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Hillshire Brands Co 10-Q 2005
For The Quarterly Period Ended April 2, 2005
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended April 2, 2005

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 1-3344

 


 

Sara Lee Corporation

(Exact name of registrant as specified in its charter)

 


 

Maryland   36-2089049

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

Three First National Plaza, Suite 4600, Chicago, Illinois 60602-4260

(Address of principal executive offices)

(Zip Code)

 

(312) 726-2600

(Registrant’s telephone number, including area code)

 


 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act)    Yes  x    No  ¨

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

On April 2, 2005, the Registrant had 787,295,157 outstanding shares of common stock $.01 par value, which is the Registrant’s only class of common stock.

 



Table of Contents

SARA LEE CORPORATION AND SUBSIDIARIES

 

INDEX

 

PART I -

ITEM 1 – FINANCIAL STATEMENTS

Preface

   3

Condensed Consolidated Balance Sheets - At April 2, 2005 and July 3, 2004

   4

Consolidated Statements of Income - For the thirteen and thirty-nine weeks ended April 2, 2005 and March 27, 2004

   5

Consolidated Statements of Common Stockholders’ Equity - For the period June 28, 2003 to April 2, 2005

   6

Consolidated Statements of Cash Flows - For the thirty-nine weeks ended April 2, 2005 and March 27, 2004

   7

Notes to Consolidated Financial Statements

   8

ITEM 2 –

  MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION    20

ITEM 4 –

  CONTROLS AND PROCEDURES    55

PART II –

        

ITEM 2(c)

         REPURCHASES OF EQUITY SECURITES BY THE ISSUER    55

ITEM 5

         OTHER INFORMATION    56

ITEM 6

         EXHIBITS    57

SIGNATURE

   58

 

Exhibit 10.1   Amendment No. 2 dated as of March 31, 2005 to the Rights Agreement dated as of March 26, 1998 between Sara Lee Corporation and EquiServe Trust Company, N.A., successor in interest to First Chicago Trust Company of New York, as rights agent
Exhibit 10.2   Retirement Agreement dated May 4, 2005 between Sara Lee Corporation and C. Steven McMillan
Exhibit 12.1   Computation of Ratio of Earnings to Fixed Charges
Exhibit 31.1   Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2   Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1   Certification of Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2   Certification of Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002

 

 

2


Table of Contents

PART I

 

SARA LEE CORPORATION AND SUBSIDIARIES

 

Preface

 

The preparation of the Consolidated Financial Statements requires management to make use of estimates and assumptions that affect the reported amount of assets and liabilities, revenue and expenses and certain financial statement disclosures. Significant estimates in these Consolidated Financial Statements include allowances for doubtful accounts receivable, net realizable value of inventories, the cost of sales incentives, useful lives of property and identifiable intangible assets, the evaluation of impairments of property, identifiable intangible assets and goodwill, income tax and valuation reserves, the valuation of assets and liabilities acquired in business combinations, and assumptions used in the determination of the funded status and annual expense of pension and postretirement employee benefit plans. Actual results could differ from these estimates.

 

The Consolidated Financial Statements for the thirteen and thirty-nine weeks ended April 2, 2005 and March 27, 2004 and the balance sheet as of April 2, 2005 included herein have not been audited by an independent registered public accounting firm, but in the opinion of Sara Lee Corporation (“the corporation”), all adjustments (which include only normal recurring adjustments) necessary to make a fair statement of the financial position at April 2, 2005 and the results of operations and the cash flows for the periods presented herein have been made. The Condensed Consolidated Balance Sheet as of July 3, 2004 and the Consolidated Statement of Common Stockholders’ Equity for the period June 28, 2003 to July 3, 2004 have been derived from the corporation’s audited financial statements included in our annual report on Form 10-K for the fiscal year ended July 3, 2004. The results of operations for the thirteen and thirty-nine weeks ended April 2, 2005 are not necessarily indicative of the operating results to be expected for the full fiscal year.

 

The consolidated financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Although the corporation believes the disclosures made are adequate to make the information presented not misleading, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the corporation’s Form 10-K for the year ended July 3, 2004 and other financial information filed with the Securities and Exchange Commission.

 

3


Table of Contents

SARA LEE CORPORATION AND SUBSIDIARIES

Condensed Consolidated Balance Sheets at April 2, 2005 and July 3, 2004

(In millions)

 

     (Unaudited)
April 2, 2005


   July 3, 2004

ASSETS

             

Cash and equivalents

   $ 521    $ 638

Trade accounts receivable, less allowances

     1,976      1,882

Inventories:

             

Finished goods

     1,958      1,921

Work in process

     385      397

Materials and supplies

     470      461
    

  

       2,813      2,779

Other current assets

     353      400

Net assets held for sale

     2      —  
    

  

Total current assets

     5,665      5,699

Other non-current assets

     167      153

Deferred tax asset

     322      275

Property, net

     3,217      3,271

Trademarks and other identifiable intangibles, net

     1,950      2,024

Goodwill

     3,472      3,414
    

  

     $ 14,793    $ 14,836
    

  

LIABILITIES AND STOCKHOLDERS’ EQUITY

             

Notes payable

   $ 139    $ 54

Accounts payable

     1,269      1,325

Accrued liabilities

     2,867      2,914

Current maturities of long-term debt

     226      1,070
    

  

Total current liabilities

     4,501      5,363

Long-term debt

     4,361      4,171

Pension obligation

     871      871

Other liabilities

     1,481      1,361

Minority interests in subsidiaries

     78      75

Common stockholders’ equity

     3,501      2,995
    

  

     $ 14,793    $ 14,836
    

  

 

See accompanying Notes to Consolidated Financial Statements.

 

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SARA LEE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income

For the Thirteen and Thirty-Nine Weeks Ended April 2, 2005 and March 27, 2004

(In millions, except per share data)

Unaudited

 

     Thirteen Weeks Ended

    Thirty-nine Weeks Ended

 
     April 2,
2005


    March 27,
2004


    April 2,
2005


    March 27,
2004


 

Net sales

   $ 4,785     $ 4,745     $ 14,845     $ 14,428  
    


 


 


 


Cost of sales

     3,018       2,888       9,374       8,826  

Selling, general and administrative expenses

     1,434       1,471       4,363       4,459  

(Income from) charges for exit activities and business dispositions

     (19 )     6       (35 )     11  

Contingent sale gain

     —         (119 )     (117 )     (119 )

Interest expense

     76       63       214       195  

Interest income

     (29 )     (21 )     (81 )     (61 )
    


 


 


 


       4,480       4,288       13,718       13,311  
    


 


 


 


Income before income taxes

     305       457       1,127       1,117  

Income taxes

     116       81       260       199  
    


 


 


 


Net income

   $ 189     $ 376     $ 867     $ 918  
    


 


 


 


Net income per common share

                                

Basic

   $ 0.24     $ 0.47     $ 1.10     $ 1.17  
    


 


 


 


Diluted

   $ 0.24     $ 0.47     $ 1.09     $ 1.15  
    


 


 


 


Average shares outstanding

                                

Basic

     791       791       790       787  
    


 


 


 


Diluted

     797       797       796       798  
    


 


 


 


Cash dividends per common share

   $ 0.1975     $ 0.1875     $ 0.5825     $ 0.5625  
    


 


 


 


 

See accompanying Notes to Consolidated Financial Statements.

 

5


Table of Contents

SARA LEE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Common Stockholders’ Equity

For the Period June 28, 2003 to April 2, 2005

(In millions, except per share data)

 

     TOTAL

    COMMON
STOCK


   CAPITAL
SURPLUS


    RETAINED
EARNINGS


    UNEARNED
STOCK


   

ACCUMULATED

OTHER
COMPREHENSIVE
INCOME

(LOSS)


    COMPREHENSIVE
INCOME


 

Balances at June 28, 2003

   $ 2,091     $ 8    $ 40     $ 3,787     $ (10 )   $ (1,734 )        

Net income

     918       —        —         918       —         —       $ 918  

Translation adjustments, net of tax

     156       —        —         —         —         156       156  

Net unrealized gain /(loss) on qualifying cash flow hedges, net of tax

     5       —        —         —         —         5       5  
                                                   


Comprehensive income

                                                  $ 1,079  
                                                   


Cash dividends -

                                                       

Common ($0.5625 per share)

     (445 )     —        —         (445 )     —         —            

Stock issuances (cancelations) -

                                                       

Stock option and benefit plans

     79       —        79       —         —         —            

Restricted stock

     15       —        15       —         —         —            

Reacquired shares - repurchases

     (350 )     —        (321 )     (29 )     —         —            

Conversion of ESOP preferred to common

     28       —        210       —         (182 )     —            

ESOP contributions and other

     35       —        23       —         12       —            
    


 

  


 


 


 


       

Balances at March 27, 2004

     2,532       8      46       4,231       (180 )     (1,573 )        

Net income

     354       —        —         354       —         —       $ 354  

Translation adjustments, net of tax

     (21 )     —        —         —         —         (21 )     (21 )

Minimum pension liability, net of tax

     202       —        —         —         —         202       202  

Net unrealized gain / (loss) on qualifying cash flow hedges, net of tax

     (2 )     —        —         —         —         (2 )     (2 )
                                                   


Comprehensive income

                                                  $ 533  
                                                   


Cash dividends -

                                                       

Common ($0.1875 per share)

     (149 )     —        —         (149 )     —         —            

Stock issuances (cancelations) -

                                                       

Stock option and benefit plans

     69       —        69       —         —         —            

Restricted stock

     7       —        7       —         —         —            

ESOP contributions and other

     3       —        (8 )     1       10       —            
    


 

  


 


 


 


       

Balances at July 3, 2004

     2,995       8      114       4,437       (170 )     (1,394 )        

Net income

     867       —        —         867       —         —       $ 867  

Translation adjustments, net of tax

     277       —        —         —         —         277       277  

Net unrealized gain / (loss) on qualifying cash flow hedges, net of tax

     (37 )     —        —         —         —         (37 )     (37 )
                                                   


Comprehensive income

                                                  $ 1,107  
                                                   


Cash dividends-common ($0.5825 per share)

     (459 )     —        —         (459 )     —         —            

Stock issuances (cancelations) -

                                                       

Stock option and benefit plans

     150       —        150       —         —         —            

Restricted stock

     35       —        35       —         —         —            

Reacquired shares - repurchases

     (345 )     —        (207 )     (138 )     —         —            

ESOP contributions and other

     18       —        12       —         6       —            
    


 

  


 


 


 


       

Balances at April 2, 2005

   $ 3,501     $ 8    $ 104     $ 4,707     $ (164 )   $ (1,154 )        
    


 

  


 


 


 


       

 

Interim period balances are unaudited.

See accompanying Notes to Consolidated Financial Statements.

