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Sysco Q4 2023 Earnings Call Transcript


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Participants

Corporate Executives

  • Kevin Kim
    Vice President of Investor Relations
  • Kevin P. Hourican
    President and Chief Executive Officer
  • Kenny Cheung
    Executive Vice President and Chief Financial Officer

Analysts

Presentation

Operator

Welcome to Sysco's Fourth Quarter Fiscal Year 2023 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.

Kevin Kim
Vice President of Investor Relations at Sysco

Good morning, everyone, and welcome to Sysco's fourth quarter fiscal year 2023 earnings call. On today's call, we have Kevin Hourican, our President and Chief Executive Officer; Kenny Cheung, our Chief Financial Officer; and Neil Russell, our Chief Administrative Officer. Before we begin, please note that statements made during this presentation that 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 2, 2022, subsequent SEC filings, and the news release issued earlier this morning. A copy of these materials can be found in the Investors section at sysco.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 Investors section of our website. During the discussion today, unless otherwise stated, all results are compared to the same quarter in the prior year. 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 Hourican.

Kevin P. Hourican
President and Chief Executive Officer at Sysco

Thank you, Kevin. Good morning, everyone, and thank you for joining our call today. I would like to cover three topics during my section of our call: first, I'll provide a summary of our Q4 results and our full-year performance; second, I'll convey an update on our Recipe for Growth strategy; and lastly, I'll provide some commentary on the macro conditions which we have modeled for fiscal '24 and how Sysco intends to operate within that environment. Kenny will provide much more detailed components of guidance during his section.

So let's get started. We are pleased with the strong finish to the fiscal year. Sysco posted record top line and bottom line results during the fourth quarter. Top line results, as seen on slide 5, were up 4.1% compared to last year, delivering $19.7 billion in sales. The strong quarter generated a full year sales result of $76.3 billion, a record at Sysco. We grew annual sales by 12.5%, or $8.6 billion, on a constant currency basis. That sales growth is the equivalent of creating a net new Fortune 500 company within Sysco.

Turning to volumes. Q4 case volume grew 2.3% and local case volume grew 0.8% across our U.S. Foodservice business, successfully growing our market share and furthering our number one position in foodservice distribution. We are pleased with our share gains for the quarter and the year, which build on meaningful gains delivered within fiscal year '22. Importantly, these gains are profitable share gains. We are not growing for the sake of growing, as we have consistently pursued profitable sales growth vectors domestically and internationally.

Moving to gross profit. Our sales and merchandising teams delivered a strong quarter from a GP growth perspective. We grew gross margin rates and GP dollars per case, which is not easy to do in a disinflationary environment. Our teams are doing excellent work in strategic sourcing to reduce COGS and further penetrating Sysco brand cases with our customers. Advancing Sysco brand helps gross profit and leads to increased customer retention. Lastly, we are growing our higher-margin Specialty business, which strengthens our overall margin profile.

Next in the P&L is operating expense. I am most proud of the quarter from the perspective of the progress that we are making in reducing our expenses. We have been clear with investors that our first half of the year in fiscal '23 had elevated expenses. This was driven by two factors: investments in our business and a supply chain struggling with new-colleague productivity. In the second half of fiscal '23, we made major progress on our expense ratios and greatly accelerated productivity improvement within our supply chain. Retention of colleagues has improved, productivity of our colleagues has improved, and our supply chain initiatives are bearing fruit. All told, we delivered an operating leverage of 370 basis points in Q4, growing GP dollars meaningfully more than expenses.

Slide 7 highlights the sequential improvement with opex over the course of the last fiscal year. We began the year in our U.S. Foodservice segment with quarterly operating expense growing over 22% but ended the year with a growth rate of 0.5%. Our focused effort to deliver supply chain efficiencies and broad-based cost reductions drove the sequential improvement across the year. We expect to make further operating expense progress in 2024. We will be zealot-like focused on ensuring our supply chain is properly staffed, properly trained, and working safely and productively. We have the leadership expertise, supply chain tools, and supply chain infrastructure to lead the industry in this regard, which is one reason why Sysco operates at an EBIT margin over 1.5 times higher than our industry distributor average.

Record top line and record bottom line performance in Q4 is a direct result of our Recipe for Growth and our focus on excellence in execution in operations. The improvement from first half to second half within fiscal '23 was notable, enabling Sysco to grow EPS more than 23% for the full year. In addition to delivering a strong P&L in Q4, we achieved record free cash flow, and we returned approximately $1.5 billion back to shareholders during the year. We are pleased with the strong financial performance in the quarter despite rapid disinflation and slower overall industry market volume growth. We believe our success in spite of those conditions positions the business to be successful in 2024, which I will speak to more in a moment.

As is my custom, I would like to provide a brief summary of select Recipe for Growth elements of our strategy from our recent quarter. I will start within our supply chain initiative. Our work on strengthening Engineered Labor Standards across our supply chain is paying dividends. As I mentioned a moment ago, we made significant headway in improving our supply chain efficiency. We have recently strengthened our Work Method Standards training within transportation roles, enabling our colleagues to work safely and work more productively. Additionally, we have increased retention rates within our workforce through our improved training programs. The Driver Academy is national, and the impact of this program is a better trained workforce.

Now we would like to highlight the progress that we have made on the food sales and marketing side of our Recipe for Growth. Last month, we announced an agreement to purchase BIX Produce. BIX Produce is a leading produce specialty distributor based in Minnesota. The acquisition is expected to provide a strategic opportunity for FreshPoint to expand its geographic footprint in an area of the country where it does not currently have operations. BIX has a strong assortment offering, including fresh cut produce, grab-and-go sandwiches, and value-added production capabilities.

