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Hillshire Brands Co 10-Q 2006
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 December 31, 2005

 

OR

 

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

 

Commission file number 1-3344

 

Sara Lee Corporation

(Exact name of registrant as specified in its charter)

 

Maryland   36-2089049

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

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

(Address of principal executive offices)

(Zip Code)

 

(312) 726-2600

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (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 December 31, 2005, the Registrant had 760,144,149 outstanding shares of common stock $.01 par value, which is the Registrant’s only class of common stock.

 


 

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Table of Contents

SARA LEE CORPORATION AND SUBSIDIARIES

 

INDEX

 

PART I –

    

ITEM 1 – FINANCIAL STATEMENTS

    

Preface

   3

Condensed Consolidated Balance Sheets - At December 31, 2005 and July 2, 2005

   4

Consolidated Statements of Income - For the thirteen and twenty-six weeks ended December 31, 2005 and January 1, 2005

   5

Consolidated Statements of Common Stockholders’ Equity - For the period July 3, 2004 to December 31, 2005

   6

Consolidated Statements of Cash Flows - For the twenty-six weeks ended December 31, 2005 and January 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

   74

PART II –

    

ITEM 2(c) - REPURCHASES OF EQUITY SECURITIES BY THE ISSUER

   75

ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

   75

ITEM 6 - EXHIBITS

   76

SIGNATURE

   77

 

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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, expected lives and forfeiture rates for stock compensation instruments granted to employees. Actual results could differ from these estimates.

 

The Consolidated Financial Statements for the thirteen and twenty-six weeks ended December 31, 2005 and January 1, 2005 and the balance sheets as of December 31, 2005 and July 2, 2005 included herein have not been audited by an independent registered public accounting firm, but in the opinion of Sara Lee Corporation (“the corporation”), all adjustments (which include only normal recurring adjustments) necessary to make a fair statement of the financial position at December 31, 2005 and the results of operations and the cash flows for the periods presented herein have been made. The Condensed Consolidated Balance Sheet as of July 2, 2005 and the Consolidated Statement of Common Stockholders’ Equity for the period July 3, 2004 to July 2, 2005 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 2, 2005. The results of operations for the thirteen and twenty-six weeks ended December 31, 2005 are not necessarily indicative of the operating results to be expected for the full fiscal year.

 

The consolidated financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Although the corporation believes the disclosures made are adequate to make the information presented not misleading, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the corporation’s Form 10-K for the year ended July 2, 2005 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 December 31, 2005 and July 2, 2005

(In millions)

Unaudited

 

     December 31,
2005


   July 2,
2005


ASSETS

             

Cash and equivalents

   $ 1,955    $ 538

Trade accounts receivable, less allowances

     1,746      1,798

Inventories:

             

Finished goods

     1,518      1,621

Work in process

     286      303

Materials and supplies

     380      360
    

  

       2,184      2,284

Other current assets

     482      336

Assets of discontinued operations held for sale

     580      860
    

  

Total current assets

     6,947      5,816

Other non-current assets

     129      117

Deferred tax asset

     391      303

Property, net

     2,992      3,030

Trademarks and other identifiable intangibles, net

     1,490      1,574

Goodwill

     3,142      3,154

Assets of discontinued operations held for sale

     52      429
    

  

     $ 15,143    $ 14,423
    

  

LIABILITIES AND STOCKHOLDERS’ EQUITY

             

Notes payable

   $ 1,378    $ 239

Accounts payable

     1,244      1,255

Accrued liabilities

     2,817      2,507

Current maturities of long-term debt

     599      381

Liabilities of discontinued operations held for sale

     386      591
    

  

Total current liabilities

     6,424      4,973

Long-term debt

     3,736      4,114

Pension obligation

     858      858

Other liabilities

     1,373      1,354

Liabilities of discontinued operations held for sale

     119      124

Minority interests in subsidiaries

     68      62

Common stockholders’ equity

     2,565      2,938
    

  

     $ 15,143    $ 14,423
    

  

 

See accompanying Notes to Consolidated Financial Statements.

 

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SARA LEE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income

For the Thirteen and Twenty-six Weeks Ended December 31, 2005 and January 1, 2005

(In millions, except per share data)

Unaudited

 

     Thirteen Weeks Ended

    Twenty-six Weeks Ended

 
     December 31,
2005


    January 1,
2005


    December 31,
2005


    January 1,
2005


 

Net sales

   $ 4,448     $ 4,512     $ 8,640     $ 8,763  
    


 


 


 


Cost of sales

     2,813       2,852       5,504       5,541  

Selling, general and administrative expenses

     1,281       1,270       2,534       2,488  

Charges for (income from) exit activities and business dispositions

     58       (10 )     57       (16 )

Contingent sale proceeds

     —         —         (114 )     (117 )

Interest expense

     76       71       150       137  

Interest income

     (19 )     (25 )     (40 )     (51 )
    


 


 


 


       4,209       4,158       8,091       7,982  
    


 


 


 


Income from continuing operations before income taxes

     239       354       549       781  

Income taxes

     46       45       111       128  
    


 


 


 


Income from continuing operations

     193       309       438       653  
    


 


 


 


Discontinued operations

                                

Net income (loss) from discontinued operations, net of tax

     30       17       (148 )     25  

Gain on sale of discontinued operations, net of tax

     215       —         215       —    
    


 


 


 


Net income

   $ 438     $ 326     $ 505     $ 678  
    


 


 


 


Income from continuing operations per common share

                                

Basic

   $ 0.25     $ 0.39     $ 0.57     $ 0.83  
    


 


 


 


Diluted

   $ 0.25     $ 0.39     $ 0.56     $ 0.82  
    


 


 


 


Net income per common share

                                

Basic

   $ 0.58     $ 0.41     $ 0.65     $ 0.86  
    


 


 


 


Diluted

   $ 0.57     $ 0.41     $ 0.65     $ 0.85  
    


 


 


 


Average shares outstanding

                                

Basic

     761       788       771       790  
    


 


 


 


Diluted

     765       795       775       796  
    


 


 


 


Cash dividends per common share

   $ 0.1975     $ 0.1975     $ 0.3950     $ 0.3850  
    


 


 


 


 

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 3, 2004 to December 31, 2005

(In millions, except per share data)

 

     TOTAL

    COMMON
STOCK


   CAPITAL
SURPLUS


    RETAINED
EARNINGS


    UNEARNED
STOCK


   

ACCUMULATED
OTHER
COMPREHENSIVE
INCOME

(LOSS)


    COMPREHENSIVE
INCOME (LOSS)


 

Balances at July 3, 2004

   $ 2,985     $ 8    $ 104     $ 4,437     $ (170 )   $ (1,394 )        

Net income

     678       —        —         678       —         —       $ 678  

Translation adjustments, net of tax

     468       —        —         —         —         468       468  

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

     (62 )     —        —         —         —         (62 )     (62 )
                                                   


Comprehensive income

                                                  $ 1,084  
                                                   


Cash dividends - Common ($0.385 per share)

     (303 )     —        —         (303 )     —         —            

Stock issuances (cancelations) -

                                                       

Stock option and benefit plans

     99       —        99       —         —         —            

Restricted stock

     22       —        22       —         —         —            

Share repurchases and retirement

     (239 )     —        (101 )     (138 )     —         —            

ESOP contributions and other

     9       —        3       —         6       —            
    


 

  


 


 


 


       

Balances at January 1, 2005

     3,657       8      127       4,674       (164 )     (988 )        

Net income

     41       —        —         41       —         —       $ 41  

Translation adjustments, net of tax

     (406 )     —        —         —         —         (406 )     (406 )

Minimum pension liability, net of tax

     (70 )     —        —         —         —         (70 )     (70 )

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

     62       —        —         —         —         62       62  
                                                   


Comprehensive income (loss)

                                                  $ (373 )
                                                   


Cash dividends - Common ($0.395 per share)

     (311 )     —        —         (311 )     —         —            

Stock issuances (cancelations) -

                                                       

Stock option and benefit plans

     62       —        62       —         —         —            

Restricted stock

     35       —        35       —         —         —            

Tax benefit related to stock-based compensation

     10       —        —         —         10       —            

Share repurchases and retirement

     (157 )     —        (157 )     —         —         —            

ESOP contributions and other

     15       —        12       4       (1 )     —            
    


 

  


 


 


 


       

Balances at July 2, 2005

     2,938       8      79       4,408       (155 )     (1,402 )        

Net income

     505       —        —         505       —         —       $ 505  

Translation adjustments, net of tax

     (61 )     —        —         —         —         (61 )     (61 )

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

     (15 )     —        —         —         —         (15 )     (15 )
                                                   


Comprehensive income

                                                  $ 429  
                                                   


Cash dividends-Common ($0.395 per share)

     (305 )     —        —         (305 )     —         —            

Stock issuances (cancelations) -

                                                       

Stock option and benefit plans

     21       —        21       —         —         —            

Restricted stock

     38       —        38       —         —         —            

Share repurchases and retirement

     (562 )     —        (108 )     (454 )     —         —            

ESOP contributions and other

     6       —        —         —         6       —            
    


 

  


 


 


 


       

Balances at December 31, 2005

   $ 2,565     $ 8    $ 30     $ 4,154     $ (149 )   $ (1,478 )        
    


 

  


 


 


 


       

 

Interim period balances are unaudited.

See accompanying Notes to Consolidated Financial Statements.

