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Hillshire Brands Co 10-Q 2007
Form 10-Q

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 30, 2006

OR

 

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

Commission file number 1-3344

 


Sara Lee Corporation

(Exact name of registrant as specified in its charter)

 


 

Maryland   36-2089049

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

3500 Lacey Road, Downers Grove, Illinois 60515

(Address of principal executive offices)

(Zip Code)

(630) 598-6000

(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 30, 2006, the Registrant had 733,471,912 outstanding shares of common stock $.01 par value, which is the Registrant's only class of common stock.

 



SARA LEE CORPORATION AND SUBSIDIARIES

INDEX

 

          Page
PART I –      
ITEM 1 –   

FINANCIAL STATEMENTS

  
  

Preface

   3
  

Condensed Consolidated Balance Sheets - At December 30, 2006 and July 1, 2006

   4
  

Consolidated Statements of Income - For the quarter and six months ended December 30, 2006 and December 31, 2005

   5
  

Consolidated Statements of Common Stockholders' Equity - For the period July 2, 2005 to December 30, 2006

   6
  

Consolidated Statements of Cash Flows - For the quarter and six months ended December 30, 2006 and December 31, 2005

   7
  

Notes to Consolidated Financial Statements

   8
ITEM 2 –   

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

   31
ITEM 4 –   

CONTROLS AND PROCEDURES

   77
PART II –      
ITEM 1 -   

LEGAL PROCEEDINGS

   78
ITEM 1A -   

RISK FACTORS

   78
ITEM 2(c) -   

REPURCHASES OF EQUITY SECURITIES BY THE ISSUER

   78
ITEM 6 -   

EXHIBITS

   79
SIGNATURE       80

 

2


PART I

SARA LEE CORPORATION AND SUBSIDIARIES

Preface

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

The corporation’s fiscal year ends on the Saturday closest to June 30. The second quarter and first six months of fiscal 2007 ended on December 30, 2006 and the second quarter and first six months of fiscal 2006 ended on December 31, 2005. Each of these quarters was a thirteen-week period and each six month period was a twenty-six week period.

The Consolidated Financial Statements for the quarters and six month periods ended December 30, 2006 and December 31, 2005 and the balance sheet as of July 1, 2006 included herein have not been audited by an independent registered public accounting firm, but in the opinion of Sara Lee Corporation ("the corporation"), all adjustments (which include only normal recurring adjustments) necessary to make a fair statement of the financial position at December 30, 2006 and the results of operations and the cash flows for the periods presented herein have been made. The Condensed Consolidated Balance Sheet as of July 1, 2006 and the Consolidated Statement of Common Stockholders’ Equity for the period July 2, 2005 to July 1, 2006 have been derived from the corporation’s audited financial statements included in our annual report on Form 10-K for the fiscal year ended July 1, 2006. The results of operations for the quarter and first six months ended December 30, 2006 are not necessarily indicative of the operating results to be expected for the full fiscal year.

The consolidated financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Although the corporation believes the disclosures are adequate to make the information presented not misleading, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the corporation's Form 10-K for the year ended July 1, 2006 and other financial information filed with the Securities and Exchange Commission.

 

3


SARA LEE CORPORATION AND SUBSIDIARIES

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

(In millions)

 

    

(Unaudited)

December 30,

2006

   July 1,
2006

Assets

     

Cash and equivalents

   $ 2,704    $ 2,231

Trade accounts receivable, less allowances

     1,354      1,216

Inventories

     

Finished goods

     636      603

Work in process

     33      38

Materials and supplies

     289      278
             
     958      919

Other current assets

     279      317

Assets of discontinued operations held for disposal

     —        2,253
             

Total current assets

     5,295      6,936

Other noncurrent assets

     109      109

Property, net

     2,323      2,319

Trademarks and other identifiable intangibles, net

     1,038      1,049

Goodwill

     2,708      2,774

Assets held for sale

     14      1

Assets of discontinued operations held for disposal

     —        1,563
             
   $ 11,487    $ 14,751
             

Liabilities and Stockholders' Equity

     

Notes payable

   $ 25    $ 1,776

Accounts payable

     967      1,022

Accrued liabilities

     2,095      2,252

Current maturities of long-term debt

     885      366

Liabilities of discontinued operations held for disposal

     —        1,024
             

Total current liabilities

     3,972      6,440

Long-term debt

     3,335      3,806

Pension obligation

     269      233

Deferred tax liability

     101      66

Other liabilities

     1,255      1,327

Liabilities of discontinued operations held for disposal

     —        367

Minority interests in subsidiaries

     55      63

Common stockholders' equity

     2,500      2,449
             
   $ 11,487    $ 14,751
             

See accompanying Notes to Consolidated Financial Statements.

 

4


SARA LEE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income

For the Quarter and Six Months Ended December 30, 2006 and December 31, 2005

(In millions, except per share data)

Unaudited

 

     Quarter Ended     Six Months Ended  
    

December 30,

2006

   

December 31,

2005

   

December 30,

2006

   

December 31,

2005

 

Continuing operations

        

Net sales

   $ 3,182     $ 2,974     $ 6,073     $ 5,737  
                                

Cost of sales

     1,972       1,816       3,768       3,523  

Selling, general and administrative expenses

     1,020       997       1,982       1,952  

Net charges for exit activities, asset and business dispositions

     40       55       39       55  

Impairment charges

     152       —         152       —    

Contingent sale proceeds

     —         —         (120 )     (114 )

Interest expense

     62       75       137       148  

Interest income

     (34 )     (18 )     (60 )     (37 )
                                
     3,212       2,925       5,898       5,527  
                                

(Loss) income from continuing operations before income taxes

     (30 )     49       175       210  

Income tax expense (benefit)

     27       7       (23 )     66  
                                

(Loss) income from continuing operations

     (57 )     42       198       144  
                                

Discontinued operations

        

Net income from discontinued operations, net of tax expense (benefit) of $0, $6, $30, and $(35)

     —         181       62       146  

(Loss) gain on disposition of discontinued operations, net of tax expense of $0, $103, $2, and $103

     (5 )     215       11       215  
                                

Net (loss) income

   $ (62 )   $ 438     $ 271     $ 505  
                                

(Loss) income from continuing operations per common share

        

Basic

   $ (0.08 )   $ 0.06     $ 0.26     $ 0.19  
                                

Diluted

   $ (0.08 )   $ 0.06     $ 0.26     $ 0.19  
                                

Net (loss) income per common share

        

Basic

   $ (0.08 )   $ 0.58     $ 0.36     $ 0.65  
                                

Diluted

   $ (0.08 )   $ 0.57     $ 0.36     $ 0.65  
                                

Average shares outstanding

        

Basic

     737       761       748       771  
                                

Diluted

     737       765       750       775  
                                

Cash dividends per common share

   $ 0.1000     $ 0.1975     $ 0.2000     $ 0.3950  
                                

See accompanying Notes to Consolidated Financial Statements.

 

5


SARA LEE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Common Stockholders' Equity

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

(In millions, except per share data)

 

     TOTAL     COMMON
STOCK
    CAPITAL
SURPLUS
    RETAINED
EARNINGS
    UNEARNED
STOCK
   

ACCUMULATED
OTHER
COMPREHENSIVE
INCOME

(LOSS)

    COMPREHENSIVE
INCOME
 

Balances at July 2, 2005

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

Net income

     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

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

ESOP contributions and other

     5       —         (1 )     —         6       —      
                                                  

Balances at December 31, 2005

     2,359       8       30       4,107       (149 )     (1,637 )  

Net income

     50       —         —         50       —         —       $ 50  

Translation adjustments, net of tax

     131       —         —         —         —         131       131  

Minimum pension liability, net of tax

     180       —         —         —         —         180       180  

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

     (13 )     —         —         —         —         (13 )     (13 )
                    

Comprehensive income

               $ 348  
                    

Cash dividends -

              

Common ($0.395 per share)

     (306 )     —         —         (306 )     —         —      

Stock issuances (cancelations) -

              

Stock option and benefit plans

     12       —         12       —         —         —      

Restricted stock

     17       —         17       —         —         —      

Tax benefit related to stock-based compensation

     1       —         1       —         —         —      

ESOP contributions and other

     18       —         2       4       12       —      
                                                  

Balances at July 1, 2006

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

Net income

     271       —         —         271       —         —       $ 271  

Translation adjustments, net of tax

     416       —         —         —         —         416       416  

Minimum pension liability, net of tax

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

Net unrealized gain / (loss) on qualifying cash flow

     —                

hedges, net of tax

     12       —         —         —         —         12       12  
                    

Comprehensive income

               $ 663  
                    

Cash dividends-common ($0.20 per share)

     (151 )     —         —         (151 )     —         —      

Spin off of Hanesbrands Inc. business

     (18 )     —           (85 )     —         67    

Stock issuances (cancelations) -

              

Stock option and benefit plans

     22       —         22       —         —         —      

Restricted stock

     21       —         21       —         —         —      

Share repurchases and retirement

     (490 )     —         (105 )     (385 )     —         —      

Other

     4       (1 )     —         —         5       —      
                                                  

Balances at December 30, 2006

   $ 2,500     $ 7     $ —       $ 3,505     $ (132 )   $ (880 )  
                                                  

Interim period balances are unaudited.