In addition to our good work in expanding specialty, we also upgraded our digital shopping platform during the quarter. Our SHOP digital platform is now available in Spanish, and we have deployed more than 100 new feature enhancements. Some of these enhancements include a new homepage, new category and cuisine pages, improved search and navigation, and lastly and new Deals for You page. These enhancements have driven an increase in product page visits, adding incremental volume through add-to-cart purchasing. There is no finish line in our digital improvement journey. We will continue to improve our digital tools over time, enabling us to reduce friction in the purchase experience and inspire our customers to buy more from Sysco.

Our centralized pricing tool has given us the ability to be what we call right on price at the region, customer, and item level. During the first half of '23, we experienced rapid inflation and in the second half of '23 we experienced rapid disinflation and even deflation towards the end of Q4 within our core USBL business. Our merchants have been fighting to secure best possible cost and our pricing tool ensures that the real-time cost fluctuations are built into our pricing strategies. Managing pricing across hundreds of thousands of customers, tens of thousands of products, and approximately 7,500 sales reps has never been stronger. This is evidenced by our consistently strong performance in GP dollars growth and adjusted gross margin rate growth up 28 basis points year over year in the quarter. We want our sales reps focused on customer engagement, relationship building, consultative selling, and solving problems for our customers. Our pricing tool enables our SCs to spend more time on those value-added activities.

Lastly, Sysco Your Way is now live in over 400 neighborhoods across five countries, and our loyalty program, Perks, is active with over 12,000 customers. Both programs are continuing to deliver compelling top and bottom line growth. The past year has been a heavy lift as we work to get these programs off the ground. In 2024, we can focus on maximizing the impact of these compelling programs with less effort and investment required than in 2023.

In summary, our Recipe for Growth is working, enabling Sysco to profitably grow our business and differentiate versus others in our space. Most compelling is that food away from home is a growth sector as seen on slides 10 and 11. Sysco has been profitably growing faster than the overall market, delivering record top and bottom line results. We expect to continue to win market share profitably in the years to come and to do so in a fiscally responsible way.

I'd like to wrap up my time this morning with some comments about the operating environment we expect for fiscal '24 and Sysco's positioning within that environment. My main message is that scale matters in this industry and that strong operators are best positioned to succeed, regardless of the environmental conditions. Sysco is a very strong operator with meaningful scale advantages. With that said, in fiscal '24, we expect the market to grow at a lower rate than '23. We also expect the rate of inflation for the year to be below historical standards. In the second half of fiscal '23, we experienced the rapid disinflation followed by deflation within our core U.S. broadline business towards the end of the fourth quarter. We expect that deflation will continue within U.S. broadline for the first half of fiscal '24, followed by muted U.S. broadline product inflation in the second half.

We expect that our international segment will remain inflationary during the coming fiscal year, given unique marketplace conditions in those geographies. Net-net, for Sysco, we expect an inflation rate that is slightly positive throughout fiscal 2024 below our historical average. We believe the Q4 environment we just exited is largely reflective of the operating environment for the coming year. Importantly, we grew our top and bottom line within that quarter. We're being very prudent in fiscal '24 in managing our expenses given the volume and inflation components that I've just conveyed. Despite these conditions, Sysco is positioned to succeed, grow faster than the market, and deliver bottom line growth.

Our confidence is also based on our structural competitive advantages. First, our international business, which is approximately 18% of sales, continues to outperform, providing a natural hedge as international inflation rates remained elevated and are expected to stay higher than the U.S. Second, our purchasing scale is the largest in the industry, and our strategic sourcing efforts will enable Sysco to secure improved pricing in a deflationary environment. Third, Sysco has a diversified business with strong sales across 12 major product categories to help buffer the impact of inflation or deflation in any one category. Additionally, our strategic pricing software will enable Sysco to be extremely purposeful on how we manage the impact of disinflation and deflation. Lastly, further advancing Sysco brand penetration domestically and internationally is another lever to pull to deliver GP dollar growth when the environment is deflationary.

The exit velocity of fiscal '23 gives us confidence in delivering strong results in 2024. In summary, here is what we expect for '24: lower rates of overall market volume growth versus '23; continued market share gains and profitable growth at Sysco; deflation in the U.S. for at least the first half of the year and muted overall company-wide inflation for the full year; disciplined expense management, Kenny and I have directed an effort to reduce structural expenses by approximately $100 million; extremely disciplined return on invested capital, or ROIC focus; continued progress in advancing Sysco brand penetration and growth within specialty. In total, given all these interworking variables, we are modeling an adjusted EPS range of $4.20 to $4.40 for the full year. The midpoint of that guide would generate approximately 7% EPS growth versus fiscal '23.

Now in our third year of Recipe for Growth, we are positioned to press the accelerator on certain proven initiatives. For example, we can optimize our performance and launch Sysco Your Way neighborhoods, which takes less effort than starting up a neighborhood. Our digital tools are becoming more and more pervasive with our customers, and we can optimize the personalization of these interactions to increase yield through each transaction. We have always said that the Recipe for Growth is a wheel where each initiative fuels the next. Fiscal '24 is a year of optimizing what we have launched versus kicking off net new efforts. This will enable Sysco to be laser focused on what matters most, executing with excellence against launched programs. This also means we will be able to grow our business with less investment. This was always our plan within the Recipe for Growth, and it is coming to reality in fiscal '24.