 

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Table of Contents

SARA LEE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the Twenty-six Weeks Ended December 31, 2005 and January 1, 2005

(In millions)

Unaudited

 

     Twenty-six Weeks Ended

 
     December 31,
2005


    January 1,
2005


 

OPERATING ACTIVITIES -

                

Net Income

   $ 505     $ 678  

Less: Cash received from contingent sale proceeds

     (114 )     (117 )

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

                

Depreciation

     260       285  

Amortization of intangibles

     83       95  

Impairment charges

     224       —    

Net gain on business dispositions

     (349 )     (10 )

Decrease in deferred income taxes

     (79 )     (31 )

Other

     5       (17 )

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

     313       (80 )
    


 


Net cash from operating activities

     848       803  
    


 


INVESTMENT ACTIVITIES -

                

Purchases of property and equipment

     (234 )     (201 )

Acquisitions of businesses

     (7 )     —    

Dispositions of businesses and investments

     514       23  

Cash received from contingent sale proceeds

     114       117  

Sales of assets

     68       54  
    


 


Net cash from (used in) investment activities

     455       (7 )
    


 


FINANCING ACTIVITIES -

                

Issuances of common stock

     17       99  

Purchases of common stock

     (562 )     (239 )

Borrowings of long-term debt

     9       336  

Repayments of long-term debt

     (189 )     (945 )

Short-term borrowings, net

     1,130       47  

Cash received from loans receivable

     34       —    

Payments of dividends

     (308 )     (152 )
    


 


Net cash from (used in) financing activities

     131       (854 )
    


 


Effect of changes in foreign exchange rates on cash

     (29 )     276  
    


 


Increase in cash and equivalents during the period

     1,405       218  

Cash and equivalents at beginning of year

     538       642  

Discontinued operations cash activity included above:

                

Add cash balance of discontinued operations at beginning of period

     31       27  

Less cash balance of discontinued operations at end of period

     (19 )     (48 )
    


 


Cash and equivalents at end of quarter

   $ 1,955     $ 839  
    


 


COMPONENTS OF CHANGES IN CURRENT ASSETS AND LIABILITIES:

                

Decrease (increase) in trade accounts receivable

   $ 30     $ (78 )

Decrease in inventories

     167       108  

(Increase) decrease in other current assets

     (59 )     16  

Decrease in accounts payable

     (90 )     (141 )

Increase in accrued liabilities

     265       15  
    


 


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

   $ 313     $ (80 )
    


 


 

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 thirteen and twenty-six week periods ended December 31, 2005, options to purchase 49.0 million and 45.3 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. For the thirteen and twenty-six week periods ended January 1, 2005, options to purchase 16.4 million and 19.7 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 six months of fiscal 2006 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. On August 1, 2005, the corporation’s Board of Directors authorized the repurchase of an additional 100 million shares of common stock. As a result of this action, the total number of shares authorized for repurchase increased to 116 million. At a $17 per share price, the additional authorization is equivalent to approximately $2 billion. During the first six months of fiscal 2006, the corporation repurchased 29.1 million shares of common stock for a purchase price of $562 million. Of this total, 20.9 million shares were purchased for $400 million under an accelerated share repurchase program where the final purchase price will be based upon the average daily share price over a period of time that will not exceed 6 months. The accelerated share repurchase program concluded on February 3, 2006 and the final purchase price settlement resulted in approximately 1.0 million additional shares of common stock being delivered to the corporation. During the accelerated share repurchase period, the corporation’s purchase of additional shares of its common stock was subject to conditions imposed by the counterparty to the transaction. At December 31, 2005, the corporation had approximately 87.2 million shares remaining on its existing share authorization. The corporation has repurchased shares with a value of $562 million in the first six months of fiscal 2006 and intends to repurchase additional shares with a value of up to $450 million in either the fourth quarter of fiscal 2006 or early in fiscal 2007. The repurchase will likely occur after the spin-off of Branded Apparel Americas / Asia, however, the timing and amount of future share repurchases may also be influenced by market conditions and other factors.

 

8


Table of Contents

The following is a reconciliation of net income to net income per share – basic and diluted for the thirteen and twenty-six weeks ended December 31, 2005 and January 1, 2005:

 

Computation of Net Income per Common Share

(In millions, except per share data)

 

     Thirteen Weeks Ended

   Twenty-six Weeks Ended

     December 31,
2005


   January 1,
2005


   December 31,
2005


   January 1,
2005


Income from continuing operations

   $ 193    $ 309    $ 438    $ 653

Net income from discontinued operations

     245      17      67      25
    

  

  

  

Net income

   $ 438    $ 326    $ 505    $ 678
    

  

  

  

Average shares outstanding – basic

     761      788      771      790

Dilutive effect of stock option and award plans

     4      7      4      6
    

  

  

  

Diluted shares outstanding

     765      795      775      796
    

  

  

  

Income from continuing operations per share

                           

Basic

   $ 0.25    $ 0.39    $ 0.57    $ 0.83
    

  

  

  

Diluted

   $ 0.25    $ 0.39    $ 0.56    $ 0.82
    

  

  

  

Income from discontinued operations per common share

                           

Basic

   $ 0.32    $ 0.02    $ 0.09    $ 0.03
    

  

  

  

Diluted

   $ 0.32    $ 0.02    $ 0.09    $ 0.03
    

  

  

  

Net income per common share

                           

Basic

   $ 0.58    $ 0.41    $ 0.65    $ 0.86
    

  

  

  

Diluted

   $ 0.57    $ 0.41    $ 0.65    $ 0.85
    

  

  

  

 

2. Segment Information

 

Effective in the first quarter of fiscal 2006, the corporation reorganized its business operations around distinct consumers, customers and geographic markets in order to build functional excellence, increase strategic focus and simplify the organization. As a result of these changes, the corporation reorganized its business operations and reported under a segment structure that included seven business segments. As part of this structure, at the end of the first quarter of fiscal 2006, the corporation’s European Meats business was reported as part of the International Beverage segment and the corporation was evaluating the disposal of this business under the corporation’s transformation plan. At the end of the second quarter of fiscal 2006, the corporation is continuing to evaluate its options relative to the European Meats business and it remains classified as held for use and reported in continuing operations. The corporation reorganized its business operations during the second quarter of fiscal 2006, and reported the European Meats business as a separate business segment. Historical results have been restated to present the business segments on a comparable basis. The following is a general description of the corporation’s eight business segments.

 

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

 

  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 to retail and foodservice customers in major markets around the world, including Europe, Australia and Brazil.

 

  European Meats – sells a variety of packaged and processed meats, cooked and dry hams and sausage to retail customers in Europe.

 

  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.

 

  Branded Apparel – sources, manufactures and markets basic branded apparel products under the categories of innerwear, outerwear and sheer hosiery in the Americas and Asia.

 

9


Table of Contents

The following is a summary of sales and operating segment income by business segment for the thirteen and twenty-six weeks ended December 31, 2005 and January 1, 2005.

 

     Thirteen Weeks Ended

 
     Net Sales

   

Income From Continuing Operations

Before Income Taxes


 

(In millions)


   December 31,
2005


    January 1,
2005


    December 31, 2005

   

January 1,

2005


 

North American Retail Meats

   $ 672     $ 650     $ 50     $ 49  

North American Retail Bakery

     463       449       (17 )     (11 )

Foodservice

     609       580       56       62  

International Beverage

     598       592       64       111  

European Meats

     285       311       21       31  

International Bakery

     190       200       21       20  

Household and Body Care

     451       491       36       82  

Branded Apparel

     1,182       1,241       169       154  
    


 


 


 


Total business segments

     4,450       4,514       400       498  

Intersegment sales

     (2 )     (2 )     —         —    
    


 


 


 


Total net sales and operating segment income, respectively

     4,448       4,512       400       498  

Amortization of intangibles

     —         —         (24 )     (24 )

General corporate expenses

     —         —         (80 )     (74 )
    


 


 


 


Total net sales and operating income, respectively

     4,448       4,512       296       400  

Net interest expense

     —         —         (57 )     (46 )
    


 


 


 


Net sales and income from continuing operations before income taxes, respectively

   $ 4,448     $ 4,512     $ 239     $ 354  
    


 


 


 


     Twenty-six Weeks Ended

 
     Net Sales

   

Income From Continuing Operations

Before Income Taxes


 

(In millions)


   December 31,
2005


    January 1,
2005


    December 31, 2005

   

January 1,

2005


 

North American Retail Meats

   $ 1,287     $ 1,246     $ 67     $ 73  

North American Retail Bakery

     923       920       (21 )     (2 )

Foodservice

     1,145       1,118       72       105  

International Beverage

     1,123       1,096       126       210  

European Meats

     569       588       51       64  

International Bakery

     382       387       33       41  

Household and Body Care

     897       953       115       149  

Branded Apparel

     2,319       2,459       291       300  
    


 


 


 


Total business segments

     8,645       8,767       734       940  

Intersegment sales

     (5 )     (4 )     —         —    
    


 


 


 


Total net sales and operating segment income, respectively

     8,640       8,763       734       940  

Amortization of intangibles

     —         —         (48 )     (54 )

General corporate expenses

     —         —         (141 )     (136 )

Contingent sale proceeds

     —         —         114       117  
    


 


 


 


Total net sales and operating income, respectively

     8,640       8,763       659       867  

Net interest expense

     —         —         (110 )     (86 )
    


 


 


 


Net sales and income from continuing operations before income taxes, respectively

   $ 8,640     $ 8,763     $ 549     $ 781  
    


 


 


 


 

10


Table of Contents

The following table summarizes the assets utilized in the corporation’s business segments as of December 31, 2005 and July 2, 2005.

