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Hillshire Brands Co 10-Q 2006

Documents found in this filing:

  1. 10-Q
  2. Ex-12.1
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32.1
  6. Ex-32.2
  7. Ex-32.2
Form 10-Q
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 September 30, 2006

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 (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  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  x        Accelerated filer  ¨        Non-accelerated filer  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

On September 30, 2006, the Registrant had 746,829,940 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 September 30, 2006 and July 1, 2006    4
  Consolidated Statements of Income - For the quarter ended September 30, 2006 and October 1, 2005    5
  Consolidated Statements of Common Stockholders’ Equity - For the period July 2, 2005 to September 30, 2006    6
  Consolidated Statements of Cash Flows - For the quarter ended September 30, 2006 and October 1, 2005    7
  Notes to Consolidated Financial Statements    8
ITEM 2 –  

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

   24
ITEM 4 –  

CONTROLS AND PROCEDURES

   50
PART II –

ITEM 1A -

  RISK FACTORS    51
ITEM 2(c) - REPURCHASES OF EQUITY SECURITES BY THE ISSUER    51
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS    52
ITEM 6 - EXHIBITS    53
SIGNATURE    54

 

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

 

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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, assumptions used in the determination of the funded status and annual expense of pension and postretirement employee benefit plans and the volatility and expected lives for stock compensation instruments granted to employees. Actual results could differ from these estimates.

The corporation’s fiscal year ends on the Saturday closest to June 30. The corporation’s first quarter of fiscal year 2007 ended on September 30, 2006 and the first quarter of fiscal 2006 ended on October 1, 2005. Each of these quarters was a thirteen-week period.

The Consolidated Financial Statements for the quarters ended September 30, 2006 and October 1, 2005 and the balance sheet as of July 1, 2006 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 September 30, 2006 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 1, 2006 and the Consolidated Statement of Common Stockholders’ Equity for the period July 2, 2005 to July 1, 2006 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 1, 2006. The results of operations for the quarter ended September 30, 2006 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 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 1, 2006 and other financial information filed with the Securities and Exchange Commission.

 

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SARA LEE CORPORATION AND SUBSIDIARIES

Condensed Consolidated Balance Sheets at September 30, 2006 and July 1, 2006

(In millions)

 

     (Unaudited)
September 30,
2006
   July 1,
2006

Assets

     

Cash and equivalents

   $ 3,042    $ 2,231

Trade accounts receivable, less allowances

     1,300      1,216

Inventories

     

Finished goods

     655      603

Work in process

     39      38

Materials and supplies

     307      278
             
     1,001      919

Other current assets

     341      317

Assets of discontinued operations held for disposal

     —        2,152
             

Total current assets

     5,684      6,835

Other non-current assets

     110      109

Property, net

     2,300      2,319

Trademarks and other identifiable intangibles, net

     1,038      1,049

Goodwill

     2,779      2,774

Assets held for sale

     13      —  

Assets of discontinued operations held for disposal

     —        1,563
             
   $ 11,924    $ 14,649
             

Liabilities and Stockholders’ Equity

     

Notes payable

   $ 108    $ 1,776

Accounts payable

     969      1,022

Accrued liabilities

     2,322      2,252

Current maturities of long-term debt

     1,195      366

Liabilities of discontinued operations held for disposal

     —        922
             

Total current liabilities

     4,594      6,338

Long-term debt

     3,005      3,806

Pension obligation

     269      233

Deferred tax liability

     71      66

Other liabilities

     1,204      1,327

Liabilities of discontinued operations held for disposal

     —        367

Minority interests in subsidiaries

     61      63

Common stockholders’ equity

     2,720      2,449
             
   $ 11,924    $ 14,649
             

See accompanying Notes to Consolidated Financial Statements.

 

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SARA LEE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income

For the Quarter Ended September 30, 2006 and October 1, 2005

(In millions, except per share data)

Unaudited

 

     Quarter Ended  
     September 30,
2006
    October 1,
2005
 

Continuing operations

    

Net sales

   $ 2,891     $ 2,763  
                

Cost of sales

     1,796       1,707  

Selling, general and administrative expenses

     962       955  

Income from exit activities, asset and business dispositions

     (1 )     —    

Contingent sale proceeds

     (120 )     (114 )

Interest expense

     75       73  

Interest income

     (26 )     (19 )
                
     2,686       2,602  
                

Income from continuing operations before income taxes

     205       161  

Income tax (benefit) expense

     (50 )     59  
                

Income from continuing operations

     255       102  
                

Discontinued operations

    

Net income (loss) from discontinued operations, net of tax expense (benefit) of $30 and $(41)

     62       (35 )

Gain on sale of discontinued operations, net of tax expense of $2

     16       —    
                

Net income

   $ 333     $ 67  
                

Income from continuing operations per share of common stock

    

Basic

   $ 0.34     $ 0.13  
                

Diluted

   $ 0.34     $ 0.13  
                

Net income per share of common stock

    

Basic

   $ 0.44     $ 0.09  
                

Diluted

   $ 0.44     $ 0.09  
                

Average shares outstanding

    

Basic

     758       779  
                

Diluted

     761       782  
                

Cash dividends per share of common stock

   $ 0.1000     $ 0.1975  
                

See accompanying Notes to Consolidated Financial Statements.

 

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SARA LEE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Common Stockholders’ Equity

For the Period July 2, 2005 to September 30, 2006

(In millions, except per share data)

 

     TOTAL    

COMMON

STOCK

   

CAPITAL

SURPLUS

   

RETAINED

EARNINGS

   

UNEARNED

STOCK

   

ACCUMULATED

OTHER

COMPREHENSIVE

INCOME

(LOSS)

   

COMPREHENSIVE

INCOME

 

Balances at July 2, 2005

   $ 2,732     $ 8     $ 79     $ 4,361     $ (155 )   $ (1,561 )  

Net income

     67       —         —         67       —         —       $ 67  

Translation adjustments, net of tax

     (11 )     —         —         —         —         (11 )     (11 )

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

     (28 )     —         —         —         —         (28 )     (28 )
                    

Comprehensive income

               $ 28  
                    

Cash dividends - Common ($0.1975 per share)

     (154 )     —         —         (154 )     —         —      

Stock issuances (cancelations) - Stock option and benefit plans

     13       —         13       —         —         —      

Restricted stock

     15       —         15       —         —         —      

Share repurchases and retirement

     (561 )     —         (107 )     (454 )     —         —      
                                                  

Balances at October 1, 2005

     2,073       8       —         3,820       (155 )     (1,600 )  

Net income

     488       —         —         488       —         —       $ 488  

Translation adjustments, net of tax

     81       —         —         —         —         81       81  

Minimum pension liability, net of tax

     180       —         —         —         —         180       180  

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

     —         —         —         —         —         —         —    
                    

Comprehensive income

               $ 749  
                    

Cash dividends -

              

Common ($0.5925 per share)

     (457 )     —         —         (457 )     —         —      

Stock issuances (cancelations) -

              

Stock option and benefit plans

     20       —         20       —         —         —      

Restricted stock

     40       —         40       —         —         —      

Tax benefit related to stock-based compensation

     1       —         1       —         —         —      

ESOP contributions and other

     23       —         1       4       18       —      
                                                  

Balances at July 1, 2006

     2,449       8       62       3,855       (137 )     (1,339 )  

Net income

     333       —         —         333       —         —       $ 333  

Translation adjustments, net of tax

     272       —         —         —         —         272       272  

Minimum pension liability, net of tax

     (36 )     —         —         —         —         (36 )     (36 )

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

     11       —         —         —         —         11       11  
                    

Comprehensive income

               $ 580  
                    

Cash dividends-common ($0.10 per share)

     (76 )     —         —         (76 )     —         —      

Spin off of Hanesbrands Inc. business

     (3 )     —         —         (70 )     —         67    

Stock issuances (cancelations) -

              

Stock option and benefit plans

     8       —         8       —         —         —      

Restricted stock

     13       —         13       —         —         —      

Share repurchases and retirement

     (250 )     —         (83 )     (167 )     —         —      

Other

     (1 )     (1 )     —         —         —         —      
                                                  

Balances at September 30, 2006

   $ 2,720     $ 7     $ —       $ 3,875     $ (137 )   $ (1,025 )  
                                                  

Interim period balances are unaudited.

See accompanying Notes to Consolidated Financial Statements.

 

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SARA LEE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the Quarter Ended September 30, 2006 and October 1, 2005

(In millions)

Unaudited

 

     Quarter Ended  
     September 30,
2006
    October 1,
2005
 

OPERATING ACTIVITIES -

    

Income from continuing operations

   $ 333     $ 67  

Less: Cash received from contingent sale proceeds

     (120 )     (114 )

Adjustments to reconcile income from continuing operations to net cash provided by operating activities:

    

Depreciation

     127       137  

Amortization of intangibles

     34       42  

Impairment charges

     —         223  

Net gain on business dispositions

     (40 )     (32 )

Increase (decrease) in deferred income taxes

     23       (58 )

Other

     24       (6 )

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

     (578 )     (71 )
                

Net cash (used in) from operating activities

     (197 )     188  

INVESTMENT ACTIVITIES -

    

Purchases of property and equipment

     (125 )     (99 )

Acquisitions of businesses

     —         (7 )

Dispositions of businesses and investments

     349       62  

Cash received from loans receivable

     688       —    

Cash received from contingent sale proceeds

     120       114  

Sales of assets

     31       49  
                

Net cash from investment activities

     1,063       119  
                

FINANCING ACTIVITIES -

    

Issuances of common stock

     —         10  

Purchases of common stock

     (185 )     (561 )

Borrowings of long-term debt

     2,558       —    

Repayments of long-term debt

     (5 )     (125 )

Short-term (repayments) borrowings, net

     (1,644 )     1,617  

Cash transferred to Hanesbrands Inc. in spin off

     (650 )     —    

Payments of dividends

     (151 )     (154 )
                

Net cash (used in) from financing activities

     (77 )     787  
                

Effect of changes in foreign exchange rates on cash

     8       (17 )
                

Increase in cash and equivalents

     797       1,077  

Add: Cash balance of discontinued operations at beginning of year

     14       36  

Less: Cash balance of discontinued operations at end of quarter

     —         (62 )

Cash and equivalents at beginning of year

     2,231       533  
                

Cash and equivalents at end of quarter

   $ 3,042     $ 1,584  
                

COMPONENTS OF CHANGES IN CURRENT ASSETS AND LIABILITIES:

    

(Increase) decrease in trade accounts receivable

   $ (43 )   $ 3  

(Increase) decrease in inventories

     (97 )     11  

Increase in other current assets

     (34 )     (84 )

Decrease in accounts payable

     (57 )     (118 )

(Decrease) increase in accrued liabilities

     (347 )     117  
                

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

   $ (578 )   $ (71 )
                

See accompanying Notes to Consolidated Financial Statements.

 

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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 quarters ended September 30, 2006 and October 1, 2005, options to purchase 45.8 million and 44.9 million shares of the corporation’s common stock had exercise prices that 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 average shares outstanding declined in the first quarter of fiscal 2007 as a result of shares repurchased under the corporation’s ongoing share repurchase program. The corporation repurchases common stock at times management deems appropriate, given current market valuations. The corporation has indicated that it expects to repurchase $500 million of the corporation’s common stock in fiscal 2007, using either cash generated from operations, proceeds from borrowings or proceeds from business dispositions. During the first quarter of fiscal 2007, the corporation repurchased 16.4 million shares of common stock for a purchase price of $250 million. Due to the timing of the purchases, $185 million of cash was expended in the first quarter with the remaining $65 million reflected in accounts payable on the Condensed Consolidated Balance Sheet at the end of the period. The $65 million payable was settled in the first several days after the end of the quarter. The timing and amount of share repurchases for the remainder of fiscal 2007 and beyond will be based upon market conditions and other factors. The following is a reconciliation of net income to net income per share – basic and – diluted for the first quarters of fiscal 2007 and fiscal 2006:

Computation of Net Income per Common Share

(In millions, except per share data)

 

     Quarter Ended  
     First Quarter
2007
   First Quarter
2006
 

Income from continuing operations

   $ 255    $ 102  

Income (loss) from discontinued operations, net of tax

     62      (35 )

Gain on sale of discontinued operations, net of tax

     16      —    
               

Net income

   $ 333    $ 67  
               

Average shares outstanding – basic

     758      779  

Dilutive effect of stock option and award plans

     3      3  
               

Diluted shares outstanding

     761      782  
               

Income from continuing operations per share

     

Basic

   $ 0.34    $ 0.13  
               

Diluted

   $ 0.34    $ 0.13  
               

Income from discontinued operations per share

     

Basic

   $ 0.10    $ (0.04 )
               

Diluted

   $ 0.10    $ (0.04 )
               

Net Income per Common Share

     

Basic

   $ 0.44    $ 0.09  
               

Diluted

   $ 0.44    $ 0.09  
               

2. Segment Information

The following is a general description of the corporation’s six business segments. In the first quarter of fiscal 2007, the corporation completed the spin off of its branded apparel operations in the Americas/Asia. The Branded Apparel Americas/Asia business was previously reported as a separate segment. This business, which is now known as Hanesbrands Inc. (Hanesbrands) was spun off to the corporation’s shareholders, and reported as a discontinued operation, in the first quarter of fiscal 2007. Prior period results have been restated to reflect this business as a discontinued operation. The spin off of Hanesbrands is more fully described below in Note 3, “Discontinued Operations.”