In addition, our expanded geography of specialty businesses, like the recently announced BIX acquisition, will increase the impact of our higher-growth specialty segment. In fiscal '24, we are committed to both profitably growing our top line, meaningfully reducing opex, and generating a higher rate of return on key initiatives. Given the confidence that we have in our long range roadmap, we are happy to announce that we have reintroduced ROIC as a long-term compensation metric for our leadership team. In addition, we have increased the weighting of financial metrics within our short-term annual bonus program. As I have said many times before, the best companies in the world are growth companies, and we expect that Sysco will continue to profitably grow faster than the overall market. I am thrilled to have Kenny as my partner on these objectives. We are committed to maximizing every dollar invested in producing the greatest shareholder value.

I'll now turn it over to Kenny who will provide additional financial details. Kenny, over to you.

Kenny Cheung
Executive Vice President and Chief Financial Officer at Sysco

Thank you, Kevin, and good morning, everyone. I would like to start off by thanking our customers, colleagues, and partners around the world for helping us deliver another record quarter. Sysco operates a high-volume business, and I'm proud of our efficient response in servicing and delighting our customers. We closed out the fiscal year strong, delivering improvement across the income statement, balance sheet, and cash flow. Q4 financials reflect positive sales and volume growth and operating expense leverage. Altogether, these rendered a record quarter of operating income, net income, and adjusted EPS. Our results also reflect improvements in operational efficiency through productivity and resource optimization. This elevated performance will enable us to reinvest back into the business and return excess cash back to shareholders, an important theme we expect for FY '24 and beyond. Our unique value proposition with the Recipe for Growth at the forefront is what differentiates us as a growth company. As Kevin stated earlier, we will continue to focus on accelerating programs that have high returns, which is a key priority in my role here at Sysco.

Now turning to a summary of our reported results for the quarter, starting on slide 14. For the fourth quarter, our enterprise sales grew 4.1% with U.S. Foodservice growing 2.5%, International growing 12.2%, and SYGMA growing 1.4%. With respect to volume, total U.S. foodservice volume increased 2.3% and local volume increased 0.8%. We produced $3.7 billion in gross profit, up 7% versus prior year. Adjusted gross margin improved to 18.7%, a sequential increase from the prior quarter and an increase of 28 bps compared to last year. Our gross profit dollar and margin percentage improvement during the fourth quarter reflected our ability to continue to effectively manage product inflation, which moderated to 2.1% for the total enterprise, consistent with our expectations. The improvement in gross profit was driven by incremental progress from our strategic sourcing efforts as well as improved penetration rates from Sysco brands products, which increased by 11 bps to 37.2% in U.S. broadline and 64 bps to 47.3% in U.S. local results. Overall, adjusted operating expenses were $2.7 billion for the quarter were 13.5% of sales, a 29 bps improvement from the prior year.

All four operating segments continue to show increases in quarterly profitability, including substantial growth in the International and SYGMA segments. As seen on slide 22 and 23, Q4 adjusted operating income of $1 billion for the enterprise showed a strong exit rate, growing 25% compared to FY '19. This is the highest adjusted operating income quarter in Sysco's history and is now the fourth consecutive period of record quarterly operating income. For the year, adjusted operating income increased to $3.2 billion, growing 17.3% compared to our prior FY '19 record, an important signal of the progress being made at Sysco.

For the quarter, adjusted EBITDA increased to $1.2 billion, growing 14.4%. We are thrilled with the progress of our International segment with adjusted operating income growing 58% for the fourth quarter. As stated earlier, our international business continues to deliver robust growth with positive momentum. I am also particularly pleased with the health of our balance sheet, which further strengthened this quarter. We delivered on our target leverage ratio, another important milestone, as we ended the year at 2.5 times net debt leverage ratio. This is within our target of 2.5 to 2.75 times, a substantial improvement from 5.1 times just over two years ago. We ended the year with $9.7 billion in net debt with total liquidity of $3.7 billion and no commercial paper outstanding. Our debt is well laddered without any maturities over $1 billion until FY '27.

Turning to our cash flow. We generated $2.9 billion in operating cash flow and $2.1 billion in free cash flow, which was a new record. Our conversion rate from adjusted EBITDA to free cash flow was 55% and operating cash flow conversion up 75% shows the company's robust earnings power. Our strong financial position enabled us to return $1.5 billion to shareholders. This was done through $500 million of share repurchases and $996 million of dividends.

Despite the changing macroeconomics landscape, we are positioned to grow both top line and bottom line results in FY '24 and the long term. The guidance we are providing is reflective of the traction our Recipe for Growth initiatives are gaining in addition to moderate industry growth rates. Furthermore, we believe our Q4 performance provides significant proof of our ability to drive shareholder value as several of these macroeconomic and industry dynamics are expected to continue into FY '24. As Kevin highlighted on slide 7, we began the year with elevated levels of operating expense growth. As a result, operating expenses were an area of focus for supply chain teams throughout the year, and we were able to produce sequential improvements. We ended the year with significant operating expense leverage, allowing us to improve margins. This is important progress, and we expect continued improvements going into FY '24.

Let's now turn to the look forward. During FY '24, we expect top line growth of mid-single digits and positive volume growth which will move Sysco to approximately $80 billion in annual sales. This will be another record for Sysco. Importantly, we expect inflation to be slightly positive on an enterprise basis for the full year. Based on our analysis and the exit rate from the fourth quarter, we believe that first half globally will be slightly positive and the second half will step up. This includes continued deflation in U.S. broadline during the first half of the fiscal year with an expected rebound in the second half of the fiscal year. Based on our structural advantages, Sysco is well positioned to manage our COGS effectively and continue to pass long pricing without impacting demand. It is all about better buying and better selling.