 

     December 31,
2005


   July, 2
2005


 

Assets

               

North American Retail Meats

   $ 1,114    $ 1,187  

North American Retail Bakery

     1,351      1,448  

Foodservice

     1,679      1,647  

International Beverage

     2,047      1,414  

European Meats

     762      798  

International Bakery

     1,378      1,126  

Household and Body Care

     2,163      1,695  

Branded Apparel

     3,591      4,003  
    

  


       14,085      13,318  

Discontinued operations

     632      1,289  

Other1

     426      (184 )
    

  


Total assets

   $ 15,143    $ 14,423  
    

  


 

1 Principally cash and equivalents, certain fixed assets, deferred tax assets and certain other noncurrent assets.

 

3. Discontinued Operations

 

As part of the corporation’s transformation plan, steps were taken to dispose of several businesses. At the end of the second quarter of fiscal 2006, five businesses were reported as discontinued operations in the current and prior periods. The comparative financial results of the discontinued operations were as follows:

 

     Fiscal 2006

 
     Direct
Selling


   U.S.
Retail
Coffee


    Branded
Apparel
Europe


    U.K.
Apparel


    European
Nuts &
Snacks


   Total

 

Second Quarter

                                              

Net Sales

   $ 90    $ 60     $ 266     $ 136     $ 15    $ 567  

Pretax Income (Loss)

     9      —         (10 )     (3 )     2      (2 )

Income (Loss)

     53      (1 )     (20 )     (4 )     2      30  

Six Months

                                              

Net Sales

   $ 202    $ 122     $ 547     $ 248     $ 29    $ 1,148  

Pretax Income (Loss)

     13      (45 )     (192 )     (8 )     4      (228 )

Income (Loss)

     54      (40 )     (156 )     (8 )     2      (148 )

 

11


Table of Contents
     Fiscal 2005

     Direct
Selling


   U.S.
Retail
Coffee


   Branded
Apparel
Europe


    U.K.
Apparel


   European
Nuts &
Snacks


   Total

Second Quarter

                                          

Net Sales

   $ 126    $ 56    $ 318     $ 171    $ 17    $ 688

Pretax Income (Loss)

     17      1      (6 )     11      3      26

Income (Loss)

     12      1      (8 )     11      1      17

Six Months

                                          

Net Sales

   $ 231    $ 105    $ 615     $ 314    $ 32    $ 1,297

Pretax Income (Loss)

     25      1      (1 )     11      5      41

Income (Loss)

     17      1      (7 )     11      3      25

 

The amounts in the table above include the results of the discontinued operations and any impairment charges that have been recognized in these discontinued operations. Gains and losses on the disposal of discontinued operations are excluded from the table above and are discussed below.

 

In December 2005, the corporation closed on the sale of the Direct Selling business and the U.S. Retail Coffee business. In addition, the corporation closed on the sale of a Turkish sewing business that was part of the Branded Apparel Europe business. The disposal of these three operations resulted in a pretax and after tax gain of $318 million and $215 million, respectively. Virtually all of this gain is related to the sale of the Direct Selling business. The following is a description of each of these businesses, including a discussion of significant items impacting the results.

 

Businesses Sold in Second Quarter

 

Direct Selling – On August 10, 2005, the corporation announced that it had entered into a definitive agreement to sell this business, and in December 2005, the corporation completed the sale of substantially all of the operations to Tupperware and received the following consideration:

 

  $370 million which consists of $413 million of cash received less $43 million of cash which was included in the net assets transferred to the buyer.

 

  The liabilities transferred to the buyer included a $34 million obligation to a retained foreign subsidiary of the corporation. Subsequent to the closing, the buyer remitted cash to the corporation to settle this obligation. The payment of this obligation is reflected in the financing activities section of the Consolidated Statement of Cash Flows.

 

  Subsequent to the closing, the buyer paid $93 million to settle certain tax obligations of Sara Lee that were directly related to the sale transaction.

 

The corporation recognized a pretax and after tax gain on the sale of Direct Selling of $314 million and $213 million, respectively.

 

The definitive sales agreement provides for the sale of the Direct Selling business in the Philippines, however, transfer of legal title to these assets is awaiting the receipt of local government approval. The selling price of this component of the business has been placed in escrow pending the receipt of these approvals. Upon receipt of the $38 million of escrowed funds and transfer of title to the assets, the corporation expects to recognize a pretax and after tax gain of $28 million and $19 million, respectively.

 

The sales 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. Under the terms of the sales agreement, the corporation has no 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.

 

12


Table of Contents

In fiscal 2006, the Direct Selling business reported pretax profits of $13 million and after tax profits of $54 million from the beginning of the fiscal year through the date of sale. A $50 million tax benefit was recognized in the second quarter of fiscal 2006 as the corporation was able to credit amounts previously accrued through operations against taxes recognized upon the sale.

 

The Direct Selling business had previously been reported within the Household and Body Care segment.

 

U.S. Retail Coffee – On October 26, 2005, the corporation announced that it had entered into an agreement to sell its U.S. Retail Coffee business and in December 2005 the transaction closed. The corporation received $82.5 million of cash at closing and recognized a pretax and after tax gain of $5 million and $3 million, respectively, in the second quarter.

 

The sales 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. In addition, the agreement provides for a future payment of up to $2.5 million if the business generates a defined level of profits in the first year after the disposal. Any amounts received will be recognized in income when they are received.

 

The assets of the U.S. Retail Coffee business were part of a larger reporting unit that also provided coffee products to the foodservice channel. In the first quarter of fiscal 2006, the U.S. Retail Coffee asset group was classified as held for sale and $29 million of the goodwill of the larger reporting unit was allocated to this asset group. Also in the first quarter of fiscal 2006, the corporation reported a pretax charge of $44 million to recognize the impairment of $29 million of goodwill allocated to the asset group and $15 million of other long-lived assets. The after tax impact of the impairment charge was $39 million and is the primary reason for the loss recognized by the discontinued operation through the date of sale.

 

Under the terms of the sales agreement, the corporation has no 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.

 

Prior to the change in the corporation’s reportable segments, the U.S. Retail Coffee business had been reported as part of the Beverage segment.

 

Carrying Value of Assets Sold – The carrying value of the major classes of assets sold were as follows:

 

    

Carrying Value of

Assets and Liabilities Sold


     Direct
Selling


   U.S. Retail
Coffee


   Total

Current Assets

   $ 161    $ 46    $ 207

Property

     36      17      53

Intangibles

     96      35      131

Other Noncurrent Assets

     13      —        13
    

  

  

Total Assets

     306      98      404
    

  

  

Current Liabilities

     102      24      126

Noncurrent Liabilities

     37      —        37
    

  

  

Total Liabilities

     139      24      163
    

  

  

Net Assets Sold

   $ 167    $ 74    $ 241
    

  

  

 

Businesses Sold Subsequent to the Second Quarter

 

European Branded Apparel Business – In the first quarter of fiscal 2006, the corporation announced that it had entered into an agreement to sell its European Branded Apparel business and also began reporting the business as a discontinued operation. Based upon the offer received to purchase this business, the corporation recognized an impairment charge of $179 million pretax and $132 million after tax in the first quarter of fiscal 2006. The loss recognized by this discontinued operation in the first six months of fiscal

 

13


Table of Contents

2006 was primarily due to this impairment charge. The carrying value of the net assets held for sale is approximately $82 million.

 

On February 3, 2006, the corporation closed on the sale of this business and received cash proceeds of $120 million using foreign exchange rates on the date of the transaction. The corporation expects to recognize a gain on this transaction in the third quarter of fiscal 2006 and will have no continuing involvement in the business subsequent to the closing date.

 

Under the terms of the transaction, the corporation will receive additional cash proceeds if the buyer receives cash distributions as a result of certain events such as the sale of the business, the payment of dividends, or redemptions of capital or loans. Distributions of available cash from the sold business will be made in the following order:

 

  The buyer will first receive any amounts owed as a result of working capital and other purchase price adjustments.

 

  After the purchase price adjustments are satisfied, the corporation will receive 49% of the next $204 million of cash distributions.

 

  If additional cash is distributed, the corporation may receive between 15% and 25% of these amounts.

 

If any amounts are received, they will be recognized in income when the cash is received. The corporation does not expect any material direct cash inflows or outflows with the sold entity.

 

The corporation retained certain under funded pension obligations when this business was sold and expects to contribute $85 million prior to the end of the current fiscal year to fully fund the retained obligations. It is anticipated that the trustees of these plans will use a substantial portion of the proceeds to purchase annuities for plan participants at a future date, and that this action will likely result in the recognition of a settlement loss. The exact timing of the settlement of these obligations has not been determined.

 

The European Apparel business was previously included in the corporation’s Branded Apparel segment.

 

Other Businesses Held for Sale

 

United Kingdom (U.K.) Apparel – The corporation’s apparel operations in the U.K. primarily consist of the design, manufacture and sale of private label apparel products. This business was reported as a discontinued operation in the second quarter of fiscal 2006 and based upon ongoing negotiations with prospective buyers, an impairment charge of $1 million was recognized in the quarter. The carrying value of the net assets held for sale are less than $10 million.