 

    North American Retail Meats – sells a variety of packaged meat products to retail customers in North America.

 

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    North American Retail Bakery – sells a variety of bakery products to retail customers in North America and includes the corporation’s U.S. Senseo retail coffee business.

 

    Foodservice – sells a variety of meats, bakery, and beverage products to foodservice customers in the U.S.

 

    International Beverage - sells coffee and tea products in major markets around the world, including Europe, Australia and Brazil.

 

    International Bakery – sells a variety of bakery and dough products to retail and foodservice customers in Europe and Australia.

 

    Household and Body Care - sells products in four primary categories – body care, air care, shoe care and insecticides.

The following is a summary of sales and operating segment income by business segment for the first quarters of fiscal years 2007 and 2006.

 

     Net Sales     Income from Continuing Operations
Before Income Taxes
 

(In millions)

   First Quarter
2007
    First Quarter
2006
    First Quarter
2007
    First Quarter
2006
 

North American Retail Meats

   $ 630     $ 615     $ 27     $ 17  

North American Retail Bakery

     498       461       5       (4 )

Foodservice

     538       527       21       15  

International Beverage

     572       532       90       62  

International Bakery

     200       192       14       12  

Household and Body Care

     465       446       78       80  
                                

Total business segments

     2,903       2,773       235       182  

Intersegment sales

     (12 )     (10 )     —         —    
                                

Total net sales and operating segment income

     2,891       2,763       235       182  

Amortization of intangibles

     —         —         (17 )     (15 )

General corporate expenses

     —         —         (84 )     (66 )

Contingent sale proceeds

     —         —         120       114  
                                

Total net sales and operating income

     2,891       2,763       254       215  

Net interest expense

     —         —         (49 )     (54 )
                                

Net sales and income from continuing operations before income taxes

   $ 2,891     $ 2,763     $ 205     $ 161  
                                

3. Discontinued Operations

As part of the corporation’s announced transformation plan, steps were taken to dispose of eight businesses. As of September 30, 2006, all of these businesses have been disposed of and are reported as discontinued operations in the current and prior periods. The amounts in the table below reflect the operating results of the businesses reported as discontinued operations. The impact of impairments, which are discussed later in this note, are included in these operating results.

 

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The following is a summary of the operating results of the corporation’s discontinued operations:

 

     First Quarter Fiscal 2007    First Quarter Fiscal 2006  

(In millions)

   Net Sales    Pretax
Income
(Loss)
   Income
(Loss)
   Net Sales    Pretax
Income
(Loss)
    Income
(Loss)
 

Direct Selling

   $ —      $ —      $ —      $ 112    $ 4     $ —    

U.S. Retail Coffee

     —        —        —        62      (45 )     (39 )

European Branded Apparel

     —        —        —        281      (179 )     (135 )

European Nuts & Snacks

     —        —        —        13      1       1  

U.K. Apparel

     —        —        —        113      (3 )     (2 )

U.S. Meat Snacks

     —        —        —        8      —         —    

European Meats

     114      7      3      284      24       44  

Branded Apparel Americas/Asia

     787      85      59      1,137      122       96  
                                            

Total

   $ 901    $ 92    $ 62    $ 2,010    $ (76 )   $ (35 )
                                            

Results of Discontinued Operations – Net sales related to the discontinued operations in the first quarter of fiscal 2007 and 2006 were $901 million and $2,010 million, respectively. Subsequent to the first quarter of fiscal 2006, the corporation disposed of the businesses classified as discontinued operations. The corporation closed on the sale of its European Meats business on August 8, 2006 and completed the spin off of the Branded Apparel Americas/Asia business on September 5, 2006. The operating results of these two businesses are reflected in discontinued operations through the date of disposition.

In the first quarter of fiscal 2007, income from discontinued operations was $62 million as compared to a loss of $35 million in the comparable period of fiscal 2006. The $35 million loss recognized in the first quarter of fiscal 2006 included a $171 million after-tax impairment charge, the components of which are set out and described below.

 

     First Quarter Fiscal 2006  

(In millions)

   Pretax
Impairment
Charge
    Tax
Benefit
   After-tax
Charge
 

European Branded Apparel

   $ (179 )   $ 47    $ (132 )

U.S. Retail Coffee

     (44 )     5      (39 )
                       

Total Impairment Charge Recognized in Discontinued Operations

   $ (223 )   $ 52    $ (171 )
                       

European Branded Apparel Impairment – During fiscal 2005, steps were taken to market and identify potential buyers for this business. As part of this process, the corporation received a series of nonbinding bids for this business. During the process, the operating results of the business deteriorated and failed to meet planned expectations. Prospective buyers reacted to this downturn by progressively lowering their offers. In the first quarter of fiscal 2006, the corporation entered into exclusive negotiations with a prospective buyer, classified the business as held for sale and reported it as a discontinued operation. As a result of these events in the first quarter of fiscal 2006, the corporation conducted an impairment review and utilizing the agreed upon selling price, a pretax impairment charge of $179 million was recognized. The sale of this business closed in the third quarter of fiscal 2006.

 

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U.S. Retail Coffee Impairment – During fiscal 2005, the corporation initiated steps to dispose of certain assets in this business. At the end of fiscal 2005, the carrying value of the business exceeded the estimated future cash flows and a pretax impairment charge of $45 million was recognized. During the first quarter of 2006, the corporation began to actively market the assets of the U.S. Retail Coffee business, classified the asset group as held for sale and allocated a portion of the goodwill associated with the U.S. coffee reporting unit to the retail coffee asset group to be sold. In October 2005, the corporation announced that it had entered into an agreement to sell the U.S. Retail Coffee business. As a result of allocating the goodwill to the U.S. Retail Coffee business to be sold, and utilizing the agreed-upon selling price of the business, the corporation recognized a pretax impairment charge of $44 million in the first quarter of fiscal 2006 to record the impairment of $29 million of goodwill and $15 million of other long-lived assets. No tax benefit was recognized on the goodwill impairment. The U.S. Retail Coffee business was sold in December 2005.

Gain on the Sale of Discontinued Operations

During the first quarter of fiscal 2007, the corporation completed the disposition of three businesses reported as discontinued operations. The gain recognized in the first quarter of fiscal 2007 is summarized in the following table. A further discussion of each disposition follows:

 

     First Quarter of Fiscal 2007  

(In millions)

   Pretax Gain
(Loss) on
Sale
    Tax
Charge
    After-tax
Gain (Loss)
 

European Meats

   $ 34     $ —       $ 34  

European Branded Apparel

     8       (2 )     6  

Branded Apparel Americas/Asia

     (24 )     —         (24 )
                        

Total

   $ 18     $ (2 )   $ 16  
                        

Transactions completed during the first quarter of fiscal 2007:

European Meats – During fiscal 2006, the corporation initiated steps to sell this business, received a series of nonbinding offers and entered into discussions with various third parties who had expressed interest in acquiring this business. At the end of the third quarter of fiscal 2006, the corporation concluded that it was probable that the business would be sold in the next year, classified the business as held for sale and reported it as a discontinued operation. The carrying value of the business, including the cumulative translation adjustment, was determined to exceed its fair value and the corporation evaluated the recoverability of the long-lived assets. The measurement process utilized the third party offers received for the business and involved a number of judgments, including estimates of the fair value of the property and amortizable intangible assets of the business. As a result of the evaluation, the corporation recognized a $125 million goodwill impairment charge with no tax benefit in the third quarter of fiscal 2006. In June 2006, the corporation entered into a definitive agreement to sell this business to Smithfield Foods. The transaction closed in August 2006 after receiving European regulatory approval and the corporation recognized a pretax and after tax gain of $34 million on the sale. The capital gain related to this transaction was offset by capital losses on other disposition transactions. A total of $337 million of cash proceeds was received from the sale of the business and an additional $238 million was received from the repayment of an obligation to the corporation, which was included in the net assets sold.

The sale agreement provides for working capital and other customary post-closing adjustments relating to the assets transferred. The final resolution of these items may impact the gain recognized. The corporation has not and will not have any significant continuing involvement in the business after the disposal date and does not expect any material direct cash inflows or outflows with the sold entity.

 

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European Branded Apparel – Substantially all of the European Branded Apparel business was sold in February 2006, except certain operations in the Philippines that were awaiting local governmental approval to legally transfer the assets. Under the terms of the sale agreement, the buyer of this business assumed financial responsibility for all of the operations, including the Philippines business, at that time, even though legal transfer of the Philippines assets had not been completed. In September 2006, upon receiving local government approval, the corporation completed the legal transfer of the assets and recognized a pretax and after-tax gain of $8 million and $6 million, respectively. Under the terms of the sale agreement of the business, the buyer assumed financial responsibility for the Philippines business in February 2006 upon the initial closing of the sale transaction. As such, no financial results for the Philippines business are included in the results of the corporation after that date.

The corporation has no significant continuing involvement in this business after the disposal date and does not expect any material direct cash inflows or outflows with the sold entity.

Branded Apparel Americas/Asia – In February 2005, as part of its transformation plan, the corporation announced its intent to spin off the corporation’s apparel business in the Americas/Asia. This business is referred to as Branded Apparel Americas/Asia. In preparation for the spin off, the corporation incorporated Hanesbrands Inc., a Maryland corporation, to which it transferred the assets and liabilities that relate to the Branded Apparel Americas/Asia business. On September 5, 2006, Hanesbrands borrowed $2,600 million from a group of banks. Net of loan origination fees, the corporation received $2,558 million of cash proceeds. Using a portion of the proceeds received from the borrowing, Hanesbrands paid a dividend of $1,950 million to the corporation. Immediately following this dividend payment, Sara Lee distributed to each stockholder of record one share of Hanesbrands common stock for every eight shares of Sara Lee common stock held. The spin off was tax free to the corporation and its shareholders. The net assets of the Hanesbrands business distributed were $3 million and this amount is reflected as a dividend in the corporation’s Consolidated Statements of Common Stockholders’ Equity.

After the spin off was completed, Hanesbrands paid $450 million to the corporation to settle the note payable it had with Sara Lee Corporation. In addition, the corporation recognized $24 million of additional investment banker and other fees as a direct result of this transaction. These amounts are recognized as part of the net gain on disposal of discontinued operations in the first quarter of fiscal 2007.

The corporation and Hanesbrands have entered into a transitional services agreement to provide for the orderly separation of the two businesses and transition of various functions and processes. The terms of the agreement apply to specific functions or actions including certain accounting, payroll and tax processing, information technology services, and other services that will be performed for certain periods of time, which in each case is less than one year. The corporation has no other significant continuing involvement in this business after the disposal date and does not expect any material direct cash inflows or outflows with this business.

The following is a summary of the net assets held for disposal as of September 30, 2006 and July 1, 2006. At September 30, 2006, all assets reported as discontinued operations had been disposed of. At July 1, 2006, these amounts included the net assets of the Branded Apparel Americas/Asia, European Meats, and the European Branded Apparel business in the Philippines. The change in the net assets held for disposal between July 1, 2006 and September 30, 2006 is the result of the assets disposed of in the spin off of Hanesbrands and completed sales transactions.