 

6


Table of Contents

SARA LEE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the Thirty-Nine Weeks Ended April 2, 2005 and March 27, 2004

(In millions)

Unaudited

     Thirty-nine Weeks Ended

 
     April 2,
2005


    March 27,
2004


 

OPERATING ACTIVITIES -

                

Net income

   $ 867     $ 918  

Cash received from contingent sale proceeds

     (117 )     (119 )

Adjustments to reconcile net income to net cash provided by operating activities

                

Depreciation

     414       393  

Amortization of intangibles

     140       121  

Net gain on business dispositions

     (57 )     (8 )

(Decrease) increase in deferred income taxes

     (36 )     54  

Other

     38       121  

Changes in current assets and liabilities, net of businesses acquired and sold

     (199 )     (105 )
    


 


Net cash from operating activities

     1,050       1,375  
    


 


INVESTMENT ACTIVITIES -

                

Purchases of property and equipment

     (347 )     (331 )

Dispositions of businesses and investments

     72       119  

Contingent sale proceeds

     117       119  

Sales of assets

     67       40  

Other

     —         1  
    


 


Net cash used in investment activities

     (91 )     (52 )
    


 


FINANCING ACTIVITIES -

                

Issuances of common stock

     150       79  

Purchases of common stock

     (345 )     (350 )

Borrowings of long-term debt

     338       6  

Repayments of long-term debt

     (983 )     (968 )

Short-term borrowings (repayments), net

     80       80  

Payments of dividends

     (458 )     (445 )
    


 


Net cash used in financing activities

     (1,218 )     (1,598 )
    


 


Effect of changes in foreign exchange rates on cash

     142       36  
    


 


Decrease in cash and equivalents

     (117 )     (239 )

Cash and equivalents at beginning of year

     638       942  
    


 


Cash and equivalents at end of quarter

   $ 521     $ 703  
    


 


COMPONENTS OF CHANGES IN CURRENT ASSETS AND LIABILITIES:

                

(Increase) in trade accounts receivable

   $ (24 )   $ (113 )

Decrease (increase) in inventories

     27       (3 )

Decrease in other current assets

     1       1  

(Decrease) in accounts payable

     (121 )     (95 )

(Decrease) increase in accrued liabilities

     (82 )     105  
    


 


Changes in current assets and liabilities, net of businesses acquired and sold

   $ (199 )   $ (105 )
    


 


 

See accompanying Notes to Consolidated Financial Statements.

 

 

7


Table of Contents

SARA LEE CORPORATION AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

 

1. Net Income Per Share

 

Net income per share – basic is computed by dividing income available to common stockholders by the weighted average number of shares of common stock outstanding for the period. Net income per share – diluted reflects the potential dilution that could occur if options or other contracts to issue common stock were exercised or converted into common stock. For the thirteen and thirty-nine week periods ended April 2, 2005, options to purchase 19.2 million and 19.5 million shares of the corporation’s common stock had exercise prices which were greater than the average market price of those shares during the respective reporting periods. For the thirteen and thirty-nine week periods ended March 27, 2004, options to purchase 37.7 million and 50.5 million shares of the corporation’s common stock had exercise prices which were greater than the average market price of those shares during the respective reporting periods. As a result, these shares are excluded from the earnings per share calculation, as they are anti-dilutive.

 

The following is a reconciliation of net income to net income per share – basic and diluted for the thirteen and thirty-nine weeks ended April 2, 2005 and March 27, 2004:

 

Computation of Net Income per Common Share

(In millions, except per share data)

 

     Thirteen Weeks Ended

   Thirty-nine Weeks Ended

     April 2,
2005


   March 27,
2004


   April 2,
2005


   March 27,
2004


Net income

   $ 189    $ 376    $ 867    $ 918
    

  

  

  

Average shares outstanding – basic

     791      791      790      787

Dilutive effect of stock option and award plans

     6      6      6      4

Dilutive effect of ESOP plan

     —        —        —        7
    

  

  

  

Average shares outstanding – diluted

     797      797      796      798
    

  

  

  

Net Income Per Common Share – Basic

   $ 0.24    $ 0.47    $ 1.10    $ 1.17
    

  

  

  

Net Income Per Common Share - Diluted

   $ 0.24    $ 0.47    $ 1.09    $ 1.15
    

  

  

  

 

2. Stock-Based Compensation

 

Employee stock options are accounted for under the provisions of Accounting Principles Board (APB) No. 25, “Accounting for Stock Issued to Employees”. APB No. 25 requires the use of the intrinsic value method, which measures compensation cost as the excess, if any, of the quoted market price of the stock at grant over the amount an employee must pay to acquire the stock. The corporation provides below the pro forma disclosures of net earnings and earnings per share as if the fair-value based method of accounting had been applied as required by Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation”. The pro forma impact of utilizing the fair value method to account for stock-based employee compensation, on an annual basis, is presented in the corporation’s annual report to stockholders.

 

8


Table of Contents
     Thirteen Weeks Ended

    Thirty-nine Weeks Ended

 

(In millions)


   April 2,
2005


    March 27,
2004


    April 2,
2005


    March 27,
2004


 

Reported net income

   $ 189     $ 376     $ 867     $ 918  

Plus – Stock-based employee compensation included in reported net income, net of related tax effects

     9       4       25       13  

Less - Total stock-based employee compensation expense determined under the fair-value method for all awards, net of related tax effects

     (14 )     (11 )     (39 )     (34 )
    


 


 


 


Pro forma net income

   $ 184     $ 369     $ 853     $ 897  
    


 


 


 


Earnings per share:

                                

Basic – as reported

   $ 0.24     $ 0.47     $ 1.10     $ 1.17  
    


 


 


 


Basic – pro forma

   $ 0.23     $ 0.47     $ 1.08     $ 1.14  
    


 


 


 


Diluted – as reported

   $ 0.24     $ 0.47     $ 1.09     $ 1.15  
    


 


 


 


Diluted – pro forma

   $ 0.23     $ 0.46     $ 1.07     $ 1.13  
    


 


 


 


 

3. Exit Activities and Business Dispositions

 

The reported results for the third quarter and first nine months of fiscal years 2005 and 2004 reflect amounts recognized for exit and disposal actions, including the impact of certain activities that were completed for amounts that differ from prior estimates. The (income) expense recognized in the various captions of the Consolidated Statements of Income are set out in the following table:

 

     Thirteen Weeks Ended

    Thirty-nine Weeks Ended

 

(In millions)


   April 2,
2005


    March
27, 2004


    April 2,
2005


    March 27,
2004


 

Cost of sales:

                                

Curtailment gain from Bakery workforce reduction

   $ (2 )   $ —       $ (28 )   $ —    

Accelerated depreciation related to facility closures in:

                                

Sara Lee Bakery segment

     —         3       10       5  

Household Products segment

     3       —         10       —    

Selling, general and administrative expenses

     1       —         9       1  

(Income from) charges for:

                                

Exit activities

     11       6       7       20  

Business dispositions

     (30 )     —         (42 )     (9 )
    


 


 


 


(Increase) decrease in pretax income

     (17 )     9       (34 )     17  

Income taxes

     7       (3 )     14       (5 )
    


 


 


 


(Increase) decrease in net income

   $ (10 )   $ 6     $ (20 )   $ 12  
    


 


 


 


(Increase) decrease in diluted EPS

   $ (0.01 )   $ 0.01     $ (0.03 )   $ 0.02  
    


 


 


 


 

9


Table of Contents

These actions (increased) decreased the reported results of the business segments, corporate unallocated expense and amortization expense as follows:

 

     Thirteen Weeks Ended

   Thirty-nine Weeks Ended

 

(In millions)


   April 2,
2005


    March 27,
2004


   April 2,
2005


    March 27,
2004


 

Sara Lee Meats

   $ (30 )   $ 2    $ (35 )   $ (3 )

Sara Lee Bakery

     (3 )     7      (19 )     9  

Beverage

     —         —        —         —    

Household Products

     1       —        (7 )     2  

Branded Apparel

     —         —        (8 )     4  
    


 

  


 


(Increase) decrease in business segment income

     (32 )     9      (69 )     12  

Increase in unallocated corporate expense

     14       —        26       4  

Increase in amortization expense

     1       —        9       1  
    


 

  


 


(Increase) decrease in pretax income

   $ (17 )   $ 9    $ (34 )   $ 17  
    


 

  


 


 

The following provides a more detailed description of the exit activities and business disposition actions recognized in the third quarter and first nine months of fiscal years 2005 and 2004.

 

Fiscal 2005

 

Amounts Recognized in Cost of Sales

 

    As a result of the termination of certain Bakery employees during fiscal 2005, the postretirement medical benefit plan in which these employees participated recognized curtailment gains in the third quarter and first nine months of fiscal 2005 of $2 million and $28 million, respectively.

 

    Decisions to dispose of six manufacturing facilities and certain manufacturing equipment related to the Sara Lee Bakery and Household Products operations resulted in increased levels of depreciation on those assets. The increased depreciation in the third quarter and first nine months of fiscal 2005 was $3 million and $20 million, respectively. As of the end of the third quarter, three of the facilities had been sold and the remaining three facilities had been closed. The carrying value of the closed facilities is $2 million and represents their estimated net realizable value.

 

Amounts Recognized in Selling, General and Administrative Expenses

 

    During the first quarter of fiscal 2005, management made a decision to exit certain regional bakery trademarks and customer relationships. A substantial portion of these actions was completed in the first quarter, with the remainder of the intangibles exited by the close of the third quarter. The accelerated amortization recognized as a result of these actions in the third quarter and first nine months of fiscal 2005 was $1 million and $9 million, respectively. There was no remaining book value for these intangible assets as of the end of the third quarter of fiscal 2005.

 

 

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Amounts Recognized in Exit Activities and Business Dispositions

 

    Costs for exit activities in the third quarter of fiscal 2005 were primarily related to severance charges for certain officers of the corporation, recognized in accordance with existing benefit plans and local employment laws. Exit costs for the first nine months of fiscal 2005 consist of these severance charges, offset in part by $4 million of income related to the completion of certain exit activities for amounts that were more favorable than previously anticipated. As of the end of the third quarter of fiscal 2005, the remaining severance obligation accrued on the Consolidated Balance Sheet was $10 million.

 

    During the third quarter of fiscal 2005, the corporation recognized $30 million of income related to various business dispositions. Of this amount, $31 million relates to the gain recognized on the disposition of certain trademarks and other assets of the corporation’s canned meats business. In addition, a $3 million gain was recognized on the disposition of trademarks and other assets of various Household Products operations. Offsetting these gains is $4 million of professional fees incurred in connection with several planned future business dispositions. For the first nine months of fiscal 2005, the corporation recognized $42 million of income related to various business dispositions. Included in this amount are $58 million of gains related to completed transactions in the Sara Lee Meats, Household Products and Branded Apparel business segments. Offsetting these gains is $16 million of professional fees incurred in connection with several planned future business dispositions.

 

Fiscal 2004

 

Amounts Recognized in Cost of Sales

 

    Decisions to dispose of certain manufacturing equipment related to Sara Lee Bakery resulted in increased levels of depreciation on those assets. When this equipment ceased being used and was available for sale, its carrying value was the estimated realizable value. The increased depreciation in the third quarter and first nine months of fiscal 2004 was $3 million and $5 million, respectively.

 

Amounts Recognized in Selling, General and Administrative Expenses

 

    Decisions to abandon certain trademarks obtained with the Earthgrains acquisition resulted in increased levels of amortization on those assets. The majority of these actions were completed during the first quarter of fiscal 2004, with the trademarks completely abandoned by the end of the third quarter. The increased amortization recognized during the first nine months of fiscal 2004 was $1 million.

 

Amounts Recognized in Exit Activities and Business Dispositions

 

    During the first nine months of fiscal 2004, management made a decision to terminate a number of employees and provide them with severance benefits in accordance with existing benefit plans or local employment laws. The costs recognized as a result of these actions in the third quarter and first nine months of fiscal 2004 was $6 million and $20 million, respectively.

 

    Decisions to dispose of certain manufacturing equipment were made during the first quarter of fiscal 2004. This equipment was classified as held for sale and its planned disposal resulted in a charge of $6 million during the first nine months of fiscal 2004.

 

    During the second quarter of fiscal 2004, the corporation completed certain exit activities for amounts that were less than previously anticipated. The completion of these actions resulted in the recognition of income in the first nine months of fiscal 2004 of $6 million.

 

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    During the first quarter of fiscal 2004, the corporation recognized a net $9 million gain on the disposal of certain businesses. The most significant of these was a $13 million gain on the disposal of a minority ownership position in a Sara Lee Meats business. Offsetting this gain was a net $4 million charge, primarily related to the disposal of a component of a European Branded Apparel business. This net gain is recognized in the results of the first nine months of fiscal 2004.

