Business Context and Reporting Period
Company: SYSCO CORPORATION
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: 13-week period ended March 31, 2007 (Third Quarter of Fiscal 2007) and the 39-week period ended March 31, 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) | 39-Week Period Ended Mar 31, 2007 | 39-Week Period Ended Apr 1, 2006 | 13-Week Period Ended Mar 31, 2007 | 13-Week Period Ended Apr 1, 2006 |
|---|---|---|---|---|
| Sales | $25,813,781 | $24,119,361 | $8,572,961 | $8,137,816 |
| Cost of Sales | $20,856,982 | $19,517,648 | $6,938,867 | $6,602,102 |
| Gross Margin % | 19.2% | 19.1% | 19.1% | 18.9% |
| Operating Expenses | $3,757,800 | $3,541,395 | $1,249,951 | $1,193,270 |
| Operating Expense % | 14.6% | 14.7% | 14.6% | 14.7% |
| Net Earnings | $697,685 | $601,216 | $220,999 | $188,539 |
| Diluted EPS | $1.11 | $0.95 | $0.35 | $0.30 |
| Cash from Operations | $952,165 | $639,211 | N/A | N/A |
| Total Assets | $9,427,321 | $8,992,025 | N/A | N/A |
| Total Debt (Current + Long-Term) | $1,737,973 | $1,733,392 | N/A | N/A |
| Cash & Equivalents | $180,943 | $201,897 | N/A | N/A |
Note: Debt figures include current maturities of long-term debt ($104,882) and long-term debt ($1,633,091) as of March 31, 2007.
Material Changes vs. Prior Period
- Sales Growth: Sales increased 7.0% for the 39-week period and 5.3% for the quarter compared to the prior year. This growth was partially offset by the adoption of EITF 04-13, which reduced reported sales by $253.7 million (39-week) and $76.7 million (quarter) due to netting certain inventory transactions.
- Earnings Growth: Net earnings increased 16.0% for the 39-week period and 17.2% for the quarter. Diluted EPS increased 16.8% and 16.7%, respectively.
- Expense Management: Operating expenses as a percentage of sales decreased slightly to 14.6% from 14.7%. This was driven by efficiencies and lower pension costs ($42.0 million decrease in 39-week period) and share-based compensation ($32.4 million decrease), partially offset by higher management incentive accruals and strategic initiative investments.
- Cash Flow: Net cash provided by operating activities increased significantly to $952.2 million from $639.2 million in the prior year, driven by improved earnings and working capital management, despite increases in receivables and inventory.
Guidance, Outlook, Risks, and Unusual Items
Management Commentary and Outlook
- Strategic Initiatives: Management is executing five strategic focus areas: Sourcing, Integrated Delivery, Demand, Organizational Capabilities, and New Growth. The National Supply Chain project is ongoing, with a third Regional Distribution Center (RDC) site purchased in Indiana.
- Capital Allocation: The company continues to repurchase shares (9.5 million shares repurchased in the 39-week period) and pay dividends ($0.55 per share declared for the 39-week period). Management anticipates incentive compensation in the fourth quarter will be $25-$30 million higher than the prior year due to improved results.
- Debt Management: The company repaid $100 million in senior notes due in April 2007 using cash flow and commercial paper. The long-term debt to capitalization ratio stood at 34.3%.
Risks and Contingencies
- Tax Audit (BSCC): The IRS has proposed adjustments regarding the taxability of the Baugh Supply Chain Cooperative (BSCC). SYSCO has recorded $825 million in deferred tax liabilities related to BSCC. If challenged successfully, the company could face additional interest liabilities estimated between $160 million and $180 million. Management plans to vigorously protest these adjustments.
- Multi-Employer Pension Plans: SYSCO participates in underfunded multi-employer plans. Potential withdrawal liability is estimated at up to $120 million. The Pension Protection Act may require increased contributions starting in 2008.
- Fuel Costs: Increased fuel costs negatively impact operating results and consumer spending. The company has hedged approximately $67 million of diesel fuel requirements through the end of 2007.
Unusual Items
- Accounting Change (EITF 04-13): Adoption of this standard required netting certain inventory purchases and sales with the same counterparty, reducing reported sales and cost of sales but having no impact on net earnings.
- Accounting Change (Pension): A change in the pension measurement date in fiscal 2006 resulted in a one-time cumulative effect of $9.3 million in net earnings for the prior year period, which is not present in the current period.
Investor Verification Checklist
- Tax Liability Exposure: Verify the status of the IRS audit regarding the BSCC cooperative structure and the potential $160-$180 million interest liability.
- Pension Obligations: Monitor the funding status of multi-employer pension plans and potential withdrawal liabilities under the Pension Protection Act.
- Margin Sustainability: Assess the ability to maintain gross margins amidst rising product costs and fuel prices, and the effectiveness of passing these costs to customers.
- Debt Refinancing: Confirm the successful repayment of the $100 million senior notes due in April 2007 and the stability of commercial paper programs.
- Share Repurchase Program: Track the remaining authorized shares for repurchase (9.8 million as of April 28, 2007) and future buyback activity.