 

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(In millions)

   September 30,
2006
   July 1,
2006
 

Cash and short-term investments

   $ —      $ 14  

Trade accounts receivable

     —        680  

Inventories

     —        1,367  

Other current assets

     —        91  
               

Total current assets of discontinued operations held for disposal

     —        2,152  
               

Property

     —        831  

Trademarks and other intangibles

     —        287  

Goodwill

     —        279  

Other assets

     —        166  
               

Assets of discontinued operations held for disposal

   $ —      $ 3,715  
               

Notes payable

   $ —      $ 7  

Accounts payable

     —        344  

Accrued expenses and other current liabilities

     —        571  
               

Total current liabilities of discontinued operations held for disposal

     —        922  
               

Other liabilities

     —        367  

Cumulative translation adjustment of businesses held for disposal

     —        (224 )
               

Liabilities and cumulative translation adjustment of discontinued operations held for disposal

   $ —      $ 1,065  
               

4. Exit, Disposal and Transformation Activities

In February 2005, the corporation announced a transformation plan designed to improve the corporation’s performance and better position it for long-term growth. This plan, which is expected to be completed by 2010, will result in the corporation taking a number of actions which can be summarized as follows:

1) Exit Activities, Asset and Business Disposition Actions – These amounts primarily relate to costs to sever employees and exit leases, as well as gains or losses on the disposition of assets or asset groupings that do not qualify as discontinued operations.

2) Transformation Costs – These amounts primarily relate to:

 

    Costs to retain and relocate employees, as well as costs to recruit new employees.

 

    Accelerated depreciation and amortization associated with decisions to dispose of or abandon the use of certain tangible and intangible assets at dates earlier than previously anticipated.

 

    Expenses associated with the installation of new information systems.

 

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The reported results for the first quarter of fiscal years 2007 and 2006 reflect amounts recognized for exit, disposal and transformation actions, including the impact of certain activities that were completed for amounts more favorable than previously estimated. The following is a summary of the (income) expense associated with these actions:

 

     First Quarter Ended  

(In millions)

   September 30,
2006
    October 1,
2005
 

Exit activities

   $ 15     $ 29  

Asset and business disposition actions

     (15 )     (29 )

Transformation and other restructuring activities

     43       34  
                
     43       34  

Adjustments to charges recognized in prior periods

     (1 )     —    
                

    Reduction in income from continuing operations before income taxes

   $ 42     $ 34  
                

The following table illustrates where the costs (income) associated with these actions are recognized in the Consolidated Statements of Income of the corporation:

 

     First Quarter Ended  

(In millions)

   September 30,
2006
   

October 1,

2005

 

Cost of sales:

    

Accelerated depreciation

   $ 15     $ 3  

Transformation charges

     3       —    

Selling, general and administrative expenses:

    

Transformation charges

     24       24  

Accelerated depreciation

     1       7  

Net charges for (income from):

    

Exit activities

     14       29  

Asset and business dispositions

     (15 )     (29 )
                

Reduction in income from continuing operations before income taxes

   $ 42     $ 34  

Income tax benefit

     (16 )     (12 )
                

Reduction in income from continuing operations

   $ 26     $ 22  
                

Impact on diluted EPS from continuing operations

   $ 0.03     $ 0.03  
                

The impact of these actions on the corporation’s business segments and unallocated corporate expenses is summarized as follows:

 

     First Quarter Ended  

(In millions)

   September 30,
2006
    October 1,
2005
 

North American Retail Meats

   $ 21     $ 10  

North American Retail Bakery

     5       9  

Foodservice

     5       3  

International Beverage

     —         18  

International Bakery

     —         5  

Household and Body Care

     (10 )     (20 )
                

Decrease in operating segment income

     21       25  

Increase in general corporate expense

     21       9  
                

Total

   $ 42     $ 34  
                

The following provides a detailed description of the exit, disposal and transformation activities impacting the reported results for the first quarter of fiscal years 2007 and 2006.

First Quarter of Fiscal 2007

The composition of the $43 million charge related to exit, disposal and transformation activities approved during the first quarter of fiscal 2007 is as follows:

Amounts Recognized in “Net charges for exit activities, asset and business dispositions” line of the Consolidated Statement of Income –

 

  $12 million of the net charge is for the cost associated with terminating 541 employees and providing them with severance benefits. Certain of these employees are receiving termination benefits in accordance with benefit plans previously communicated to the affected employee group or with local employment laws. The remaining employees are receiving benefits under a special events termination plan and their termination costs are being accrued over their remaining service period. The specific locations of these employees are summarized in a table contained in this note.

 

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$3 million of the net charge is for the cost of certain noncancelable lease obligations. The lease costs relate to the exit of two administrative buildings for the Foodservice and Household and Body Care segments. Both facilities have been exited.

 

$15 million of the net charge relates to the net gains realized on various asset and business disposition actions. Included in this amount is a $19 million gain related to completed transactions in the Household and Body Care business segment. The most significant of these transactions is a $14 million gain on the sale of a Spanish office building and a $4 million gain on the sale of an Australian manufacturing and administrative facility. The total cash proceeds from these asset dispositions were $26 million. Offsetting these gains are $4 million of net charges consisting primarily of costs associated with the disposal of businesses.

Amounts Recognized in “Cost of sales” and “Selling, general and administrative expenses” lines of the Consolidated Statement of Income –

 

$16 million of the net charge is related to accelerated depreciation recognized on certain assets targeted for disposal. Of the $16 million total charge, $15 million is reflected in the “Cost of sales” line and relates to the disposal of equipment from various U.S. manufacturing sites. The remaining $1 million of accelerated depreciation is reflected in the “Selling, general and administrative expenses” line and relates to the closure of a domestic research and development facility.

 

$27 million of the net charge relates to various costs associated with the corporation’s ongoing transformation plan. Of this amount, $3 million is recognized in the “Cost of sales” line and $24 million is recognized in the “Selling, general and administrative expenses” line. Substantially all of these costs are included in the following categories:

Employee Related Costs – As part of the transformation plan, the corporation decided to centralize the management of its North American and European operations. As a result of this action, costs were incurred to relocate employees, recruit new employees and pay retention bonuses in order to preserve business continuity.

Information Technology Costs – In order to improve operational efficiency, the corporation decided to implement common information technology systems across the organization. Costs associated with assessing current systems, the evaluation of alternatives and process re-engineering were expensed as incurred.

Consulting Costs – The corporation engaged a number of third-party consultants to assist in the development of strategic operating and financial plans, as well as to provide employee training and assistance in implementing the transformation plan.

 

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The following table summarizes the location and business segment of the 541 employees included in the first quarter charge:

 

Number of Employees

   North
American
Retail
Meats
   North
American
Retail
Bakery
   Foodservice    International
Beverage
   International
Bakery
   Household
and Body
Care
   Corporate    Total

United States

   409    19    58    —      —      —      2    488

Europe

   —      —      —      —      —      53    —      53
                                       
   409    19    58    —      —      53    2    541
                                       

First Quarter of Fiscal 2006

The composition of the $34 million charge related to exit, disposal and transformation activities approved during the first quarter of fiscal 2006 was as follows:

Amounts Recognized in “Net charges for exit activities, asset and business dispositions” line of the Consolidated Statement of Income –

 

  $29 million of the net charge was for the cost associated with terminating 446 employees and providing them with severance benefits in accordance with benefit plans previously communicated to the affected employee group or with local employment laws.

 

  $29 million of the net charge related to the net gains realized on various asset and business disposition actions. The most significant of these transactions was a $28 million gain realized on the sale of certain European skincare and sunscreen assets. Also included in this amount was a $4 million gain realized on the disposal of an investment in a foreign business and a $3 million gain related to the sale of a corporate aircraft. The total cash proceeds from these asset dispositions were $99 million. Offsetting these gains was $6 million of professional fees incurred in connection with preparing certain businesses for disposition.

Amounts Recognized in “Cost of sales” and “Selling, general and administrative expenses” lines of the Consolidated Statement of Income –

 

  $10 million of the net charge was related to accelerated depreciation recognized on certain assets targeted for disposal. Of the $10 million total charge, $3 million was reflected in the “Cost of sales” line and related to the disposal of two manufacturing facilities and certain manufacturing equipment related to the North American Retail Bakery operation. The remaining $7 million of accelerated depreciation was reflected in the “Selling, general and administrative expenses” line and relates to the closure of four facilities and the related disposal of furniture, leasehold improvements and equipment.

 

  $24 million of the net charge related to various costs associated with the corporation’s ongoing transformation plan. All of these costs were recognized in the “Selling, general and administrative expenses” line. Substantially all of the costs can be classified as either employee related costs or consulting costs. Each of these categories has been previously described in this note.

Status of Restructuring Reserves

In prior periods, the corporation approved and executed a number of actions to lower its overall cost structure. These actions are more fully described in the corporation’s annual Form 10-K and the following presents the current status of those actions and the amounts recognized on the Condensed Consolidated Balance Sheets of the corporation.

 

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Fiscal 2006 Restructuring Actions

The following table summarizes the net charges recognized for the exit, disposal and transformation activities approved during fiscal 2006 for continuing operations and the related status as of September 30, 2006.

 

(In millions)

   Exit and
Disposal Costs
Recognized
    Non-Cash
Credits and
(Charges)
    Asset and
Business
Disposition
Gains
   Cash
Payments
    Change in
Estimate
   

Accrued
Costs
as of

Sept. 30,
2006

Employee termination and other benefits

   $ 159     $ —       $ —      $ (53 )   $ (1 )   $ 105

Noncancelable lease and other contractual obligations

     8       —         —        (6 )     —         2

Losses on abandonment of assets

     6       (6 )     —        —         —         —  

Asset and business disposition actions

     (79 )     —         118      (39 )     —         —  

Accelerated depreciation

     39       (39 )     —        —         —         —  

Transformation costs

     159       (26 )     —        (126 )     —         7

Vacation policy change

     (14 )     14       —        —         —         —  
                                             
   $ 278     $ (57 )   $ 118    $ (224 )   $ (1 )   $ 114
                                             

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

 

Number of Employees

   North
American
Retail
Meats
   North
American
Retail
Bakery
   Foodservice    International
Beverage
   International
Bakery
   Household
and Body
Care
   Corporate    Total

United States

   339    291    94    —      —      2    25    751

Canada

   —      —      —      —      —      1    —      1

Europe

   —      —      —      737    138    200    1    1,076

Australia

   —      —      —      39    17    75    —      131

Asia

   —      —      —      —      —      33    —      33
                                       
   339    291    94    776    155    311    26    1,992
                                       

As of Sept. 30, 2006

                       

Actions Completed

   259    206    94    534    91    246    26    1,456

Actions Remaining

   80    85    —      242    64    65    —      536
                                       
   339    291    94    776    155    311    26    1,992
                                       

Significant actions completed during the quarter and the status of the remaining elements of the fiscal 2006 plan can be summarized as follows:

Employee termination and other benefits – During the first quarter of fiscal 2007, the corporation severed 358 employees and expects to sever the remaining 536 employees before the end of the fiscal year. During the quarter, certain of these actions were completed for amounts that differed from those originally estimated. Actual costs to settle termination obligations varied from original estimates, and certain employees originally targeted for termination were not severed as originally planned. As a result, costs previously accrued were adjusted and resulted in an increase of $1 million to income from continuing operations before income taxes. Substantially all of the $105 million of remaining accrued costs is expected to be paid out within the next two years.

 

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Non-cancelable lease and other contractual obligations – As of the end of fiscal 2006, the corporation had exited all of the facilities contemplated in this charge, and it is expected that the remaining accrual represents the amounts currently due under these arrangements.

Accelerated depreciation – Of the $39 million total accelerated depreciation recognized, $30 million was reflected in the “Cost of sales” line and relates to the disposal of four manufacturing facilities and various manufacturing equipment. The three owned facilities had been closed as of end of fiscal 2006 and one of these has since been sold. The fourth facility was leased and had been exited by the end of fiscal 2006. For the manufacturing equipment, a portion has ceased being used with the remainder still in service. Additional accelerated depreciation has been recognized on this equipment during the first quarter of fiscal 2007. All of the equipment is expected to be taken out of service by the end of fiscal 2007. The remaining $9 million of accelerated depreciation was reflected in the “Selling, general and administrative expenses” line and relates to the exit of four administrative offices. One of the four facilities is owned and was closed as of the end of fiscal 2006. It is currently being marketed for sale. For the three leased facilities, two have been exited as of the end of the first quarter of fiscal 2007, with the remaining one scheduled to be exited by the end of fiscal 2007.

Fiscal 2005 Restructuring Actions

The following table summarizes the net charges taken for the exit, disposal and restructuring actions approved during fiscal 2005 for continuing operations and the related status as of September 30, 2006.