 

Status of Restructuring Reserves

 

Over the past several years, the corporation has initiated and executed a number of restructuring programs. The charges and credits recognized in the third quarter and first nine months of fiscal 2005 and 2004 related to these programs are as follows:

 

     Thirteen Weeks Ended

   Thirty-nine Weeks Ended

 

(In millions)


   April 2,
2005


    Mar. 27,
2004


   April 2,
2005


    Mar. 27,
2004


 

Exit and disposal programs:

                               

Fiscal 2005 restructuring actions

   $ 13     $ —      $ 12     $ —    

Fiscal 2004 restructuring actions

     —         9      —         32  

Fiscal 2003 Bakery and Beverage Restructuring

     —         —        —         (1 )

Business Reshaping

     —         —        —         (5 )

Other restructuring actions

     —         —        (4 )     —    
    


 

  


 


Total exit costs (income)

     13       9      8       26  

Business dispositions

     (30 )     —        (42 )     (9 )
    


 

  


 


Total costs (income) from exit activities and business dispositions

   $ (17 )   $ 9    $ (34 )   $ 17  
    


 

  


 


 

Fiscal 2004 Restructuring Actions

 

During fiscal 2004, the corporation approved a series of actions to exit certain defined business activities and lower its cost structure. The net impact of these actions was to reduce income before income taxes by $82 million, which consisted of decreases in the results of the following segments: Sara Lee Meats – $11 million; Sara Lee Bakery – $26 million; Beverage – $6 million; Household Products – $1 million; Branded Apparel – $34 million; and the corporate headquarters – $4 million. The components of the net charge are as follows:

 

    $70 million of the net charge was for the cost associated with terminating 6,222 employees and providing them with severance benefits in accordance with existing benefit plans or local employment laws. The specific location of these employees is summarized in a table contained in this note. As of the end of the third quarter of fiscal 2005, 5,964 of the employees have been terminated and the severance obligation remaining in accrued liabilities on the Condensed Consolidated Balance Sheet was $18 million.

 

    $11 million of the net charge was related to the cost to dispose of certain manufacturing equipment. As of the end of the third quarter of fiscal 2005, the corporation is in the process of completing the disposition of these assets, and any remaining assets have a current net book value of zero. The estimated realizable value of these assets was based upon management’s estimates.

 

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    $1 million of the net charge was related to the decision to abandon certain trademarks obtained with the Earthgrains acquisition. By the end of fiscal 2004, these trademarks had been abandoned and their net book value was zero.

 

The following table summarizes the employee terminations by location and business segment:

 

Number of employees


   Sara Lee
Meats


   Sara Lee
Bakery


   Beverage

   Household
Products


   Branded
Apparel


   Corporate

   Total

United States

   44    1,073    37    —      624    48    1,826

Canada

   —      —      —      12    —      —      12

Puerto Rico, Mexico and Latin America

   —      —      155    —      3,919    —      4,074

Europe

   58    31    19    1    201    —      310
    
  
  
  
  
  
  
     102    1,104    211    13    4,744    48    6,222
    
  
  
  
  
  
  

As of April 2, 2005

                                  

Actions Completed

   99    1,101    211    13    4,492    48    5,964

Actions Remaining

   3    3    —      —      252    —      258
    
  
  
  
  
  
  
     102    1,104    211    13    4,744    48    6,222
    
  
  
  
  
  
  

 

Fiscal 2003 Bakery and Beverage Restructuring Actions

 

During fiscal 2003, the corporation’s management approved actions to reduce the cost structure of the Bakery and Beverage businesses. All actions approved under this plan were completed by the end of fiscal 2004. As of the end of the third quarter of fiscal 2005, the severance and lease obligations related to these actions remaining in accrued liabilities on the Condensed Consolidated Balance Sheet was less than $1 million.

 

Business Reshaping

 

The following table summarizes the charges taken for approved exit activities under the Business Reshaping program that commenced in fiscal 2001, and the related status of this program as of April 2, 2005. All actions included in this program have been completed. The accrued amounts remaining as of the end of the third quarter of fiscal 2005 represent those cash expenditures necessary to satisfy remaining obligations.

 

(In millions)


   Cumulative
Exit Costs
Recognized


   Actual Loss
on Asset
Disposal


    Cash
Payments


    Accrued Exit
Costs as of
April 2, 2005


Employee termination and other benefits

   $ 196    $ —       $ (187 )   $ 9

Other exit costs – includes noncancelable lease and other contractual obligations

     54      —         (50 )     4

Losses on disposals of property and equipment and other related costs

     54      (54 )     —         —  

Losses on disposal of inventories

     19      (19 )     —         —  

Moving and other related costs

     10      —         (10 )     —  
    

  


 


 

Total exit costs

   $ 333    $ (73 )   $ (247 )   $ 13
    

  


 


 

 

The completion of the remainder of the Business Reshaping program is expected to require the use of $13 million in cash, which will be funded from operations.

 

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4. Accumulated Other Comprehensive Income

 

The components of accumulated other comprehensive income are as follows:

 

(In millions)


   Cumulative
Translation
Adjustment


   

Net Unrealized
Gain (Loss)

On Qualifying
Cash Flow Hedges


    Minimum
Pension
Liability
Adjustment


    Accumulated
Other
Comprehensive
Income


 

Balance at June 28, 2003

   $ (928 )   $ (17 )   $ (789 )   $ (1,734 )

Other comprehensive income (loss) activity

     156       5       —         161  
    


 


 


 


Balance at March 27, 2004

     (772 )     (12 )     (789 )     (1,573 )
    


 


 


 


Other comprehensive income (loss) activity

     (21 )     (2 )     202       179  
    


 


 


 


Balance at July 3, 2004

     (793 )     (14 )     (587 )     (1,394 )
    


 


 


 


Other comprehensive income (loss) activity

     277       (37 )     —         240  
    


 


 


 


Balance at April 2, 2005

   $ (516 )   $ (51 )   $ (587 )   $ (1,154 )
    


 


 


 


 

5. Derivative Reporting

 

The corporation is exposed to changes in interest rates, foreign exchange rates and commodity prices. To manage the risk from these changes, the corporation uses derivative instruments and enters into various hedging transactions. A complete description of the corporation’s hedging programs and instruments is included in the corporation’s annual report on Form 10-K which is filed with the Securities and Exchange Commission. As of July 3, 2004, the net accumulated derivative loss recorded in Accumulated Other Comprehensive Income was $14 million. During the nine months ended April 2, 2005, $85 million of accumulated net derivative losses were deferred into Accumulated Other Comprehensive Income and $48 million of accumulated net derivative losses were released from Accumulated Other Comprehensive Income into earnings since the related hedged item was realized during the period, resulting in a balance in Accumulated Other Comprehensive Income at April 2, 2005 of an accumulated loss of $51 million. At April 2, 2005, the maximum maturity date of any cash flow hedge was approximately 1¼ years, excluding derivative hedges related to the payment of variable interest on existing financial instruments. The corporation expects to reclassify into earnings during the next twelve months net losses from Accumulated Other Comprehensive Income of approximately $46 million, at the time the underlying hedged transaction is realized.

 

During the first nine months of fiscal 2005, the corporation recognized an expense of $11 million for hedge ineffectiveness related to cash flow hedges which is recorded in the “Selling, general and administrative expenses” line in the Consolidated Statement of Income. Other disclosures related to gains and losses excluded from the assessment of hedge effectiveness and amounts reclassified into earnings as a result of the discontinuation of hedge accounting because it was probable that the original forecasted transaction would not occur, have been omitted due to the insignificance of these amounts. During the nine months ended April 2, 2005, a net loss of $81 million arising from effective hedges of net investments has been reflected in the cumulative translation adjustments account within consolidated stockholders’ equity.

 

6. Segment Information

 

The following is a summary of sales and operating segment income by business segment for the thirteen and thirty-nine weeks ended April 2, 2005 and March 27, 2004.

 

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Table of Contents
     Thirteen Weeks Ended

 
     Net Sales

    Income Before Income Taxes

 

(In millions)


   April 2,
2005


    March 27,
2004


    April 2,
2005


    March 27, 2004

 

Sara Lee Meats

   $ 1,029     $ 976     $ 104     $ 97  

Sara Lee Bakery

     790       810       31       26  

Beverage

     844       801       123       140  

Household Products

     599       599       102       109  

Branded Apparel

     1,524       1,562       90       142  
    


 


 


 


Total business segments

     4,786       4,748       450       514  

Intersegment sales

     (1 )     (3 )     —         —    
    


 


 


 


Total net sales and operating segment income

     4,785       4,745       450       514  

Amortization of intangibles

     —         —         (30 )     (28 )

General corporate expenses

     —         —         (68 )     (106 )

Contingent sale proceeds

     —         —         —         119  
    


 


 


 


Total net sales and operating income

     4,785       4,745       352       499  

Net interest expense

     —         —         (47 )     (42 )
    


 


 


 


Net sales and income before income taxes

   $ 4,785     $ 4,745     $ 305     $ 457  
    


 


 


 


     Thirty-nine Weeks Ended

 
     Net Sales

    Income Before Income Taxes

 

(In millions)


   April 2,
2005


    March 27,
2004


   

April 2,

2005


   

March 27,

2004


 

Sara Lee Meats

   $ 3,188     $ 3,054     $ 251     $ 313  

Sara Lee Bakery

     2,481       2,517       160       121  

Beverage

     2,486       2,314       344       361  

Household Products

     1,782       1,743       280       279  

Branded Apparel

     4,912       4,805       379       401  
    


 


 


 


Total business segments

     14,849       14,433       1,414       1,475  

Intersegment sales

     (4 )     (5 )     —         —    
    


 


 


 


Total net sales and operating segment income

     14,845       14,428       1,414       1,475  

Amortization of intangibles

     —         —         (92 )     (78 )

General corporate expenses

     —         —         (179 )     (265 )

Contingent sale proceeds

     —         —         117       119  
    


 


 


 


Total net sales and operating income

     14,845       14,428       1,260       1,251  

Net interest expense

     —         —         (133 )     (134 )
    


 


 


 


Net sales and income before income taxes

   $ 14,845     $ 14,428     $ 1,127     $ 1,117  
    


 


 


 


 

7. Sale of Canned and Shelf-Stable Meat and Poultry Assets

 

In January 2005, the corporation disposed of the trademarks, working capital and certain fixed assets related to a line of canned and shelf-stable meat and poultry products and received cash proceeds of $45.5 million. The impact of this transaction on pretax income is reflected in the line in the Consolidated Income Statement titled, “ (Income from) charges for exit activities and business dispositions”. This transaction increased pretax income, net income and diluted earnings per share in the third quarter of fiscal 2005 by $31 million, $20 million and $0.025 per share, respectively. The annual sales of this product line are approximately $80 million.

 

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8. Pension and Other Postretirement Benefit Plans

 

The components of the net periodic pension cost and the postretirement medical cost for third quarter and first nine months of fiscal 2005 and 2004 are as follows:

 

    

Thirteen Weeks Ended

April 2, 2005


   

Thirteen Weeks Ended

March 27, 2004


 

(In millions)


   Pension

   

Postretirement
Medical and

Life Insurance


    Pension

   

Postretirement
Medical and

Life Insurance


 

Service cost

   $ 37     $ 3     $ 35     $ 4  

Interest cost

     71       6       61       7  

Expected return on plan assets

     (63 )     —         (52 )     —    

Amortization of

                                

Transition (asset) obligation

     —         —         1       —    

Prior service cost

     1       (4 )     1       (2 )

Net actuarial loss

     21       1       32       1  
    


 


 


 


Net periodic benefit cost

   $ 67     $ 6     $ 78     $ 10  
    


 


 


 


Curtailment gain

   $ —       $ 2     $ —       $ —    
    


 


 


 


     Thirty-nine Weeks Ended
April 2, 2005


    Thirty-nine Weeks Ended
March 27, 2004


 
     Pension

    Postretirement
Medical and
Life Insurance


    Pension

    Postretirement
Medical and
Life Insurance


 

Service cost

   $ 110     $ 11     $ 102     $ 12  

Interest cost

     209       18       178       21  

Expected return on plan assets

     (186 )     —         (152 )     —    

Amortization of

                                

Transition (asset) obligation

     —         (1 )     3       (1 )

Prior service cost

     3       (12 )     4       (7 )

Net actuarial loss

     62       2       93       4  
    


 


 


 


Net periodic benefit cost

   $ 198     $ 18     $ 228     $ 29  
    


 


 


 


Curtailment gain

   $ —       $ 28     $ —       $ —    
    


 


 


 


 

The primary factors causing the decline in the net periodic benefit cost of the corporation’s defined benefit pension plans were better than expected asset returns in fiscal 2004, offset in part by a lower long-term rate of return on plan assets, and the strengthening of foreign currencies versus the dollar. The net periodic benefit cost of the corporation’s postretirement medical and life insurance plans declined primarily as a result of benefit plan changes which eliminated coverage for certain active and retired participants over the age of 65 and increased the premiums required to obtain retiree medical coverage between the ages of 55 and 65. These changes primarily impacted employees in the Sara Lee Bakery segment and brought the benefits provided to these individuals in line with those provided to other employees of the corporation. In addition, the federal subsidy associated with the Medicare Prescription Drug Improvement and Modernization Act reduced the cost of providing postretirement medical coverage to all employees.

