How did Sysco's profitability change in fiscal 2007?

Net earnings increased to $1,001,076 thousand from $855,325 thousand, a 17.0% increase, and diluted EPS before the cumulative effect of an accounting change rose 18.5% to $1.60. The filing attributes the gain to sales growth, a gross margin held at 19.3% of sales, and lower operating expenses as a percentage of sales.

What is the BSCC tax issue and how large could it be?

The Baugh Supply Chain Cooperative (BSCC) is taxed as a cooperative under subchapter T. Sysco has recorded $988 million of deferred tax liabilities tied to it. The IRS proposed adjustments in its audit of 2003 and 2004 returns, which Sysco is vigorously protesting. If the structure were successfully challenged, Sysco could have to accelerate those tax payments, and it estimates interest of $185 million to $205 million before tax benefit, which it has not accrued because it does not consider the loss probable.

Are there any material legal or product liability exposures disclosed?

Sysco was found contractually liable in a July 2007 arbitration over a product liability claim from a former customer. It recorded a $50.3 million accrual and a $48.3 million receivable, which it expects to recover from product suppliers, under hold-harmless agreements, and through its own insurance. Management believes the recorded loss is probable of recovery. Other legal proceedings are described as not expected to have a material adverse effect.

What are the company's capital allocation priorities?

Cash from operations is first used for working capital, facility and fleet investment, dividends, and acquisitions. Dividends paid totaled $445.4 million, or $0.72 per share, in fiscal 2007, and the quarterly dividend was raised to $0.19 per share. Share repurchases totaled $550.9 million in fiscal 2007, and the company targets a long-term debt to total capitalization ratio of 35% to 40%.

What risks does the filing highlight for the business model?

The filing cites a low-margin business exposed to product cost inflation and deflation, sensitivity to fuel costs and consumer spending on food away from home, reliance on third-party suppliers without long-term contracts, potential work stoppages as 14 union agreements covering about 2,300 employees expire in fiscal 2008, and possible increases in multi-employer pension contributions under the Pension Protection Act.

SYY 10-K FY2007 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed August 28, 2007. Cited figures are marked; the original filing is the authoritative source.

Sysco Corporation (SYY) reported fiscal 2007 (year ended June 30, 2007) sales of $35.04 billion^a, up from $32.63 billion in fiscal 2006, with net earnings of $1.00 billion, or $1.60 per diluted share, compared with $855.3 million, or $1.36 per diluted share, a year earlier.

Earnings before income taxes rose to $1.62 billion^b from $1.39 billion. Management attributed the improvement to sales growth, stable gross margins of 19.3% of sales, and lower operating expenses as a percentage of sales (14.4% versus 14.7%), partly offset by higher incentive bonus accruals and strategic initiative investments. Cash flow from operations increased to $1.40 billion from $1.12 billion, and capital expenditures were $603.2 million.

Long-term debt to total capitalization was 35.0%, within the company's stated 35% to 40% target range. The filing highlights several contingent exposures. The IRS has proposed adjustments related to the taxability of the Baugh Supply Chain Cooperative (BSCC), on which Sysco has recorded $988 million^c of deferred tax liabilities; management estimates possible additional interest of $185 million to $205 million, which it does not consider probable and has not accrued.

Sysco also recorded a $50.3 million^d product liability accrual tied to a July 2007 arbitration loss, offset by a $48.3 million receivable it expects to recover, and estimates its share of multi-employer pension withdrawal liability could reach $120 million. Management also expects FIN 48 adoption in fiscal 2008 to increase tax liabilities by $70 million to $100 million. The company operated 177 distribution facilities serving about 391,000 customers, and its Board approved an additional 20,000,000-share repurchase program in July 2007, with 19,950,000 shares available as of August 15, 2007.

02—Key points

Key Highlights

Sales rose 7.4% to $35.04 billion in fiscal 2007, with Broadline sales of $27.56 billion and SYGMA sales of $4.38 billion.
Diluted earnings per share before the cumulative effect of accounting change rose 18.5% to $1.60; net earnings rose 17.0% to $1.00 billion.
Operating expenses fell to 14.4% of sales from 14.7%, reflecting operating company efficiencies, lower pension and share-based compensation costs.
Operating cash flow was $1.40 billion, up from $1.12 billion, and capital expenditures were $603.2 million, with fiscal 2008 guidance of $625 million to $650 million.
Deferred tax liabilities of $988 million relate to the BSCC; the IRS has proposed adjustments that Sysco is protesting, and potential interest of $185 million to $205 million is not accrued.
Board approved a new 20,000,000-share repurchase program on July 18, 2007; 19,950,000 shares remained available as of August 15, 2007.
Long-term debt to total capitalization was 35.0%, and total debt was $1.78 billion, with 68% at fixed rates averaging 5.8%.

03—Questions

Frequently Asked Questions

How did Sysco's profitability change in fiscal 2007?
Net earnings increased to $1,001,076 thousand from $855,325 thousand, a 17.0% increase, and diluted EPS before the cumulative effect of an accounting change rose 18.5% to $1.60. The filing attributes the gain to sales growth, a gross margin held at 19.3% of sales, and lower operating expenses as a percentage of sales.
What is the BSCC tax issue and how large could it be?
The Baugh Supply Chain Cooperative (BSCC) is taxed as a cooperative under subchapter T. Sysco has recorded $988 million of deferred tax liabilities tied to it. The IRS proposed adjustments in its audit of 2003 and 2004 returns, which Sysco is vigorously protesting. If the structure were successfully challenged, Sysco could have to accelerate those tax payments, and it estimates interest of $185 million to $205 million before tax benefit, which it has not accrued because it does not consider the loss probable.
Are there any material legal or product liability exposures disclosed?
Sysco was found contractually liable in a July 2007 arbitration over a product liability claim from a former customer. It recorded a $50.3 million accrual and a $48.3 million receivable, which it expects to recover from product suppliers, under hold-harmless agreements, and through its own insurance. Management believes the recorded loss is probable of recovery. Other legal proceedings are described as not expected to have a material adverse effect.
What are the company's capital allocation priorities?
Cash from operations is first used for working capital, facility and fleet investment, dividends, and acquisitions. Dividends paid totaled $445.4 million, or $0.72 per share, in fiscal 2007, and the quarterly dividend was raised to $0.19 per share. Share repurchases totaled $550.9 million in fiscal 2007, and the company targets a long-term debt to total capitalization ratio of 35% to 40%.
What risks does the filing highlight for the business model?
The filing cites a low-margin business exposed to product cost inflation and deflation, sensitivity to fuel costs and consumer spending on food away from home, reliance on third-party suppliers without long-term contracts, potential work stoppages as 14 union agreements covering about 2,300 employees expire in fiscal 2008, and possible increases in multi-employer pension contributions under the Pension Protection Act.

04—Continue

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