 

(In millions)

   Exit and
Disposal Costs
Recognized
    Non-Cash
Credits and
(Charges)
    Asset and
Business
Disposition
Gains
   Cash
Payments
    Change in
Estimate
   

Accrued
Costs

as of

Sept. 30,
2006

Employee termination and other benefits

   $ 73     $ —       $ —      $ (45 )   $ (2 )   $ 26

Noncancelable lease and other contractual obligations

     6       —         —        (6 )     —         —  

Asset and business disposition actions

     (27 )     —         61      (34 )     —         —  

Curtailment gains on benefit plans

     (28 )     28       —        —         —         —  

Accelerated depreciation

     21       (21 )     —        —         —         —  

Accelerated amortization

     9       (9 )     —        —         —         —  

Transformation costs

     9       —         —        (9 )     —         —  
                                             
   $ 63     $ (2 )   $ 61    $ (94 )   $ (2 )   $ 26
                                             

The following table summarizes the employee terminations by location and business segment. All actions had been completed by the end of fiscal 2006.

 

Number of Employees

   North
American
Retail
Meats
   North
American
Retail
Bakery
   Foodservice    International
Beverage
   International
Bakery
   Household
and Body
Care
   Corporate    Total

United States

   23    152    198    —      —      —      10    383

Europe

   —      —      —      110    48    137    1    296

Australia

   —      —      —      —      —      60    —      60
                                       
   23    152    198    110    48    197    11    739
                                       

Significant actions completed during the quarter and the status of the remaining elements of the fiscal 2005 plan can be summarized as follows:

Employee terminations and other benefits – All termination actions were completed as of the end of fiscal 2006 and substantially all of the $26 million of accrued costs is expected to be paid out within the next year.

 

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Accelerated depreciation – The $21 million of accelerated depreciation related to the disposal of six owned manufacturing facilities and certain manufacturing equipment. As of the end of the first quarter of fiscal 2007, three of the facilities have been sold and the remaining three facilities have been closed and are currently being marketed for sale.

Other Restructuring Actions

In prior periods, the corporation had approved and completed various actions to exit certain defined business activities and lower its cost structure. As of September 30, 2006, the accrued liabilities remaining in the Condensed Consolidated Balance Sheet related to these actions total $6 million and represent various severance and noncancelable lease obligations. These accrued amounts are expected to be satisfied in cash and will be funded from operations.

5. 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
    Additional
Minimum
Pension Liability
Adjustment
    Accumulated
Other
Comprehensive
Income
 

Balance at July 2, 2005

   $ (731 )   $ (14 )   $ (816 )   $ (1,561 )

Other comprehensive income (loss) activity

     (11 )     (28 )     —         (39 )
                                

Balance at October 1, 2005

     (742 )     (42 )     (816 )     (1,600 )

Other comprehensive income (loss) activity

     81       —         180       261  
                                

Balance at July 1, 2006

     (661 )     (42 )     (636 )     (1,339 )

Spin off of Hanesbrands

     5       4       58       67  

Disposition of European Meats business

     229       —         —         229  

Other comprehensive income (loss) activity

     43       11       (36 )     18  
                                

Balance at September 30, 2006

   $ (384 )   $ (27 )   $ (614 )   $ (1,025 )
                                

6. 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 description of the corporation’s hedging programs and instruments is included in the corporation’s fiscal 2006 annual report on Form 10-K which is filed with the Securities and Exchange Commission. As of July 1, 2006, the net accumulated derivative loss recorded in Accumulated Other Comprehensive Income was $42 million. During the three months ended September 30, 2006, $15 million of accumulated net derivative gains were deferred into Accumulated Other Comprehensive Income, $4 million of accumulated net derivative gains were released from Accumulated Other Comprehensive Income into earnings since the related hedged item was realized during the period, and $4 million of net derivative losses were transferred to Hanesbrands as part of the spin off of this business, resulting in a balance in Accumulated Other Comprehensive Income at September 30, 2006 of an accumulated loss of $27 million. During the first quarter of fiscal 2007, the corporation recognized a $3 million loss due to hedge ineffectiveness. At September 30, 2006, the maximum maturity date of any cash flow hedge was approximately 1.0 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 $14 million, at the time the underlying hedged transaction is realized.

 

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Other disclosures related to amounts excluded from the assessment of 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 three months ended September 30, 2006, a net loss of $16 million arising from effective hedges of net investments has been reflected in the cumulative translation adjustments account within consolidated stockholders’ equity.

7. Pension and Other Postretirement Benefit Plans

The components of the net periodic pension cost and the postretirement medical cost (income) related to continuing operations for the first quarter of fiscal 2007 and 2006 are as follows:

 

     

First Quarter

Fiscal 2007

   

First Quarter

Fiscal 2006

 

(In millions)

   Pension     Postretirement
Medical and
Life Insurance
    Pension     Postretirement
Medical and
Life Insurance
 

Service cost

   $ 24     $ 2     $ 26     $ 2  

Interest cost

     62       3       58       3  

Expected return on plan assets

     (69 )     —         (56 )     —    

Amortization of

        

Transition (asset) obligation

     —         (1 )     —         —    

Prior service cost

     2       (6 )     —         (5 )

Net actuarial loss

     16       1       18       1  
                                

Net periodic benefit cost

   $ 35     $ (1 )   $ 46     $ 1  
                                

The net periodic benefit cost for continuing operations of the corporation’s defined benefit pension plans in the first quarter of fiscal 2007 was $11 million lower than in fiscal 2006 as a result of the following:

 

  Service cost declined primarily as a result of changes in the corporation’s benefit plans and an increase in the discount rate. Individuals hired to work in domestic operations after January 1, 2006 are no longer eligible to participate in the corporation’s defined benefit pension plans. In addition, certain domestic employees on January 1, 2006 elected to terminate their participation in defined benefit pension plans and began participating in a company sponsored defined contribution plan.

 

  The expected return on assets increased as a result of significant cash contributions made to the corporation’s pension plans in fiscal 2006 and better than expected returns on plan assets in fiscal 2006. Both of these events resulted in plan assets at the start of fiscal 2007 exceeding plan assets at the start of fiscal 2006.

 

  Unrecognized losses at the start of fiscal 2007 were lower than at the start of fiscal 2006 primarily as a result of better than anticipated asset returns and the impact of eliminating benefits to certain employee groups. This in turn resulted in a lower level of unrecognized loss amortization.

 

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As a result of the spin off of Hanesbrands, the corporation transferred certain liabilities and assets associated with defined benefit pension plans and postretirement medical and life plans to Hanesbrands. The following tables present the funded status of all Sara Lee plans as of the end of fiscal 2006 and the amounts transferred to Hanesbrands measured as of the spin off date.

 

     Defined Benefit Pension Plans     Postretirement Medical and Life
Insurance Plans
 
     Total
Sara Lee
    Transferred to
Hanesbrands
    Total
Sara Lee
    Transferred to
Hanesbrands
 

Projected benefit / Accumulated postretirement benefit obligation

   $ 5,764     $ 857     $ 279     $ 51  

Plan assets

     4,744       634       1       —    
                                

Funded status

     (1,020 )     (223 )     (278 )     (51 )

Unrecognized -

        

Net initial asset

     —         —         (11 )     1  

Prior service cost

     90       —         (245 )     (36 )

Net actuarial loss

     1,055       88       53       10  
                                
   $ 125     $ (135 )   $ (481 )   $ (76 )
                                

During the first quarters of fiscal 2007 and 2006, the corporation contributed $88 million and $22 million, respectively, to its defined benefit pension plans. At the present time, the corporation expects to contribute $184 million of cash to its defined benefit pension plans in fiscal 2007. The exact amount of cash contributions made to pension plans in any year is dependent upon a number of factors including minimum funding requirements in the jurisdictions in which the corporation operates and arrangements made with trustees of certain foreign plans. As a result, the actual funding in fiscal 2007 may differ from the current estimate.

8. 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 July 15, 2009. 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 fiscal 2007 and fiscal 2006 payments each passed in the first quarter of each fiscal year and the corporation received the annual payments. The fiscal 2007 annual payment was equivalent to $120 million and the fiscal 2006 annual payment was equivalent to $114 million based upon the respective exchange rates on the dates of receipt. These amounts were recognized in the corporation’s earnings when received. The amount received in fiscal 2006 increased diluted earnings per share by $0.15 per share and the amount received in fiscal 2007 is expected to increase diluted earnings per share by $0.16 per share.

9. Goodwill

Substantially all of the change in the goodwill balance between July 1, 2006 and September 30, 2006 is due to the impact of changes in foreign currency exchange rates.

 

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10. Income Taxes

Effective Annual Tax Rate for Interim Reporting—Generally accepted accounting standards require that interim period tax provisions be determined as follows:

 

  At the end of each quarter, the corporation estimates the tax that will be provided for the fiscal year stated as a percentage of estimated “ordinary” income for the fiscal year. The term ordinary income refers to income from continuing operations before income taxes, excluding significant unusual or infrequently occurring items. Discontinued operations are excluded in determining ordinary income. Changes in tax laws or rates and effects of changes in judgment about beginning of the year valuation allowances are excluded from the estimated annual effective rate.

This estimated annual effective rate is applied to the year-to-date “ordinary” income at the end of each quarter to compute the year-to-date tax applicable to ordinary income. The tax expense or benefit related to ordinary income in each quarter is the difference between the most recent year-to-date and the prior quarter year-to-date computations.

 

  The tax effects of significant unusual or infrequently occurring items, as well as the tax effects of changes in tax rates or laws and changes in judgments about beginning of the year valuation allowances are recognized in the interim period in which the events occur.

The determination of the annual effective tax rate is based upon a number of significant estimates and judgments, including the estimated annual pretax income of the corporation in each tax jurisdiction in which it operates and the development of tax planning strategies during the year. In addition, as a global commercial enterprise, the corporation’s interim tax expense can be impacted by changes in tax rates or laws, the finalization of tax audits or reviews, as well as other factors that cannot be predicted with certainty. As such, there can be significant volatility in interim tax provisions.

First Quarter Tax Expense (Benefit) – In the first quarter of fiscal 2007, the corporation’s continuing operations recognized a tax benefit of $50 million and an effective tax rate of (24.3%) as compared to tax expense of $59 million and an effective tax rate of 36.7% in the comparable period of the prior year. This rate is primarily due to the following factors:

 

  In the first quarter of fiscal 2007, the corporation signed an agreement to sell the shares of a subsidiary, which resulted in a $158 million tax benefit. As a result of the nature of this transaction, the tax benefit was recognized entirely in the first quarter and increased diluted EPS in the quarter by $0.21 per share. This transaction closed in October 2006 and the proceeds received and the net book value of the entity sold were both less than $1 million.

 

  Excluding the impact of the $158 million tax benefit, the tax expense on the continuing operations was $108 million and the effective rate was 52.5%. This effective annual tax rate on ordinary income includes an estimated charge of $194 million to repatriate all fiscal 2007 earnings outside the U.S. This estimated charge increases the estimated annual effective tax rate in the first quarter by 24%. As a result of the spin off of the Hanesbrands business and the share buyback program, the corporation concluded that it was necessary to remit all fiscal 2007 foreign earnings to the U.S.

 

  Prior to the spin off of Hanesbrands, an intercompany transaction occurred in which certain apparel trademarks were sold to a wholly-owned subsidiary in return for the shares of the subsidiary and a $450 million note. The shares of the subsidiary holding the apparel trademarks and note payable were included in the spin off of Hanesbrands and, after the completion of the spin off, this note was repaid to the corporation by Hanesbrands. As a result of these transactions, the tax basis of the apparel trademarks increased and the corporation was responsible for the related capital gain. The deferred tax asset related to the increase in the tax basis of the trademarks was transferred as part of the spin off transaction and recognized as a reduction in the corporation’s equity. The capital gain resulting from this transaction will be used to offset capital losses.

 

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11. Issued But Not Yet Effective Accounting Standards

Accounting for Uncertainty in Income Taxes – In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN48), which outlines how companies should reflect uncertain tax positions in the financial statements and expands disclosures relating to these tax positions. Under the provisions of FIN 48, an uncertain tax amount should be recognized in the financial statements if it is more likely than not that the company’s tax position will prevail and the tax amount recognized should not exceed the amount that is probable of being paid or collected. FIN 48 becomes effective for the corporation in fiscal 2008. The corporation is currently evaluating the provisions of this new standard and has not determined the impact of adopting at this time.