 

The curtailment gains recognized in fiscal 2005 were as a result of the termination of certain Bakery employees. The postretirement medical benefit plan in which these individuals participated had negative prior service cost from a previous plan amendment that was recognized upon termination of the employees.

 

The corporation expects to make cash contributions to its defined benefit pension plans of $331 million in fiscal 2005 as compared to $112 million in fiscal 2004. In the first nine months of fiscal 2005, the corporation contributed $299 million to the defined benefit plans that it sponsors.

 

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9. Taxes

 

During the third quarter of fiscal 2005, the corporation adopted a plan to repatriate approximately $928 million of accumulated income from controlled foreign corporations to the U.S. under the American Jobs Creation Act of 2004 (“the Act”). The Act creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain dividends from controlled foreign corporations. The deduction is subject to a number of limitations. The corporation recognized in the third quarter of fiscal 2005 a tax charge of $51 million, which increased the tax rate during the third quarter of fiscal 2005 and first nine months of fiscal 2005 by 16.8% and 4.5%, respectively, and reduced diluted EPS for the third quarter of fiscal 2005 and the first nine months of fiscal 2005 by $0.06.

 

During the second quarter of fiscal 2005, the government of the Netherlands enacted legislation that provides for a graduated reduction in the statutory tax rate of profits from 34.5% in calendar 2004 to 30% in calendar 2007. The impact of this change reduced the corporation’s deferred tax liability by $24 million and this benefit was recognized in the tax provision in the second quarter of fiscal year 2005. This tax rate reduction reduced the effective tax rate for the corporation during the first nine months of fiscal 2005 by 2.1%, which increased diluted earnings per share by $0.03.

 

10. Receipt of Contingent Sale Proceeds

 

The corporation sold its European cut tobacco business in fiscal 1999. Under the terms of that agreement, the corporation will receive an annual cash payment of 95 million euros if tobacco continues to be a legal product in the Netherlands, Germany and Belgium through 2010. The legal status of tobacco in each country accounts for a portion of the total contingency with the Netherlands accounting for 67%, Germany 22% and Belgium 11%. If tobacco ceases to be a legal product within any of these countries, the corporation forfeits the receipt of all future amounts related to that country. The contingencies associated with the first payment passed in the third quarter of fiscal 2004 and the corporation received the annual payment which was equivalent to $119 million based upon the exchange rates on the date of receipt. The contingencies associated with the second annual contingent payment passed in the first quarter of fiscal 2005 and the corporation received the payment which was equivalent to $117 million based upon exchange rates on the date of receipt. Each of these amounts is recognized in the corporation’s earnings when received and each of the payments increased diluted earnings per share by $0.15 when they were recognized.

 

11. Goodwill

 

Substantially all of the change in the goodwill balance between July 3, 2004 and April 2, 2005 is due to the impact of changes in foreign currency exchange rates.

 

12. Impairment Review

 

The corporation tests goodwill and intangible assets not subject to amortization for impairment during the second quarter of each fiscal year. As a result of the annual review, the corporation concluded that certain intangible assets with a value of $51 million had lives that were no longer indefinite and economic useful lives of 10 years were assigned to these intangible assets. At the end of fiscal 2004, $1,595 million of the $2,024 million of total intangible assets were subject to amortization. After reclassifying these intangible assets to the finite lived category, the annual amortization of intangibles is expected to be approximately $180 million.

 

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13. Issued But Not Yet Effective Accounting Standards

 

Share-Based Payments

 

Currently, the corporation recognizes employee services received in exchange for equity instruments in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB No. 25). APB No. 25 requires the use of the intrinsic value method, which measures compensation cost as the excess, if any, of the quoted market price of the stock over the amount the employee must pay for the stock. Compensation for substantially all of the corporation’s equity-based awards is measured on the date the shares are granted. Under APB No. 25, no compensation expense has been recognized for stock options, replacement stock options and shares purchased under the Employee Stock Purchase Plan. Compensation expense is, however, recognized for the cost of restricted share unit awards granted to employees under the provisions of APB No. 25.

 

In October 1995, the FASB issued Statement No. 123, “Accounting for Stock-Based Compensation”. Statement 123 allowed, but did not require, the recognition of compensation cost for employee stock options based on the estimated fair value of those options. Statement No. 123 did, however, require companies to include certain disclosures about stock based compensation arrangements regardless of the method used to account for them. The pro forma amounts required to be disclosed by a company that continued to apply the accounting provisions of APB No. 25 reflect the difference between compensation cost, if any, included in net income and the related cost measured by the fair value based method defined in Statement 123. For the fiscal year ended July 3, 2004, these disclosures indicated that diluted earnings per share would have been $0.03 lower under the provisions of Statement 123. In fiscal 2005, these disclosures are contained in note 2 of this document and indicate that diluted EPS would have been $0.01 lower in the third quarter and $0.02 lower for the nine months ended April 2, 2005.

 

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123R (Statement 123R), “Share-Based Payments”, the provisions of which become effective for the corporation on July 3, 2005. This Statement eliminates the alternative to use APB No. 25’s intrinsic value method of accounting that was provided in Statement 123 as originally issued. Statement 123R requires companies to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards. While the fair-value-based method prescribed by Statement 123R is similar to the fair-value-based method disclosed under the provisions of Statement 123 in most respects, there are some differences. The corporation is currently evaluating the provisions of Statement 123R and has not determined the impact of adopting this statement at this time.

 

Inventory Costs

 

In November 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 151, “Inventory Costs” (Statement 151). The provisions of this statement become effective for the corporation in fiscal 2006. Statement 151 amends the existing guidance on the recognition of inventory costs to clarify the accounting for abnormal amounts of idle expense, freight, handling costs, and wasted material (spoilage). Existing rules indicate that under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal as to require treatment as current period charges. Statement 151 requires that those items be recognized as current period charges regardless of whether they meet the criterion of “so abnormal”. In addition, Statement 151 requires that allocation of fixed

 

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production overheads to the costs of conversion be based on the normal capacity of the production facilities. The corporation’s existing policies with regard to inventory accounting are consistent with the provisions of Statement 151 and the adoption of this Statement is not expected to have a material impact on the valuation of inventory or operating results.

 

14. Reclassifications

 

Certain prior year amounts have been reclassified to conform to the current year’s presentation.

 

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Table of Contents

Item II

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Introduction

 

The following is management’s discussion and analysis of the results of operations for the third quarter and first nine months of fiscal 2005 compared with the third quarter and first nine months of fiscal 2004 and a discussion of the changes in financial condition and liquidity during the first nine months of fiscal 2005. The following is an outline of the analyses included herein:

 

    Overview

 

    Third Quarter of Fiscal 2005

 

    First Nine Months of Fiscal 2005

 

    Cash Flow

 

    Transformation Plan

 

    Consolidated Results – Third Quarter of Fiscal 2005 Compared with Third Quarter of Fiscal 2004

 

    Operating Results by Business Segment – Third Quarter of Fiscal 2005 Compared with Third Quarter of Fiscal 2004

 

    Consolidated Results – First Nine Months of Fiscal 2005 Compared with First Nine Months of Fiscal 2004

 

    Operating Results by Business Segment – First Nine Months of Fiscal 2005 Compared with First Nine Months of Fiscal 2004

 

    Financial Condition

 

    Liquidity

 

    Significant Accounting Policies and Critical Estimates

 

    Forward-looking Information

 

Overview

 

Third Quarter of Fiscal 2005

 

Net sales in the third quarter of fiscal 2005 increased 0.8%, primarily attributable to the strengthening of foreign currencies versus the U.S. dollar and price increases in certain categories, substantially offset by declines in net sales from lower unit volume. Changes in foreign currency increased net sales by 2.0% during the quarter with the European euro and the British pound primarily responsible for the increase. Unit volumes declined during the third quarter in the Sara Lee Bakery, Beverage, Household Products and Branded Apparel segments, which partially offset the net sales increase. There were no business acquisitions completed after the start of the third quarter of fiscal 2004; however, the corporation began consolidating the sales of a joint venture in the fourth quarter of fiscal 2004 as a result of the requirements of FASB Interpretation No. 46, “Consolidation of Variable Interest Entities”. The incremental sales recognized in the third quarter of fiscal 2005 from this action were $26 million and were essentially offset by the elimination of sales associated with the disposition of certain operations.

 

Operating income for the corporation decreased by $147 million, or 29.3%, in the third quarter of fiscal 2005. Operating income was comprised of the following items:

 

    The gross margin declined by $90 million as a 2.1% decline in the gross margin percentage more than offset the increase in the gross margin resulting from increased sales. The gross margin percentage declined in each business segment except the Sara Lee Bakery, primarily due to increased raw material costs in all segments.

 

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    Selling, general and administrative (SG&A) expenses in the third quarter of fiscal 2005 were $37 million lower than in the comparable period of the prior year. This was primarily due to the benefits of ongoing restructuring efforts, lower employee benefit plan costs and lower corporate office expenses. Partially offsetting these reductions was a $2 million increase in intangible amortization costs. SG&A costs as a percentage of sales declined from 31.0% in the third quarter of fiscal 2004 to 30.0% in the third quarter of fiscal 2005. SG&A costs as a percentage of sales declined or were unchanged in each of the business segments except the Branded Apparel segment.

 

    Income from exit activities and business dispositions in the third quarter of fiscal 2005 was $19 million as compared to a $6 million charge in the comparable period of fiscal 2004. The income in fiscal 2005 resulted from $30 million of income from certain business disposition actions that occurred during the quarter, which was partially offset by a charge of $11 million that primarily consisted of certain approved severance actions.

 

    The corporation received and recognized contingent sale proceeds of $119 million in the third quarter of fiscal 2004 from the sale of the corporation’s cut tobacco business which represents the payment for fiscal 2004. The corporation subsequently received and recognized the payment for fiscal 2005 in the first quarter of fiscal 2005.

 

Income before income taxes in the third quarter of fiscal 2005 decreased by $152 million as a result of the $147 million decrease in operating income, plus a $5 million increase in net interest expense which was due to higher average borrowing rates during the quarter.

 

Income tax expense increased by $35 million in the third quarter of fiscal 2005, primarily from the following factors:

 

    During the third quarter of fiscal 2005, the corporation adopted a plan to repatriate approximately $928 million of accumulated income from controlled foreign corporations to the U.S. under the American Jobs Creation Act of 2004 (“the Act”). The Act creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain dividends from controlled foreign corporations. The deduction is subject to a number of limitations. Upon adopting the plan to repatriate these funds, the corporation recognized in the third quarter of fiscal 2005 a tax charge of $51 million.