See accompanying Notes to Consolidated Financial Statements.

 

6


SARA LEE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the Six Months Ended December 30, 2006 and December 31, 2005

(In millions)

Unaudited

 

     Six Months Ended  
     December 30,
2006
    December 31,
2005
 

OPERATING ACTIVITIES -

    

Net income

   $ 271     $ 505  

Less: Cash received from contingent sale proceeds

     (120 )     (114 )

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

    

Depreciation

     229       260  

Amortization of intangibles

     60       83  

Impairment charges

     152       224  

Net gain on business dispositions

     (35 )     (349 )

Decrease in deferred taxes

     (25 )     (79 )

Other

     88       5  

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

     (582 )     324  
                

Net cash from operating activities

     38       859  
                

INVESTMENT ACTIVITIES -

    

Purchases of property and equipment

     (278 )     (234 )

Acquisitions of businesses and investments

     —         (7 )

Dispositions of businesses and investments

     349       514  

Cash received from loans receivable

     688       34  

Cash received from contingent sale proceeds

     120       114  

Cash used in derivative transactions

     (25 )     (11 )

Sales of assets

     39       68  
                

Net cash from investment activities

     893       478  
                

FINANCING ACTIVITIES -

    

Issuances of common stock

     17       17  

Purchases of common stock

     (490 )     (562 )

Borrowings of long-term debt

     2,894       9  

Repayments of long-term debt

     (369 )     (189 )

Short-term (repayments) borrowings, net

     (1,728 )     1,130  

Cash transferred to Hanesbrands Inc. in spin off

     (650 )     —    

Payments of dividends

     (227 )     (308 )
                

Net cash (used in) from financing activities

     (553 )     97  
                

Effect of changes in foreign exchange rates on cash

     81       (29 )
                

Increase in cash and equivalents

     459       1,405  

Add: Cash balance of discontinued operations at beginning of year

     14       36  

Less: Cash balance of discontinued operations at end of quarter

     —         (12 )

Cash and equivalents at beginning of year

     2,231       533  
                

Cash and equivalents at end of quarter

   $ 2,704     $ 1,962  
                

COMPONENTS OF CHANGES IN CURRENT ASSETS

    

AND LIABILITIES:

    

(Increase) decrease in trade accounts receivable

   $ (64 )   $ 30  

(Increase) decrease in inventories

     (35 )     167  

Increase in other current assets

     (19 )     (59 )

Decrease in accounts payable

     (5 )     (90 )

(Decrease) increase in accrued liabilities

     (202 )     144  

(Decrease) increase in accrued taxes

     (257 )     132  
                

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

   $ (582 )   $ 324  
                

See accompanying Notes to Consolidated Financial Statements.

 

7


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 quarter and six month periods ended December 30, 2006, options to purchase 43.7 million and 43.8 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 quarter and six month 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. 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 2007 as a result of shares repurchased under the corporation’s ongoing share repurchase program. The corporation repurchases common stock at times management deems appropriate, given current market valuations. During the first six months of fiscal 2007, the corporation repurchased 30.7 million shares of common stock for a purchase price of $490 million. The corporation has a continuing share repurchase program under which the corporation may repurchase shares of common stock. At December 30, 2006, 55.6 million shares remain authorized for repurchase under this program. The timing and amount of future share repurchases will be based upon market conditions and other factors.

The following is a reconciliation of net income to net income per share – basic and – diluted for the second quarter and first six months of fiscal 2007 and fiscal 2006:

Computation of Net Income per Common Share

(In millions, except per share data)

 

     Quarter ended    Six Months ended
     Dec. 30,
2006
    Dec. 31,
2005
   Dec. 30,
2006
   Dec. 31,
2005

Income (loss) from continuing operations

   $ (57 )   $ 42    $ 198    $ 144

Income (loss) from discontinued operations, net of tax

     —         181      62      146

Gain on disposition of discontinued operations, net of tax

     (5 )     215      11      215
                            

Net income

   $ (62 )   $ 438    $ 271    $ 505
                            

Average shares outstanding – basic

     737       761      748      771

Dilutive effect of stock option and award plans

     —         4      2      4
                            

Diluted shares outstanding

     737       765      750      775
                            

Income (loss) from continuing operations per share

          

Basic

   $ (0.08 )   $ 0.06    $ 0.26    $ 0.19
                            

Diluted

   $ (0.08 )   $ 0.06    $ 0.26    $ 0.19
                            

Income (loss) from discontinued operations per share

          

Basic

   $ (0.01 )   $ 0.52    $ 0.10    $ 0.47
                            

Diluted

   $ (0.01 )   $ 0.52    $ 0.10    $ 0.47
                            

Net income (loss) per common share

          

Basic

   $ (0.08 )   $ 0.58    $ 0.36    $ 0.65
                            

Diluted

   $ (0.08 )   $ 0.57    $ 0.36    $ 0.65
                            

 

8


  2. Segment Information

The following is a general description of the corporation’s six business segments. In the first quarter of fiscal 2007, the corporation completed the spin off of its branded apparel operations in the Americas/Asia. The Branded Apparel Americas/Asia business was previously reported as a separate segment. This business, which is now known as Hanesbrands Inc. (Hanesbrands), was spun off to the corporation’s shareholders and began being reported as a discontinued operation in the first quarter of fiscal 2007. The spin off of Hanesbrands is more fully described below in Note 4, “Discontinued Operations.” In the second quarter of fiscal 2007, the corporation changed the reporting structure of its internal organization and management responsibility for an operating plant was moved from the International Beverage segment to the Foodservice segment. Prior period results have been restated to reflect both the Hanesbrands business as a discontinued operation and the change in operating responsibility for the operating plant from the International Beverage segment to the Foodservice segment.

 

   

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 in major markets around the world, including Europe, Australia and Brazil.

 

   

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

 

   

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

The following is a summary of sales and operating segment income by business segment for the second quarter and first six months of fiscal years 2007 and 2006:

 

     Net Sales    

Income from Continuing
Operations

Before Income Taxes

 

(In millions)

   Second
Quarter
2007
    Second
Quarter
2006
   

Second

Quarter

2007

   

Second

Quarter

2006

 

North American Retail Meats

   $ 688     $ 672     $ (6 )   $ 50  

North American Retail Bakery

     500       462       3       (17 )

Foodservice

     614       603       59       55  

International Beverage

     675       598       (10 )     66  

International Bakery

     199       190       4       21  

Household and Body Care

     509       451       56       35  
                                

Total business segments

     3,185       2,976       106       210  

Intersegment sales

     (3 )     (2 )     —         —    
                                

Total net sales and operating

segment income

     3,182       2,974       106       210  

Amortization of intangibles

     —         —         (15 )     (14 )

General corporate expenses

     —         —         (93 )     (90 )
                                

Total net sales and operating income

     3,182       2,974       (2 )     106  

Net interest expense

     —         —         (28 )     (57 )
                                

Net sales and income from continuing

    operations before income taxes

   $ 3,182     $ 2,974     $ (30 )   $ 49  
                                

 

9


     Net Sales    

Income from Continuing Operations

Before Income Taxes

 

(In millions)

   Six Months
Fiscal 2007
    Six Months
Fiscal 2006
    Six Months
Fiscal 2007
    Six Months
Fiscal 2006
 

North American Retail Meats

   $ 1,318     $ 1,287     $ 21     $ 67  

North American Retail Bakery

     998       923       8       (21 )

Foodservice

     1,152       1,130       78       68  

International Beverage

     1,238       1,123       82       130  

International Bakery

     399       382       18       33  

Household and Body Care

     974       897       134       115  
                                

Total business segments

     6,079       5,742       341       392  

Intersegment sales

     (6 )     (5 )     —         —    
                                

Total net sales and operating segment income

     6,073       5,737       341       392  

Amortization of intangibles

     —         —         (32 )     (29 )

General corporate expenses

     —         —         (177 )     (156 )

Contingent sale proceeds

     —         —         120       114  
                                

Total net sales and operating income

     6,073       5,737       252       321  

Net interest expense

     —         —         (77 )     (111 )
                                

Net sales and income from continuing operations before income taxes

   $ 6,073     $ 5,737     $ 175     $ 210  
                                

The following table summarizes the assets utilized in the corporation’s business segments as of December 30, 2006 and July 1, 2006.