Accounting for Defined Benefit Pension and Other Postretirement Plans – In September 2006, the FASB issued Statement of Financial Accounting Standard (SFAS) No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” an amendment of FASB Statements Nos. 87, 88, 106, and 132(R). SFAS No. 158 requires an employer to recognize the funded status of defined benefit pension and other postretirement benefit plans as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through other comprehensive income in shareholders’ equity. The company is required to initially recognize the funded status of its defined benefit pension and other postretirement benefit plans and to provide the required disclosures as of the end of fiscal 2007. At the end of fiscal 2006, the summation of the corporation’s projected benefit obligation from defined benefit plans and the corporation’s accumulated postretirement benefit obligation exceeded plan assets by approximately $1.3 billion. The statement also eliminates the option for the corporation to use a measurement date prior to the corporation’s fiscal year end. The corporation is currently evaluating the effect that the recognition of the funded status of its plans will have on the company’s consolidated financial position, but does not believe that the adoption will have a material impact on the corporation’s consolidated results of operations.

Fair Value Measurements – In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which provides enhanced guidance for using fair value to measure assets and liabilities. SFAS No. 157 establishes a common definition of fair value, provides a framework for measuring fair value under U.S. GAAP and expands disclosure requirements about fair value measurements. SFAS No. 157 is effective for the corporation at the beginning of fiscal 2009. The corporation is currently evaluating the provisions of this new standard and has not determined the impact of adopting at this time.

SAB No. 108 – In September 2006, the SEC issued Staff Accounting Bulletin (SAB) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB No. 108). SAB No. 108 eliminates the diversity in practice surrounding how public companies quantify financial statement misstatements and establishes an approach that requires quantification and assessment of misstatements based on the effects of the misstatements on each of the company’s financial statements and the related footnote disclosures. Adoption of this new standard, which will be effective for the company’s financial statements beginning in the second quarter of fiscal 2007, is not expected to impact the company’s financial statements.

 

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Item 2

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

Introduction

The following is management’s discussion and analysis of the results of operations for the first quarter of fiscal 2007 compared with the first quarter of fiscal 2006 and a discussion of the changes in financial condition and liquidity during the first three months of fiscal 2007. The following is an outline of the analyses included herein:

 

    Overview

 

    First Quarter of Fiscal 2007

 

    Cash Flow

 

    Transformation Plan

 

    Consolidated Results – First Quarter of Fiscal 2007 Compared with First Quarter of Fiscal 2006

 

    Operating Results by Business Segment – First Quarter of Fiscal 2007 Compared with First Quarter of Fiscal 2006

 

    Financial Condition

 

    Liquidity

 

    Significant Accounting Policies and Critical Estimates

 

    Forward-looking Information

Overview

First Quarter of Fiscal 2007

During the first quarter of fiscal 2007, net sales increased $128 million, or 4.7%, over the first quarter of fiscal 2006, to $2,891 million. The strengthening of foreign currencies, particularly the euro, British pound and Brazilian real increased reported net sales by $41 million, or 1.5%. Net sales were impacted by acquisitions and dispositions in the first quarters of both fiscal 2007 and 2006. Net sales in the first quarter of fiscal 2007 include $41 million from businesses acquired after the start of the first quarter of fiscal 2006, while the first quarter of fiscal 2006 includes sales of $19 million from businesses that have been disposed of after the start of the first quarter of fiscal 2006. The net impact of acquisitions and dispositions between the first quarters of fiscal 2007 and 2006 increased net sales by $22 million, or 0.8%. The remaining net sales increase was $65 million, or 2.4%, as each of the corporation’s business segments contributed to the increase in net sales.

Operating income for the corporation in the first quarter of fiscal 2007 increased by $39 million, or 18.4%, and was composed of the following:

 

    The corporation’s gross profit margin was 37.9% in the first quarter of fiscal 2007 as compared to 38.2% in the comparable period of the prior year. The gross margin percentage declined in each of the corporation’s business segments, with the exception of the North American Retail Meats and North American Retail Bakery segments, as the corporation experienced higher costs for certain raw materials, commodities and energy, and experienced pricing pressure from a competitive marketplace. The gross profit recognized in the first quarter of fiscal 2007 was $39 million greater than in the first quarter of fiscal 2006 primarily as a result of the strengthening of foreign currencies versus the U.S. dollar and unit sales volume increases offset in part by higher business transformation costs and lower gross profit margins.

 

    Selling, general and administrative (SG&A) expenses in the first quarter of fiscal 2007 increased by $7 million over the comparable period of the prior year primarily as a result of the strengthening of foreign currencies versus the U.S. dollar offset in part by lower retirement plan costs, lower advertising and promotion costs and lower business transformation costs. SG&A expenses as a percentage of sales decreased from 34.6% in the first quarter of fiscal 2006 to 33.3% in the first quarter of fiscal 2007 primarily as a result of lower retirement plan expenses, lower advertising and promotion costs and lower costs associated with the corporation’s business transformation program.

 

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    In the first quarter of fiscal 2007, the corporation recognized $1 million of income from exit activities, asset and business dispositions, while in the first quarter of fiscal 2006, the corporation had no net charges or income.

 

    The corporation received and recognized contingent sale proceeds of $120 million in the first quarter of fiscal 2007 and $114 million in the first quarter of fiscal 2006 from the sale of the corporation’s cut tobacco business that represents the annual payments for fiscal 2007 and 2006. The difference in amounts is due to changes in foreign currency exchange rates between the periods.

In the first quarter of fiscal 2007, the corporation’s continuing operations recognized a tax benefit of $50 million and an effective tax rate of (24.3%) as compared to tax expense of $59 million and an effective tax rate of 36.7% in the comparable period of the prior year. The fiscal 2007 tax benefit is impacted by the following:

 

    In the first quarter of fiscal 2007, the corporation signed an agreement to sell the shares of a subsidiary, which resulted in a $158 million tax benefit. As a result of the nature of this transaction, the tax benefit was recognized entirely in the first quarter and increased diluted EPS in the quarter by $0.21 per share.

 

    As a result of the spin off of the Hanesbrands business and the planned share buyback program, the corporation concluded in the fourth quarter of fiscal 2006 that it was necessary to remit all fiscal 2007 foreign earnings to the U.S. The effective annual tax rate for fiscal 2007 includes an estimated charge for $194 million to repatriate all fiscal 2007 earnings outside the U.S. and this charge is being recognized in proportion to each quarter’s income.

Income from continuing operations in the first quarter of fiscal 2007 was $255 million, an increase of $153 million over the $102 million reported in the first quarter of fiscal 2006. The increase in income from continuing operations was primarily due to the increase in operating income and the decline in income taxes.

The corporation has reported its Direct Selling, U.S. Retail Coffee, European Branded Apparel, European Nuts and Snacks, U.K. Apparel, U.S. Meat Snacks, European Meats and Branded Apparel Americas/Asia businesses as discontinued operations. Further information regarding these operations is included in Note 3 to the Consolidated Financial Statements and below. The net income from discontinued operations in the first quarter of fiscal 2007 was $62 million, as compared to a net loss of $35 million in the first quarter of fiscal 2006, or an increase of $97 million between the periods. The net loss in the first quarter of fiscal 2006 was primarily due to impairment charges, exit activities and tax charges that reduced net income from discontinued operations by $175 million. The first quarter of fiscal 2007 includes a net gain on the sale of discontinued operations of $16 million, which primarily relates to the sale of the European Meats business, partially offset by expenses associated with the spin off of the Branded Apparel Americas/Asia business.

Net income in the first quarter of fiscal 2007 was $333 million, an increase of $266 million over the $67 million reported in the prior year first quarter. Diluted EPS increased from $0.09 in the first quarter of fiscal 2006 to $0.44 in the first quarter of fiscal 2007. A table which summarizes the significant items that impacted the first quarter of fiscal 2007 and 2006 is presented below.

 

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Impact of Significant Items on Income From Continuing Operations and Net Income

Amounts in millions

 

     Quarter Ended September 30, 2006     Quarter Ended October 1, 2005  

In millions, except per share data

   Pretax
Impact
    Tax     Net
Income
    Diluted
EPS
Impact(1)
    Pretax
Impact
    Tax     Net
Income
    Diluted
EPS
Impact (1)
 

Income (loss) from continuing operations

   $ 205     $ 50     $ 255     $ 0.34     $ 161     $ (59 )   $ 102     $ 0.13  
                                                                

Net (loss) income

       $ 333     $ 0.44         $ 67     $ 0.09  
                                        

Significant items affecting comparability of income from continuing operations and net income:

                

Charges for (income from) exit activities, asset and business dispositions

                

Charges for (income from) exit activities

   $ (14 )   $ 5     $ (9 )   $ (0.01 )   $ (29 )   $ 10     $ (19 )   $ (0.02 )

Income from (charges) for business disposition activities

     15       (4 )     11       0.02       29       (10 )     19       0.02  
                                                                

Subtotal

     1       1       2       —         —         —         —         —    

Charges to cost of sales and SG&A expenses

                

Transformation charges in cost of sales and SG&A

     (27 )     9       (18 )     (0.02 )     (24 )     8       (16 )     (0.02 )

Hurricane losses

     —         —         —         —         (3 )     1       (2 )     —    

Accelerated depreciation

     (16 )     6       (10 )     (0.01 )     (10 )     4       (6 )     (0.01 )
                                                                

Impact of significant items on income from continuing operations before income taxes

     (42 )     16       (26 )     (0.03 )     (37 )     13       (24 )     (0.03 )

Significant tax matters affecting comparability:

                

Tax benefit on disposition of a business

     —         158       158       0.21       —         —         —         —    
                                                                

Impact of significant items on income from continuing operations

     (42 )     174       132       0.18       (37 )     13       (24 )     (0.03 )
                                                                

Significant items impacting discontinued operations

                

European Branded Apparel impairment

     —         —         —           (179 )     47       (132 )     (0.17 )

U.S. Retail Coffee impairment

     —         —         —           (44 )     5       (39 )     (0.05 )

Charges for exit activities and transformation expenses

     —         —         —         —         (2 )     1       (1 )  

Branded Apparel Americas/Asia spin off costs

     (24 )     —         (24 )     (0.03 )        

Tax charge from European Meats business

     —         (2 )     (2 )     —         —         (3 )     (3 )     —    

Gain on sale of discontinued operations

     42       (2 )     40       0.05          
                                                                

Impact of significant items on net income

   $ (24 )   $ 170     $ 146     $ 0.19     $ (262 )   $ 63     $ (199 )   $ (0.25 )
                                                                

    Notes:

(1) EPS amounts are rounded to the nearest $0.01 and may not add to the total.

 

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Cash Flow

The corporation’s cash flow statements include amounts related to discontinued operations through the date of disposal. The cash flows related to the discontinued operations are quantified under the discussion of “Discontinued Operations” in the Consolidated Results - First Quarter of Fiscal 2007 Compared with the First Quarter of Fiscal 2006 section within Management Discussion and Analysis of Results of Operations and Financial Condition.

Cash From Operating Activities

In the first quarter of fiscal 2007, $197 million of cash was used in operating activities, while $188 million of cash was generated from operating activities in the same period of the prior year. A significant portion of the decline is related to the spin off of Hanesbrands and the disposition of the European Meats business. During the first quarter of fiscal 2007, the changes in current assets and liabilities resulted in the use of $578 million of cash. This was primarily attributable to the following:

 

  $347 million was used to pay accrued liabilities primarily related to taxes, pension and postretirement benefits, incentive compensation and interest.

 

  $97 million of cash was used to finance increases in inventory in all of the corporation’s operating segments.

 

  $57 million was used to fund accounts payable primarily in the International Beverage segment.

 

  $43 million of cash was used to finance increases in accounts receivable, primarily in the Foodservice, International Bakery and Household and Body Care segments.

 

  $34 million of cash was used to finance other current assets which primarily reflect amounts for prepaid insurance and other services.

Cash From Investment Activities

Net cash generated from investment activities was $1,063 million in the first three months of fiscal 2007 as compared to $119 million in the comparable period of fiscal 2006. In the first three months of fiscal 2007, $19 million more was spent on purchases of property and equipment and the acquisition of businesses than in the comparable quarter of the prior year. The corporation received $500 million in proceeds related to the disposition of businesses, contingent sale proceeds and the sale of assets in the first quarter of fiscal 2007 as compared to $225 million in the first quarter of fiscal 2006. The corporation received $688 million from the collection of loans receivable - $450 million was received from Hanesbrands in connection with the spin off and $238 million was collected upon the sale of the European Meats business.