 

    Lower operating income, including the country-by-country mix in earnings during the third quarter of fiscal 2005, decreased income tax expense by $16 million.

 

Net income in the third quarter of fiscal 2005 decreased by $187 million or 49.7% as a result of the above, while diluted earnings per share decreased $0.23 or 48.9%.

 

First Nine Months of Fiscal 2005

 

For the first nine months of fiscal 2005, net sales increased $417 million, or 2.9%, to $14,845 million as the impact of changes in foreign currency and price increases in certain categories were partially offset by lower unit volumes. Changes in foreign currency, particularly the European euro and British pound, increased net sales by $419 million, or 2.9%. The corporation recognized $76 million of sales in the first nine months of fiscal 2005 from the consolidation of a joint venture in which the corporation has an ownership position, and the first nine months of fiscal 2004 include net sales of $81 million from businesses that have been disposed of after the start of fiscal 2004. The difference between these amounts reduced net sales by $5 million.

 

Operating income for the corporation increased by $9 million, or 0.7%, in the first nine months of fiscal 2005 and was comprised of the following:

 

    The gross margin declined by $131 million as a 1.9% decline in the gross margin percentage more than offset the increase in the gross margin resulting from increased sales. The gross margin percentage declined in each business segment except the Sara Lee Bakery, primarily due to increased raw material costs in all segments.

 

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    Selling, general and administrative (SG&A) expenses in the first nine months of fiscal 2005 were $96 million lower than in the comparable period of the prior year. This was primarily due to lower benefit plan costs, lower corporate office expenses, the benefits of ongoing restructuring efforts, favorable comparisons to the prior year for certain administrative costs and the disposition of certain businesses in fiscal 2004. Partially offsetting these reductions was a $14 million increase in intangible amortization costs. SG&A costs as a percentage of sales declined from 30.9% in the first nine months of fiscal 2004 to 29.4% in the first nine months of fiscal 2005. SG&A costs as a percentage of sales declined or were unchanged in each of the corporation’s business segments.

 

    Income from exit activities and business dispositions in the third quarter of fiscal 2005 was $35 million as compared to an $11 million charge in the comparable period of fiscal 2004. The income in fiscal 2005 resulted from $42 million of income from certain business disposition actions that occurred during the nine month period, which was partially offset by a net charge of $7 million which primarily consisted of certain approved severance actions, net of certain exit activities that were completed for amounts more favorable than originally estimated.

 

    The corporation received and recognized contingent sale proceeds of $117 million in the first nine months of fiscal 2005 and $119 million in the first nine months of fiscal 2004 from the sale of the corporation’s cut tobacco business. Under the terms of the sale agreement, the corporation received this cash payment because tobacco continues to be a legal product in the countries in which the business operated. The corporation recognized the income associated with this contingency when the cash was received.

 

Income before income taxes in the first nine months of fiscal 2005 increased by $10 million primarily due to the increase in operating income, plus a $1 million reduction in net interest expense.

 

Income tax expense increased by $61 million in the first nine months of fiscal 2005, primarily from three factors:

 

    During the third quarter of fiscal 2005, the corporation adopted a plan to repatriate approximately $928 million of accumulated income from controlled foreign corporations to the U.S. under the American Jobs Creation Act of 2004 (“the Act”). The Act creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain dividends from controlled foreign corporations. The deduction is subject to a number of limitations. Upon the approval to repatriate these funds, the corporation recognized in the first nine months of fiscal 2005 a tax charge of $51 million.

 

    During the second quarter of fiscal 2005, the government of the Netherlands passed legislation that will reduce the statutory tax rate on profits that went into effect on January 1, 2005. The impact of this change reduced the corporation’s deferred tax liability by $24 million and this benefit was recognized in the tax provision in the first nine months of fiscal 2005.

 

    The change in operating income plus the country-by-country mix in earnings during the first nine months of fiscal 2005 as compared to the prior year comparable period, increased income tax expense by $34 million.

 

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Net income in the first nine months of fiscal 2005 decreased by $51 million, or 5.5%, primarily as a result of changes in income tax expense. Diluted earnings per share in the first nine months of fiscal 2005 decreased 5.2%.

 

Cash Flow

 

The corporation’s cash flow from operations decreased from $1,375 million in the first nine months of fiscal 2004 to $1,050 million in the first nine months of fiscal 2005, a decline of 23.6%. This decline was primarily related to lower profitability, higher cash utilization for working capital purposes and funding of employee benefit obligations.

 

The corporation used cash on hand and borrowings of short- and long-term indebtedness to repay $983 million of long-term debt, repurchase $345 million of common stock and pay $458 million of dividends. The corporation issued $338 million of long-term debt and $80 million of net short-term debt to help fund the debt repayment. Further information and details regarding the performance of the corporation and its business segments follows.

 

Transformation Plan

 

In February 2005, the corporation announced a transformation plan designed to improve the corporation’s performance and better position Sara Lee for long-term growth. The plan includes the following significant components:

 

    Effective July 3, 2005 the corporation will re-organize its business operations around distinct consumers, customers and geographic markets in order to build functional excellence, increase strategic focus, simplify the organization and eliminate layers. The company’s new structure will be organized around the following groups:

 

    Sara Lee Food & Beverage - will include bakery, packaged meats and the Senseo retail coffee business in North America;

 

    Sara Lee Foodservice - will include the bakery, coffee and meats foodservice business in North America; and

 

    Sara Lee International – will include the bakery and beverage businesses outside of North America, the global household products business, as well as the European packaged meats business.

 

In conjunction with this reorganization the corporation announced plans to locate the management of its North American businesses along with a majority of its corporate staff at a single site in Downers Grove, Illinois. In the fourth quarter of 2005, the corporation expects to begin recognizing material costs associated with the simplification of the organization structure and the relocation of the operating management of the North American businesses. At the present time the corporation is evaluating the segments to be reported under the new organization structure.

 

    The corporation also announced plans to dispose of certain businesses. These actions include:

 

    The spin off of the Sara Lee Branded Apparel Americas/Asia business

 

    The sale of the European Apparel business, European Meats business and the Direct Selling business

 

    The sale of certain assets of the U.S. retail coffee operations, excluding Senseo

 

At the end of the quarter the only business that was being actively marketed was the European Apparel operation and no decision has been made as to the structure of these dispositions.

 

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    The corporation expects to reduce the number of brands utilized in its North American Bakery business as well as increase the research and development and marketing spending behind a smaller group of large brands. The net book value of the trademarks currently used in the North American Bakery operation is $327 million and a substantial portion of this asset will be written off as customers are transitioned to the larger brands. The exact amount and timing of the non-cash charge associated with these actions has not yet been determined.

 

    The corporation also announced its intent to improve its information technology systems and processes. The primary elements of this program are the continued consolidation of information processing and technology resources and the costs to implement a standard information technology platform across the North American businesses. There are a number of variables that impact the cost of installing and transitioning to new information systems. At this point, the company has not estimated the timing and amount of the capital versus expense element of this project.

 

 

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Consolidated Results – Third Quarter of Fiscal 2005 Compared with Third Quarter of Fiscal 2004

 

Operating results by business segment in the third quarter of fiscal 2005 compared with the third quarter of fiscal 2004 are as follows:

 

     Thirteen Weeks Ended

 
     Net Sales

    Income Before Income Taxes

 

(In millions)


   April 2,
2005


    March 27,
2004


    April 2,
2005


    March 27,
2004


 

Sara Lee Meats

   $ 1,029     $ 976     $ 104     $ 97  

Sara Lee Bakery

     790       810       31       26  

Beverage

     844       801       123       140  

Household Products

     599       599       102       109  

Branded Apparel

     1,524       1,562       90       142  
    


 


 


 


Total business segments

     4,786       4,748       450       514  

Intersegment sales

     (1 )     (3 )     —         —    
    


 


 


 


Total net sales and operating segment income

     4,785       4,745       450       514  

Amortization of intangibles

     —         —         (30 )     (28 )

General corporate expenses

     —         —         (68 )     (106 )

Contingent sale proceeds

     —         —         —         119  
    


 


 


 


Total net sales and operating income

     4,785       4,745       352       499  

Net interest expense

     —         —         (47 )     (42 )
    


 


 


 


Net sales and income before income taxes

   $ 4,785     $ 4,745     $ 305     $ 457  
    


 


 


 


 

The following table summarizes net sales and operating income performance for the third quarter of fiscal 2005 and 2004 and certain significant items that affected the comparability of these amounts.

 

     Thirteen Weeks Ended

 

Corporate Performance - (In millions)


   April 2,
2005


    March 27,
2004


    Change

    Percent
Change


 

Net sales

   $ 4,785     $ 4,745     $ 40     0.8 %
    


 


 


 

Increase / (Decrease) in net sales from

                              

Changes in foreign currency exchange rates

   $ —       $ (95 )   $ 95        

Acquisitions / dispositions

     26       27       (1 )      
    


 


 


     

Total

   $ 26     $ (68 )   $ 94        
    


 


 


     

Operating income

   $ 352     $ 499     $ (147 )   (29.3 )%
    


 


 


 

Increase / (Decrease) in operating income from

                              

Receipt of contingent sale proceeds

   $ —       $ 119     $ (119 )      

Changes in foreign currency exchange rates

     —         (17 )     17        

Exit activities and business dispositions

     19       (6 )     25        

Curtailment gain

     2       —         2        

Accelerated depreciation on facilities sold

     (3 )     (3 )     —          

Accelerated amortization of intangibles

     (1 )     —         (1 )      

Acquisitions/dispositions

     —         5       (5 )      
    


 


 


     

Total

   $ 17     $ 98     $ (81 )      
    


 


 


     

 

Net Sales

 

Consolidated net sales increased $40 million, or 0.8%, in the third quarter of fiscal 2005 over the third quarter of fiscal 2004, to $4,785 million. The strengthening of foreign currencies, particularly

 

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the euro, increased reported net sales by 2.0%, or $95 million. Net sales in the third quarter of fiscal 2005 include sales of $26 million from a joint venture that the corporation started to consolidate upon the adoption of Statement of Financial Accounting Standards Interpretation No. 46, “Consolidation of Variable Interest Entities” in the fourth quarter of fiscal 2004. The impact of these sales is included in the table above in the line labeled “Acquisitions / dispositions.” Net sales in the third quarter of fiscal 2004 include $27 million from businesses disposed of after the start of the third quarter of fiscal 2004. The net impact of acquisitions and dispositions between the third quarters of fiscal 2005 and 2004 reduced net sales by $1 million, or 0.1%. The remaining net sales decrease of $54 million, or 1.1%, resulted from decreases in net sales in the Sara Lee Bakery, Household Products and Branded Apparel business segments. The Sara Lee Bakery Group experienced lower net sales under a continuing program to reduce sales of low margin institutional and private label fresh breads, plus the impact of lower U.S. frozen retail bakery shipments during the quarter. Net sales in the Household Products segment decreased primarily due to lower unit volumes of air care products and lower average selling prices, while net sales declined in the Branded Apparel segment primarily due to lower unit volumes. The Sara Lee Meats and Beverage segments increased selling prices during the quarter to pass along higher raw material costs which had a negative impact on unit volumes, but increased net sales.

 

Unit Volumes

 

Unit volumes in the Sara Lee Meats segment increased 1% in the third quarter with increases in the three geographic areas of the U.S., Europe and Mexico. In a planned effort to reduce sales of low margin U.S. fresh bread, Sara Lee Bakery exited certain unprofitable non-core bakery businesses. These exits, plus lower shipments of U.S. frozen retail baked goods, reduced the Sara Lee Bakery segment unit volumes by 6% in the third quarter of fiscal 2005. In the Beverage segment in the third quarter, unit volumes for roasted coffee declined by 2% from continued weakness in the U.S. and European coffee markets. The unit volumes for the four core categories of the Household Products segment decreased 4% in the third quarter due primarily to lower shipments of air care products due to a competitive marketplace. In the third quarter, unit volumes declined in the Branded Apparel segment based upon declines in the three categories of intimates, knit products, and legwear.

