our return of capital to shareholders. With EBITDA growing, we expect to make further progress on our net debt to adjusted EBITDA leverage in service of our target of 2.5 times to 2.75 times. Also note that we are positioned well in the current rising interest rate environment. It's approximately 95% of our debt is fixed. Just last week, Moody's reaffirmed Cisco's strong investment grade credit rating and stabilized our rating outlook. We are committed to completing up to $500 million of share repurchases in fiscal 23 and indeed have already completed $267 million of that repurchase commitment during Q1 of this year. We will be assessing the operating environment and the cash needs of further M&A opportunities before committing to any incremental share purchase activity beyond the $500 million during the year. Our status as a dividend aristocrat is important to us, and we already announced the effective 8% annual dividend increase for our fiscal year 23. In summary, we view fiscal 23 as an excellent build upon fiscal 22, as we grow both the top line and the bottom line. while playing the long game and investing for the future at Cisco. All of these efforts are consistent with fulfilling our long-term guidance from Investor Day, which includes exceeding 1.5 times market share growth by the end of fiscal year 2024 and adjusted EPS growth of at least 30% over our record 2019 levels. With that, I will turn the call back over to Kevin for closing remarks. Thank you, Aaron. As we conclude, I'd like to provide a brief summary on slide 25. Cisco already is the industry leader from an EBITDA margin perspective. And as you heard from Aaron, we plan to build on that position of strength in fiscal 2023. Our key takeaways from today's call reflect three points. First, we advanced our recipe for growth strategy and grew more than 1.3 times the market for the year, with the second half even stronger than the first. Second, we improved profitability with sequential progress in both gross profit and operating margin rates. And third, Recognizing macroeconomic pressures as well as the resiliency of our industry, we are confident in our external guidance for fiscal year 2023. This assumes at least 10% sales growth and 30% EPS growth at the midpoint as we continue to grow with new and existing customers. We will also remain disciplined in expense management with a strong plan to drive increased operating leverage. Turning to the next slide, we are generating substantial top line momentum and accelerating market share gains. Our recipe for growth transformation is winning in the marketplace and creating capabilities at Cisco that will help us profitably grow for the long term. We are further building upon and enhancing 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 our long-term financial outlook, which includes significant sales and EPS growth, and returning value to our 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. Operator, you can now open the line for questions.