 

(In millions)

   December 30,
2006
   July 1,
2006

Assets

     

North American Retail Meats

   $ 1,176    $ 1,212

North American Retail Bakery

     1,259      1,275

Foodservice

     1,738      1,732

International Beverage

     2,536      2,219

International Bakery

     1,431      1,352

Household and Body Care

     2,633      2,406
             
     10,773      10,196

Net assets held for sale

     14      1

Discontinued operations

     —        3,816

Other1

     700      738
             

Total assets

   $ 11,487    $ 14,751
             

1

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

 

10


  3. Impairment Charges – Continuing Operations

The corporation recognized a $152 million pretax and $131 million after tax impairment charge in the second quarter of fiscal 2007 which is comprised of the following components:

 

(In millions)

   Goodwill
Impairment
   Trademark
Impairment
    Property
Impairment
    Total
Impairment
 

International Beverage

   $ 92    $ 26     $ —       $ 118  

North American Retail Meats

     —        —         34       34  
                               

Pretax impairment charge

     92      26       34       152  

Tax expense (benefit)

     —        (9 )     (12 )     (21 )
                               

Impact on net income

   $ 92    $ 17     $ 22     $ 131  
                               

Goodwill Impairment – The corporation tests the goodwill associated with each of its reporting units for impairment in the second quarter of each year. As part of this review the corporation concluded that the carrying amount of its Brazilian and Austrian coffee reporting units, which are reported in the International Beverage segment, exceeded their respective fair values. As a result, the corporation compared the implied fair value of the goodwill in each reporting unit with the carrying value and concluded that a $92 million impairment loss needed to be recognized. Of this amount, $86 million relates to the Brazilian reporting unit and $6 million relates to the Austrian reporting unit. The impairment loss recognized equals the entire remaining amount of goodwill in each reporting unit. In prior years, the corporation had recognized goodwill impairment losses of $23 million and $1 million for the Brazilian and Austrian reporting units, respectively.

The Brazilian coffee operation has experienced a sustained decline in profitability due to a highly competitive market in which the business operates. In management's judgment, the Brazilian market has experienced a significant amount of price competition as a result of general economic conditions, and consumers have been unwilling to pay the premium prices previously anticipated. As a result of the sustained underperformance of this business, management has revised its future cash flow expectations. These revised future cash flow expectations along with comparable fair value information from the recent sale of a coffee business of comparable size and profitability, resulted in the corporation lowering its estimate of fair value of the business in the fiscal 2007 impairment review. Similarly, the underperformance of the Austrian business in recent periods led the corporation to lower its forecasted future cash flow expectations and resultant estimate of fair value.

No tax benefit will be recognized on either the Brazilian or Austrian goodwill impairment losses.

After considering the lower future profit expectations for the Brazilian operations, the corporation has concluded that it was necessary to recognize a full $27 million valuation reserve on the net deferred tax assets related to the Brazilian tax jurisdiction which is reported as tax expense in the Consolidated Statement of Income.

 

11


Trademark Impairment – In conjunction with the actions resulting in the impairment of the Brazilian goodwill, the corporation assessed the realization of its long-lived assets associated with this held for use asset grouping. The primary asset in the asset group was determined to be trademarks, which had a carrying value of $47 million and are being amortized over 10 years. Using the anticipated undiscounted cash flows of the asset group, the corporation concluded that the asset group was not fully recoverable. As a result of this evaluation, the corporation concluded that the carrying value of the trademarks exceeded the fair value by $26 million. The fair value of the trademarks was estimated using the royalty saved method. The after tax impact of the trademark impairment is $17 million.

In conjunction with the annual impairment review, the corporation also concluded that certain Household and Body Care trademarks, having a carrying value of $99 million, no longer had an indefinite life and would be amortized over periods ranging from 5 to 20 years. The carrying value of all trademarks and identifiable intangible assets as of December 30, 2006 was $1,038 million of which $952 million is subject to amortization and $86 million is not subject to amortization.

Property Impairment – During the second quarter of fiscal 2007, management completed an analysis of the manufacturing activities being conducted at a facility that is part of the North American Retail Meats segment. As a result of this analysis, the corporation concluded that operations at this facility would be substantially reduced in order to improve efficiency and long-term profitability. Certain of the activities performed at the location will be transferred to more efficient third party suppliers and others will be eliminated. These actions are consistent with the corporation's previously announced transformation plan. Based upon the results of a third party appraisal and internal estimates of cash flows to be generated through the date of disposition, the corporation concluded that it was necessary to recognize an impairment charge of $34 million for this asset group in the second quarter of fiscal 2007. The after tax impact of this impairment loss is $22 million.

 

  4. Discontinued Operations

As part of the corporation’s announced transformation plan, steps were taken to dispose of eight businesses. Six of the eight dispositions were completed in fiscal 2006. The following two businesses were disposed of in fiscal 2007. The European Meats discontinued operation was sold on August 8, 2006 and through the date of sale, the net sales, pretax income and income were $114 million, $7 million and $3 million, respectively. The Branded Apparel Americas/Asia discontinued operation was spun off on September 5, 2006 and through the date of disposal, the net sales, pretax income and income were $787 million, $85 million and $59 million, respectively.

 

12


The amounts in the table below reflect the operating results of the businesses reported as discontinued operations for the second quarter and first half of fiscal 2006.

 

     Second Quarter Fiscal 2006     Six Months - Fiscal 2006  

(In millions)

   Net Sales    Pretax
Income
(Loss)
   

Income

(Loss)

    Net Sales    Pretax
Income
(Loss)
   

Income

(Loss)

 

Direct Selling

   $ 90    $ 10     $ 53     $ 202    $ 13     $ 54  

U.S. Retail Coffee

     60      —         —         122      (45 )     (39 )

European Branded Apparel

     266      (9 )     (17 )     547      (187 )     (152 )

European Nuts & Snacks

     16      2       2       29      4       2  

U.K. Apparel

     136      (2 )     (3 )     248      (5 )     (6 )

U.S. Meat Snacks

     7      (1 )     (1 )     16      (1 )     (1 )

European Meats

     285      13       4       569      37       48  

Branded Apparel

              

Americas/Asia

     1,181      174       143       2,318      295       240  
                                              

Total

   $ 2,041    $ 187     $ 181     $ 4,051    $ 111     $ 146  
                                              

The fiscal 2006 operating results of discontinued operations were impacted by certain impairment charges. The charges and the factors which gave rise to these charges are set out below.

 

     Quarter ended December 30, 2006     Six Months ended December 30, 2006  

(In millions)

   Pretax
Impairment
Charge
    Tax
Benefit
   After Tax
Charge
    Pretax
Impairment
Charge
    Tax
Benefit
   After Tax
Charge
 

European Branded Apparel

   $ —       $ 1    $ 1     $ (179 )   $ 48    $ (131 )

U.S. Retail Coffee

     —         —        —         (44 )     5      (39 )

U.K. Apparel

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

Total Impairment Charge Recognized in Discontinued Operations

   $ (1 )   $ 1    $ —       $ (224 )   $ 53    $ (171 )
                                              

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

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

 

13


U.K. Apparel – During 2005, steps were taken to market and identify potential buyers for the U.K. Apparel business. As part of this process, the corporation concluded that it would need to reach an agreement with the trustees of the U.K. pension plans regarding how the pension obligation related to this business would be funded prior to finalizing a decision to dispose of the apparel business. In the second quarter of fiscal 2006, the future funding of the U.K. plans was resolved with plan trustees and the corporation concluded that it would sell these operations while retaining the pension and certain other obligations of the business. At this time, the corporation also concluded that it would dispose of this business in two separate sales transactions: one being the Courtaulds operations and the other being the corporation’s ownership interest in several Sri Lankan ventures that supply a portion of the Courtaulds inventory needs. As a result of this activity, at the end of the second quarter of 2006, the corporation concluded that both businesses were held for sale, reported them as discontinued operations and recognized an impairment loss of $1 million to write down the carrying value of the Courtaulds business to zero. Both the Courtaulds business and the corporation’s ownership interest in the Sri Lankan ventures were sold in June 2006.