 

Gross Margin Percent

 

The gross margin percentage declined from 39.1% in the third quarter of fiscal 2004 to 37.0% in the third quarter of fiscal 2005. The gross margin percentage of Sara Lee Meats declined by 4 points, Beverage declined by 3 points, Branded Apparel declined by 2 points, and the Household Products segment declined by 1 point. The Sara Lee Bakery segment increased by approximately  1/2 of a point. The gross margin percentages in the Sara Lee Meats and Beverage operations reflect the impact of higher raw material costs that the corporation was not able to pass along to customers through higher selling prices. These cost increases exceeded cost reductions resulting from ongoing restructuring efforts and lower benefit plan costs. The Branded Apparel operations reflect continued higher raw material costs, continued competitive product pricing, costs associated with slow moving inventory and the impact of lower unit volumes on manufacturing costs. The lower gross margin percentage in the Household Products segment is primarily due to lower net selling prices due to competitive market conditions. The improved gross margin percentage in the Sara Lee Bakery business is primarily due to improvements in the mix of products sold and the benefits resulting from ongoing restructuring efforts and lower benefit plan costs.

 

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Selling, General and Administrative Expenses

 

     Thirteen Weeks Ended

 

(In millions)


   April 2,
2005


   March 27,
2004


   Change

    Percent
Change


 

Selling, general and administrative expenses:

                            

SG&A expenses in the business segment results

   $ 1,336    $ 1,337    $ (1 )   —   %

Amortization of identifiable intangibles

     30      28      2     6.5  

General corporate expenses

     68      106      (38 )   (35.9 )
    

  

  


 

Total SG&A expenses

   $ 1,434    $ 1,471    $ (37 )   (2.5 )%
    

  

  


 

 

Total selling, general and administrative (“SG&A”) expenses decreased $37 million, or 2.5%, in the third quarter of fiscal 2005 over the comparable prior year quarter. Changes in foreign currency exchange rates, primarily in the euro, increased SG&A expenses by $26 million, or 1.7%. Therefore, the remaining decrease in SG&A expenses was $63 million, or 4.2%. Measured as a percent of sales, SG&A expenses declined from 31.0% in the third quarter of fiscal 2004 to 30.0% in the third quarter of fiscal 2005 as SG&A expenses as a percentage of sales declined in Sara Lee Meats, Sara Lee Bakery and Household Products, and increased in Branded Apparel. SG&A expenses as a percentage of sales was unchanged in the Beverage segment. Total SG&A expenses reported in the business segments was virtually unchanged between the third quarter of fiscal 2004 and the third quarter of fiscal 2005. Amortization of intangibles increased by $2 million, or 6.5%, primarily from a $1 million charge in the Sara Lee Bakery segment to accelerate the amortization of certain intangibles that are to be abandoned, plus the impact of changes in foreign currency and the reclassification of certain trademarks to the finite lived category. General corporate expenses, which are not allocated to the individual business segments, declined by $38 million, or 35.9%, primarily due to a decline in benefit plan costs and certain corporate office and administrative costs and favorable foreign exchange costs as compared to the prior year.

 

(Income from) Charges for Exit Activities and Business Dispositions

 

The reported results for the third quarter of fiscal 2005 and 2004 reflect amounts recognized for exit and business disposition actions, including the impact of certain activities that were completed for amounts more favorable than previously estimated. The following table illustrates where the costs (income) associated with all exit and disposal activities are recognized in the Consolidated Statements of Income of the corporation.

 

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Table of Contents
     Thirteen Weeks Ended

 

(In millions)


   April 2,
2005


    March 27,
2004


 

Cost of sales

                

Curtailment gain from Sara Lee Bakery workforce reduction

   $ (2 )   $ —    

Accelerated depreciation related to facility closures in

                

Sara Lee Bakery segment

     —         3  

Household Products segment

     3       —    

Selling, general and administrative expenses

     1       —    

(Income from) charges for

                

Exit activities

     11       6  

Business dispositions

     (30 )     —    
    


 


Impact on income before income taxes

     (17 )     9  

Income taxes on exit activities and business dispositions

     7       (3 )
    


 


Impact on net income

   $ (10 )   $ 6  
    


 


 

The following is a summary of the actions that impacted the third quarter of fiscal 2005. The amount recognized on the line titled “Cost of sales”, as noted in the table above, consists of a $2 million curtailment gain from the closure of certain Sara Lee Bakery plants, which was partially offset by a $3 million charge for accelerated depreciation on certain facilities to be sold in the Household Products segment. SG&A expenses include a $1 million charge for accelerated amortization for the cost to abandon certain Sara Lee Bakery intangible assets. The line titled “(Income from) charges for exit activities and business dispositions” includes income of $19 million which consists of the following components: an $11 million charge for exit activities and a $30 million net gain from business dispositions. The $11 million charge relates to certain approved severance actions. The $30 million net gain consists of the following: a $34 million gain relates to the disposition of trademarks, working capital and certain fixed assets related to a canned and shelf-stable meat and poultry products business; plus, certain non-core Household Products brands. Offsetting these amounts is a $4 million charge that relates to the cost to evaluate the disposition of certain other businesses. The net impact of these actions was to increase pretax income and net income by $17 million and $10 million, respectively, and increased diluted earnings per share by $0.01.

 

The total charge recognized in fiscal 2004 consists of the following components. Included on the line titled “Cost of sales” is a $3 million charge for accelerated depreciation expense related to assets to be disposed. Included on the line titled “(Income from) charges for exit activities and business dispositions” is a $6 million charge associated with terminating a number of employees. These charges reduced diluted earnings per share during the period by $0.01.

 

The costs (income) of the above actions on the corporation’s business segments and amortization expense are summarized as follows:

 

     Thirteen Weeks Ended

(In millions)


   April 2,
2005


    March 27,
2004


Sara Lee Meats

   $ (30 )   $ 2

Sara Lee Bakery

     (3 )     7

Beverage

     —         —  

Household Products

     1       —  

Branded Apparel

     —         —  
    


 

Impact on the business segments

     (32 )     9

Corporate office

     14       —  

Accelerated amortization of intangibles

     1       —  
    


 

Impact on income before income taxes

   $ (17 )   $ 9
    


 

 

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These actions are more fully explained in the Exit and Disposal Activities note to the Consolidated Financial Statements. As a result of the exit activities taken since the beginning of fiscal 2004, the corporation’s cost structure was reduced and efficiency improved. The total annual savings expected to be generated from restructuring efforts is $62 million in fiscal 2005, of which $18 million was realized in the third quarter of fiscal 2005.

 

Net Interest Expense

 

Net interest expense increased by $5 million in the third quarter of fiscal 2005, to $47 million primarily as a result of higher average interest rates.

 

Income Tax Expense

 

The effective tax rate increased from 17.6% in the third quarter of fiscal 2004 to 37.9% in the third quarter of fiscal 2005 primarily due to the following factors:

 

    During the third quarter of fiscal 2005, the corporation adopted a plan to repatriate approximately $928 million of accumulated income from controlled foreign corporations to the U.S. under the American Jobs Creation Act of 2004 (“the Act”). The Act creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85% dividends received deduction for certain dividends from controlled foreign corporations. The deduction is subject to a number of limitations. Upon the approval to repatriate these funds, the corporation recognized in the third quarter of fiscal 2005 a tax charge of $51 million, which increased the tax rate during the third quarter by 16.8%.

 

    The exit activities and business dispositions that were recognized by the corporation during the third quarter of fiscal 2005, plus changes in the country-by-country mix in earnings, increased the tax rate by 3.5% during the third quarter.

 

Consolidated Net Income and Diluted Earnings Per Share (“EPS”)

 

Consolidated net income of $189 million in the third quarter of fiscal 2005 was $187 million, or 49.7% lower than the prior year comparable quarter. The decline in net income was primarily due to the following factors:

 

    The corporation’s gross margin percentage declined by 2.1% as the corporation’s business segments experienced higher costs for certain commodity based raw materials in the Sara Lee Meats, Beverage and Branded Apparel business and experienced pricing pressures from a competitive marketplace which reduced the corporation’s gross profit by $90 million.

 

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Table of Contents
    Selling, general and administrative (SG&A) expenses in the third quarter of fiscal 2005 were $37 million lower than in the comparable period of the prior year. This was primarily due to the benefits of ongoing restructuring efforts, lower employee benefit plan costs and lower corporate office expenses. Partially offsetting these reductions was a $2 million increase in intangible amortization costs. SG&A costs as a percentage of sales declined from 31.0% in the third quarter of fiscal 2004 to 30.0% in the third quarter of fiscal 2005. SG&A costs as a percentage of sales declined or was unchanged in each of the business segments except the Branded Apparel segment.

 

    In the third quarter of fiscal 2005, the corporation recognized income from exit activities and business dispositions of $19 million, while in the third quarter of fiscal 2004, the corporation recognized charges for exit activities of $6 million.

 

    The corporation received and recognized contingent sale proceeds of $119 million in the third quarter of fiscal 2004 from the sale of the corporation’s cut tobacco business which represents the payment for fiscal 2004. The corporation subsequently received and recognized the payment for fiscal 2005 in the first quarter of fiscal 2005.

 

    Due to the increase in average borrowing rates, net interest expense increased by $5 million in the third quarter of fiscal 2005.

 

    Income tax expense increased by $35 million, primarily as a result of the charge for the corporation’s plan to repatriate accumulated income from controlled foreign corporations.

 

Diluted EPS decreased from $0.47 in the third quarter of fiscal 2004 to $0.24 in the third quarter of fiscal 2005, a decrease of 48.9%.

 

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Table of Contents

Operating Results by Business Segment – Third Quarter of Fiscal 2005 Compared with Third Quarter of Fiscal 2004

 

Sara Lee Meats

 

     Thirteen Weeks Ended

 

(In millions)


   April 2,
2005


   March 27,
2004


    Change

    Percent
Change


 

Change in unit volume

                          1 %
                           

Net sales

   $ 1,029    $ 976     $ 53     5.5 %
    

  


 


 

Increase / (Decrease) in net sales from

                             

Changes in foreign currency exchange rates

   $ —      $ (12 )   $ 12        

Dispositions

     —        19       (19 )      
    

  


 


     

Total

   $ —      $ 7     $ (7 )      
    

  


 


     

Operating segment income

   $ 104    $ 97     $ 7     8.2 %
    

  


 


 

Increase / (Decrease) in operating segment income from

                             

Changes in foreign currency exchange rates

   $ —      $ (1 )   $ 1        

Exit activities and business dispositions

     30      (2 )     32        

Dispositions

     —        2       (2 )      
    

  


 


     

Total

   $ 30    $ (1 )   $ 31        
    

  


 


     

 

Unit volumes in the Sara Lee Meats segment for processed meats increased 1% as compared to the prior year third quarter consisting of increases of 1% in the U.S. and 2% in both Mexico and Europe. In the U.S., unit volumes increased in the foodservice channel primarily due to expanded foodservice distribution and sector improvements, while in the retail channel, unit volumes were unchanged from the prior year quarter. Unit volumes in Mexico increased primarily due to improvement in sales in the traditional channel, while in Europe, unit volumes increased based upon strong shipments in the Netherlands.

 

Net sales in the Sara Lee Meats segment increased by $53 million, or 5.5%, to $1,029 million in the third quarter of fiscal 2005 from $976 million in the prior year third quarter. During the quarter, the strengthening of the euro, partially offset by the weakening of the Mexican peso, increased reported net sales by $12 million, or 1.3%. Net sales of businesses disposed of since the beginning of the third quarter of fiscal 2004 reduced net sales by $19 million, or 2.1%. The remaining net sales increase of $60 million, or 6.3%, was due to unit selling prices that increased as the corporation passed on certain raw material cost increases to the customer, the impact of a favorable product mix and increased unit volumes.