 

The corporation’s planned sale of its apparel operations in the U.K. will result in the corporation retaining the pension obligations associated with the businesses to be sold. The projected benefit obligation of these plans, using a 5.3% discount rate, exceeded plan assets by $483 million at the close of fiscal 2005. The fiscal 2006 net periodic benefit cost of these plans was $52 million and these costs are recognized in selling, general and administrative expenses of the corporation’s continuing operations. The corporation is currently in discussions with the trustees of all of its U.K. plans and representatives of the government agency responsible for the oversight of pension plans regarding the full funding of these plans over the next ten years. The exact amount of the annual contributions will depend upon the outcome of these discussions.

 

The corporation does not expect to have any significant continuing involvement in the U.K. Apparel business after it is sold and does not expect to have any material direct cash inflows or outflows with the sold entity.

 

The operations of this business were previously included in the Branded Apparel segment.

 

European Nuts and Snacks – During the second quarter of fiscal 2006, the corporation entered into a definitive agreement to sell its European Nuts and Snacks business for 130 million euro which is equivalent to $154 million at the end of the second quarter of fiscal 2006. The sale transaction is subject

 

14


Table of Contents

to regulatory and other government approvals before the transaction can be completed. The carrying value of the net assets held for sale is approximately $30 million and the corporation expects to recognize a gain when this transaction closes. The closing date is expected to take place prior to the end of the current fiscal year.

 

The corporation does not expect to have any significant continuing involvement in this business after it is sold and does not expect to have any material direct cash inflows or outflows with the sold entity. The operations of this business were previously included in the International Food and Beverage segment.

 

The following is a summary of the net assets held for sale as of December 31, 2005. These amounts include the net assets of the Branded Apparel Europe business, the U.K. Apparel business, the European Nuts and Snacks business, as well as the net assets of the Direct Selling business in the Philippines. The summary below also includes certain assets that are held for sale and do not qualify as discontinued operations. The change in the net assets held for sale between July 2, 2005 and December 31, 2005 is primarily the result of the assets disposed of in completed sale transactions and impairments recognized in the first quarter of fiscal 2006.

 

     December 31,
2005


   July 2,
2005


Cash and short-term investments

   $ 19    $ 31

Trade accounts receivable

     229      285

Inventories

     275      474

Other current assets

     57      70
    

  

Total current assets held for sale

     580      860
    

  

Property

     25      149

Trademarks and other intangibles

     1      147

Goodwill

     19      108

Other assets

     7      25
    

  

Assets of discontinued operations held for sale

   $ 632    $ 1,289
    

  

Notes payable

   $ 20    $ 27

Accounts payable

     146      239

Accrued expenses

     220      325
    

  

Total current liabilities held for sale

     386      591
    

  

Other liabilities

     119      124
    

  

Liabilities of discontinued operations held for sale

   $ 505    $ 715
    

  

 

15


Table of Contents
4. Exit Activities and Business Dispositions

 

The reported results for the second quarter and first six months of fiscal years 2006 and 2005 reflect amounts recognized for exit and disposal actions. Reported amounts also include the impact of certain activities that were completed for amounts more favorable than previously estimated. The following is a summary of the expense (income) associated with these actions. These amounts are recognized in the “Charges for (income from) exit activities and business dispositions” line of the Consolidated Statements of Income.

 

     Thirteen Weeks Ended

    Twenty-six Weeks Ended

 

(In millions)


   December 31,
2005


   January 1,
2005


    December 31,
2005


   

January 1,

2005


 

Exit and disposal programs:

                               

Fiscal 2006 restructuring actions

   $ 46    $ —       $ 71     $ —    

Other restructuring actions

     —        (2 )     —         (4 )
    

  


 


 


Total exit costs (income)

     46      (2 )     71       (4 )

Business dispositions

     12      (8 )     (14 )     (12 )
    

  


 


 


Impact on income from continuing operations before income taxes

   $ 58    $ (10 )   $ 57     $ (16 )
    

  


 


 


 

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

 

     Thirteen Weeks Ended

    Twenty-six Weeks Ended

 

(In millions)


   December 31,
2005


   January 1,
2005


    December 31,
2005


    January 1,
2005


 

North American Retail Meats

   $ 6    $ (5 )   $ 10     $ (5 )

North American Retail Bakery

     1      (1 )     2       (1 )

Foodservice

     —        —         —         —    

International Beverage

     29      —         45       —    

European Meats

     3      —         3       —    

International Bakery

     —        —         5       —    

Household and Body Care

     6      (14 )     (20 )     (14 )

Branded Apparel

     —        (2 )     —         (8 )
    

  


 


 


Decrease (increase) in operating segment income

     45      (22 )     45       (28 )

Increase in general corporate expenses

     13      12       12       12  
    

  


 


 


Total

   $ 58    $ (10 )   $ 57     $ (16 )
    

  


 


 


 

The following provides a detailed description of the exit activities and business disposition actions impacting the reported results for the second quarter and first six months of fiscal years 2006 and 2005.

 

Fiscal 2006

 

The reported results for the second quarter and first six months of fiscal 2006 reflect amounts recognized for exit activities and disposal actions that decreased income from continuing operations before income taxes by $58 million and $57 million, respectively. During the second quarter and first six months, the corporation approved a series of actions to exit certain business activities and lower its cost structure. Each of these actions is to be completed within a 12-month period after being approved. Offsetting these charges, in part, were gains realized on the disposal of certain assets. The components of the net charges recognized in the second quarter and first six months of fiscal 2006 were as follows:

 

  The corporation’s management approved a series of actions to terminate employees and provide them with severance benefits in accordance with benefit plans previously communicated to the affected employee groups. Actions to terminate 566 employees at a cost of $41 million were approved in the second quarter. For the first six months of fiscal 2006, actions to terminate 1,012 employees at a cost of $69 million were approved. The specific location of these employees and the status of the terminations are summarized in a table contained in this note.

 

16


Table of Contents
  During the second quarter and first six months of fiscal 2006, the corporation recognized a $5 million charge for the exit of two leased facilities in connection with the transformation efforts of the corporation. These costs consist of noncancelable lease and other contractual obligations.

 

  Partially offsetting the charges noted above is a $3 million credit recognized in the first six months of fiscal 2006. This credit relates to the sale of a corporate aircraft for an amount more favorable than originally estimated.

 

  During fiscal 2006, the corporation completed the disposal of certain trademarks and other assets and incurred costs associated with the preparation of certain businesses for disposal. The net effect of these actions was a net charge of $12 million for the second quarter and a net gain of $14 million for the first six months of fiscal 2006. The most significant of these transactions is a $28 million gain realized on the sale of certain trademarks and inventory related to a line of skin care and sunscreen products. In addition, another $4 million gain was realized on the disposal of an investment in a foreign branded apparel business. Offsetting these gains is $18 million of professional fees incurred in connection with preparing certain businesses for disposition. The total cash proceeds from the investment and asset dispositions were $62 million.

 

The following table summarizes the charges recognized for exit activities approved during fiscal 2006, excluding business dispositions, and the related status as of December 31, 2005. Any accrued liabilities remaining in the Condensed Consolidated Balance Sheet represent those cash expenditures necessary to satisfy remaining obligations.

 

(In millions)


   Exit Costs
Recognized


    Non-Cash
Credits and
(Charges)


   Cash
Payments


    Accrued
Exit Costs
as of Dec. 31,
2005


Employee termination and other benefits

   $ 69     $ —      $ (9 )   $ 60

Noncancelable lease and other contractual obligations

     5       —        (1 )     4

Disposal of assets

     (3 )     3      —         —  
    


 

  


 

     $ 71     $ 3    $ (10 )   $ 64
    


 

  


 

 

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

 

Number of Employees


   North
American
Retail Meats


   North
American
Retail Bakery


   Food-
service


   International
Beverage


  

European

Meats


   International
Bakery


   Household
and Body
Care


   Branded
Apparel


   Corporate

   Total

United States

   94    65    8    —      —      —      1    —      11    179

Europe

   —      —      —      452    50    174    48    —      —      724

Australia

   —      —      —      16    —      17    76    —      —      109
    
  
  
  
  
  
  
  
  
  
     94    65    8    468    50    191    125    —      11    1,012
    
  
  
  
  
  
  
  
  
  

As of December 31, 2005:

                                                 

Actions completed

   59    42    6    344    3    8    38    —      5    505

Actions remaining

   35    23    2    124    47    183    87    —      6    507
    
  
  
  
  
  
  
  
  
  
     94    65    8    468    50    191    125    —      11    1,012
    
  
  
  
  
  
  
  
  
  

 

Fiscal 2005

 

The reported results for the second quarter and first six months of fiscal 2005 reflected amounts recognized for exit activities and disposal actions that increased income from continuing operations before income taxes by $10 million and $16 million, respectively. During the second quarter and first six months, the corporation approved actions to exit certain business activities and lower its cost structure. In addition, certain exit activities were completed for amounts that were less than previously anticipated. The components of the net credits recognized in the second quarter and first six months of fiscal 2005 were as follows:

 

  During the first six months of fiscal 2005, the corporation completed certain previously approved exit activities for amounts that were less than originally anticipated. The completion of these actions resulted in the recognition of income in the second quarter and first six months of fiscal 2005 of $2 million and $4 million, respectively.

