Why did Sysco's net earnings decline in fiscal 2006 despite higher sales?

The filing attributes the 11.0% decline in net earnings primarily to $118.0 million of incremental share-based compensation expense from adopting SFAS 123(R), along with higher fuel costs, increased pension costs, and expenses from the National Supply Chain project. Lower management performance-based incentive bonuses partially offset these factors.

How much did the National Supply Chain project affect fiscal 2006 results?

Management estimated that expenses and direct benefits related to the National Supply Chain project had a net negative impact of approximately $40,000,000 on earnings before income taxes in fiscal 2006. The long-term benefits are expected to appear in sales, cost of sales, operating expenses and interest expense.

What is Sysco's debt position and what are its capital spending plans?

Total debt at July 1, 2006 was $1.76 billion, about 75% at fixed rates averaging 6.0%. The long-term debt to total capitalization ratio was 36.2%, against a management target of 35% to 40%. The company estimates fiscal 2007 capital expenditures of $575 million to $625 million, to be financed from internally generated funds, commercial paper and borrowings.

Are there tax risks that could affect Sysco's cash flows?

Yes. Sysco's Baugh Supply Chain Cooperative is treated as a cooperative for income tax purposes. If a tax authority disallowed that structure, Sysco could have to accelerate payment of deferred tax liabilities, which were $924.9 million at July 1, 2006. The 2003 and 2004 federal tax returns were also under IRS audit.

SYY 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed September 14, 2006. Cited figures are marked; the original filing is the authoritative source.

Sysco Corporation's fiscal 2006 Form 10-K (fiscal year ended July 1, 2006) reports sales of $32.63 billion^a, up 7.8% from $30.28 billion in fiscal 2005, but net earnings fell 11.0% to $855.3 million from $961.5 million.

Diluted earnings per share were $1.36^b versus $1.47. The filing attributes the decline primarily to $118.0 million of incremental share-based compensation expense from adopting SFAS 123(R), higher fuel costs, higher pension costs and continued investment in the National Supply Chain project, which had a net negative impact of approximately $40 million on earnings before income taxes. Operating expenses rose to 14.7% of sales from 13.9%, and interest expense increased 45.5% to $109.1 million on higher borrowing rates and levels.

The balance sheet shows total assets of $8.99 billion^c and total long-term debt of $1.73 billion, with a long-term debt to capitalization ratio of 36.2%, slightly above management's 35% to 40% target range midpoint discussion and up from 33.1% a year earlier. Operating cash flow was $1.12 billion, capital expenditures were $514.8 million, and the company repurchased 16.5 million shares for $544.1 million during the year.

Management guides fiscal 2007 capital expenditures of $575 million to $625 million^d and expects net pension costs to decrease by approximately $53.9 million. The company also disclosed a one-time after-tax, non-cash benefit of $9.3 million from changing the pension measurement date, an upcoming $39.7 million cumulative-effect charge from adopting FSP FTB 85-4-1 in fiscal 2007, and that its 2003 and 2004 federal tax returns are under IRS audit, with $924.9 million of deferred tax liabilities tied to Baugh Supply Chain Cooperative distributions.

02—Key points

Key Highlights

Sales rose 7.8% to $32.63 billion, with acquisitions contributing 1.4 percentage points of growth; estimated product cost inflation was 0.6% versus 3.5% in fiscal 2005.
Net earnings declined 11.0% to $855.3 million, and diluted EPS fell to $1.36 from $1.47.
Incremental share-based compensation of $118.0 million ($105.8 million after tax) from adopting SFAS 123(R) was the largest drag on operating expenses.
Gross margin improved to 19.3% of sales from 19.1%, while operating expenses rose to 14.7% of sales from 13.9%.
Interest expense increased 45.5% to $109.1 million due to higher borrowing rates and levels.
Operating cash flow was $1.12 billion; the company repurchased 16.5 million shares for $544.1 million and paid $397.5 million in dividends.
Long-term debt to capitalization was 36.2%, up from 33.1%; fiscal 2007 capex is guided to $575 million to $625 million.

03—Questions

Frequently Asked Questions

Why did Sysco's net earnings decline in fiscal 2006 despite higher sales?
The filing attributes the 11.0% decline in net earnings primarily to $118.0 million of incremental share-based compensation expense from adopting SFAS 123(R), along with higher fuel costs, increased pension costs, and expenses from the National Supply Chain project. Lower management performance-based incentive bonuses partially offset these factors.
How much did the National Supply Chain project affect fiscal 2006 results?
Management estimated that expenses and direct benefits related to the National Supply Chain project had a net negative impact of approximately $40,000,000 on earnings before income taxes in fiscal 2006. The long-term benefits are expected to appear in sales, cost of sales, operating expenses and interest expense.
What is Sysco's debt position and what are its capital spending plans?
Total debt at July 1, 2006 was $1.76 billion, about 75% at fixed rates averaging 6.0%. The long-term debt to total capitalization ratio was 36.2%, against a management target of 35% to 40%. The company estimates fiscal 2007 capital expenditures of $575 million to $625 million, to be financed from internally generated funds, commercial paper and borrowings.
Are there tax risks that could affect Sysco's cash flows?
Yes. Sysco's Baugh Supply Chain Cooperative is treated as a cooperative for income tax purposes. If a tax authority disallowed that structure, Sysco could have to accelerate payment of deferred tax liabilities, which were $924.9 million at July 1, 2006. The 2003 and 2004 federal tax returns were also under IRS audit.

04—Continue

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