 

The Sara Lee Meats gross margin percentage decreased from 30.1% in the third quarter of fiscal 2004 to 26.4% in the third quarter of fiscal 2005 as the impact of higher raw material costs during the quarter was only partially mitigated by a combination of higher selling prices, a favorable product mix and various production efficiency programs.

 

Operating segment income in Sara Lee Meats increased by $7 million, or 8.2%, from $97 million in the prior year third quarter to $104 million in the third quarter of fiscal 2005. Changes in foreign currency, particularly the euro, increased reported operating segment income by $1 million, or 1.4%. The impact of exit activities and the disposition of certain non-core brands impacted both the third quarters of fiscal 2005 and 2004. During the third quarter of fiscal 2005, the gain on the disposition of certain non-core brands of $30 million was recognized, while in the third quarter of fiscal 2004, a charge for exit activities of $2 million was recognized. The difference between these amounts increased operating segment income by $32 million, or 32.9%. The operating segment income from brands disposed of since the beginning of the third quarter of fiscal 2004 reduced operating segment income by $2 million, or 1.9%. The remaining operating

 

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Table of Contents

segment income decrease of $24 million, or 24.2%, as compared to the same quarter of the prior year is primarily the result of lower gross margins and higher promotion expenses, which were partially offset by lower administrative costs.

 

In February 2005, the corporation announced that it is exploring the sale of the corporation’s European meats business. No decisions have been made at this time regarding the ultimate actions that may be taken regarding these operations.

 

Sara Lee Bakery

 

     Thirteen Weeks Ended

 

(In millions)


   April 2,
2005


   March 27,
2004


    Change

    Percent
Change


 

Change in unit volume

                          (6 )%
                           

Net sales

   $ 790    $ 810     $ (20 )   (2.4 )%
    

  


 


 

Increase / (Decrease) in net sales from

                             

Changes in foreign currency exchange rates

   $ —      $ (8 )   $ 8        
    

  


 


     

Operating segment income

   $ 31    $ 26     $ 5     20.1 %
    

  


 


 

Increase / (Decrease) in operating segment income from

                             

Changes in foreign currency exchange rates

   $ —      $ (1 )   $ 1        

Exit activities and business dispositions

     —        (4 )     4        

Curtailment gain

     2      —         2        

Accelerated depreciation on facilities to be sold

     1      (3 )     4        
    

  


 


     

Total

   $ 3    $ (8 )   $ 11        
    

  


 


     

 

Net unit volumes in the Sara Lee Bakery segment declined 6% during the quarter primarily as a result of declines in the lower margin U.S. fresh bread market, particularly in institutional and private label. Unit volumes also declined for U.S. refrigerated dough products and frozen retail bakery items. These declines were partially offset by higher unit volumes for frozen foodservice channel bakery products based upon the strength of pie shipments and refrigerated dough products in Europe from expanded distribution.

 

Net sales in the Sara Lee Bakery segment decreased $20 million, or 2.4% over the comparable prior year quarter. Changes in foreign currency exchange rates increased reported net sales by $8 million, or 1.0%. There were no acquisitions or dispositions that impacted the Sara Lee Bakery segment during the quarter. The remaining net sales decrease of $28 million, or 3.4%, was primarily a result of reduced sales of low margin institutional and private label fresh bread, lower regional brand sales and lower frozen retail bakery shipments during the quarter, which were partially offset by an improved product mix.

 

The gross margin percentage in the Sara Lee Bakery segment increased 0.5% from 41.4% in the third quarter of fiscal 2004 to 41.9% in the third quarter of fiscal 2005 as a favorable product mix from the continued strength of the Sara Lee brand and increased operational efficiency from the discontinuation of certain lower margin product lines offset increases in key commodities and employee benefit and wage expenses. These factors increased the gross margin percentage, however, the total gross profit in dollars declined as the impact of the decline in unit volume on the gross profit dollars was only partially offset by the improved product mix.

 

Operating segment income in the Sara Lee Bakery segment increased by $5 million, or 20.1%, from $26 million in the third quarter of fiscal 2004 to $31 million in the third quarter of fiscal 2005. Changes in foreign currency, particularly the euro, increased reported operating segment income by $1 million, or 2.1%. In the third quarter of fiscal 2005, as a result of the decision to close a Sara

 

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Lee Bakery plant, a curtailment gain of $2 million and a depreciation credit of $1 million was recognized. In the third quarter of fiscal 2004, the Sara Lee Bakery group recognized charges for exit activities of $4 million and charges for accelerated depreciation of $3 million. The net impact of the accelerated depreciation, curtailment gain and exit activities recognized in fiscal 2005 versus fiscal 2004 increased operating segment income by $10 million, or 33.2%. The remaining operating segment income decrease of $6 million, or 15.2% during the quarter, was primarily attributable to lower gross profit, which was partially offset by the benefits of previous restructuring actions.

 

Beverage

 

     Thirteen Weeks Ended

 

(In millions)


   April 2,
2005


   March 27,
2004


    Change

    Percent
Change


 

Change in unit volume

                          (2 )%
                           

Net sales

   $ 844    $ 801     $ 43     5.2 %
    

  


 


 

Increase / (Decrease) in net sales from

                             

Changes in foreign currency exchange rates

   $ —      $ (31 )   $ 31        
    

  


 


     

Operating segment income

   $ 123    $ 140     $ (17 )   (12.8 )%
    

  


 


 

Increase / (Decrease) in operating segment income from

                             

Changes in foreign currency exchange rates

   $ —      $ (8 )   $ 8        
    

  


 


     

 

Net unit volumes in the Beverage segment declined 2% as compared to the prior year quarter as unit volumes declined in both the retail and the foodservice channels. In the retail channel, declines in the U.S. and Europe were due to increased price competition in the marketplace that was only partially offset by increases in Brazil. In the foodservice channel, unit volumes declined in the U.S., but increased in Europe.

 

Net sales in the Beverage segment increased by $43 million, or 5.2%, to $844 million in the third quarter of fiscal 2005, reflecting the impact of changes in foreign currency, higher green coffee commodity prices and improvements in product mix. The impact of foreign currency changes, particularly in the euro, increased reported net sales by $31 million, or 3.9%. There were no acquisitions and dispositions that impacted the Beverage segment during the quarter. The remaining net sales increase of $12 million, or 1.3%, compared to the comparable period of the prior year was primarily due to unit selling prices which increased as the corporation passed on certain raw material cost increases to the customer.

 

The gross margin percent in the Beverage segment decreased 3.0% from 44.6% in the third quarter of fiscal 2004 to 41.6% in the third quarter of fiscal 2005 primarily as a result of higher raw material costs which were passed along to the customer, but have a negative impact on the gross margin percentage, plus the impact of lower unit volumes.

 

Operating segment income for the Beverage segment decreased $17 million, or 12.8%, to $123 million in the third quarter of fiscal 2005. The strengthening of foreign currencies versus the U.S. dollar increased operating segment income by $8 million, or 4.5%. The remaining operating segment income decrease was $25 million, or 17.3%, primarily from lower gross margins and unit volumes and increases in media advertising to support the continued rollout of Senseo and other key brands.

 

In February 2005, the corporation announced that it would explore the sale of the corporation’s U.S. retail coffee business, excluding Senseo. No decisions have been made at this time regarding the ultimate actions that may be taken regarding these operations.

 

33


Table of Contents

Household Products

 

     Thirteen Weeks Ended

 

(In millions)


   April 2,
2005


    March 27,
2004


    Change

    Percent
Change


 

Change in unit volume of core categories (a)

                           (4 )%
                            

Net sales

   $ 599     $ 599     $ —       (0.1 )%
    


 


 


 

Increase / (Decrease) in net sales from

                              

Changes in foreign currency exchange rates

   $ —       $ (20 )   $ 20        

Dispositions

     —         7       (7 )      
    


 


 


     

Total

   $ —       $ (13 )   $ 13        
    


 


 


     

Operating segment income

   $ 102     $ 109     $ (7 )   (6.2 )%
    


 


 


 

Increase / (Decrease) in operating segment income from

                              

Changes in foreign currency exchange rates

   $ —       $ (4 )   $ 4        

Exit activities and business dispositions

     3       —         3        

Accelerated depreciation on facilities to be sold

     (4 )     —         (4 )      

Dispositions

     —         3       (3 )      
    


 


 


     

Total

   $ (1 )   $ (1 )   $ —          
    


 


 


     

(a) – Core categories include body care, shoe care, air care and insecticides

 

Unit volumes in the Household Products segment for the four core categories – shoe care, body care, insecticides and air care – decreased 4% in the third quarter of fiscal 2005. Unit volumes decreased in the shoe care category in both the U.S. and Europe, while in the air care and body care categories, unit volumes decreased due to increased competition, primarily in Europe. In the insecticides category, unit volumes increased due to higher sales in Asia, driven by promotional support.

 

Net sales in the Household Products segment were unchanged at $599 million in both the third quarter of fiscal 2004 and third quarter of fiscal 2005. The impact of changes in foreign currency exchange rates increased reported net sales by $20 million, or 3.3%, primarily due to the strengthening of currencies in Europe, the United Kingdom, Australia and South Africa. The third quarter of fiscal 2004 includes sales of $7 million from product lines that had been disposed of after the start of the third quarter of fiscal 2004, which reduced net sales by 1.2%. The remaining net sales decrease of $13 million, or 2.2%, was primarily due to lower unit volumes in the air care, shoe care and body care categories, which were partially offset by improved results in the direct selling category.

 

The gross margin percentage in the Household Products segment decreased 1.2% from the third quarter of the prior year to 54.0% in the third quarter of fiscal 2005, primarily from competitive pricing in the marketplace and the decline in unit volumes.

 

Operating segment income decreased $7 million, or 6.2%, to $102 million in the third quarter of fiscal 2005. Changes in foreign currency exchange rates increased operating segment income by $4 million, or 3.0%. In the third quarter of fiscal 2005, the Household Products segment disposed of certain non-core product lines and recognized income of $3 million. Additionally, accelerated depreciation of $4 million was recognized on certain assets to be disposed. The net of these items decreased operating segment income by $1 million, or 0.1%. The third quarter of fiscal 2004 includes income of $3 million from businesses that had been disposed of after the start of the third quarter of fiscal 2004, which reduced operating segment income by 2.2%. The remaining operating segment income decrease of $7 million, or 6.9%, was primarily due to the impact of lower unit volumes and gross margins, which were partially offset by lower administrative expenses.

 

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Table of Contents

As part of its ongoing brand segmentation strategy, the corporation is continuing with the evaluation of a number of smaller brands in this business segment. This review has resulted in the sale of a number of smaller non-core brands which resulted in the gain recognized in the third quarter. Additional brands are being analyzed and no decisions have been made regarding these brands at the present time.

 

In February 2005, the corporation announced that it is exploring the sale of the corporation’s direct selling business which is included in the Household Products business segment. No decisions have been made at this time regarding the ultimate actions that may be taken regarding these operations.

 

Branded Apparel

 

     Thirteen Weeks Ended

 

(In millions)


   April 2,
2005


   March 27,
2004


    Change

    Percent
Change


 

Change in unit volume (a)

                          (8 )%
                           

Net sales

   $ 1,524    $ 1,562     $ (38 )   (2.4 )%
    

  


 


 

Increase / (Decrease) in net sales from

                             

Changes in foreign currency exchange rates

   $ —      $ (24 )   $ 24        

Acquisitions/dispositions

     26      1       25        
    

  


 


     

Total

   $ 26    $ (23 )   $ 49        
    

  


 


     

Operating segment income

   $ 90    $ 142     $ (52 )   (36.4 )%
    

  


 


 

Increase / (Decrease) in operating segment income from

                             

Changes in foreign currency exchange rates

   $ —      $ (3 )   $ 3        
    

  


 


     

Total

   $ —      $ (3 )   $ 3        
    

  


 


     

(a) – Excludes the impact of acquisitions and dispositions

 

Unit volumes in the Branded Apparel segment, excluding acquisitions and dispositions, decreased by 8% during the quarter with a 1% decrease in legwear, a 6% decrease in knit products and a 13% decrease in intimates. Legwear unit volumes declined with a 6% decrease in sheer hosiery which was only partially offset by a 5% increase in socks. The 6% decrease in knit products was the result of a 4% decline in underwear shipments after a strong prior year comparison and a 9% decline in activewear. The 13% decline in intimates was due to a decline in unit volumes in Europe and the U.S. where competition from specialty stores and category and market weakness continue.