Turning to expenses. We expect further improvements in operating expense leverage based on a continuation of the process improvements from this past year. One month into the new year, we've already executed actions to support $100 million of cost out which has been factored into the guidance. We will continue finding incremental opportunities to enhance operational efficiency and adapt swiftly to the constant evolving business environment in which we function. We will manage our business with discipline and agility. We have bottled our [Phonetic] frontline operations wage growth to be approximately 4.5% to 5%. This is higher than our historical average, but much lower than select other industry news due to the fact that in many instances our supply chain colleagues are paid above market and our drivers can earn as much as $100,000 per year. We also expect free cash flow to grow further in FY '24 on top of a record performance in FY '23.

We wanted to also provide guidance on several other important modeling elements. The tax rate for FY '24 is expected to step up to approximately 24.5% compared to 23% in FY '23. The increase is driven by geographical mix related to strong international growth and increases in state tax rates. We plan to remain in line with our net debt leverage ratio for the year. Related interest expense is expected to step up by about $13 million [Phonetic] for the year due to cash uses for growth investments, dividend payments, share repurchases, and anticipated M&A activity. Other expenses is expected to be approximately $30 million for the year, driven primarily by pension expense.

All in, we are guiding to adjusted EPS for FY '24 at $4.20 to $4.40. This reflects adjusted EPS growth of approximately 5% to 10%. Our capital allocation strategy will continue to focus on investing in the business. Examples include M&A, maintaining our strong investment-grade credit rating, and continuing our return of capital to shareholders through dividends and share repurchases. Capex should be consistent with prior year at approximately 1% of sales.

Returning cash back to shareholders is important, as is our dividend aristocrat status, and we plan to step up these efforts in the coming year. In FY '24, we will have a $0.04 dividend increase, and we expect to complete approximately $750 million of share repurchases as we start the fiscal year with $4 billion in remaining authorization. Depending on the volume of M&A done in FY '24, we could increase share repurchases further while continuing to operate within our stated goal of 2.5 to 2.75 times leverage. We will look at each investment through the lens of driving growth and ROIC, and I am pleased to state that our ROIC for FY '24 is expected to surpass our pre-COVID levels through sales growth, margin expansion, and prudent management of the balance sheet. As a company, ROIC will dynamically guide our operating and investment decisions, which will accrete shareholder value over time as we continue to focus on both margin dollars and percentage growth.

Now in my role for a few months, I'm constantly impressed by the size and scale advantages at Sysco. This is a high-volume business that runs fast and any micro adjustments around operational efficiencies are felt quick. Our scale advantages are also reflected in our industry-leading margins. Our diversification as the industry leader across customer types with two-third in restaurants and one-third in recession-resistant category, such as education and healthcare, is also a structural advantage. Our robust industry-leading operating cash flow and strong investment grade rated balance sheet gives us access to capital at attractive rates, so we're able to take advantage of opportunities as they present themselves. As you can see in our performance results, our international segment is proving to be an advantage, contributing higher rates of growth than our mature [Phonetic] U.S. business and the inflation dynamics and other geographies are helping create a bit of a natural hedge across our business portfolio. We believe that international can continues to be a profitable growth engine for Sysco. I am even more excited 90 days into this role than I was on day one, and I look forward to our progress ahead.

With that, I will turn the call back over to Kevin for closing remarks.

Kevin P. Hourican
President and Chief Executive Officer at Sysco

Thank you, Kenny. As we conclude, I would like to provide a brief summary on slide 28. Sysco has a strong record of generating consistent results. In fact, Sysco has grown annual sales in 51 years out of our 54-year history. We expect our positive momentum to continue in 2024. In addition to compelling top line growth, Sysco is the industry leader from an adjusted EBITDA margin perspective, with the strongest balance sheet. We plan to build on that position of strength in fiscal year 2024. We ended our fiscal year 2023 with strong sales volume and share growth, growing volumes across both our chain and independent business. The result was a 23% adjusted EPS growth for the year with record top and bottom line contribution. We have momentum going into the year as our Recipe for Growth transformation, now in its third year, is further building upon and enhancing our competitive scale advantages. Importantly, we have demonstrated our third consecutive quarter of operating leverage with gross profits outpacing operating expense growth. For fiscal year '24, our dual focus on core efficiency measures and optimization from proven growth opportunities will deliver another year of top and bottom line growth. There are bright days ahead for the food away from home industry and more specifically, Sysco. I am both excited and proud to be a part of the journey and, as always, I want to thank our 72,000-plus fiscal colleagues for their commitment to our customers and our shareholders.

Operator, you can now open the line for questions.

Questions and Answers

Operator

[Operator Instructions] Your first question will come from Edward Kelly at Wells Fargo. Please go ahead.

Ed Kelly
Analyst at Wells Fargo Securities

Hi, guys. Good morning. Kevin, so my question is on the guidance. Obviously, the backdrop for the industry is a little bit tougher than what it would normally be and providing guidance in that backdrop is not easy. 5% to 10% earnings growth against that is certainly respectable. But can you talk about the confidence in that level of growth, the cadence that we could be expecting? And if you were to be at the bottom end of the range or worse, what would drive that? And if you were at the better end of the range, what would cause that outcome?