Cash From Financing Activities

Net cash used in financing activities was $77 million during the first three months of fiscal 2007 as compared to $787 million of cash generated from financing activities in the prior year period. Prior to being spun off, Hanesbrands borrowed $2,600 million from a group of banks. Net of loan organization fees, the corporation received $2,558 million of cash proceeds, and this amount is included in the corporation’s borrowing of long-term debt. Using a portion of the proceeds received from the borrowing, Hanesbrands paid a dividend of $1,950 million to the corporation. Immediately following this dividend payment, Sara Lee distributed to each stockholder of record one share of Hanesbrands common stock for every eight shares of Sara Lee common stock held. $650 million of cash remained on the Hanesbrands balance sheet at the spin off date. The proceeds of the dividend from Hanesbrands and the $688 million of loan repayments were used to repay $1,644 million of short-term borrowings, repurchase $185 million of common stock and pay dividends of $151 million. The corporation repurchased a total of $250 million of common stock during the first quarter of fiscal 2007, although $185 million of this total was paid during the quarter and the remainder shortly after the end of the quarter.

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 is expected to be completed by fiscal 2010. A number of significant milestones have been completed and a number remain to be completed. Additionally, over the course of the plan, a number of significant gains and losses have been and will be recognized. The following is an update on the actions taken in the transformation plan and the impact on the first quarter of fiscal 2007.

Organization Structure

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 suburban Chicago. In Europe, the corporation announced plans to centralize management on a regional basis. The corporation expects to finalize the employee centralization in the U.S. during fiscal 2007. Management also intends on centralizing the research and development activities for North America and has established a temporary single site at the present time, while management concludes on the location of the final site. It is expected that the R&D center centralization will be finalized in fiscal 2008.

 

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In Europe, the corporation continues to execute plans to centralize management into a single location per country or region. Each centralized location will be supported by a shared services organization that will provide back-office functions. As a result of the plans to centralize management and eliminate operating locations, certain planned workforce reductions are in process.

As a result of these actions, pretax charges of $57 million were recognized in the first quarter of fiscal 2007 related to exit activities, transformation costs and accelerated depreciation in order to execute these plans, which includes $11 million of net severance costs, $3 million of costs to exit certain leased and owned facilities, $16 million of accelerated depreciation, $15 million of information technology costs related to system implementations and conversions, $5 million of relocation costs, $3 million of recruiting costs and $4 million related to consulting and other transformation and exit efforts. Transformation, exit activities and accelerated depreciation and amortization costs of $366 million were incurred for the full year in fiscal 2006. Additional restructuring actions are expected over the life of the transformation plan and further details regarding these actions are contained in this Management Discussion and Analysis and in Note 4, “Exit, Disposal and Transformation Activities,” of the Consolidated Financial Statements.

Portfolio Changes

The corporation disposed of certain businesses in order to concentrate financial and management resources on a smaller number of entities that are better positioned for increased growth.

Businesses Reported as Discontinued Operations – By the end of the first quarter of fiscal 2007, the corporation had completed the disposition of each of the businesses identified for disposal. This included eight businesses which are now reported in discontinued operations, and historical financial results have been restated to reflect these businesses as discontinued operations. Two of these business dispositions were completed in the first quarter of fiscal 2007, while the remaining transactions were completed in fiscal 2006. The following is a summary of those transactions that were completed in the first quarter of fiscal 2007.

Transactions completed during the first quarter of fiscal 2007:

European Meats – In June 2006, the corporation entered into a definitive agreement to sell the European Meats business to Smithfield Foods for $575 million in cash and the assumption of certain pension liabilities related to the business. The transaction closed in August 2006 after receiving European regulatory approval and the corporation recognized an after-tax gain of $34 million. The $575 million received at closing consists of $337 million of cash proceeds from the sale and $238 million as repayment of a loan to the corporation.

European Branded Apparel – Substantially all of this business was sold in February 2006 and an after-tax gain of $86 million was recognized in the fourth quarter of fiscal 2006. However, the sale of the operations located in the Philippines closed in the first quarter of fiscal 2007 after receiving local governmental approval. An after-tax gain of $6 million was recognized on the sale of the Philippines operations.

Branded Apparel Americas/Asia – In February 2005, the corporation announced its intent to spin off the corporation’s apparel business in the Americas and Asia. This business is referred to as Branded Apparel Americas/Asia. In preparation for the spin off, the corporation incorporated Hanesbrands Inc., a Maryland corporation, to which it transferred the assets and liabilities that relate to the Branded Apparel Americas/Asia business. On September 5, 2006,

 

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Hanesbrands borrowed $2.6 billion from a group of banks. Using a portion of the proceeds from the borrowing, Hanesbrands paid to the corporation a dividend of $1.95 billion. Sara Lee distributed pro rata to each stockholder of record as of the close of business on the record date one share of Hanesbrands common stock for every eight shares of Sara Lee common shares held. After the spin off was completed, Hanesbrands paid $450 million to the corporation to settle the note payable it had with Sara Lee Corporation. No gain or loss was recognized upon the spin off of the Hanesbrands business other than $24 million of transaction expenses that are recognized in discontinued operations. The net assets of the Hanesbrands business that were distributed totaled $3 million and are reflected in Retained Earnings and Other Comprehensive Income (Loss) in the corporation’s Statement of Common Stockholders’ Equity.

Transactions completed during fiscal 2006:

The following businesses were disposed of in fiscal 2006: Direct Selling, U.S. Retail Coffee, European Branded Apparel, European Nuts and Snacks, U.K Apparel and U.S. Meat Snacks.

Improving Operational Efficiency

The third element of the transformation plan involves initiatives to improve the operational efficiency of the corporation. These initiatives include the following:

 

    The corporation has made investments to improve information technology systems and processes. This is primarily related to the costs to implement a standardized information technology platform in the North American operations and the continued consolidation of information processing in both the U.S. and Europe. During the first quarter of fiscal 2007, the corporation recognized $15 million of expenses related to these projects and expended $4 million related to the purchase of software items. At the present time, the corporation expects that through fiscal 2010 the cost of these information technology initiatives will be approximately $200 million with approximately 75% of these costs being incurred in the remainder of fiscal 2007 and 2008.

 

    The simplification of the organization structure will result in the termination of a number of employees and the elimination of certain manufacturing facilities. The exit activities initiated by the corporation in the first quarter of fiscal 2007 are fully explained in Note 4, “Exit, Disposal and Transformation Activities,” to the Consolidated Financial Statements. The corporation expects to recognize additional exit costs to reduce employment levels in the organization and eliminate manufacturing capacity throughout the transformation plan.

 

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Consolidated Results – First Quarter of Fiscal 2007 Compared with First Quarter of Fiscal 2006

Operating results by business segment in the first quarter of fiscal 2007 compared with the first quarter of fiscal 2006 are as follows:

 

     Quarter Ended  
     Net Sales    

Income from Continuing Operations

Before Income Taxes

 

(In millions)

  

September 30,

2006

   

October 1,

2005

   

September 30,

2006

   

October 1,

2005

 

North American Retail Meats

   $ 630     $ 615     $ 27     $ 17  

North American Retail Bakery

     498       461       5       (4 )

Foodservice

     538       527       21       15  

International Beverage

     572       532       90       62  

International Bakery

     200       192       14       12  

Household and Body Care

     465       446       78       80  
                                

Total business segments

     2,903       2,773       235       182  

Intersegment sales

     (12 )     (10 )     —         —    
                                

Total net sales and operating segment income

     2,891       2,763       235       182  

Amortization of intangibles

     —         —         (17 )     (15 )

General corporate expenses

     —         —         (84 )     (66 )

Contingent sale proceeds

     —         —         120       114  
                                

Total net sales and operating income

     2,891       2,763       254       215  

Net interest expense

     —         —         (49 )     (54 )
                                

Net sales and income from continuing operations before income taxes

   $ 2,891     $ 2,763     $ 205     $ 161  
                                

The following table summarizes net sales and operating income performance for the first quarter of fiscal 2007 and 2006 and certain significant items that affected the comparability of these amounts.

 

     Quarter Ended  

Corporate Performance - (In millions)

  

September 30,

2006

   

October 1,

2005

    Change    

Percent

Change

 

Net sales

   $ 2,891     $ 2,763     $ 128     4.7 %
                              

Increase / (Decrease) in net sales from Changes in foreign currency exchange rates

   $ —       $ (41 )   $ 41    

Acquisitions / dispositions

     41       19       22    
                          

Total

   $ 41     $ (22 )   $ 63    
                          

Operating income

   $ 254     $ 215     $ 39     18.4 %
                              

Increase / (Decrease) in operating income from Contingent sale proceeds

   $ 120     $ 114     $ 6    

Changes in foreign currency exchange rates

     —         (5 )     5    

Exit activities, asset and business dispositions

     1       —         1    

Accelerated depreciation on facilities sold

     (16 )     (10 )     (6 )  

Hurricane losses

     —         (3 )     3    

Transformation charges

     (27 )     (24 )     (3 )  

Acquisitions/dispositions

     1       4       (3 )  
                          

Total

   $ 79     $ 76     $ 3    
                          

 

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Net Sales

Consolidated net sales in the first quarter of fiscal 2007 were $2,891 million, an increase of $128 million, or 4.7%, over the first quarter of fiscal 2006. The strengthening of foreign currencies, particularly the euro, British pound and Brazilian real increased reported net sales by 1.5%, or $41 million. Net sales in the first quarter of fiscal 2007 include $41 million from businesses acquired after the start of the first quarter of fiscal 2006, while the first quarter of fiscal 2006 includes sales of $19 million from businesses that have been disposed of after the start of the first quarter of fiscal 2006. The net impact of acquisitions and dispositions between the first quarters of fiscal 2007 and 2006 increased net sales by $22 million, or 0.8%. The remaining net sales increase of $65 million, or 2.4%, resulted from increases in net sales in each of the corporation’s business segments. Net sales increased in the North American Retail Meats segment due to higher unit volumes. The North American Retail Bakery segment experienced higher sales due to an improved product mix and higher prices to cover increases in commodity costs partially offset by a continuing program to reduce sales of low margin bakery products and the impact of lower U.S. frozen retail bakery shipments during the quarter. Net sales in the Foodservice segment increased on the strength of higher volumes for meat products and an improved sales mix, while increases in the International Beverage and International Bakery segments were due to higher unit volumes. Net sales in the Household and Body Care segment increased primarily due to higher unit volumes for air care products and insecticides.

Unit Volumes

Unit volumes in the North American Retail Meats segment increased 2% with the increase coming in the U.S., while Mexico was unchanged. In the North American Retail Bakery segment, unit volumes declined by 4% as declines in unbranded fresh bread were only partially offset by increases in branded product sales, and unit shipments of frozen bakery products declined in the quarter. Unit volumes increased 1% in the Foodservice segment as higher unit sales of meat products more than offset flat bakery product volumes and lower unit sales of coffee products. In the International Beverage segment, unit volumes increased 11% with higher volumes in both the retail and foodservice channels. The increase in retail unit volumes was driven by strong volume growth in Brazil and in single serve coffee products in Europe. In the International Bakery segment, unit volumes increased 1% as a result of growth in refrigerated dough products in Europe and frozen bakery products in Australia, partially offset by declines in fresh bread products in Europe. The unit volumes for the four core categories of the Household and Body Care segment increased 4% in the first quarter due primarily to higher shipments of air care and insecticide products. The discussion of unit volumes in this Management Discussion and Analysis excludes the impact of acquisitions and dispositions.

Gross Margin Percent

The gross margin percentage declined from 38.2% in the first quarter of fiscal 2006 to 37.9% in the first quarter of fiscal 2007, a decline of 0.3%, as two business segments experienced a higher gross margin percentage and four segments experienced a lower gross margin percentage.

Both the North American Retail Meats and North American Retail Bakery segments experienced higher gross margins. The North American Retail Meats segment gross margin percentage increased by 0.4% due to the impact of prior restructuring and cost-saving initiatives. The gross margin percentage in the North American Retail Bakery segment increased 1.0% due to certain selling price increases to offset higher raw material costs, the impact of an improved sales mix and benefits of prior restructuring actions.

The gross margin percentage declined in the International Bakery segment by 1.7% and declined in both the International Beverage and the Household and Body Care segments by just over 1% as these segments experienced an unfavorable sales mix and lower product pricing. In the Foodservice segment, the gross margin percentage declined by 0.8% as this segment experienced increased commodity costs during the period.