 

Net sales decreased by $38 million, or 2.4%, from $1,562 million in the third quarter of fiscal 2004 to $1,524 million in the third quarter of fiscal 2005. The impact of foreign currency exchange rate changes during the quarter, particularly the euro and British pound, increased reported sales during the quarter by $24 million, or 1.5%. The third quarter of fiscal 2005 includes sales of $26 million from a joint venture that the corporation started to consolidate upon the adoption of Statement of Financial Accounting Standards Interpretation No. 46, “Consolidation of Variable Interest Entities” in the fourth quarter of fiscal 2004. The impact of these sales is shown in the table above under the caption “Acquisitions / dispositions”. The third quarter of fiscal 2004 includes $1 million of sales from businesses that have been disposed of after the start of the third quarter of fiscal 2004. The net impact of the acquisitions and dispositions increased net sales by $25 million, or 1.6%, during the quarter. As a result, the remaining net sales decrease was $87 million, or 5.5%, which was primarily due to unit volume declines.

 

The gross margin percent decreased by 2.3%, from 34.6% in the third quarter of fiscal 2004 to 32.3% in the third quarter of fiscal 2005, reflecting the impact of higher raw material costs, supply chain disruptions related to a facility relocation, the $20 million cost of slow moving inventory, the impact of lower unit volumes on manufacturing costs and an unfavorable sales mix.

 

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Table of Contents

Branded Apparel operating segment income decreased by $52 million, or 36.4%, in the third quarter of fiscal 2005, from $142 million in the third quarter of fiscal 2004, to $90 million in the third quarter of fiscal 2005. Changes in foreign currency exchange rates increased operating segment income during the quarter by $3 million, or 1.2%. The remaining decrease in operating segment income was $55 million, or 38.0%, which was primarily due to decreases in unit volume and lower gross margins.

 

In January 2005, the corporation announced that it would formally explore the option of selling its branded apparel operations in Europe, the United Kingdom and South Africa. These operations include certain dedicated manufacturing operations in other parts of the world. No decisions have been made at this time regarding the ultimate actions that may be taken regarding these operations. In February 2005, the corporation announced that it would explore the option of spinning-off the remaining Branded Apparel business. No decisions have been made at this time regarding the ultimate actions that may be taken regarding these operations.

 

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Table of Contents

Consolidated Results – First Nine Months of Fiscal 2005 Compared with First Nine Months of Fiscal 2004

 

Operating results by business segment in the first nine months of fiscal 2005 compared with the first nine months of fiscal 2004 are as follows:

 

     Thirty-nine Weeks Ended

 
     Net Sales

    Income Before Income Taxes

 

(In millions)


   April 2,
2005


    March
27, 2004


    April 2,
2005


    March 27,
2004


 

Sara Lee Meats

   $ 3,188     $ 3,054     $ 251     $ 313  

Sara Lee Bakery

     2,481       2,517       160       121  

Beverage

     2,486       2,314       344       361  

Household Products

     1,782       1,743       280       279  

Branded Apparel

     4,912       4,805       379       401  
    


 


 


 


Total business segments

     14,849       14,433       1,414       1,475  

Intersegment sales

     (4 )     (5 )     —         —    
    


 


 


 


Total net sales and operating segment income

     14,845       14,428       1,414       1,475  

Amortization of intangibles

     —         —         (92 )     (78 )

General corporate expenses

     —         —         (179 )     (265 )

Contingent sale proceeds

     —         —         117       119  
    


 


 


 


Total net sales and operating income

     14,845       14,428       1,260       1,251  

Net interest expense

     —         —         (133 )     (134 )
    


 


 


 


Net sales and income before income taxes

   $ 14,845     $ 14,428     $ 1,127     $ 1,117  
    


 


 


 


 

The following table summarizes net sales and operating income performance for the first nine months of fiscal 2005 and 2004 and certain significant items that affected the comparability of these amounts.

 

     Thirty-nine Weeks Ended

 

Corporate Performance - (In millions)


   April 2,
2005


    March
27, 2004


    Change

    Percent
Change


 

Net sales

   $ 14,845     $ 14,428     $ 417     2.9 %
    


 


 


 

Increase / (Decrease) in net sales from

                              

Changes in foreign currency exchange rates

   $ —       $ (419 )   $ 419        

Acquisitions/dispositions

     76       81       (5 )      
    


 


 


     

Total

   $ 76     $ (338 )   $ 414        
    


 


 


     

Operating income

   $ 1,260     $ 1,251     $ 9     0.7 %
    


 


 


 

Increase / (Decrease) in operating income from

                              

Receipt of contingent sale proceeds

   $ 117     $ 119     $ (2 )      

Changes in foreign currency exchange rates

     —         (53 )     53        

Exit activities and business dispositions

     35       (11 )     46        

Curtailment gain

     28       —         28        

Accelerated depreciation on facilities sold

     (20 )     (5 )     (15 )      

Accelerated amortization of intangibles

     (9 )     (1 )     (8 )      

Acquisitions/dispositions

     6       5       1        
    


 


 


     

Total

   $ 157     $ 54     $ 103        
    


 


 


     

 

Net Sales

 

Consolidated net sales increased $417 million, or 2.9%, in the first nine months of fiscal 2005 over the first nine months of fiscal 2004, to $14,845 million. The strengthening of foreign currencies, particularly the euro and British pound, increased reported net sales by 2.9%, or $419

 

37


Table of Contents

million. Net sales in the first nine months of fiscal 2005 include sales of $76 million from a joint venture that the corporation started to consolidate upon the adoption of Statement of Financial Accounting Standards Interpretation No. 46, “Consolidation of Variable Interest Entities” in the fourth quarter of fiscal 2004. The impact of these sales is included in the table above in the line labeled “Acquisitions / dispositions.” Net sales in the first nine months of fiscal 2004 include $81 million from businesses disposed of after the start of fiscal 2004. The net impact of acquisitions and dispositions between the first nine months of fiscal 2005 and 2004 reduced net sales by $5 million. The remaining net sales increase of $3 million resulted from increases in net sales in the Sara Lee Meats and Beverage business segments, which were substantially offset by declines in the Sara Lee Bakery, Household Products and Branded Apparel segments. The Sara Lee Meats and Beverage segments increased selling prices during the period to pass along higher raw material costs. In the Sara Lee Meats and Beverage segments, the higher selling prices had a negative impact on unit volumes, but increased net sales. Net sales in the Household Products segment decreased primarily due to lower net selling prices due to a competitive marketplace and to lower unit volumes of air care products. The Sara Lee Bakery segment experienced lower net sales under a continuing program to reduce sales of low margin institutional and private label fresh breads and lower unit volumes for frozen bakery products. In the Branded Apparel segment, unit volumes decreased based upon lower consumer demand in an increasingly competitive marketplace.

 

Unit Volumes

 

Unit volumes in the Sara Lee Meats segment declined 3% in the first nine months of fiscal 2005 with reductions in the U.S. and Mexico as higher commodity costs led to higher customer selling prices which negatively impacted unit volume. Unit volumes in Europe were unchanged from the prior year period. The Sara Lee Bakery segment unit volumes declined by 6% in the first nine months of fiscal 2005 primarily from a strategy to reduce unit volumes for low margin U.S. fresh bread and from lower unit volumes of frozen baked goods. In the Beverage segment in the first nine months of fiscal 2005, unit volumes declined by 1% from continued weakness in the U.S. and European retail coffee markets, which were only partially offset by higher unit volumes in Brazil. The unit volumes for the four core categories of the Household Products segment decreased 2% in the first nine months of fiscal 2005 primarily due to lower unit volumes for air care products due to the continued category weakness. In the first nine months of fiscal 2005, unit volumes decreased 2% in the Branded Apparel segment as lower unit volume in the intimates category was only partially offset by increases in legwear and knit products.

 

Gross Margin Percent

 

The gross margin percentage declined from 38.8% in the first nine months of fiscal 2004 to 36.9% in the first nine months of fiscal 2005. The gross margin percent of the Sara Lee Meats and Branded Apparel segments each declined by 3 points during the period, the Beverage segment gross margin percentage declined by 2 points and the Household Products segment declined by 1 point. The gross margin percentage in the Sara Lee Bakery segment increased by almost 1 point. The gross margin percentages in the Sara Lee Meats and Beverage operations reflect the impact of higher raw material costs that the corporation was not able to pass along to customers through higher selling prices. The Branded Apparel operations represent higher raw material costs, charges for slow moving inventory, plus costs associated with new product roll-outs. The Household Products segment reflects lower net selling prices due to a competitive market place. The improved gross margin percentage in the Sara Lee Bakery business is primarily due to improvements in the mix of products sold and the benefits resulting from ongoing restructuring efforts and lower benefit plan costs.

 

38


Table of Contents

Selling, General and Administrative Expenses

 

     Thirty-nine Weeks Ended

 

(In millions)


   April 2,
2005


   March 27,
2004


   Dollar
Change


    Percent
Change


 

Selling, general and administrative expenses:

                            

SG&A expenses in the business segment results

   $ 4,092    $ 4,116    $ (24 )   (0.6 )%

Amortization of identifiable intangibles

     92      78      14     18.4  

General corporate expenses

     179      265      (86 )   (32.5 )
    

  

  


 

Total SG&A expenses

   $ 4,363    $ 4,459    $ (96 )   (2.1 )%
    

  

  


 

 

Total selling, general and administrative (“SG&A”) expenses decreased $96 million, or 2.1%, in the first nine months of fiscal 2005 over the comparable prior year period. Changes in foreign currency exchange rates, primarily in the euro, increased SG&A expenses by $142 million, or 3.1%. Therefore, the remaining decrease in SG&A expenses was $238 million, or 5.2%. SG&A expenses reported in the business segment results declined primarily from lower benefit plan costs, and the disposition of certain businesses in fiscal 2004. Measured as a percent of sales, SG&A expenses declined from 30.9% in the first nine months of fiscal 2004 to 29.4% in the first nine months of fiscal 2005 as each of the business segments declined except for Sara Lee Meats which was unchanged. Amortization of intangibles increased by $14 million, or 18.4%, primarily from a $9 million charge in the Sara Lee Bakery group to accelerate the amortization of certain intangibles that are to be abandoned, the impact of changes in foreign exchange rates and the reclassification of certain trademarks to the finite lived category. General corporate expenses, which are not allocated to the individual business segments, declined by $86 million, or 32.5%, primarily due to a decline in benefit plan costs, lower corporate office and administrative expenses and favorable foreign currency costs as compared to the prior year.

 

(Income from) Charges for Exit Activities and Business Dispositions

 

The reported results for the first nine months of fiscal 2005 and 2004 reflect amounts recognized for exit and disposal actions, including the impact of certain activities that were completed for amounts more favorable than previously estimated. The following table illustrates where the costs (income) associated with all exit and disposal activities are recognized in the Consolidated Statements of Income of the corporation.

 

     Thirty-nine Weeks Ended

 

(In millions)


   April 2,
2005


    March 27,
2004


 

Cost of Sales

                

Curtailment gain from Sara Lee Bakery workforce reduction

   $ (28 )   $ —    

Accelerated depreciation related to facility closures in

                

Sara Lee Bakery segment

     10       5  

Household Products segment

     10       —    

Selling, general and administrative expenses

     9       1  

(Income from) charges for