 

17


Table of Contents
  During the second quarter of fiscal 2005, the corporation recognized a $20 million gain from the sale of inventory and trademarks related to certain product lines and other previously completed business dispositions. This amount consisted of a $14 million gain related to the disposal of an ethnic skin care products line primarily sold in the U.S., a $4 million gain recognized as a result of the disposal of a line of meat products sold in the southern portion of the U.S., and $2 million of credits related to certain previously completed business dispositions. Offsetting these amounts was $12 million of professional service fees resulting from a strategic evaluation of certain businesses. During the first six months of fiscal 2006, an additional credit of $4 million was recognized resulting from the completion of certain previously approved business disposition activities.

 

Status of Restructuring Reserves

 

Fiscal 2005 Exit Activities

 

During fiscal 2005, the corporation approved a series of actions to exit certain defined business activities and lower its cost structure. Each of these actions was to be completed within a 12-month period after being approved. The net impact was to reduce income from continuing operations before income taxes by $131 million. The components of this charge are as follows:

 

  $123 million of the charge was for the cost associated with terminating 1,882 employees and providing them with severance benefits in accordance with benefits plans previously communicated to the affected employee groups. Certain changes have been made to the originally targeted headcount due to voluntary departures and other plan changes. Adjustments have been made to reflect the actual cost of these terminations and are reflected in the net charge. The specific location of the employees and the status of the terminations is summarized in a table contained in this note.

 

  $8 million of the net charge was for the cost of certain noncancelable lease and other contractual obligations. The lease costs related to the exit of 11 retail stores for the Branded Apparel segment. The other contractual obligations related to the exit of a German distribution agreement for the International Beverage business. The retail spaces had been exited by the end of fiscal 2005 and there are no remaining obligations owed to third parties.

 

The following table summarizes the charges taken for the exit activities approved during fiscal 2005 and the related status as of December 31, 2005. Any accrued liabilities remaining in the Condensed Consolidated Balance Sheet represent those cash expenditures necessary to satisfy remaining obligations.

 

(In millions)


   Exit Costs
Recognized


   Cash
Payments


    Accrued
Exit Costs
as of Dec. 31,
2005


Employee termination and other benefits

   $ 123    $ (28 )   $ 95

Noncancelable lease and other contractual obligations

     8      (3 )     5
    

  


 

     $ 131    $ (31 )   $ 100
    

  


 

 

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

 

Number of Employees


   North
American
Retail
Meats


   North
American
Retail
Bakery


   Food-
service


   International
Beverage


  

European

Meats


   International
Bakery


   Household
and Body
Care


   Branded
Apparel


   Corporate

   Total

United States

   24    152    241    —      —      —      —      716    10    1,143

Canada

   —      —      —      —      —      —      —      216    —      216

Mexico

   —      —      —      —      —      —      —      139    —      139

Europe

   —      —      —      122    —      60    139    —      1    322

Australia

   —      —      —      —      —      —      62    —      —      62
    
  
  
  
  
  
  
  
  
  
     24    152    241    122    —      60    201    1,071    11    1,882
    
  
  
  
  
  
  
  
  
  

As of December 31, 2005:

                                                 

Actions Completed

   23    110    124    62    —      42    14    692    11    1,078

Actions Remaining

   1    42    117    60    —      18    187    379    —      804
    
  
  
  
  
  
  
  
  
  
     24    152    241    122    —      60    201    1,071    11    1,882
    
  
  
  
  
  
  
  
  
  

 

18


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Other Restructuring Actions

 

In prior periods, the corporation had approved various actions to exit certain defined business activities and lower its cost structure. As of the end of the second quarter of fiscal 2006, these actions had been completed. The accrued liabilities remaining in the Condensed Consolidated Balance Sheet related to these actions total $16 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. Pensions

 

The components of the net periodic pension cost and the postretirement medical cost related to continuing operations for the second quarter and first six months of fiscal 2006 and 2005 are as follows:

 

     Thirteen Weeks Ended
December 31, 2005


   

Thirteen Weeks Ended

January 1, 2005


 

(In millions)


   Pension

   

Postretirement
Medical and

Life Insurance


    Pension

   

Postretirement
Medical and

Life Insurance


 

Service cost

   $ 35     $ 3     $ 36     $ 4  

Interest cost

     69       5       68       6  

Expected return on plan assets

     (65 )     —         (61 )     —    

Amortization of

                                

Transition (asset) obligation

     —         —         —         —    

Prior service cost

     —         (5 )     1       (4 )

Net actuarial loss

     21       —         21       —    
    


 


 


 


Net periodic benefit cost

   $ 60     $ 3     $ 65     $ 6  
    


 


 


 


Curtailment gain

   $ —       $ —       $ —       $ 10  
    


 


 


 


    

Twenty-six Weeks Ended

December 31, 2005


   

Twenty-six Weeks Ended

January 1, 2005


 

(In millions)


   Pension

    Postretirement
Medical and
Life Insurance


    Pension

    Postretirement
Medical and
Life Insurance


 

Service cost

   $ 70     $ 6     $ 71     $ 8  

Interest cost

     138       10       134       12  

Expected return on plan assets

     (131 )     —         (121 )     —    

Amortization of

                                

Transition (asset) obligation

     —         (1 )     —         (1 )

Prior service cost

     1       (9 )     2       (8 )

Net actuarial loss

     42       1       42       1  
    


 


 


 


Net periodic benefit cost

   $ 120     $ 7     $ 128     $ 12  
    


 


 


 


Curtailment gain

   $ —       $ —       $ —       $ 26  
    


 


 


 


 

As indicated in the above table, the net periodic benefit cost of the corporation’s defined benefit pension plans was lower in the second quarter and first half of fiscal 2006 than in the comparable periods of fiscal 2005, primarily as a result of the expected return on plan assets increasing by a greater amount than the interest on plan obligations increased.

 

  The expected return on plan assets is based upon the fair value of plan assets and the assumed rate of return on those assets at the start of the year. The higher level of expected returns in fiscal 2006 is primarily due to an increase in the fair value of plan assets during fiscal 2005.

 

  The interest on plan obligations is based upon the projected benefit obligation of the plans and the discount rate assumption at the start of the fiscal year. The higher level of interest on plan obligations in fiscal 2006 is primarily due to an increase in plan obligations in fiscal 2005.

 

The net periodic benefit cost of the corporation’s postretirement medical and life insurance plans declined primarily as a result of plan amendments instituted in fiscal 2005 which eliminated post-65 coverage and increased cost sharing by covered employees in the North American bakery operations. These benefit changes reduced plan obligations and the interest on those obligations. In addition, the amendments

 

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increased the level of negative prior service cost being amortized in the determination of the net periodic benefit expense.

 

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

 

In the first six months of fiscal 2006, the corporation contributed $52 million in cash to its defined benefit pension plans. At the present time, the corporation expects to contribute $324 million of cash to its pension plans in fiscal 2006.

 

  Approximately $3 million of the full year funding is related to pension plans which have been transferred to the buyers of certain businesses as a result of transactions completed in fiscal 2006.

 

  Included in the current year estimate is the anticipated payment of $85 million to fully fund certain pension obligations associated with the Branded Apparel Europe business. These obligations were retained when the business was sold on February 3, 2006. It is anticipated that the trustees of these plans will use a substantial portion of the proceeds to purchase annuities for plan participants at a future date, and that this action will likely result in the recognition of a settlement loss. The exact timing of the settlement of these obligations has not been determined.

 

  The corporation’s planned sale of its apparel operations in the U.K. will result in the corporation retaining the pension obligations associated with the businesses to be sold. The projected benefit obligation of these plans, using a 5.3% discount rate, exceeded plan assets by $483 million at the close of fiscal 2005. The fiscal 2006 net periodic benefit cost of these plans was $52 million and these costs are recognized in selling, general and administrative expenses of the corporation’s continuing operations. The corporation is currently in discussions with the trustees of all of its U.K. plans and representatives of the government agency responsible for the oversight of pension plans regarding the full funding of the U.K. plans over the next ten years. The exact amount of the annual contributions will depend upon the outcome of these discussions. The estimated 2006 cash contributions reflect the corporation’s best estimate of the funding that will result from these ongoing discussions.

 

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 company operates. In addition, the corporation has announced its intent to dispose of certain businesses and the terms of those transactions may impact the timing and amount of future contributions to these plans. As a result, the actual funding in fiscal 2006 may differ from the current estimate.

 

6. Impairment Review and Goodwill

 

The corporation tests goodwill and intangible assets not subject to amortization for impairment in the second quarter of each fiscal year. As a result of the annual review, the corporation:

 

  Recognized a $1 million charge to write off goodwill related to an International Beverage business. The remaining change in the goodwill balance between July 2, 2005, and December 31, 2005, is due to changes in foreign currency exchange rates.

 

  Concluded that an apparel trademark with a carrying value of $79 million no longer had an indefinite life and it would be amortized in future periods.

 

At the end of the second quarter of fiscal 2006, $1,281 million of the corporation’s total intangible assets of $1,490 million were subject to amortization. After reclassifying these intangible assets to the finite lived category, the annual amortization expense is expected to be approximately $160 million.

 

7. Contingent Sale

 

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

 

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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 2006 and fiscal 2005 payments each passed in the first quarter, respectively, of each fiscal year and the corporation received the annual payments. The fiscal 2006 annual payment was equivalent to $114 million, and the fiscal 2005 annual payment was equivalent to $117 million based upon the respective exchange rates on the dates of receipt. Each of these amounts was recognized in the corporation’s earnings when received and each of the payments increased diluted earnings per share by $0.15 when they were recognized.