Kevin P. Hourican
President and Chief Executive Officer at Sysco

Hey, good morning, Ed. This is Kevin. I'll start and I'll toss to Kenny for additional comments. I'd start with a few points. The guide is based on a continuation of momentum that the company has been building over the past six months, most notably tied to our operating expense improvements. We call our planning process three big boulders: volume of the market, inflation projections of the market, and then our expense ratios. And we worked very hard to make sure that we can do the best job possible in guiding what these individual three components will be.

So let's start with volume. As I said in my prepared remarks, we do expect for the volume growth of the industry to be more muted this coming year. We have factored that into our guide. We've triangulated that from supplier partners, from economists, from bankers, and our own data. We have a treasure trove of data across all of the different business segments that we serve. So we do expect for volume growth of the market to be more muted. With that said, and we're confident that we Sysco can grow faster than the market, and we are committed to doing so profitably.

Topic two is inflation or deflation as it is -- as it were, and we have to break that down into individual businesses and individual countries. As I said in my prepared remarks, USBL we expect to be deflationary for at least the first half of the year. We do have a natural hedge at Sysco given the fact that we have an international segment that is still experiencing inflation due to unique geography considerations and purchasing considerations within those countries. So when you put that all together for the year, I'll use that same term a second time, we expect for muted inflation for the entire year that's below our historical standards.

On the positive side, continued logistics efficiency, a chart in our slide that we're really pleased with is page 7 in our slides that are out there. The progress that was sequentially made throughout the year quarter over quarter on improving our logistics efficiency we expect to continue. There's some important below-the-line things in the guide that Kenny can talk to about tax and interest. To answer your question on confidence, Ed, I'll end with Q4, the environment that we've just exited and most notably June, we believe to be reasonably consistent with what we expect the overall environmental conditions to be in fiscal '24. And we had a solid performance ending the year and a solid performance in June.

So when I put all those things together, that's why the guide. What would have to be true to be at the top end? Continued performance on operating cost efficiency improvement; accelerate our growth versus the market, those would be the two things directly within our control that could enable us to be at the top. For us to be at the bottom end of that range would be, I'd say, if deflation lasted longer or persisted longer or were deeper than had been modeled, that would be a headwind that would put it more towards the bottom end of the range.

So we focus on what we can control at Sysco. We're going to drive operating efficiency, Kenny and I, as announced today, have issued $100 million cost out improvement, which is baked into the guidance that we just provided, and we've actually executed already against the major component of that plan, and we've got our sales teams focused on driving profitable sales growth.

With that, I'm going to toss to Kenny for any additional comments.

Kenny Cheung
Executive Vice President and Chief Financial Officer at Sysco

Thank you, Kevin. I'll talk about two things. One, the confidence level around the guidance and second, as Kevin alluded to, a couple of below-the-line items that I think needs a bit more color. The first is around the confidence in the guidance. Our confidence in the guidance is based on how we successfully managed Q4. So if you think about Q4, we ended the quarter deflationary in the U.S., and with that, we still managed to expand GP margins by 28 bps and operating margins by 56 bps. So again, we're doing it right now. The second piece I would say is that if the environment were to change, we have the agility to flex up and down given the fact that our we have a world class balance sheet, and we have a very agile cost structure, and we have productivity in place. The $100 million that has already been executed and baked in our guidance. So that is around the confidence of the guidance.

In terms of the below-the-line items, there are two areas I want to go a bit deeper on. One is tax rates. We expect our tax rate to step up in '23 to 24.5%. There's two pieces to the tax side. First, we are seeing earnings strengthening across our international markets, which is yielding a higher tax charge. This is a good thing. We are seeing our international arm growing fast. The second piece is here in the U.S., we are expecting a higher state tax expense due to various factors, including the mix of earnings across the state. This is our current view. We are continuing to evaluate tax planning strategies, and we'll report back as appropriate. The second piece is around interest expense. Overall, the rate has risen, and we also plan to raise capital to deploy against high-returning accretive initiatives, which includes gross investments, M&A, return excess cash to shareholders. This is driving the higher interest expense; again, $13 million increase year over year. The last bucket is other expenses. As I mentioned in my prepared remarks, we expect it to be roughly $30 million related to pension expense.

Ed Kelly
Analyst at Wells Fargo Securities

Thanks, guys.

Kevin P. Hourican
President and Chief Executive Officer at Sysco

Thanks, Ed.

Operator

Your next question will come from Joshua Long at Stephens, Inc. Please go ahead.

Joshua Long
Analyst at Stephens

Great. Thank you. Hopefully you might be able to dig into some of the underlying core customer segments. Obviously, we were able to see some of the case volume trends there that you provided in the release and that's helpful. And just curious if you could tie that together, Kevin, with some of your higher-level thoughts on where the consumer is at, how they're choosing to spend their dollars, and maybe how that corresponds with your customer makeup as we think about the fiscal '24 guide.

Kevin P. Hourican
President and Chief Executive Officer at Sysco

Yeah, Joshua. Thank you for the question. I'll start just at the more aggregate level. As you know, we serve every segment of the food away from home industry, which is what I meant in the answer to Ed's question about we have a treasure trove of data. We can see macro trends. So our national sales team had a banner year this past year, that's on top of a banner year in 2022. I want to be very clear that those growth constructs are profitable growth, so that's healthcare, education, and travel and hospitality business and industry. Those sectors have been continuing to see a tailwind of recovery, and we're winning market share profitably in those sectors.

National restaurants, we are winning large in that regard as well, mostly because those partners view Sysco as a backbone for them. We're in every state, including Alaska and Hawaii, not every food distributor is, and it's an easy button for them to be able to partner with someone like Sysco because we can distribute coast to coast. And many of these restaurants have international doors, and through our international freight group business, we can export their product overseas to usually a licensee partner that they use in those countries. So again, for these national restaurant chains, we are a very attractive option for them, and we've been winning big. Those contracts are multiyear contracts, and as I've mentioned, we've been signing those contract at above historical profit margin rates.