Gain on the Disposition of Discontinued Operations

During the first six months of fiscal 2007 and fiscal 2006, the corporation completed the disposition of certain businesses that were reported as discontinued operations. The gain (loss) recognized is summarized in the following tables. A further discussion of each disposition follows:

 

     Quarter ended December 30, 2006     Six Months ended December 30, 2006  

(In millions)

   Pretax Gain
(Loss) on
Disposition
    Tax Charge   

After Tax

Gain (Loss)

    Pretax Gain
(Loss) on
Disposition
    Tax Charge     After Tax
Gain (Loss)
 

European Meats

   $ (5 )   $ —      $ (5 )   $ 29     $ —       $ 29  

Philippines Portion of European Branded Apparel

     —         —        —         8       (2 )     6  

Branded Apparel Americas/Asia

     —         —        —         (24 )     —         (24 )
                                               

Total

   $ (5 )   $ —      $ (5 )   $ 13     $ (2 )   $ 11  
                                               

 

     Quarter ended December 31, 2005     Six Months ended December 31, 2005  

(In millions)

   Pretax Gain
(Loss) on
Disposition
    Tax Charge    

After Tax

Gain (Loss)

    Pretax Gain
(Loss) on
Disposition
    Tax Charge     After Tax
Gain (Loss)
 

Direct Selling

   $ 314     $ (101 )   $ 213     $ 314     $ (101 )   $ 213  

Turkish Portion of European Branded Apparel

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

U.S. Retail Coffee

     5       (2 )     3       5       (2 )     3  
                                                

Total

   $ 318     $ (103 )   $ 215     $ 318     $ (103 )   $ 215  
                                                

 

14


Transactions Completed During the First Six Months of Fiscal 2007

European Meats – During fiscal 2006, the corporation initiated steps to sell this business, received a series of nonbinding offers and entered into discussions with various third parties who had expressed interest in acquiring this business. At the end of the third quarter of fiscal 2006, the corporation concluded that it was probable that the business would be sold in the next year, classified the business as held for sale and reported it as a discontinued operation. The carrying value of the business, including the cumulative translation adjustment, was determined to exceed its fair value and the corporation evaluated the recoverability of the long-lived assets. The measurement process utilized the third-party offers received for the business and involved a number of judgments, including estimates of the fair value of the property and amortizable intangible assets of the business. As a result of the evaluation, the corporation recognized a $125 million goodwill impairment charge with no tax benefit in the third quarter of fiscal 2006. In June 2006, the corporation entered into a definitive agreement to sell this business. The transaction closed in August 2006 after receiving European regulatory approval and the corporation recognized a pretax and after tax gain of $29 million on the disposition. The year-to-date gain on disposition includes a charge of $5 million taken in the second quarter of fiscal 2007 to recognize certain customary postclosing adjustments related to the disposition of this business. The capital gain related to this transaction was offset by capital losses on other disposition transactions. A total of $337 million of cash proceeds was received from the disposition of the business and an additional $238 million was received from the repayment of an obligation to the corporation, which was included in the net assets sold.

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

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

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

Branded Apparel Americas/Asia – In February 2005, as part of its transformation plan, the corporation announced its intent to spin off the corporation’s apparel business in the Americas/Asia. This business is referred to as Branded Apparel Americas/Asia. In preparation for the spin off, the corporation incorporated Hanesbrands Inc., a Maryland corporation to which it transferred the assets and liabilities that relate to the Branded Apparel Americas/Asia business. On September 5, 2006, Hanesbrands borrowed $2,600 million from a group of banks. Net of loan origination fees the corporation received $2,558 million of cash proceeds. Using a portion of the proceeds received from the borrowing, Hanesbrands paid a dividend of $1,950 million to the corporation. Immediately

 

15


following this dividend payment, Sara Lee distributed to each stockholder of record one share of Hanesbrands common stock for every eight shares of Sara Lee common stock held. The spin off was tax free to the corporation and its shareholders. The net assets of the Hanesbrands business distributed were $18 million and this amount is reflected as a dividend in the corporation’s Consolidated Statements of Common Stockholders’ Equity.

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

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

Transactions Completed During the First Six Months of Fiscal 2006

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 except certain operations located in the Philippines which were awaiting local governmental approval. The net pretax and after tax gain recognized in the first six months of fiscal 2006 was $314 million and $213 million, respectively, and the corporation received the following consideration during the second quarter of fiscal 2006:

 

   

$370 million, which consists of $413 million of cash received less $44 million of cash that 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 investing activities section of the Consolidated Statement of Cash Flows.

 

   

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

In June 2006, after receiving local governmental approval, the corporation recognized the sale of the Philippines operations and completed certain customary postclosing adjustments related to the disposition and recognized the receipt of an additional $50 million of net cash proceeds. The net pretax and after tax gain recognized from the sale of this business in fiscal 2006 was $327 million and $220 million, respectively.

The sale agreement provides for working capital and other customary post closing adjustments relating to the assets transferred. The final resolution of these items will impact the gain recognized. The corporation expects to complete the remaining post closing adjustments in 2007. Under the terms of the sale 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.

Turkish Portion of European Branded Apparel – During the second quarter of fiscal 2006, the corporation completed the sale of a Turkish sewing operation that was part of the European Branded Apparel business and recognized a pretax and after tax loss of $1 million.

 

16


U.S. Retail Coffee – In the first quarter of fiscal 2006, the corporation announced that it had entered into an agreement to sell its U.S. Retail Coffee business, and in the second quarter of fiscal 2006, the transaction closed. The corporation received $82 million of cash at closing and recognized a pretax and after tax gain of $5 million and $3 million, respectively. The sale agreement provides for a future payment to be made to the corporation 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.

Under the terms of the sale 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 within the Beverage segment.

The following is a summary of the net assets held for disposal as of December 30, 2006 and July 1, 2006. At December 30, 2006, all assets reported as discontinued operations had been disposed of. At July 1, 2006, these amounts included the net assets of the Branded Apparel Americas/Asia, European Meats and the European Branded Apparel business in the Philippines. The change in the net assets held for disposal between July 1, 2006 and December 30, 2006 is the result of the assets disposed of in the spin off of Hanesbrands and completed sales transactions. Amounts reported for July 1, 2006 in Note 3 to our first quarter fiscal 2007 financial statements have been revised to correct a misclassification between other current assets and other current liabilities.

 

17


(In millions)

   December 30,
2006
   July 1,
2006
 

Cash and short-term investments

   $ —      $ 14  

Trade accounts receivable

     —        680  

Inventories

     —        1,367  

Other current assets

     —        192  
               

Total current assets of discontinued operations held for disposal

     —        2,253  
               

Property

     —        831  

Trademarks and other intangibles

     —        287  

Goodwill

     —        279  

Other assets

     —        166  
               

Assets of discontinued operations held for disposal

   $ —      $ 3,816  
               

Notes payable

   $ —      $ 7  

Accounts payable

     —        344  

Accrued expenses and other current liabilities

     —        673  
               

Total current liabilities of discontinued operations held for disposal

     —        1,024  
               

Other liabilities

     —        367  

Cumulative translation adjustment of businesses held for disposal

     —        (224 )
               

Liabilities and cumulative translation adjustment of discontinued operations held for disposal

   $ —      $ 1,167  
               

 

  5. Exit, Disposal and Transformation Activities

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

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

2) Transformation Costs – These amounts primarily relate to:

 

   

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

 

   

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

 

   

Expenses associated with the installation of new information systems.

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

 

18


     Second Quarter Ended    Six Months Ended  

(In millions)

  

Dec. 30,

2006

   Dec. 31,
2005
   Dec. 30,
2006
    Dec. 31,
2005
 

Exit activities

   $ 37    $ 42    $ 52     $ 71  

Asset and business disposition actions

     3      13      (12 )     (16 )

Transformation and other restructuring activities

     45      39      88       73  
                              
     85      94      128       128  

Adjustments to charges recognized in prior years

     —        —        (1 )     —    
                              

Reduction in income from continuing operations before income taxes

   $ 85    $ 94    $ 127     $ 128  
                              

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

 

     Second Quarter Ended     Six Months Ended  

(In millions)

  

Dec. 30,

2006

    Dec. 31,
2005
    Dec. 30,
2006
   

Dec. 31,

2005

 

Cost of sales:

        

Accelerated depreciation

   $ 14     $ 1     $ 29     $ 4  

Transformation charges

     1       —         4       —    

Selling, general and administrative expenses:

        

Transformation charges

     30       42       54       66  

Accelerated depreciation

     —         10       1       17  

Vacation policy change

     —         (14 )     —         (14 )

Net charges for (income from):

        

Exit activities

     37       42       51       71  

Asset and business dispositions

     3       13       (12 )     (16 )
                                

Reduction in income from continuing operations before income taxes

     85       94       127       128  

Income tax benefit

     (31 )     (32 )     (47 )     (44 )
                                

Reduction in income from continuing operations

   $ 54     $ 62     $ 80     $ 84  
                                

Impact on diluted EPS from continuing operations

   $ 0.07     $ 0.08     $ 0.11     $ 0.11  
                                

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

 

     Second Quarter Ended    Six Months Ended  

(In millions)

  

Dec. 30,

2006

   Dec. 31,
2005
   Dec. 30,
2006
  

Dec. 31,

2005

 