 

8. Acquisitions

 

During the first quarter of fiscal 2006, the corporation acquired National Textiles, LLC, a domestic yarn and textile production company for $3 million in cash and the assumption of $84 million of debt. The fair value of the assets acquired, net of liabilities assumed, approximated the $3 million purchase price based upon preliminary valuations and no goodwill has been recognized as a result of the transaction. The corporation expects to finalize the purchase price allocation after third party appraisers have completed their valuation work. Substantially all of the yarn and textiles produced by the acquired business will be used in products produced by the domestic Branded Apparel business.

 

9. Stock Based Compensation

 

On July 3, 2005, the corporation adopted the provisions of Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (FAS No. 123(R)) using the modified prospective method. FAS No. 123(R) requires companies to recognize the cost of employee services received in exchange for awards of equity instruments based upon the grant date fair value of those awards. Under the modified prospective method of adopting FAS No. 123(R), the corporation will recognize compensation cost for all share-based payments granted after July 3, 2005, plus any awards granted to employees prior to July 3, 2005 that remain unvested at that time. Under this method of adoption, no restatement of prior periods is made. The impact of adopting FAS No. 123(R) did not have a significant impact on income from continuing operations, income before income taxes, net income, cash flow from operations, or earnings per share during the period. Financial statement disclosures relating to the corporation’s various stock option, employee stock purchase and stock award plans under FAS 123(R) can be found in the corporation’s first quarter 10-Q, which was filed with the Securities and Exchange Commission, for the period ended October 1, 2005.

 

Prior to July 3, 2005, the corporation recognized the cost of employee services received in exchange for equity instruments in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB No. 25). APB No. 25 required the use of the intrinsic value method, which measures compensation cost as the excess, if any, of the quoted market price of the stock over the amount the employee must pay for the stock. Compensation expense for substantially all of the corporation’s equity-based awards was measured under APB No. 25 on the date the shares were granted. Under APB No. 25, no compensation expense has been recognized for stock options, replacement stock options and shares sold under the Employee Stock Purchase Plan. Compensation expense was recognized under APB No. 25 for the cost of restricted share unit awards granted to employees.

 

During the thirteen and twenty-six weeks ended January 1, 2005, had the cost of employee services received in exchange for equity instruments been recognized based on the grant date fair value of those instruments in accordance with the provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-based Compensation,” the corporation’s net income and earnings per share would have been impacted as shown in the following table.

 

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(In millions)


  

Thirteen
Weeks Ended

January 1,
2005


   

Twenty-six
Weeks Ended

January 1,
2005


 

Reported net income

   $ 326     $ 678  

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

     8       16  

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

     (13 )     (25 )
    


 


Pro forma net income

   $ 321     $ 669  
    


 


Earnings per share:

                

Basic – as reported

   $ 0.41     $ 0.86  
    


 


Basic – pro forma

   $ 0.41     $ 0.85  
    


 


Diluted – as reported

   $ 0.41     $ 0.85  
    


 


Diluted – pro forma

   $ 0.40     $ 0.84  
    


 


 

10. Accumulated Other Comprehensive Income (Loss)

 

The components of accumulated other comprehensive income (loss) are as follows:

 

     Cumulative
Translation
Adjustment


   

Net Unrealized

Gain (Loss) on

Qualifying Cash

Flow Hedges


   

Minimum
Pension Liability

Adjustment


    Accumulated
Other
Comprehensive
Income (Loss)


 

Balance at July 3, 2004

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

Other comprehensive income (loss) activity

     468       (62 )     —         406  
    


 


 


 


Balance at January 1, 2005

     (325 )     (76 )     (587 )     (988 )
    


 


 


 


Other comprehensive income (loss) activity

     (406 )     62       (70 )     (414 )
    


 


 


 


Balance at July 2, 2005

     (731 )     (14 )     (657 )     (1,402 )
    


 


 


 


Other comprehensive income (loss) activity

     (61 )     (15 )     —         (76 )
    


 


 


 


Balance at December 31, 2005

   $ (792 )   $ (29 )   $ (657 )   $ (1,478 )
    


 


 


 


 

Comprehensive income in second quarters of fiscal 2006 and 2005 was $401 million and $657 million, respectively. Comprehensive income in the first six months of fiscal 2006 and 2005 was $429 million and $1,084 million, respectively.

 

11. 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 2005 annual report on Form 10-K which is filed with the Securities and Exchange Commission. As of July 2, 2005, the net accumulated derivative loss recorded in Accumulated Other Comprehensive Income was $14 million. During the six months ended December 31, 2005, $16 million of accumulated net derivative gains were deferred into Accumulated Other Comprehensive Income and $31 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, resulting in a balance in Accumulated Other Comprehensive Income at December 31, 2005 of an accumulated loss of $29 million. At December 31, 2005, the maximum maturity date of any cash flow hedge was approximately 1 1/2 years, excluding derivative hedges related to the payment of variable

 

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Table of Contents

interest on existing financial instruments. The corporation expects to reclassify into earnings during the next twelve months, net gains from Accumulated Other Comprehensive Income of approximately $7 million, at the time the underlying hedged transaction is realized.

 

During the first six months of fiscal 2006, the corporation recognized a gain of $3 million for certain amounts that were excluded from the assessment of effectiveness. Other disclosures related to hedge ineffectiveness 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 six months ended December 31, 2005, a net gain of $29 million arising from effective hedges of net investments has been reflected in the cumulative translation adjustments account within consolidated stockholders’ equity.

 

12. Issued But Not Yet Effective Accounting Standards

 

Accounting Changes and Error Corrections

 

The FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections” (Statement No. 154), which requires retroactive application of a voluntary change in accounting principle to prior period financial statements unless it is impractical. Statement No. 154 also requires that a change in method of depreciation, amortization, or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate that is affected by a change in accounting principle. Statement No. 154 replaces APB Opinion 20, “Accounting Changes,” and SFAS 3, “Reporting Accounting Changes in Interim Financial Statements.” The corporation will adopt the provisions of Statement No. 154, effective in fiscal 2007. Management currently believes that adoption of the provisions of Statement No. 154 will not have a significant impact on the corporation’s consolidated financial statements.

 

Rental Costs Incurred During a Construction Period

 

The FASB issued FASB Staff Position FAS 13-1 (FSP 13-1), which requires companies to expense rental costs associated with ground or building operating leases that are incurred during a construction period. As a result, entities that are currently capitalizing these rental costs are required to expense them beginning in its first reporting period beginning after December 15, 2005. FSP 13-1 is effective for the corporation as of the third quarter of fiscal 2006. The corporation does not believe that the adoption of FSP 13-1 will have a material impact on the corporation’s financial condition or results of operations.

 

13. Subsequent Events

 

In January 2006, the corporation entered into a definitive agreement to acquire Butter-Krust Baking, a Northeastern United States based fresh bread and baking company, for approximately $72 million. The transaction is subject to regulatory approval and other customary closing conditions.

 

On February 3, 2006, the corporation completed the sale of its European Branded Apparel business that has been reported as a discontinued operation and received cash proceeds of $120 million. This transaction will be reported in the corporation’s third quarter of fiscal 2006.

 

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Table of Contents

Item II

 

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

 

Introduction

 

The following is management’s discussion and analysis of the results of operations for the second quarter and first six months of fiscal 2006 compared with the second quarter and first six months of fiscal 2005 and a discussion of the changes in financial condition and liquidity during the first six months of fiscal 2006. The following is an outline of the analyses included herein:

 

  Overview

 

    Second Quarter of Fiscal 2006

 

    First Six Months of Fiscal 2006

 

    Cash Flow

 

    Description of the Business Segments

 

    Transformation Plan

 

  Consolidated Results – Second Quarter of Fiscal 2006 Compared with Second Quarter of Fiscal 2005

 

  Operating Results by Business Segment – Second Quarter of Fiscal 2006 Compared with Second Quarter of Fiscal 2005

 

  Consolidated Results – First Six Months of Fiscal 2006 Compared with First Six Months of Fiscal 2005

 

  Operating Results by Business Segment – First Six Months of Fiscal 2006 Compared with First Six Months of Fiscal 2005

 

  Financial Condition

 

  Liquidity

 

  Significant Accounting Policies and Critical Estimates

 

  Forward-looking Information

 

Overview

 

Second Quarter of Fiscal 2006

 

Continuing Operations – During the second quarter of fiscal 2006, net sales decreased by $64 million, or 1.4%, over the second quarter of fiscal 2005, to $4,448 million. Changes in foreign currencies, particularly in the European euro and the British pound, decreased reported net sales by $93 million, or 2.1%. Net sales were impacted by acquisitions and dispositions in the first quarters of both fiscal 2006 and 2005 and these reduced net sales by $36 million, or 0.8%. The remaining net sales increase was $65 million, or 1.5%, as sales increases in the North American Retail Meats, North American Retail Bakery, Foodservice, International Beverage and International Bakery segments were partially offset by declines in the European Meats, Household and Body Care and Branded Apparel segments.

 

Operating income for the corporation in the second quarter of fiscal 2006 declined by $104 million, or 26.3%, and was composed of the following:

 

  The corporation’s gross profit declined by $25 million, primarily as a result of the $64 million decline in sales and a slight decline in the gross profit margin.