On the local side, we've been winning in specialty. As I mentioned, the BIX Produce acquisition intent today. That will be a tailwind for us in fiscal '24. We're winning with our Italian segment, and we're winning market share in aggregate as a company. So when I think about the end consumer, the rapid rate of inflation increased this past year, put a strain on the American consumer, specifically beef at one point was 35%-plus inflationary. You saw portion sizes being reduced at menus, you saw menu price increases, and I do think that had an impact on particularly the independent sector. And as I think about the future, the deflation that we're currently experiencing and to return to eventually what we would say would be normal rates of inflation, which are 2% to 3%, will be good for the end consumer. So when I talk about our teams internally, think about a graph chart where inflation was well above healthy. Now we're dealing with disinflation into deflation, and now that curve is going to come back to normal over the next period of time. And as we're thinking about fiscal '25, you would see more normal rates of inflation, and that should drive a tailwind in volume. And those two things together for 2025 would be favorable elements for Sysco.

So how are we thinking about this to help our customers? As Kenny said, well, we're going to work our tails off to have best possible purchasing economics so that we can share in value with our consumers, things like discounts on appetizers, so that in fact that can be added to the purchase because when that center of plate cost goes up, what we tend to see is dessert and app [Phonetic] purchases go down, and we want to help our end consumers and customers be successful by providing them with strong and compelling value through Sysco.

Joshua Long
Analyst at Stephens

It's helpful. Thank you. And then one follow up, if I could. When we think about the $100 million in cost-outs, that comes on the heels of some other great work over the last year or two coming out of COVID. Curious if you could dimensionalize that $100 million a little bit more and maybe not getting into the specifics of it, but just the visibility you have into maybe the timing or the realization of those, is that relatively balanced across the year, do we think about this in terms of just maybe second or third round iterations of initiatives that you've had more experience with in the past, and just as you have more time, you found new wins there or are these entirely new categories. Just any additional commentary you could provide there as we think about the ability to drive margins and pull costs out of the system would be very helpful.

Kenny Cheung
Executive Vice President and Chief Financial Officer at Sysco

Thanks, Josh. This is Kenny. I'll say a couple things, and I'll go a bit more detail. So for us it's all about driving operating leverage in our business. And what does that mean? That means our GP growth will be faster than expense growth, our EBITDA will be faster than sales, operating leverage in our business. As it relates to the $100 million, to your question directly, yes, it will be more balanced across the year. And why is that? Because we've started already, right? It started on day one. So all the actions have already been executed, meaning it's already baked into our guidance and all actions are underway. That's point number one.

Point number two, this is incremental to the continued productivity gains in supply chain operations and efficiency that Kevin described earlier. The last thing I would say is that we're not stopping, right? We will continue to flex in line with market conditions. Now I know you asked for a bit more detailed detail. Let me give you a tangible example. There are multiple parts to $100 million, but let me give you an example. We've been able to expand our Global Support Center, GSC, into other markets, most recently in Costa Rica, I was there about a month ago, where we have access to great talent and to further build our scale advantage. So as our business grows, we're able to leverage a platform that scales accretively and effectively for earnings.

Joshua Long
Analyst at Stephens

Thank you.

Kevin P. Hourican
President and Chief Executive Officer at Sysco

Thanks, Josh.

Operator

Your next question will come from John Heinbockel at Guggenheim Securities. Please go ahead.

John Heinbockel
Analyst at Guggenheim Securities

So Kevin, two topics, I'll hit them both upfront. So number one, maybe update on wallet share. You've talked about that in the past. Where's that opportunity today, and obviously, if you drive drop size, that's the most efficient thing you can do. So where is that? And then two, I think your overtime is down to zero, so volumes were a little lighter. What lever do you now pull on? Because I don't think you guys want to furlough folks. Where do you go next if overtime is at zero?

Kevin P. Hourican
President and Chief Executive Officer at Sysco

Yeah. Thanks, John. I'll do the second question first, and then your first question second. I want to be crystal clear on what we meant by overtime at zero. It's excess overtime was taken to zero. So the industry runs at a, let's call it, an average rate of overtime because some overtime is good. Our employees desire some amount of overtime. Your truck that leaves the warehouse and doesn't get back for 12 hours because that's the nature of the route. There's going to be some overtime, etc. So what we meant by that is that excess overtime. And during the worst of the supply chain disruption, we had meaningful, meaningful excess overtime. So we feel really good about that. Where can additional efficiencies come from? Retention improvement, John. So our turnover has dramatically improved, and it can still further improve to get back to historical levels of retention. And if you asked me six months ago, what's the single most important thing that we need to do more effectively? It was improve retention because that flows through in many different ways; lower hiring costs, lower training costs, higher productivity because a two-year veteran is much more productive than a two-day newbie. They're also safer. Fewer accidents occur because they're trained and know how to do their job.

So retention improvement would be the number one lever, but the second lever is just improving discipline to what we call Sysco's work standards. The Driver Academy, we have a Selector Academy, and our Engineered Labor Standards keep getting better and stronger. We improved processes through leveraging technology and that's the next wave of productivity improvement is to have better discipline to a standard work process. So we still have opportunity to improve. I'm really pleased, most particularly pleased with the improvement we've made in supply chain, and we have factored continued improvement into our 2024 guidance.