 

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Selling, General and Administrative Expenses

 

     Quarter Ended  

(In millions)

  

September 30,

2006

  

October 1,

2005

   Change    

Percent

Change

 

Selling, general and administrative expenses:

          

SG&A expenses in the business segment results

   $ 861    $ 874    $ (13 )   (1.5 )%

Amortization of identifiable intangibles

     17      15      2     6.5  

General corporate expenses

     84      66      18     28.6  
                            

Total SG&A expenses

   $ 962    $ 955    $ 7     0.7 %
                            

Selling, general and administrative (SG&A) expenses in the business segment results declined by $13 million. This was primarily attributable to $7 million of lower advertising and promotion expense, $6 million of lower business transformation costs, lower retiree benefit costs and savings from the ongoing transformation plan, offset in part by the strengthening of foreign currencies, which increased SG&A by $14 million. The increase in general corporate expenses is primarily attributable to higher business transformation and hedging costs offset by lower corporate office expenses. Measured as a percentage of sales, SG&A expenses were 33.3% in fiscal 2007 as compared to 34.6% in the comparable period of the prior year. This improvement was primarily related to an $8 million reduction in business transformation costs, a $7 million reduction in advertising and promotion expense, lower retiree benefit costs and lower costs from the severance of employees and facility closures.

Transformation Actions and other Significant Items

The reported results for the first quarter of fiscal 2007 and 2006 reflect amounts recognized for actions associated with the corporation’s ongoing business transformation program and other significant items. The following table illustrates where the costs (income) associated with these activities are recognized in the Consolidated Statements of Income of the corporation.

 

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     Quarter Ended  

(In millions)

  

September 30,

2006

   

October 1,

2005

 

Cost of sales

    

Accelerated depreciation related to facility closures

   $ 15     $ 3  

Transformation charges

     3       —    

Hurricane losses

     —         1  

Selling, general and administrative expenses

    

Transformation charges

     24       24  

Accelerated depreciation related to facility closures

     1       7  

Hurricane losses

     —         2  

Charges for (income from)

    

Exit activities

     14       29  

Asset and business dispositions

     (15 )     (29 )
                

Reduction in income from continuing operations before income taxes

     42       37  

Income tax benefit

     (16 )     (13 )
                

Reduction in income from continuing operations

   $ 26     $ 24  
                

The following is a summary of the actions that impacted the first quarter of fiscal 2007. The amount recognized in “Cost of sales,” as noted in the table above, consists of $15 million of accelerated depreciation on equipment from various U.S. manufacturing sites and $3 million of transformation expenses. Transformation expenses recognized in cost of sales generally include costs for information technology projects related to new information system installations. The amount recognized in “Selling, general and administrative expenses” includes a charge of $24 million for actions related to the corporation’s transformation plan and $1 million for accelerated depreciation on a domestic research and development facility that has been closed. Transformation expenses recognized in SG&A generally include retention, relocation and recruiting expenses related to the centralization of the corporation’s management team, costs for third-party consultants to assist in the development of strategic operating and financial plans and certain training efforts, and costs associated with the implementation of new information technology systems. The corporation recognized a net $1 million of income related to exit activities, asset and business dispositions during the first quarter of fiscal 2007. The net $1 million of income consists of a net $14 million charge for exit activities and a net $15 million of income related to asset and business dispositions. The $14 million charge for exit activities consists of a $12 million charge for management’s approved actions related to the termination of 541 employees and $3 million related to the cost of exiting certain leased facilities, which was partially offset by a $1 million credit related to employee terminations that were completed for amounts more favorable than originally estimated. The net $15 million of income from asset and business dispositions consists of $19 million in gains on the sale of an administrative office building and a production and distribution facility in the Household and Body Care segment, partially offset by $4 million of charges primarily associated with the disposal of businesses. The net impact of these actions was to decrease income from continuing operations before income taxes and income from continuing operations by $42 million and $26 million, respectively, which reduced diluted EPS by $0.03.

The following is a summary of the actions that impacted the first quarter of fiscal 2006. The amount recognized in “Cost of sales,” as noted in the table above, consists of $3 million of accelerated depreciation on two manufacturing facilities and related equipment targeted for sale in the North American Retail Bakery segment and $1 million in losses related to the hurricanes in the

 

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southeastern portion of the U.S. The amount recognized in “Selling, general and administrative expenses” includes a charge of $24 million for actions related to the corporation’s transformation plan, $7 million for accelerated depreciation on facilities targeted for closure and $2 million of hurricane losses. Transformation expenses recognized in SG&A generally include retention, relocation and recruiting expenses related to the centralization of the corporation’s management team and costs associated with third-party consultants to assist in the development of strategic operating and financial plans and certain training efforts. The corporation recognized no net impact related to exit activities, asset and business dispositions during the first quarter of fiscal 2006 since a net $29 million charge for exit activities was offset by a net $29 million of income related to asset and business dispositions. The $29 million charge for exit activities consists of costs to terminate 446 employees. The $29 million of income from asset and business dispositions consists of a $35 million gain on the sale of certain skincare and sunscreen assets, the sale of a minority investment in a foreign operation and the sale of a corporate aircraft, partially offset by $6 million of charges to prepare other businesses for disposition. The net impact of these actions was to decrease income from continuing operations before income taxes and income from continuing operations by $37 million and $24 million, respectively, and reduce diluted EPS by $0.03.

The costs (income) of the above actions on the corporation’s businesses are summarized as follows:

 

      Quarter Ended  

(In millions)

  

September 30,

2006

   

October 1,

2005

 

North American Retail Meats

   $ 21     $ 10  

North American Retail Bakery

     5       9  

Foodservice

     5       6  

International Beverage

     —         18  

International Bakery

     —         5  

Household and Body Care

     (10 )     (20 )
                

Impact on the business segments

     21       28  

Corporate office

     21       9  
                

Impact on income from continuing operations before income taxes

   $ 42     $ 37  
                

These actions are more fully described in the Exit, Disposal and Transformation Activities note to the Consolidated Financial Statements. As a result of exit activities taken since the beginning of fiscal 2005, and transformation actions taken since the beginning of the transformation plan in fiscal 2005, the corporation’s cost structure was reduced and efficiency improved. The following table summarizes the actual and projected savings from these actions.

 

(In millions)

  

Actual Savings

Recognized in Fiscal

2006

  

Anticipated Savings

in

Fiscal 2007

  

Actual Savings in the

1st Quarter of Fiscal

2006

  

Actual Savings in

the 1st Quarter of

Fiscal 2007

Restructuring Actions Approved in:

           

Fiscal 2005

   $ 34    $ 36    $ 5    $ 10

Fiscal 2006

     27      67      —        15

Fiscal 2007

     —        1      —        —  
                           
   $ 61    $ 104    $ 5    $ 25
                           

In the remaining portion of fiscal 2007, the corporation expects to recognize additional transformation, exit and accelerated depreciation costs as the corporation reduces employment levels and eliminates manufacturing capacity.

 

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Receipt of Contingent Sales 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 fiscal 2007 and fiscal 2006 payment each passed in the first quarter of each fiscal year and the corporation received the annual payments. The fiscal 2007 annual payment was equivalent to $120 million and the fiscal 2006 annual payment was equivalent to $114 million based upon the respective exchange rates on the dates of receipt. Each of these amounts is recognized in the corporation’s earnings when received, and the payments increased diluted earnings per share by $0.16 and $0.15 when they were recognized in fiscal 2007 and 2006, respectively.

Net Interest Expense

Net interest expense decreased by $5 million in the first quarter of fiscal 2007, to $49 million. During the quarter, the corporation received the proceeds from the spin off of the Hanesbrands business and a portion of these funds were invested which generated higher interest income during the quarter. A portion of these proceeds was also used to repay outstanding notes payable which resulted in lower average debt outstanding during the quarter. However, higher average interest rates during the quarter offset the impact of the lower average debt balances.

Income Tax Expense

In the first quarter of fiscal 2007, the corporation’s continuing operations recognized a tax benefit of $50 million and an effective tax rate of (24.3%) as compared to tax expense of $59 million and an effective tax rate of 36.7% in the comparable period of the prior year. The fiscal 2007 tax benefit is impacted by the following:

 

  In the first quarter of fiscal 2007, the corporation signed an agreement to sell the shares of a subsidiary, which resulted in a $158 million tax benefit. As a result of the nature of this transaction, the tax benefit was recognized entirely in the first quarter and increased diluted EPS in the quarter by $0.21 per share.

 

  As a result of the spin off of the Hanesbrands business and the share buyback program, the corporation concluded in the fourth quarter of fiscal 2006 that it was necessary to remit all fiscal 2007 foreign earnings to the U.S. The effective annual tax rate for fiscal 2007 includes an estimated charge for $194 million to repatriate all fiscal 2007 earnings outside the U.S. and this charge is being recognized over the entire year.

Income from Continuing Operations and Diluted Earnings Per Share (EPS)

Income from continuing operations in the first quarter of fiscal 2007 was $255 million versus $102 million in the comparable period of the prior year, an increase of $153 million, which is due to the following factors.

 

  The corporation’s gross profit increased by $39 million, despite a small decline in the gross margin percentage of 0.3%, primarily as a result of the strengthening of foreign currencies versus the U.S. dollar and unit sales volume increases offset in part by higher business transformation costs and lower gross profit margins. The gross margin percentage declined in each of the corporation’s business segments, with the exception of the North American Retail Meats and North American Retail Bakery segments, as the corporation experienced higher costs for certain raw materials, commodities and energy, and experienced pricing pressure from a competitive marketplace.

 

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Table of Contents
  Selling, general and administrative (SG&A) expenses in the first quarter of fiscal 2007 increased by $7 million over the comparable period of the prior year primarily as a result of the strengthening of foreign currencies versus the U.S. dollar offset in part by lower retirement plan costs, lower advertising and promotion costs and lower business transformation costs. SG&A expenses as a percentage of sales decreased from 34.6% in the first quarter of fiscal 2006 to 33.3% in the first quarter of fiscal 2007 primarily as a result of lower retirement plan expenses, lower advertising and promotion costs and lower costs associated with the corporation’s business transformation program.

 

  In the first quarter of fiscal 2007, the corporation recognized $1 million of income from exit activities, asset and business dispositions, while in the first quarter of fiscal 2006, the corporation had no net charges or income.

 

  The corporation received and recognized contingent sale proceeds of $120 million in the first quarter of fiscal 2007 and $114 million in the first quarter of fiscal 2006 from the sale of the corporation’s cut tobacco business that represents the annual payments for fiscal 2007 and 2006. The difference in amounts is due to changes in foreign currency exchange rates.

 

  Net interest expense decreased by $5 million, primarily due to higher interest income during the period.
  Income tax expense declined by $109 million as the corporation recognized a significant tax benefit in the current period.

Diluted EPS from continuing operations increased from $0.13 in the first quarter of fiscal 2006 to $0.34 in the first quarter of fiscal 2007, an increase of $0.21. Diluted EPS increased at a higher rate than income from continuing operations as a result of lower average shares outstanding during the first quarter of fiscal 2007 than the first quarter of fiscal 2006. The lower average shares are due to the corporation’s ongoing share repurchase program. Under this program, the corporation repurchased 16.4 million shares during the first quarter of fiscal 2007, and 30.1 million shares in fiscal 2006.

Discontinued Operations

Discontinued operations includes the results of the corporation’s Direct Selling, U.S. Retail Coffee, European Branded Apparel, European Nuts and Snacks, U.K. Apparel, U.S. Meat Snacks, European Meats and Branded Apparel Americas/Asia businesses. The following summarizes the results of the discontinued operations for the first quarters of fiscal 2007 and 2006.

 

In millions

  

First Quarter of

Fiscal 2007

   

First Quarter of

Fiscal 2006

   

Dollar

Change

   

Percent

Change

 

Net Sales

   $ 901     $ 2,010     $ (1,109 )   (55.2 )%
                              

Income (loss) from operations before income taxes

   $ 92     $ (76 )   $ 168    

Income tax (expense) benefit on income from operations

     (30 )     41       (71 )  

Gain on sale of discontinued operations

     18       —         18    

Income tax on gain of sale of discontinued businesses

     (2 )     —         (2 )  
                          

Net income (loss) from discontinued operations

   $ 78     $ (35 )   $ 113    
                          

Net sales for discontinued operations was $901 million in the first quarter of fiscal 2007 and $2,010 million in fiscal 2006. The decline is primarily due to the fact that a majority of the businesses were sold in fiscal 2006 and as such there are no comparable reported sales in fiscal 2007. In addition, the European Meats and Branded Apparel Americas/Asia results reported in fiscal 2007 are less than a full quarter of results as the transactions were completed prior to the end of the first quarter of fiscal 2007.