 

 

SG&A expenses in the second quarter of fiscal 2006 increased by $11 million over the comparable period of the prior year. As a percent of sales, SG&A expenses increased from 28.2% in the second quarter of fiscal 2005 to 28.8% in the second quarter of fiscal 2006. The

 

24


Table of Contents
 

impact of the ongoing transformation expenses and other cost increases more than offset savings from the transformation plan and lower advertising and promotion costs.

 

  In the second quarter of fiscal 2006, the corporation recognized a $58 million charge for exit activities and business dispositions, while in the second quarter of fiscal 2005, the corporation recognized $10 million of income.

 

Pretax income from continuing operations declined $115 million or 32.8% as result of the $104 million decline in operating income and an $11 million increase in interest expense. The effective tax rate on continuing operations was 19.2% in the second quarter of fiscal 2006 as compared to 12.7% in the comparable period of the prior year. The lower effective tax rate in fiscal 2005 was primarily attributable to a reduction in the statutory tax rate in the Netherlands that reduced deferred tax obligations in that jurisdiction. As a result of these factors, income from continuing operations declined by $116 million or 37.8%.

 

Discontinued Operations - The corporation has reported its Direct Selling, U.S. Retail Coffee, European Branded Apparel, U.K. Apparel and European Nuts and Snacks businesses as discontinued operations and several operations were sold in the second quarter.

 

  The operating results of the discontinued businesses are presented in Note 3 to the Consolidated Financial Statements. In the second quarter of fiscal 2006, these businesses reported income of $30 million as compared to $17 million of income in the comparable period of the prior year. This increase was primarily due to a $50 million tax benefit attributable to the Direct Selling business, as the corporation was able to credit taxes previously recognized in the operation of this business against taxes paid upon the sale.

 

  During the second quarter of fiscal 2006, the corporation sold its Direct Selling and U.S. Retail Coffee operations and also disposed of certain Turkish manufacturing assets of its European Branded Apparel business. As a result of these transactions, the corporation recognized pretax and after tax gains of $318 million and $215 million, respectively.

 

Net income in the second quarter of fiscal 2006 increased by $112 million, or 34.4%, and diluted EPS increased $0.16, or 39%, as a $228 million increase in income from discontinued operations offset a $116 million decline in income from continuing operations.

 

First Six Months of Fiscal 2006

 

Continuing Operations – During the first six months of fiscal 2006, net sales decreased by $123 million, or 1.4%, over the first six months of fiscal 2005, to $8,640 million. Changes in foreign currencies, particularly in the European euro and the British pound, decreased reported net sales by $67 million, or 0.8%. Net sales were impacted by acquisitions and dispositions in the first six months of both fiscal 2006 and 2005 and the impact of these transactions reduced net sales by $55 million, or 0.6%. The remaining net sales decrease was $1 million as sales decreased in the Household and Body Care and Branded Apparel segments and increased in each of the other segments.

 

Operating income for the corporation in the first six months of fiscal 2006 declined by $208 million, or 24.1%, and was composed of the following:

 

  The corporation’s gross profit declined by $86 million primarily as a result of the $123 million decline in sales and a 0.5% decline in the gross profit margin.

 

  SG&A expenses in the first six months of fiscal 2006 increased by $46 million over the comparable period of the prior year. As a percent of sales, SG&A expenses increased from 28.4% in the first six months of fiscal 2005 to 29.3% in the first six months of fiscal 2006. The impact of the ongoing transformation expenses and other cost increases more than offset savings from the transformation plan and lower advertising and promotion costs.

 

  In the first six months of fiscal 2006, the corporation recognized a charge of $57 million for exit activities and business dispositions, while in the first six months of fiscal 2005, the corporation recognized $16 million of income from exit and business disposition activities.

 

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Table of Contents
  The corporation received and recognized contingent sales proceeds of $114 million in the first six months of fiscal 2006 and $117 million of contingent sales proceeds in the first six months of fiscal 2005 from the sale of the corporation’s cut tobacco business. These payments represent the annual payments for fiscal 2006 and 2005.

 

Income from continuing operations before income taxes declined by $232 million or 29.8% as a result of the $208 million decline in operating income and higher short term interest rates which increased interest expense by $24 million. The effective tax on continuing operations was 20.2% for the first six months of fiscal 2006 as compared to 16.4% in fiscal 2005. The lower effective tax rate in fiscal 2005 was primarily attributable to the change in the statutory tax rate in the Netherlands. As a result of these factors, income from continuing operations declined by $215 million or 32.9%.

 

Discontinued Operations – The corporation reported its Direct Selling, U.S. Retail Coffee, European Branded Apparel, U.K. Apparel and European Nuts and Snacks businesses as discontinued operations and several operations were sold prior to the close of the period.

 

  The operating results of the discontinued businesses are presented in Note 3 to the financial statements. For the first six months of fiscal 2006, these businesses reported a loss of $148 million as compared to income of $25 million in the prior year. This is a change of $173 million between the periods. The operating loss recognized by discontinued businesses was primarily due to a $130 million impairment charge recognized for the Branded Apparel Europe operations, a $39 million impairment charge recognized for the U.S. Retail Coffee operation and a $1 million impairment charge in the U.K. Apparel operations.

 

  As noted earlier, the corporation also recognized an after tax gain of $215 million as a result of disposing of several businesses in the second quarter of fiscal 2006.

 

Net income in the first six months of fiscal 2006 decreased by $173 million, or 25.6% and diluted EPS decreased by $0.20, or 23.5%, as a $215 million decline in income from continuing operations more than offset a $42 million increase in income from discontinued operations.

 

A table which summarizes the significant items that impacted the second quarters and first six months of fiscal 2006 and 2005 is presented below.

 

26


Table of Contents

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

 

     13 Weeks Ended December 31, 2005

    13 Weeks Ended January 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 from continuing operations

   $ 239     $ (46 )   $ 193     $ 0.25     $ 354     $ (45 )   $ 309     $ 0.39  
    


 


 


 


 


 


 


 


Net income

                   $ 438     $ 0.57                     $ 326     $ 0.41  
                    


 


                 


 


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

                                                                

(Charges for) income from exit activities and business dispositions

                                                                

(Charges for) income from exit activities

   $ (46 )   $ 15     $ (31 )   $ (0.04 )   $ 2     $ (1 )   $ 1     $ —    

(Charges for) income from business disposition activities

     (12 )     5       (7 )     (0.01 )     8       (2 )     6       0.01  
    


 


 


 


 


 


 


 


Subtotal

     (58 )     20       (38 )     (0.05 )     10       (3 )     7       0.01  

(Charges) income to cost of sales and SG&A expenses

                                                                

Transformation charges in cost of sales and SG&A

     (42 )     14       (28 )     (0.04 )     —         —         —         —    

Hurricane losses

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

Accelerated depreciation and amortization

     (11 )     4       (7 )     (0.01 )     (7 )     2       (5 )     (0.01 )

Change in vacation policy

     14       (5 )     9       0.01       —         —         —         —    

Bakery curtailment gain

     —         —         —         —         10       (4 )     6       0.01  
    


 


 


 


 


 


 


 


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

     (99 )     34       (65 )     (0.09 )     13       (5 )     8       0.01  
    


 


 


 


 


 


 


 


Significant tax matters affecting comparability

                                                                

Dutch tax rate change

     —         —         —         —         —         24       24       0.03  
    


 


 


 


 


 


 


 


Impact of significant items on income from continuing operations:

     (99 )     34       (65 )     (0.09 )     13       19       32       0.04  
    


 


 


 


 


 


 


 


Significant items impacting discontinued operations

                                                                

European Branded Apparel impairment

     —         2       2       —         —         —         —         —    

U.K. Branded Apparel impairment

     (1 )     —         (1 )     —         —         —         —         —    

Charges for exit activities and transformation expenses

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

Tax benefit on Direct Selling transaction

     —         50       50       0.07       —         —         —         —    

Gain on sale of Direct Selling and other businesses

     318       (103 )     215       0.28       —         —         —         —    
    


 


 


 


 


 


 


 


Impact of significant items on net income

   $ 215     $ (15 )   $ 200     $ 0.26     $ 13     $ 19     $ 32     $ 0.04  
    


 


 


 


 


 


 


 


 

Notes:

 

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

 

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

 

     26 Weeks Ended December 31, 2005

    26 Weeks Ended January 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 from continuing operations

   $ 549     $ (111 )   $ 438     $ 0.56     $ 781     $ (128 )   $ 653     $ 0.82  
    


 


 


 


 


 


 


 


Net income

                   $ 505     $ 0.65                     $ 678     $ 0.85  
                    


 


                 


 


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

                                                                

(Charges for) income from exit activities and business dispositions

                                                                

(Charges for) income from exit activities

   $ (71 )   $ 24     $ (47 )   $ (0.06 )   $ 4     $ (2 )   $ 2     $ —    

(Charges for) income from business disposition activities

     14       (5 )     9       0.01       12       (2 )     10       0.01  
    


 


 


 


 


 


 


 


Subtotal

     (57 )     19       (38 )     (0.05 )     16       (4 )     12       0.02  

(Charges) income to cost of sales and SG&A expenses

                                                                

Transformation charges in cost of sales and SG&A

     (68 )     23       (45 )     (0.06 )     —         —         —         —    

Hurricane losses

     (5 )     2       (3 )     —         —         —         —         —    

Accelerated depreciation and amortization

     (21 )     8       (13 )     (0.02 )     (25 )     7       (18 )     (0.02 )