On the wallet share side of the business, what excites me the most on our opportunity, and we're not going to quote a share-of-wallet percentage today. But Sysco Your Way and Perks are doing what we want and need for them to do, which is further penetrating additional categories of merchandise with existing customers. The Sysco Your Way model is through increased delivery frequency, a dedicated sales rep, a dedicated delivery driver, and our consistent presence in that neighborhood six days a week with an afternoon recovery delivery, we are seeing what we would expect to see, which is customers in those neighborhoods are adding specialty to their basket, eliminating another distributor from the purchase consideration, and rolling up more with us. And Perks essentially does the same thing, but it's for our customer who happens not to be within a Sysco Your Way neighborhood. They could be 45 miles from the warehouse, but not within current Sysco Your Way neighborhood. And by providing them with the Perks service capabilities and dedicating marketing support, we're seeing incremental purchases. Last but not least is specialty. We're doing a really good job in our SSMG, which is our meat business and our produce business. And now we have our next specialty business with Italian. When we put those specialty businesses together, we're making a lot of progress on what we call total team selling, which is bringing that specialist into the account along with the generalist, the SC generalist, and we're moving the needle on what we call total team selling. So it's those three things together, John, that are helping us with share of wallet, which as you said is the most profitable case we can put on the truck.

John Heinbockel
Analyst at Guggenheim Securities

Okay. Thank you.

Kevin P. Hourican
President and Chief Executive Officer at Sysco

Thanks, John.

Operator

Your next question will come from Kelly Bania at BMO Capital Markets. Please go ahead.

Kelly Bania
Analyst at BMO Capital Markets

Good morning. Thanks for taking our question. I was wondering if we could talk a little bit more about the centralized pricing tool and the price optimization work that you've been doing, particularly as we do transition here, it sounds like into some deflation for certain categories. And just how investors should think about modeling your gross margin as we move forward, given not much disclosure at this point on how much of your business was on a percentage markup versus the dollar markup or how this centralized pricing tool can change that. And maybe included in that, can you just give us a little color on how the deflation that you're seeing right now is impacting the gross profit dollars?

Kevin P. Hourican
President and Chief Executive Officer at Sysco

Okay, Kelly. Thank you for the question. I'll start just with how we leverage the pricing tool and then I'll toss to Kenny in regards to your questions on GP dollars in percent and he'll handle that in whatever manner he deems appropriate. On the tool, this was what I tried to articulate during our prepared remarks. During a period of rapid inflation, it was extraordinarily helpful because we had discipline in regards to passing through what was an extraordinary increase in cost, especially in center of plate. We had proteins going up 35%, as I mentioned a few moments ago.

In the older manual world, it would have been unlikely that all 7,500 sales consultants would have passed that through. They would have put too much of a humanistic flair into it and said, you know what, I just know that they can't absorb this and I'm not going to pass it through, and we would have not actually seen the GP dollars per case growth that we experienced past year. So I'm going to call it the discipline to perform within guardrails on the way up. Well, the exact same thing happens on the way down, but it's a different consideration. What I said on the prepared remarks is we will be very purposeful about when we are able to secure improved COGS, how we pass that value on to our customers. Our intention is to pass that volume on to our customers, and we need to be thoughtful, disciplined, and pragmatic about how we do that. We have to be competitive with the market, and we have to understand the volatility of categories that went from 30% up to double-digits down in a short period of time.

So the tool provides structure and discipline and a performance within guardrails. I do want to be very clear about one point. It does not replace the importance of an SC and that relationship they have at that local restaurant and being what I call again right on price at the local level. And if we have a competitive pressure at the local level, our SCs have a process they can follow to ask for an exception. And we have a Redman [Phonetic] team that manages and adjudicates those decisions with financial discipline. So it's a combination of two things. It's a tool that provides guardrails that we operate within with discipline and predictability, and then we have the ability to respond at the local level through the sales force when in fact something unique is happening that the system can't see through data. And we're going to get better and better at that second point. We believe we can make that process faster, more agile, and more efficient to give our SCs the ability to respond in the moment, and that's something that we're working on in fiscal '24. Kenny, I toss to you for any comments from a financial perspective.

Kenny Cheung
Executive Vice President and Chief Financial Officer at Sysco

Yeah. Thank you, Kevin. Couple things I want to add, just to recap. In Q4, as I mentioned earlier, we did experience deflation rate in our U.S. market. And with that, we still expanded both GP dollars per case, GP margins, as well as operating margins, all three of them. Yes, to directly answer your question, the centralized pricing tool, it does help on the margin side. There is quite a few other levers that we have as an enterprise besides pricing. So let me walk you through some of those other things that our enterprise is working on. This includes: one is strengthening our international segments. This obviously helps on the inflation side. They're currently right now international is close to double-digit right now on inflation. The second piece is strategic sourcing. Third, Sysco brand penetration, which we made immense progress this quarter. And then last is a growing specialty and the likes. All these four things I just mentioned, in addition to what you brought up, Kelly, around pricing, drives a higher earnings margin profile for enterprise going forward.

Kelly Bania
Analyst at BMO Capital Markets

And I guess just in terms of this lower pricing environment, do you expect your restaurant or your customers to pass on these lower prices to consumers?

Kevin P. Hourican
President and Chief Executive Officer at Sysco

Kelly, on the national restaurant business, I would defer to the leaders of those companies to comment. I think they'll all make their own individual choices. I think at the local mom-and-pop independent level, it's an efficient market and center of plate purchase costs will come down for them. And will some of them choose to lower the price point on the menu? I think some will, and they'll see volume benefit from that. So it's fungible. These things are levers that get pulled, but I'll defer to our large customer base to answer that question, especially the national chains.