North American Retail Meats

   $ 19    $ 12    $ 40    $ 22  

North American Retail Bakery

     5      5      10      14  

Foodservice

     1      —        6      3  

International Beverage

     9      34      9      52  

International Bakery

     9      1      9      6  

Household and Body Care

     13      13      3      (7 )
                             

Decrease (increase) in operating segment income

     56      65      77      90  

Increase in general corporate expenses

     29      29      50      38  
                             

Total

   $ 85    $ 94    $ 127    $ 128  
                             

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

 

19


Fiscal 2007

As a part of the transformation plan, the corporation approved a series of actions in the second quarter and first half of fiscal 2007 related to exit, disposal and transformation activities. Net charges of $85 million and $128 million were recognized during the second quarter and first half of fiscal 2007, respectively, related to these approved actions. The composition of these charges is as follows:

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

 

   

$24 million of the second quarter charge is for the cost associated with terminating 489 employees and providing them with severance benefits in accordance with benefit plans previously communicated to the affected employee group or with local employment laws. In addition, another $3 million of severance benefits were recorded in the second quarter to accrue for actions approved in the first quarter to terminate employees receiving benefits under a special events termination plan. These benefits were accrued over the employees’ remaining service period. For the first half of fiscal 2007, a net charge of $39 million was incurred related to the cost to terminate 994 employees, which includes the impact of employees who voluntarily left during this time period. The specific locations of these employees and the status of the terminations are summarized in a table contained in this note.

 

   

$9 million of the second quarter charge is for the net cost of certain noncancelable lease obligations. Of this amount, $10 million relates to the net present value of the cost to exit certain leased space in connection with the relocation of the corporation’s headquarters to Downers Grove, Illinois, net of anticipated sublease income. Offsetting this amount is a $1 million decrease in the estimated cost to exit an administrative building originally accrued for in the first quarter. For the first six months of fiscal 2007, $12 million of the net charge is for the cost to exit certain leased space, including the former corporate headquarters and two administrative buildings for the Foodservice and Household and Body Care segments. As of the end of the second quarter, these spaces have all been exited.

 

   

$1 million of the net charges for the second quarter and first half of fiscal 2007 is related to the decision to abandon certain capitalized software in the International Beverage segment. With the corporation’s initiative to replace and improve information and technology systems under the transformation plan, certain software was identified as no longer being viable in the new technology environment. As a result, this software was abandoned and written off in the second quarter of fiscal 2007.

 

   

$3 million of the net charge for the second quarter relates to costs and certain net losses realized on various asset and business disposition actions, which primarily relates to additional costs associated with the spin off of the Branded Apparel business in the first quarter. For the first six months of fiscal 2007, a net gain of $12 million was realized and related to various asset and business disposition actions. Included in this amount is a $19 million gain related to completed transactions in the Household and Body Care business segment, the most significant of which are a $14 million gain on the sale of a Spanish office building and a $4 million gain on the sale of an Australian manufacturing and administrative facility. The total cash proceeds from these asset dispositions were $26 million. Offsetting these gains are $7 million of net charges consisting primarily of costs associated with the disposal of businesses.

 

20


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

 

   

Accelerated Depreciation – In the second quarter of fiscal 2007, the corporation recognized a $14 million expense in cost of sales for increased depreciation on facilities and equipment previously targeted for disposal. Substantially all of this cost relates to North American meat processing facilities.

For the first six months of fiscal 2007, the corporation recognized a $30 million expense for increased depreciation on facilities and equipment previously targeted for disposition. Of this total, $26 million relates to North American meat processing facilities.

 

   

Other Transformation Costs – In the second quarter and first six months of fiscal 2007, the corporation recognized other transformation costs of $31 million and $58 million, respectively. Substantially all of these costs are included in the following categories:

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

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

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

The following table summarizes the net charges recognized for exit, disposal and transformation activities approved during fiscal 2007 for continuing operations and the related status as of December 30, 2006.

 

(In millions)

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

Accrued

Costs

as of

Dec. 30, 2006

Employee termination and other benefits

   $ 39     $ —       $ —      $ (3 )   $ —      $ 36

Noncancelable lease and other contractual obligations

     12       —         —        —         —        12

Losses on abandonment of assets

     1       (1 )     —        —         —        —  

Asset and business disposition actions

     (12 )     —         19      (7 )     —        —  

Accelerated depreciation

     30       (30 )     —        —         —        —  

Transformation costs

     58       (8 )     —        (43 )     —        7
                                            
   $ 128     $ (39 )   $ 19    $ (53 )   $ —      $ 55
                                            

 

21


The following table summarizes the location and business segment of the 994 employees targeted for termination in the fiscal 2007 charge:

 

Number of Employees

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

United States

   381    139    91       —      —      3    614

Europe

   —      —      —      21    76    91    —      188

South America

   —      —      —      192    —      —      —      192
                                       
   381    139    91    213    76    91    3    994
                                       

As of Dec. 30, 2006

                       

Actions Completed

   328    110    38    —      9    —      2    487

Actions Remaining

   53    29    53    213    67    91    1    507
                                       
   381    139    91    213    76    91    3    994
                                       

Fiscal 2006

As a part of the transformation plan, the corporation approved a series of actions in the second quarter and first half of fiscal 2006 related to exit, disposal and transformation activities. Net charges of $94 million and $128 million were recognized during the second quarter and first half of fiscal 2006, respectively, related to these approved actions. The composition of these charges is as follows:

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

 

   

$37 million of the net charge for the second quarter was for the cost associated with terminating 513 employees and providing them with severance benefits in accordance with benefit plans previously communicated to the affected employee group or with local employment laws. For the first six months of fiscal 2006, $66 million of the net charge was for the cost to terminate 959 employees.

 

   

$5 million of the net charge for the second quarter and first half of fiscal 2006 was related to the noncancelable lease and other contractual obligations associated with exiting two leased facilities for the North American Retail Meats and International Beverage segments. Both of these facilities have been exited.

 

   

$13 million of the net charge for the second quarter relates primarily to professional fees incurred in connection with preparing certain businesses for disposition. For the first six months of fiscal 2006, a net gain of $16 million was realized on various asset and business disposition actions. The most significant of these transactions was a $28 million gain realized on the sale of certain European skincare and sunscreen assets. Also included in this amount was a net $3 million gain realized on the disposal of certain foreign investments and a $3 million gain related to the sale of a corporate aircraft. The total cash proceeds from these asset dispositions were $99 million. Offsetting these gains was $18 million of professional fees incurred in connection with preparing certain businesses for disposition.

 

22


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

 

   

Accelerated Depreciation – In the second quarter of fiscal 2006, the corporation recognized an $11 million expense for increased depreciation on facilities and equipment previously targeted for disposal. Increased depreciation expense related to the North American Retail Bakery, International Beverage, and Household and Body Care operations were $2 million, $3 million and $4 million, respectively.

For the first six months of fiscal 2006, the corporation recognized a $21 million expense for increased depreciation on facilities and equipment previously targeted for disposition. Increased depreciation expense related to the North American Retail Bakery, International Beverage, and Household and Body Care operations were $6 million, $3 million and $9 million, respectively.

 

   

Other Transformation Costs – In the second quarter and first six months of fiscal 2006, the corporation recognized other transformation costs of $42 million and $66 million, respectively. Substantially all of these costs are either related to the relocation, recruiting or retention of employees, third party consultants or costs related to the improvement of information technology.

 

   

Change in Vacation Policy – $14 million of the net charge for the second quarter and first half of fiscal 2006 related to income recognized as a result of the corporation’s decision to modify its vacation policy for U.S. employees during fiscal 2006. This change resulted in the forfeiture of certain vacation benefits that had been previously earned by employees. This credit is reflected in the “Selling, general and administrative expenses” line.