Change in vacation policy

     14       (5 )     9       0.01       —         —         —         —    

Bakery curtailment gain

     —         —         —         —         26       (10 )     16       0.02  
    


 


 


 


 


 


 


 


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

     (137 )     47       (90 )     (0.12 )     17       (7 )     10       0.01  
    


 


 


 


 


 


 


 


Significant tax matters affecting comparability

                                                                

Dutch tax rate change

     —         —         —         —         —         24       24       0.03  
    


 


 


 


 


 


 


 


Impact of significant items on income from continuing operations:

     (137 )     47       (90 )     (0.12 )     17       17       34       0.04  
    


 


 


 


 


 


 


 


Significant items impacting discontinued operations

                                                                

European Branded Apparel impairment

     (179 )     49       (130 )     (0.17 )     —         —         —         —    

U.S. Retail Coffee impairment

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

U.K. Branded Apparel impairment

     (1 )     —         (1 )     —         —         —         —         —    

Charges for exit activities and transformation expenses

     (4 )     2       (2 )     —         —         —         —         —    

Tax benefit on Direct Selling transaction

     —         50       50       0.07       —         —         —         —    

Gain on sale of Direct Selling and other businesses

     318       (103 )     215       0.28       —         —         —         —    
    


 


 


 


 


 


 


 


Impact of significant items on net income

   $ (47 )   $ 50     $ 3     $ —       $ 17     $ 17     $ 34     $ 0.04  
    


 


 


 


 


 


 


 


 

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 from operations in the first six months of fiscal 2006 was $848 million as compared to $803 million in the comparable period of fiscal 2005. The following significant factors impacted these results:

 

  The corporation’s income from continuing operations in the six months ended December 31, 2005 declined by $215 million as compared to the comparable period of the prior year. In addition, the operating results of discontinued businesses were lower than the comparable period of the prior year.

 

  The lower profitability of the business was largely offset by a $393 million improvement in working capital. Significant factors impacting working capital were:

 

    a $108 million reduction in outstanding receivables as a result of lower sales and improved collection efforts,

 

    a $59 million reduction in inventory which was largely attributable to better inventory management in the North American branded apparel business,

 

    a $51 million improvement in the amount of cash used in the settlement of trade payables, and

 

    a $99 million reduction in the amount of cash contributed to the corporation’s defined benefit pension plans, as well as lower cash bonus payments.

 

Cash generated from investment activities was $455 million in the first six months of fiscal 2006, as compared to cash used of $7 million in the comparable period of fiscal 2005. At the end of the second quarter of fiscal 2006, the corporation did not utilize cash on the balance sheet to repay outstanding notes payable borrowings as it had done at the end of the second quarter of fiscal 2005 or the end of fiscal 2005. At the end of the second quarter of fiscal 2005 and the end of fiscal 2005, the corporation scheduled certain notes payable obligations, primarily in the form of short-term commercial paper, to mature prior to the end of the fiscal period. Cash generated from operations, which includes cash on hand in various operating units in different geographic locations, was utilized to repay these commitments when they matured. At the beginning of the subsequent quarter, issuances of commercial paper were made and cash was returned to the corporation’s operating locations. Shortly before the end of fiscal 2005, using cash on hand, the corporation repaid $2,080 million of outstanding notes payable. Notes payable and cash would have been higher at the end of fiscal 2005 by $2,080 million had the cash repayments not been made. As a result of the decision not to utilize cash on hand to repay outstanding notes payable, the corporation had $1,955 million of cash on the balance sheet at the end of the second quarter of fiscal 2006, versus $538 million at the end of fiscal 2005, and had outstanding notes payable of $1,378 million at the end of the second quarter of fiscal 2006, versus $239 million at the end of fiscal 2005.

 

During the first six months of fiscal 2006 and 2005, the corporation repaid borrowings of long-term debt of $189 million and $945 million, respectively, by utilizing a combination of cash on hand and the issuance of short- and long-term debt.

 

During the first six months of fiscal 2006, the corporation repurchased 29.1 million shares of its common stock for $562 million under the corporation’s ongoing share repurchase program. Of this total, 20.9 million shares were repurchased for $400 million under an accelerated share repurchase program where the final purchase price will be based upon the average daily share price over a period of time not to exceed 6 months. The accelerated share repurchase program concluded on February 3, 2006 and the final purchase price settlement resulted in approximately 1.0 million additional shares of common stock being delivered to the corporation. During the accelerated share repurchase period, the corporation’s purchase of additional shares of its common stock was subject to conditions imposed by the counterparty to the transaction.

 

Further information and details regarding the performance of the corporation and its business segments follows.

 

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Description of the Business Segments

 

During fiscal 2006, the corporation reorganized its business operations around distinct customers, consumers and geographic markets in order to build functional excellence, increase strategic focus and simplify the organization. As a result of these changes, the corporation reorganized its business operations and reports its results in eight business segments. Historical results have been restated to present the business segments on a comparable basis. The following is a general description of the corporation’s eight business segments.

 

  North American Retail Meats – sells a variety of meat products, including hot dogs, corn dogs, breakfast sausages and sandwiches, bacon, smoked and dinner sausages, as well as premium deli and luncheon meats.

 

  North American Retail Bakery – sells a wide variety of fresh and frozen baked products including bread, buns and bagels as well as specialty items including frozen pies, cakes, and cheesecakes.

 

  Foodservice – sells meats, bakery and coffee products to foodservice customers in the U.S.

 

  International Beverage – sells coffee and tea products to retail and foodservice customers primarily in Europe, Brazil and Australia.

 

  European Meats – sells a variety of packaged and processed meats as well as cooked and dry hams and sausage products to retail customers in Europe. Previously, the operations of this business were grouped with the International Beverage business.

 

  International Bakery – sells frozen bakery, dough products and a variety of fresh bread 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.

 

  Branded Apparel – sources, manufactures and markets basic branded apparel products including men’s and women’s underwear, intimate apparel, casualwear, socks and sheer hosiery in the Americas and Asia.

 

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 and a number of significant gains and losses are anticipated to be recognized over this period. The following is an update on the actions taken in the transformation plan and the impact on the second quarter and first six months of fiscal 2006.

 

Organization Structure

 

The corporation reorganized its operations around distinct consumers, customers and geographic markets in order to build functional excellence, increase strategic focus and simplify the organization. The corporation’s new structure is organized around eight business segments, which were described above.

 

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 (Downers Grove, Illinois). As a result of this change:

 

  Costs are being incurred to relocate those individuals who were requested to remain with the organization and elected to do so.

 

  A number of individuals elected not to relocate to Chicago and it was necessary to pay certain of these personnel stay bonuses to preserve business continuity while replacements were hired.

 

  Certain positions and employees are being eliminated from the organization structure and severance benefits are being paid to these individuals.

 

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  Costs were incurred to recruit new employees to work in the Chicago area as well as to staff positions in newly created functions. During the first six months of fiscal 2006, the corporation hired more than 500 new employees in the United States.

 

  Bonuses are being accrued for certain employees deemed critical to the success of the transformation effort. These amounts are to incent individuals to remain with the organization and compensate them for an increased workload.

 

The corporation expects to finalize the employee centralization in the fall of 2006. In the third quarter of fiscal 2006, management expects to approve a formal plan to centralize the research and development activities for North America into a temporary single site by the summer of 2006, while management starts construction on a permanent North American research center.

 

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

 

As a result of these actions, pretax charges of $99 million were recognized in the second quarter of fiscal 2006 related to exit activities, transformation costs and accelerated depreciation and amortization in order to simplify the organizational structure. In the first six months of fiscal 2006, the corporation has recognized pretax charges from transformation and exit activities of $160 million, including $69 million of severance costs, $21 million of accelerated depreciation and amortization, $17 million of employee retention costs, $13 million of relocation costs, $8 million of recruiting costs, and $32 million related to consulting, information technology and other transformation and exit efforts. Additional restructuring actions are expected over the life of the transformation plan and further details regarding these actions is contained in this Management Discussion and Analysis section and in Note 4, titled “Exit Activities and Business Dispositions” to the Consolidated Financial Statements.

 

Portfolio Changes

 

The corporation announced plans to dispose of seven businesses in order to concentrate financial and management resources on a smaller number of entities that are better positioned for growth. At the close of the second quarter of fiscal 2006, five of these businesses had been reported as discontinued operations. The status of the announced portfolio changes is as follows:

 

  Direct Selling – Substantially all of this business was sold in December 2005 and an after tax gain of $213 million was recognized as a result of this transaction. The disposition of the Direct Selling operations in the Philippines is expected to close in fiscal 2006 after receiving government approval.

 

  U.S. Retail Coffee – This business was sold in December 2005. An after tax gain of $3 million was recognized as a result of this transaction.

 

  Branded Apparel Europe – This business was sold on February 3, 2006 and the transaction will be recognized in the third quarter of fiscal 2006.

 

  European Nuts and Snacks – The corporation has entered into an agreement to sell this business and expects to close on this transaction in fiscal 2006. The timing of the closing date is dependent upon the receipt of regulatory and government approvals.

 

  United Kingdom (U.K.) Apparel – The corporation anticipates that this business will be sold prior to the end of the fiscal year.

 

  European Meats – At the end of the second quarter of fiscal 2006, the corporation is continuing to evaluate its options relative to the European Meats business and it remains classified as held for use and reported in continuing operations.

 

  Branded Apparel Americas / Asia – The corporation is in the process of preparing to spin-off this business in the early part of fiscal 2007.

 

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