Operator

Your next question will come from John Ivankoe at JP Morgan. Please go ahead.

John Ivankoe
Analyst at J.P. Morgan Securities

Hi. Thank you very much. The question is on sales force compensation. I know there's been a couple of changes or enhancements in the past years. Maybe one being in terms of new account generation, market share per account, Sysco brand product sales. I think there were a couple of different things, including I think most recently through removal of some ceilings that certain sales force members were actually hitting in terms of total comps. So just wanted to get a sense of what we should be focused on in '24, especially in terms of like a stable comp plan, how it works for both Sysco and the sales force members, and if you can make a comment in terms of the number of sales people in the Sysco organization. Does it make sense to add more or you give more responsibility to the best? Thank you so much.

Kevin P. Hourican
President and Chief Executive Officer at Sysco

Yeah, John, thanks for the question. I appreciate it. We are making some improvements to our compensation model this year. What John's referring to is we're actually in pilot right now with a improved program. By the way, we like our current program our sales consultant retention is at all-time highs, and we believe the program we have motivates behavior and motivates our colleagues on the right things.

With that said, continuous improvement, you can always make something better and stronger. Feedback from our sales consultants has been what John just said, which is there is a cap that exists today. People that do that type of work don't like caps, more I sell the more I should earn and the more Sysco can make. And we agree with our sales consultants on that. So we are piloting a new structure, a new program, which if they profitably grow their business, they continue to earn. And by the way, that's good for Sysco, too. So it's a big company, it's a big machine, it's a big engine. As I said on my call today, it's more than 7,000 sales consultants. We need to make sure we get it right. We need to make sure it's clear, simple, and understandable, and therefore that's why we're doing a pilot. We're pleased with the results of the pilot. We're going to announce actually in August through our sales force the details of that compensation change. So with professional discretion, I'm going to choose not to comment on what it will be on this call because we haven't even told our colleagues yet. But in August, we're going to announce at worldwide sales meeting the change. It will be very well received because it's exactly what they've been asking for, and we're optimistic that will help us deliver the guidance that we covered today and to win more share profitably at the local level. So we're pleased with that change. We believe it will motivate even more the right behaviors, and it's good for the colleague and it's also good for Sysco, and it's good for the shareholder because it's profitable growth.

John Ivankoe
Analyst at J.P. Morgan Securities

Thank you.

Kevin P. Hourican
President and Chief Executive Officer at Sysco

Thank you, John.

Operator

Your next question will come from Alex Slagle at Jefferies. Please go ahead.

Alex Slagle
Analyst at Jefferies Financial Group

Thanks. Good morning. Wanted to dive in a little more on the local restaurant business and you touched on some of this with Kelly's question. But your views on the health of these independent restaurant operators, both for the Sysco customers and more broadly, as you think about the traffic environment being a little bit more difficult, inflation pressures coming down. But if you're seeing any evidence of stress out there or closures or erosion in receivables, bad debt that you see on the horizon for that group of customers?

Kevin P. Hourican
President and Chief Executive Officer at Sysco

Okay, Alex. Thanks for the question. I'll start just on sentiment of that very important customer segment of ours, and then I'll toss to Kenny for any comments on receivables and bad debt. From the very beginning of COVID, I've said the following. That local mom-and-pop entrepreneur is just that, they're an entrepreneur. This is their business. They are agile, they're scrappy, they're fighters, and they've dealt with a lot over the last four years, and disinflation to deflation in aggregate will be a good thing for them. Because think about that curve I was doing. I wish we were on Zoom and you could see me, right? Like the 18% inflation followed by deflation will come back to a normalized 2% to 3% inflation once we've gotten through this transition period, and that will be good for the local operator. It would be good because it will help with volume and frankly a little bit of margin is benefited from a little bit of inflation.

So the environmental conditions are going to transition to more favorable for that local operator. As it relates to how we, Sysco, can help them? That is the core of who we are. Drive to the best possible cost for that operator through strategic sourcing,, have a sales consultant who is an expert in their craft who can help them with menu optimization, productivity improvement, Sysco brand conversion which Kenny covered very well. We made tremendous strides in this past year on further penetrating Sysco brand. We expect for that to continue. And to introduce innovation and newness to our customers through cutting edge solutions. So we believe in the independent customer. We believe there's a real reason they exist, which is people like local, they like to eat fresh, and those local operators do a wonderful job of buying local product, and again, Sysco buys and sells more local produce than any other distributor despite our size.

And when I think about outlook for where we head from here, we have the ability to win more of those customers even if that overall customer base is going through this transition period. We serve roughly half of those independent doors, and we have a big opportunity to grow the number of doors we cover and increased share of wallet, going back to John's question, with those customers. So independent customers will be a source of growth for us this coming year, which we've built into our guidance. Kenny, I toss to you for any comment on AR, bad debt.

Kenny Cheung
Executive Vice President and Chief Financial Officer at Sysco

Sure. Thanks, Kevin. With respect to AR and bad debt, we are not seeing any drag on working capital. If anything, it's the opposite. In fiscal year '23, we actually saw improvement in AR and AP and inventory and DSO. All these few factors provided a tailwind for working capital, therefore driving our record free cash flow and operating cash flow conversion from EBITDA.

Alex Slagle
Analyst at Jefferies Financial Group

Great. Thank you.

Kevin P. Hourican
President and Chief Executive Officer at Sysco

Thanks, Alex.

Operator

[Operator Closing Remarks]

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