Status of Restructuring Reserves

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

Fiscal 2006 Restructuring Actions

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

 

(In millions)

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

Accrued
Costs

as of
Dec. 30, 2006

Employee termination and other benefits

   $ 159     $ —       $ —      $ (64 )   $ —      $ 95

Noncancelable lease and other contractual obligations

     8       —         —        (8 )     —        —  

Losses on abandonment of assets

     6       (6 )     —        —         —        —  

Asset and business disposition actions

     (79 )     —         118      (39 )     —        —  

Accelerated depreciation

     39       (39 )     —        —         —        —  

Transformation costs

     159       (26 )     —        (129 )     —        4

Vacation policy change

     (14 )     14       —        —         —        —  
                                            
   $ 278     $ (57 )   $ 118    $ (240 )   $ —      $ 99
                                            

 

23


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

 

Number of Employees

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

United States

   339    290    94    —      —      2    25    750

Canada

   —      —      —      —      —      1    —      1

Europe

   —      —      —      737    138    200    1    1,076

Australia

   —      —      —      39    17    75    —      131

Asia

   —      —      —      —      —      33    —      33
                                       
   339    290    94    776    155    311    26    1,991
                                       

As of Dec. 30, 2006

                       

Actions Completed

   326    261    94    594    128    265    26    1,694

Actions Remaining

   13    29    —      182    27    46    —      297
                                       
   339    290    94    776    155    311    26    1,991
                                       

Significant actions completed during the second quarter and first six months of fiscal 2007 and the status of the remaining elements of the fiscal 2006 plan can be summarized as follows:

Employee Termination and Other Benefits – During the second quarter and first six months of fiscal 2007, the corporation severed 238 and 596 employees associated with the fiscal 2006 charge, respectively, and expects to sever the remaining 297 employees before the end of the fiscal year. During the first six months of fiscal 2007, certain of these actions were completed for amounts that differed from those originally estimated. Actual costs to settle termination obligations varied from original estimates, and certain employees originally targeted for termination were not severed as originally planned. As a result, costs previously accrued were adjusted and resulted in a decrease of $1 million to income from continuing operations before income taxes for the second quarter and had no net impact for the first six months of fiscal 2007. Substantially all of the $95 million of remaining accrued costs is expected to be paid out within the next two years.

Noncancelable lease and other contractual obligations – As of the end of fiscal 2006, the corporation had exited all of the facilities contemplated in this charge and the related obligations have been satisfied.

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

 

24


Fiscal 2005 Restructuring Actions

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

 

(In millions)

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

Accrued
Costs

as of

Dec. 30, 2006

Employee termination and other benefits

   $ 73     $ —       $ —      $ (50 )   $ (2 )   $ 21

Noncancelable lease and other contractual obligations

     6       —         —        (6 )     —         —  

Asset and business disposition actions

     (27 )     —         61      (34 )     —         —  

Curtailment gains on benefit plans

     (28 )     28       —        —         —         —  

Accelerated depreciation

     21       (21 )     —        —         —         —  

Accelerated amortization

     9       (9 )     —        —         —         —  

Transformation costs

     9       —         —        (9 )     —         —  
                                             
   $ 63     $ (2 )   $ 61    $ (99 )   $ (2 )   $ 21
                                             

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

 

Number of Employees

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

United States

   23    152    198    —      —      —      10    383

Europe

   —      —      —      110    48    137    1    296

Australia

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

Significant actions completed during the second quarter and the first six months of fiscal 2007 and the status of the remaining elements of the fiscal 2005 plan can be summarized as follows:

Employee Terminations and Other Benefits – All termination actions were completed as of the end of fiscal 2006 and substantially all of the $21 million of accrued costs is expected to be paid out within the next year.

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

Other Restructuring Actions

In prior periods, the corporation had approved and completed various actions to exit certain defined business activities and lower its cost structure. During the second quarter of fiscal 2007, it was determined that the actual costs to settle certain of these remaining obligations were less than originally estimated. As a result, costs previously accrued were adjusted and resulted in an increase of $1 million to income from continuing operations before income taxes for the second quarter and first six months of fiscal 2007. As of December 30, 2006, the accrued liabilities remaining in the Condensed Consolidated Balance Sheet related to these actions total $5 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.

 

25


  6. Accumulated Other Comprehensive Income

The components of accumulated other comprehensive income are as follows:

 

(In millions)

   Cumulative
Translation
Adjustment
    Net Unrealized
Gain (Loss) on
Qualifying Cash
Flow Hedges
    Additional
Minimum
Pension Liability
Adjustment
    Accumulated
Other
Comprehensive
Income
 

Balance at July 2, 2005

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

Other comprehensive income (loss) activity

     (61 )     (15 )     —         (76 )
                                

Balance at December 31, 2005

     (792 )     (29 )     (816 )     (1,637 )

Other comprehensive income (loss) activity

     131       (13 )     180       298  
                                

Balance at July 1, 2006

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

Spin off of Hanesbrands

     5       4       58       67  

Disposition of European Meats business

     229       —         —         229  

Other comprehensive income (loss) activity

     187       12       (36 )     163  
                                

Balance at December 30, 2006

   $ (240 )   $ (26 )   $ (614 )   $ (880 )
                                

Comprehensive income in the second quarters of fiscal 2007 and 2006 was $83 million and $401 million, respectively. Comprehensive income in the first six months of fiscal 2007 and 2006 was $663 million and $429 million, respectively.

 

  7. Derivative Reporting

The corporation is exposed to changes in interest rates, foreign exchange rates and commodity prices. To manage the risk from these changes, the corporation uses derivative instruments and enters into various hedging transactions. A description of the corporation’s hedging programs and instruments is included in the corporation’s fiscal 2006 annual report on Form 10-K which is filed with the Securities and Exchange Commission. As of July 1, 2006, the net accumulated derivative loss recorded in Accumulated Other Comprehensive Income was $42 million. During the six months ended December 30, 2006, $4 million of accumulated net derivative gains were deferred into Accumulated Other Comprehensive Income, $8 million of accumulated net derivative losses were released from Accumulated Other Comprehensive Income into earnings since the related hedged item was realized during the period, and $4 million of net derivative losses were transferred to Hanesbrands as part of the spin off of this business, resulting in a balance in Accumulated Other Comprehensive Income at December 30, 2006 of an accumulated loss of $26 million. At December 30, 2006, the maximum maturity date of any cash flow hedge was approximately 0.5 years, excluding derivative hedges related to the payment of variable interest on existing financial instruments. The corporation expects to reclassify into earnings during the next twelve months net losses from Accumulated Other Comprehensive Income of approximately $22 million, at the time the underlying hedged transaction is realized.

Other disclosures related to amounts excluded from the assessment of effectiveness, amounts of 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 30, 2006, a net loss of $47 million arising from effective hedges of net investments has been reflected in the cumulative translation adjustments account within consolidated stockholders’ equity.

 

26


  8. Pension and Other Postretirement Benefit Plans

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

 

    

Second Quarter

Fiscal 2007

   

Second Quarter

Fiscal 2006

 

(In millions)

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

Service cost

   $ 24     $ 2     $ 27     $ 2  

Interest cost

     63       3       57       4  

Expected return on plan assets

     (69 )     —         (56 )     —    

Amortization of

        

Transition (asset) obligation

     —         —         —         (1 )

Prior service cost

     2       (6 )     1       (5 )

Net actuarial loss

     16       1       17       —    
                                

Net periodic benefit cost

   $ 36     $ —       $ 46     $ —    
                                

Settlement loss

   $ 5     $ —       $ —       $ —    
                                

 

    

Six Months

Fiscal 2007

   

Six Months

Fiscal 2006

 

(In millions)

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

Service cost

   $ 48     $ 4     $ 53     $ 4  

Interest cost

     125       6       115       7  

Expected return on plan assets

     (138 )     —         (112 )     —    

Amortization of

        

Transition (asset) obligation

     —         (1 )     —         (1 )

Prior service cost

     4       (12 )     1       (10 )

Net actuarial loss

     32       2       35       1  
                                

Net periodic benefit cost

   $ 71     $ (1 )   $ 92     $ 1  
                                

Settlement loss

   $ 5     $ —       $ —       $ —    
                                

The periodic benefit cost of the corporation’s defined benefit pension plans for continuing operations declined $10 million in the second quarter of fiscal 2007 versus the second quarter of fiscal 2006, and declined $21 million in the first six months of fiscal 2007 versus the first six months of fiscal 2006, as a result of the following:

 

   

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

 

   

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

 

   

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

The settlement loss recognized in the second quarter of fiscal 2007 was the result of the termination of certain foreign employees.

 

27


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

 

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

Projected benefit / Accumulated postretirement benefit obligation

   $ 5,764     $ 857     $ 279     $ 51  

Plan assets

     4,744       634       1       —    
                                

Funded status

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

Unrecognized -

        

Net initial asset

     —         —         (11 )     1  

Prior service cost

     90       —         (245 )     (36 )

Net actuarial loss

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

During the first six months of fiscal 2007 and 2006, the corporation contributed $97 million and $52 million, respectively, to its defined benefit pension plans. At the present time, the corporation expects to contribute $184 million of cash to its defined benefit pension plans in fiscal 2007. The exact amount of cash contributions made to pension plans in any year is dependent upon a number of factors including minimum funding requirements in the jurisdictions in which the corporation operates and arrangements made with trustees of certain foreign plans. As a result, the actual funding in fiscal 2007 may differ from the current estimate.

