Business Context and Reporting Period
Company: SYSCO CORP
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2006 (First Quarter of Fiscal 2007)
Business Overview: SYSCO distributes food and related products to restaurants, healthcare, educational facilities, and lodging establishments across the United States and Canada. The company operates through Broadline, SYGMA (chain restaurant distribution), and Other segments.
Key Financial Metrics
| Metric (in thousands) | Q1 FY2007 (Ended Sep 30, 2006) |
Q1 FY2006 (Ended Oct 1, 2005) |
|---|---|---|
| Sales | $8,672,072 | $8,010,484 |
| Cost of Sales | $7,002,856 | $6,480,793 |
| Gross Margin % | 19.2% | 19.1% |
| Operating Expenses | $1,278,277 | $1,176,656 |
| Operating Expenses % of Sales | 14.7% | 14.7% |
| Earnings Before Tax (Excl. Accounting Change) | $374,211 | $333,904 |
| Net Earnings | $189,018 | $208,495 |
| Diluted EPS (Excl. Accounting Change) | $0.37 | $0.31 |
| Diluted EPS (Reported) | $0.30 | $0.33 |
| Cash from Operating Activities | $173,183 | $200,340 |
| Total Debt (Current + Long-Term) | $1,851,791 | $1,662,128 |
| Cash and Cash Equivalents | $180,721 | $177,918 |
Material Changes vs. Prior Period
- Sales Growth: Sales increased 8.3% year-over-year. This growth was negatively impacted by 1.1% due to the adoption of EITF 04-13, which requires certain inventory transactions with the same counterparty to be recorded on a net basis (reducing reported sales by $91.5 million).
- Profitability: Earnings before the cumulative effect of accounting changes increased 14.8%. However, reported Net Earnings decreased 9.3% primarily due to a one-time cumulative effect of accounting change charge of $39.7 million related to the adoption of FSP FTB 85-4-1 (accounting for life settlement contracts).
- Operating Expenses: Expenses increased 8.6% as a percentage of sales, remaining flat at 14.7%. Increases in fuel costs (~$9.0 million) were offset by decreases in share-based compensation ($11.7 million) and net pension costs ($14.0 million).
- Segment Performance:
- Broadline: Sales up 6.9%; Earnings before tax up 9.2%.
- SYGMA: Sales up 6.3%; Earnings before tax improved from a loss of $2.8 million to a profit of $1.4 million.
- Other: Sales up 26.8%.
Guidance, Outlook, and Risks
- Strategic Initiatives: Management is executing a "National Supply Chain Project" to build regional distribution centers (RDCs) to lower inventory and operating costs. The first RDC is operational; a second in Florida is under construction (expected operational in FY2008).
- Capital Allocation: The company continues a share repurchase program. In Q1, 2.04 million shares were repurchased for $65.3 million. Dividends were increased to $0.17 per share.
- Debt Management: The company extended its revolving credit facility termination date to November 2011. It intends to fund the repayment of $100 million in senior notes due April 2007 through commercial paper or senior notes.
- Risks and Contingencies:
- Fuel Costs: Increased fuel costs negatively impact margins and consumer spending. The company entered into forward diesel contracts totaling ~$103 million in October 2006 to fix prices through calendar year 2007.
- Accounting Standards: Adoption of SFAS 158 (pension accounting) is expected to decrease shareholders' equity by approximately $195 million upon implementation.
- Legal/Tax: 2003 and 2004 federal tax returns are under audit. Management believes ongoing legal proceedings will not have a material adverse effect.
Investor Verification Checklist
- Accounting Adjustments: Verify the impact of the $39.7 million charge for life settlement contracts (FSP FTB 85-4-1) and the $91.5 million sales reduction from EITF 04-13 on year-over-year comparisons.
- Fuel Hedging: Confirm the effectiveness of the $103 million forward diesel contracts entered in October 2006 in mitigating Q2 and Q3 fuel cost volatility.
- Debt Maturity: Monitor the refinancing of the $100 million senior notes due April 2007 and the company's reliance on commercial paper ($513 million outstanding).
- Pension Liability: Assess the potential impact of SFAS 158 adoption on the balance sheet, specifically the projected $195 million reduction in equity.
- Working Capital: Review the increase in accounts receivable ($151 million) and inventory ($104 million) which reduced operating cash flow, ensuring these are driven by sales growth rather than collection issues.