 

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The discontinued operations reported income before income taxes of $92 million in the first quarter of fiscal 2007 and a loss of $76 million in the first quarter of fiscal 2006. The reported results for the first quarter of fiscal 2006 included $223 million of impairment charges to recognize an impairment in the European Branded Apparel and the U.S. Retail Coffee businesses. These impairment charges are more fully described in Note 3 to the Consolidated Financial Statements.

The effective tax rate for the discontinued operations in the first quarter of fiscal 2007 was 33.0% as compared to an effective tax rate in the first quarter of fiscal 2006 of 54.2%. The higher effective rate in fiscal 2006 was due to several factors: first, the impairment charges recognized included $34 million of non-deductible goodwill; second, certain of the impairment charges are in tax jurisdictions in which the corporation cannot obtain a tax benefit; and finally, the timing of the Direct Selling transaction resulted in the repayment of certain tax benefits claimed in a foreign jurisdiction. The repayment of these tax benefits could, however, be credited against the earnings of the U.S. businesses included in continuing operations.

The discontinued operations also reported a gain on sale of operations before income taxes of $18 million which consisted of a $34 million gain from the sale of the European Meats business and an $8 million gain from the sale of the European Branded Apparel operations in the Philippines, partially offset by $24 million of costs associated with the spin off of the Hanesbrands business. The net gain on the business dispositions after tax was $16 million.

The corporation’s discontinued operations impacted the cash flows of the corporation as summarized in the table below.

 

(In millions) – Increase / (Decrease)

  

First Quarter

Ended

September

30, 2006

   

First Quarter

Ended October 1,

2005

 

Discontinued operations impact on:

    

Cash flow from operating activities

   $ 108     $ 233  

Cash flow (used in) from investing activities

     (35 )     (53 )

Cash flow (used in) from financing activities

     (87 )     (154 )

Effect of foreign exchange rates on cash

     —         (1 )
                

Net cash impact of discontinued operations

   $ (14 )   $ 25  
                

Cash balance of discontinued operations:

    

At start of period

   $ 14     $ 37  

At end of period

     —         62  
                

(Decrease) increase in cash of discontinued operations

   $ (14 )   $ 25  
                

The lower level of cash flow from operating activities related to discontinued operations in fiscal 2007 was primarily attributable to the timing of the disposition of these businesses. The sale of European Meats was completed in August 2006 and the spin off of the Hanesbrands business occurred on September 5, 2006.

Consolidated Net Income and Diluted Earnings Per Share

Net income of $333 million in the first quarter of fiscal 2007 was $266 million higher than the $67 million reported in the prior year comparable period. The increase in net income was primarily due to the $153 million increase in income from continuing operations and a $113 million increase in income from discontinued operations. Diluted EPS increased from $0.09 in the first quarter of fiscal 2006 to $0.44 in the first quarter of fiscal 2007, an increase of $0.35.

 

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Operating Results by Business Segment – First Quarter of Fiscal 2007 Compared with First Quarter of Fiscal 2006

North American Retail Meats

 

     Quarter Ended  

(In millions)

  

September 30,

2006

   

October 1,

2005

    Change    

Percent

Change

 

Change in unit volume

         2 %
            

Net sales

   $ 630     $ 615     $ 15     2.4 %
                              

Increase / (Decrease) in net sales from

        

Changes in foreign currency exchange rates

   $ —       $ 1     $ (1 )  

Acquisitions / Dispositions

     6       —         6    
                          

Total

   $ 6     $ 1     $ 5    
                          

Operating segment income

   $ 27     $ 17     $ 10     55.9 %
                              

Increase / (Decrease) in operating segment income from

        

Changes in foreign currency exchange rates

   $ —       $ —       $ —      

Exit activities, asset and business dispositions

     (4 )     (4 )     —      

Transformation charges

     (3 )     (5 )     2    

Accelerated depreciation

     (14 )     (1 )     (13 )  

Acquisitions

     (1 )     —         (1 )  
                          

Total

   $ (22 )   $ (10 )   $ (12 )  
                          

Unit volumes in the North American Retail Meats segment for processed meats increased 2% as compared to the first quarter of the prior year. Unit volumes in the U.S. increased 3%, while unit volumes in Mexico were unchanged.

Net sales in the North American Retail Meats segment increased by $15 million, or 2.4%, to $630 million in the first quarter of fiscal 2007 from $615 million in the prior year first quarter. During the quarter, the weakening of the Mexican peso decreased reported net sales by $1 million, or 0.2%. Net sales of businesses acquired since the beginning of the first quarter of fiscal 2006 increased net sales by $6 million, or 1.0%. The remaining net sales increase of $10 million, or 1.6%, was primarily due to the increase in unit volumes.

The North American Retail Meats gross margin percentage increased from 27.8% in the first quarter of fiscal 2006 to 28.2% in the first quarter of fiscal 2007 due to the impact of continuous improvement programs which reduced the cost structure, higher unit volumes and an improved sales mix.

Operating segment income in North American Retail Meats increased by $10 million, or 55.9%, from $17 million in the first quarter of fiscal 2006 to $27 million in the first quarter of fiscal 2007. Changes in foreign currency exchange rates did not have a significant impact on reported operating segment income. The net impact of the change in exit activities, asset and business dispositions, transformation charges and accelerated depreciation between the first quarter of fiscal 2007 and the first quarter of fiscal 2006 decreased operating segment income by $11 million, or 21.9%. The impact of businesses acquired after the beginning of the first quarter of fiscal 2006 decreased operating segment income by $1 million, or 3.4%. The remaining operating segment income increase of $22 million, or 81.5%, as compared to the same quarter of the prior year was primarily the result of higher gross margins, a $5 million reduction in media advertising and promotion expense as certain media programs were delayed and a $3 million reduction in pension and post-retirement benefit plan costs.

 

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North American Retail Bakery

 

     Quarter Ended  

(In millions)

  

September 30,

2006

   

October 1,

2005

    Change   

Percent

Change

 

Change in unit volume

          (4 )%
             

Net sales

   $ 498     $ 461     $ 37    8.1 %
                             

Increase (decrease) in net sales from Acquisitions

   $ 35     $ —       $ 35   
                         

Operating segment income (loss)

   $ 5     $ (4 )   $ 9    NM %
                             

Increase / (Decrease) in operating segment income from

         

Exit activities, asset and business dispositions

   $ (1 )   $ (2 )   $ 1   

Transformation charges

     (3 )     (4 )     1   

Accelerated depreciation on facilities to be sold

     (1 )     (4 )     3   

Acquisitions

     2       —         2   
                         

Total

   $ (3 )   $ (10 )   $ 7   
                         

The North American Retail Bakery segment also includes the results of the corporation’s Senseo retail coffee business in the U.S.

Net unit volumes in the North American Retail Bakery segment declined 4% during the first quarter, as declines in certain unbranded lower margin U.S. fresh bread business, particularly with private label customers, and a decline in shipments of frozen bakery products offset an increase in unit volumes for branded bakery products during the quarter.

Net sales in the North American Retail Bakery segment increased $37 million, or 8.1%, over the comparable prior year quarter. The impact of acquisitions increased net sales by $35 million, or 7.6%. The remaining increase in net sales of $2 million, or 0.5%, was primarily attributable to positive pricing actions and a favorable product mix driven by increased sales of Sara Lee branded products, partially offset by lower unit volumes of unbranded products, as the segment exited certain low margin bread business.

The gross margin percentage in the North American Retail Bakery segment increased 1.0% from 46.0% in the first quarter of fiscal 2006 to 47.0% in the first quarter of fiscal 2007 primarily from increased selling prices which offset higher costs for key ingredients and wages, the impact of an improved sales mix which included higher sales of branded bakery products and the benefits of continuous improvement programs that have reduced costs.

Operating segment income in the North American Retail Bakery segment increased by $9 million, from a loss of $4 million in the first quarter of fiscal 2006, to income of $5 million in the first quarter of fiscal 2007. The first quarters of fiscal 2007 and 2006 were impacted by some or all of the following: exit activities, asset and business dispositions, transformation expenses and accelerated depreciation. The net impact of the exit activities, asset and business dispositions, transformation expenses and accelerated depreciation in fiscal 2007 versus fiscal 2006 increased operating segment income by $5 million. The impact of acquisitions made after the beginning of the first quarter of fiscal 2006 increased operating segment income by $2 million, or 43.6%. The remaining operating segment income increase of $2 million, or 63.9%, during the quarter was primarily attributable to higher gross margins and lower pension and post-retirement benefit plan costs, partially offset by higher media advertising and promotion expenses.

 

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Foodservice

 

     Quarter Ended  

(In millions)

  

September 30,

2006

   

October 1,

2005

    Change    

Percent

Change

 

Change in unit volume

         1 %
            

Net sales

   $ 538     $ 527     $ 11     1.9 %
                              

Increase / (Decrease) in net sales from

        

Changes in foreign currency exchange rates

   $ —       $ —       $ —      

Dispositions

     —         —         —      
                          
   $ —       $ —       $ —      
                          

Operating segment income

   $ 21     $ 15     $ 6     38.4 %
                              

Increase / (Decrease) in operating segment income from

        

Changes in foreign currency exchange rates

   $ —       $ —       $ —      

Exit activities, asset and business dispositions

     (3 )     —         (3 )  

Hurricane losses

     —         (3 )     3    

Transformation charges

     (1 )     (2 )     1    

Accelerated depreciation on facilities to be sold

     (1 )     (1 )     —      
                          

Total

   $ (5 )   $ (6 )   $ 1    
                          

Net unit volumes in the Foodservice segment increased 1% during the quarter as higher volumes for meat products more than offset the lower volumes in coffee products. Unit volumes for bakery products were unchanged.

Net sales in the Foodservice segment increased $11 million, or 1.9%, over the comparable prior year quarter. Changes in foreign currency, primarily the Canadian dollar, increased net sales by less than $1 million, or 0.1%. Acquisitions and dispositions did not impact the reported results in the first quarter. The remaining net sales increase of $11 million, or 1.8%, was primarily due to the impact of higher unit volumes of meat products, a favorable sales mix and selected price increases to cover higher costs, partially offset by lower unit volumes of coffee products.

The gross margin percentage in the Foodservice segment decreased 0.8% from 26.1% in the first quarter of fiscal 2006 to 25.3% in the first quarter of fiscal 2007 primarily due to increased commodity costs, partially offset by the benefits of continuous improvement programs which resulted in cost savings and selected selling price increases.

Operating segment income in the Foodservice segment increased by $6 million, or 38.4%, from $15 million in the first quarter of fiscal 2006 to $21 million in the first quarter of fiscal 2007. The first quarters of fiscal 2007 and fiscal 2006 were impacted by some or all of the following: hurricane losses, accelerated depreciation, exit activities, asset and business dispositions and transformation expenses. In the first quarter of fiscal 2007, charges for exit activities, asset and business dispositions, transformation expenses and accelerated depreciation totaled $5 million, while in the first quarter of fiscal 2006, the segment reported charges of $6 million for transformation expenses, accelerated depreciation and hurricane losses. The net impact of these items increased operating segment income by $1 million, or 17.4%. The remaining operating segment income increased by $5 million, or 20.9%, primarily from lower SG&A costs which include the impact of lower pension and post-retirement benefit plan costs, the benefits of certain cost saving programs and lower media advertising and promotion expenses.

 

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International Beverage

 

     Quarter Ended  

(In millions)

  

September 30,

2006

   

October 1,

2005

    Change    

Percent

Change

 

Change in unit volume

         11 %
            

Net sales

   $ 572     $ 532     $ 40     7.6 %
                              

Increase / (Decrease) in net sales from

        

Changes in foreign currency exchange rates

   $ —       $ (22 )   $ 22    

Dispositions

     —         17       (17 )  
                          
   $ —       $ (5 )   $ 5    
                          

Operating segment income

   $ 90     $ 62     $ 28     45.1 %
                              

Increase / (Decrease) in operating segment income from

        

Changes in foreign currency exchange rates

   $ —       $ (3