 

  9. Receipt of Contingent Sale Proceeds

The corporation sold its European cut tobacco business in fiscal 1999. Under the terms of that agreement, the corporation will receive an annual cash payment of 95 million euros if tobacco continues to be a legal product in the Netherlands, Germany and Belgium through July 15, 2009. The legal status of tobacco in each country accounts for a portion of the total contingency with the Netherlands accounting for 67%, Germany 22% and Belgium 11%. If tobacco ceases to be a legal product within any of these countries, the corporation forfeits the receipt of all future amounts related to that country. The contingencies associated with the fiscal 2007 and fiscal 2006 payments each passed in the first quarter of each fiscal year and the corporation received the annual payments. The fiscal 2007 annual payment was equivalent to $120 million and the fiscal 2006 annual payment was equivalent to $114 million based upon the respective exchange rates on the dates of receipt. These amounts were recognized in the corporation’s earnings when received. The amount received in fiscal 2006 increased diluted earnings per share by $0.15 per share and the amount received in fiscal 2007 is expected to increase diluted earnings per share by $0.16 per share.

 

  10. Litigation

Aris – Since 1995, three complaints have been filed on behalf of employees of a former subsidiary of the corporation known as Aris Philippines, Inc. (Aris) alleging unfair labor practices associated with Aris’ termination of manufacturing operations in the Philippines. Each of these three complaints includes allegations with the same issues and facts. With regard to two of these complaints, Aris prevailed in the administrative hearings held in the Philippines. Although implicated in these complaints, the corporation was not a party. The third complaint is a consolidation of cases filed from 1998 through July 1999 by individual complainants in the

 

28


Republic of the Philippines, Department of Labor and Employment, National Labor Relations Commission. On December 11, 1998, the third complaint was amended to name the corporation as a party. The case is styled: Emelinda Mactlang, et al. v. Aris Philippines, Inc., et al. In the underlying proceedings during 2006, the arbitrator ruled against the corporation and awarded the plaintiffs $60 million in damages and fees. The corporation appealed this administrative ruling. On December 19, 2006, the National Labor Relations Commission ruled upon the corporation’s appeal and set aside the arbitrator’s ruling, and remanded the case to the arbitrator for further proceedings. The complainants and the corporation have filed motions for reconsideration – the corporation seeking reconsideration of the ruling to remand to the arbitrator. The corporation believes that the plaintiffs’ claims are without merit; however, no assurance can be given that the matter will not have a material adverse impact on the corporation’s financial position, results of operations or cash flows.

American Bakers Association (ABA) Retirement Plan – The corporation is a participating employer in the American Bakers Association Retirement Plan. In 1979, the Pension Benefit Guaranty Corporation (PBGC) determined that the ABA plan was an aggregate of single-employer pension plans, rather than a multi-employer plan. Under the express terms of the ABA plan’s governing documents, the corporation's contributions can only be used to pay for benefits of its own employee-participants. Based upon the PBGC determination and the advice of counsel, the corporation has accounted for this plan as a multiple employer plan and recognized its obligations under the plan as if it participated in a single employer defined contribution plan under the provisions of Statement of Financial Accounting Standards No. 87 "Employers Accounting for Pensions."

In fiscal 2007, the PBGC rescinded its 1979 determination and concluded that the ABA plan was a multi-employer plan in which the participating parties share in the plan underfunding. The other major participant in the ABA plan is a bankrupt third party that is seeking an injunction to enforce the PBGC determination made earlier this year. The PBGC has indicated that the obligations associated with the bankrupt third party plan participants are approximately $60 million and there are no assets to fund these obligations. The corporation has initiated litigation seeking to overturn the fiscal 2007 PBGC determination and intends to vigorously defend the position that it is responsible only for the obligations related to its current and former employees. The corporation believes that the PBGC’s fiscal 2007 determination is without merit; however, no assurance can be given that the matter will not have a material adverse impact on the corporation’s financial position, results of operations or cash flows.

 

  11. Income Taxes

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

 

   

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

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

 

   

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

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

Continuing operations – The following table sets out the tax expense (benefit) and effective tax rate for the corporation’s continuing operations:

 

     Second Quarter     Six Months ended  

(In millions)

   2007     2006     2007     2006  

Continuing Operations

        

(Loss) income before income taxes

   $ (30 )   $ 49     $ 175     $ 210  

Income tax expense (benefit)

     27       7       (23 )     66  

Effective tax rate

     (88.6 )%     14.0 %     (13.1 )%     31.4 %

The estimated annual effective tax rate related to ordinary income for the first six months of fiscal 2007 was 61.4%. This tax rate assumes the recognition of a $194 million cost to repatriate substantially all foreign earnings to the U.S. and 43 percentage points of the annual effective rate relates to this annual cost.

 

29


The tax expense and related effective tax rate on continuing operations, for the first six months of fiscal 2007 was determined by applying the 61.4% annual rate to pretax earnings and then recognizing the full impact of the following unusual and infrequently occurring items:

 

   

The corporation sold the shares of a subsidiary which resulted in a $158 million tax benefit that was recognized in the first quarter of fiscal 2007. The proceeds received and the net book value of the entity sold were less than $1 million.

 

   

After considering the lower future profit expectations of a Brazilian coffee operation, the corporation concluded that it was necessary to recognize a full $27 million valuation allowance on the deferred tax assets related to the Brazilian tax jurisdiction in the second quarter of fiscal 2007.

In the second quarter of fiscal 2007, the corporation recognized a tax expense on continuing operations of $27 million despite recognizing a pretax loss of $30 million. The tax expense was primarily attributable to the $27 million valuation allowance on the deferred tax assets in the Brazilian tax jurisdiction and the impact of recognizing a $92 million goodwill impairment charge in the second quarter of fiscal 2007. No tax benefit will be recognized on the goodwill impairment and this cost was included in the determination of the estimated annual effective tax rate.

The effective tax rate from continuing operations for the second quarter and first six months of fiscal 2006 was 14.0% and 31.4%, respectively, after recognizing the full impact of an unusual tax benefit of $14 million related to a second quarter transaction.

Discontinued Operations - For the first six months of fiscal 2007, the pretax earnings of discontinued operations were $92 million and the related tax expense and effective tax rate were $30 million and 33%, respectively. For the first six months of fiscal 2006, the pretax earnings of discontinued operations were $11 million and the corporation recognized a tax benefit of $36 million. The tax benefit recognized in fiscal 2006 was attributable to several factors. First, the closing of the transaction to dispose of the Direct Selling business resulted in the corporation receiving certain tax benefits in fiscal 2006 for taxes incurred in 2005. Second, a significant portion of the pretax profits of the discontinued operations were related to the corporation’s Branded Apparel Americas/Asia business which had a 19% effective tax rate.

The corporation completed the disposition of all discontinued operations in the first quarter of fiscal 2007 and there were no material operating results for these businesses in the second quarter of fiscal 2007. In the second quarter of fiscal 2006, the pretax earnings of discontinued operations were $197 million and the tax expense was $6 million. The recognition of tax benefits related to the Direct Selling business essentially offset the tax expense associated with the pretax profits of the other discontinued operations.

Gain on Sale of Discontinued Operations - In the second quarter and first half of fiscal 2006, the corporation recognized a pretax gain of $318 million, which was primarily associated with disposition of the Direct Selling business. The tax expense and effective tax rate associated with the sale of the discontinued operations were $103 million and 32.5%, respectively. In the first six months of fiscal 2007, the corporation recognized a pretax gain on the disposition of discontinued operations of $13 million and the related tax expense was $2 million.

 

  12. Proceeds from the Spin Off of Hanesbrands and Restrictions on the Use of the Proceeds

As more fully described in Note 4, “Discontinued Operations” to the Consolidated Financial Statements, the spin off of the Hanesbrands business was completed in the first six months of fiscal 2007 as a tax free transaction for both the corporation and its shareholders. As part of the spin off, the corporation received a dividend from Hanesbrands of $1.95 billion. To maintain the tax free nature of the transaction, the $1.95 billion the corporation received as a dividend from Hanesbrands is restricted and can only be used by the corporation for the repayment of outstanding debt, repurchase of the corporation’s common stock and the payment of dividends to shareholders. At the end of the first six months of fiscal 2007, the corporation had $493 million of cash that is available for these restricted uses.

 

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Item 2

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

Introduction

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

 

   

Overview

 

  ¡  

Second Quarter of Fiscal 2007

 

  ¡  

First Six Months of Fiscal 2007

 

  ¡  

Cash Flow

 

  ¡  

Transformation Plan

 

   

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

 

   

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

 

   

Consolidated Results – First Six Months of Fiscal 2007 Compared with First Six Months of Fiscal 2006

 

   

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

 

   

Financial Condition

 

   

Liquidity

 

   

Significant Accounting Policies and Critical Estimates

 

   

Forward-looking Information

Overview

Second Quarter of Fiscal 2007

Continuing Operations –

During the second quarter of fiscal 2007, net sales increased $208 million, or 7.0%, over the second quarter of fiscal 2006, to $3,182 million. The strengthening of foreign currencies, particularly the European euro, British pound, Danish krone and Brazilian real increased reported net sales by $85 million, or 2.9%. Net sales were impacted by acquisitions and dispositions in the second quarters of both fiscal 2007 and 2006. Net sales in the second quarter of fiscal 2007 include $42 million from businesses acquired after the start of the second quarter of fiscal 2006, while the second quarter of fiscal 2006 includes sales of $18 million from businesses that have been disposed of after the start of the second quarter of fiscal 2006. The net impact of acquisitions and dispositions between the second quarters of fiscal 2007 and 2006 increased net sales by $24 million, or 0.8%. The remaining net sales increase was $99 million, or 3.3%, as each of the corporation’s business segments, with the exception of International Bakery, contributed to the increase in net sales.

Operating income for the corporation in the second quarter of fiscal 2007 decreased by $108 million, and was composed of the following:

 

   

The corporation’s gross profit percentage was 38.0% in the second quarter of fiscal 2007 as compared to 38.9% in the comparable period of the prior year. The gross margin percentage declined in each of the corporation’s business segments, with the exception of the North American Retail Bakery segment, as the corporation experienced higher costs for certain raw materials, commodities and energy, higher transformation costs and experienced pricing pressure from a competitive

 

31


 

marketplace. The gross profit recognized in the second quarter of fiscal 2007 was $52 million greater than in the second quarter of fiscal 2006 primarily as a result of higher unit sales volume of lower margin products and changes in foreign currency exchange rates.

 

   

Selling, general and administrative (SG&A) expenses in the second quarter of fiscal 2007 increased by $23 million over the comparable period of the prior year primarily as a result of the strengthening of foreign currencies versus the U.S. dollar offset in part by lower retirement plan costs, lower advertising and promotion costs and lower business transformation costs. SG&A expenses as a percentage of sales decreased from 33.5% in the second quarter of fiscal 2006 to 32.1% in the second quarter of fiscal 2007.

 

   

In the second quarter of fiscal 2007, the corporation recognized $40 million of charges for exit activities, asset and business dispositions, while in the second quarter of fiscal 2006, the corporation had $55 million of net charges.

 

   

The second quarter of fiscal 2007 includes a pretax charge of $152 million to recognize the impairment of $92 million of goodwill and $26 million of trademarks in the International Beverage segment and $34 million of property in the North American Retail Meats segment. These actions are more fully described in Note 3 to the Consolidated Financial Statements titled, “Impairment Charges – Continuing Operations.”

In the second quarter of fiscal 2007, the corporation recognized a tax expense on continuing operations of $27 million despite recognizing a pretax loss of $30 million. The tax expense was primarily attributable to a $27 million valuation allowance on the deferred tax assets in the Brazilian tax jurisdiction and the impact of recognizing a $92 million goodwill impairment charge in the second quarter of fiscal 2007. No tax benefit will be recognized on the goodwill impairment and this cost was included in the determination of the estimated annual effective tax rate. In the second quarter of fiscal 2006, the corporation recognized tax expense from continuing operations of $7 million on pretax income of $49 million.

A $57 million loss from continuing operations was recognized in the second quarter of fiscal 2007 as compared to $42 million of income from continuing operations in the comparable period of the prior year. The $99 million decline in income from continuing operations was primarily due to the impact of the impairment charge and the related tax impact. Diluted EPS from continuing operations decreased from $0.06 in the second quarter of fiscal 2006 to a loss of $0.08 in the second quarter of fiscal 2007.

Discontinued Operations –

The corporation has reported its Direct Selling, U.S. Retail Coffee, European Branded Apparel, European Nuts and Snacks, U.K. Apparel, U.S. Meat Snacks, European Meats and Branded Apparel Americas/Asia businesses as discontinued operations. Further information regarding these operations is included in Note 4 to the Consolidated Financial Statements and below. In the second quarter of fiscal 2007, the corporation reported no income from discontinued operations as all of these operations had been sold prior to the start of the quarter. In the second quarter of fiscal 2006, the discontinued operations reported net income of $181 million.

 

32


The loss on sale of discontinued operations in the second quarter of fiscal 2007 represents a charge of $5 million to recognize certain customary post closing adjustments related to the disposition of the European Meats business. The $215 million gain on sale of discontinued operations in the second quarter of fiscal 2006 relates primarily to the sale of the Direct Selling business and the U.S. Retail Coffee business.

Net Income –

Net income in the second quarter of fiscal 2007 was a loss of $62 million, a decrease of $500 million over the $438 million of income reported in the prior year second quarter. Diluted EPS decreased from $0.57 in the second quarter of fiscal 2006 to a loss of $0.08 in the second quarter of fiscal 2007. A table which summarizes the significant items that impacted the second quarter of fiscal 2007 and 2006 is presented below.

 

33


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

Amounts in millions, except EPS

 

     Quarter Ended December 30, 2006     Quarter Ended December 31, 2005  

In millions, except per share data

   Pretax
Impact
    Tax (2)     Net
Income
    Diluted
EPS
Impact(1)
    Pretax
Impact
   

Tax (2)

    Net
Income
   Diluted
EPS
Impact (1)
 

Income (loss) from continuing operations

   $ (30 )   $ (27 )   $ (57 )   $(0.08)     $ 49     $ (7 )   $42    $ 0.06  
                                                                       

Net (loss) income

       $ (62 )   $(0.08)         $438    $ 0.57  
                                               

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

                 

Charges for exit activities, asset and business dispositions:

                 

Charges for exit activities

   $ (37 )   $ 13     $ (24 )   $(0.03)     $ (42 )   $ 14     $(28)    $ (0.04 )

Charges for business disposition activities

     (3 )     1       (2 )   —         (13 )     4     (9)      (0.01 )
                                                                       

Subtotal

     (40 )     14       (26 )   (0.03)       (55 )     18     (37)      (0.05 )

Charges to cost of sales and SG&A expenses:

                 

Transformation charges in cost of sales and SG&A

     (32 )     13       (19 )   (0.03)       (42 )     15     (27)      (0.04 )

Impairment charges

     (152 )     21       (131 )   (0.18)       —         —       —        —    

Hurricane losses

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

Change in vacation policy

     —         —         —       —         14       (5 )   9      0.01  

Accelerated depreciation

     (13 )     4       (9 )   (0.01)       (11 )     4     (7)      (0.01 )
                                                                       

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

     (237 )     52       (185 )   (0.25)       (95 )     32     (63)      (0.08 )

Significant tax matters affecting comparability:

                 

Tax charge for deferred tax valuation allowance

     —         (27 )     (27 )   (0.04)       —         —       —        —    
                                                                       

Impact of significant items on income

       25                  

from continuing operations

     (237 )       (212 )      (0.29 )     (95 )     32     (63)      (0.08 )
                                                                       

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

     —         —         —       —         (6 )     2     (4)      (0.01 )

Tax benefit on Direct Selling transaction

     —         —         —       —           50     50      0.07  

Gain (loss) on sale of discontinued operations

     (5 )     —         (5 )   (0.01)       318       (103 )   215      0.28  
                                                                       

Impact of significant items on net income

   $ (242 )   $
 
 
25
 
 
  $ (217 )   $(0.29)     $ 216     $ (17 )      $ 199    $ 0.26  
                                                                       

Notes:

  (1) EPS amounts are rounded to the nearest $0.01 and may not add to the total.
  (2) Taxes computed at applicable statutory rates.

 

34


First Six Months of Fiscal 2007

Continuing Operations –

During the first six months of fiscal 2007, net sales increased $336 million, or 5.9%, over the first six months of fiscal 2006, to $6,073 million. The strengthening of foreign currencies, particularly the European euro, British pound and Brazilian real increased reported net sales by $126 million, or 2.3%. Net sales were impacted by acquisitions and dispositions in the first six months of both fiscal 2007 and 2006. Net sales in the first six months of fiscal 2007 include $83 million from businesses acquired after the start of fiscal 2006, while the first six months of fiscal 2006 includes sales of $37 million from businesses that have been disposed of after the start of fiscal 2006. The net impact of acquisitions and dispositions between the first six months of fiscal 2007 and 2006 increased net sales by $46 million, or 0.8%. The remaining net sales increase was $164 million, or 2.8%, as each of the corporation’s business segments, with the exception of International Bakery, contributed to the increase in net sales.

Operating income for the corporation in the first six months of fiscal 2007 decreased by $69 million, or 21.7%, and was composed of the following:

 

   

The corporation’s gross profit margin was 37.9% in the first six months of fiscal 2007 as compared to 38.6% in the comparable period of the prior year. The gross margin percentage declined in each of the corporation’s business segments, with the exception of the North American Retail Bakery segment, as the corporation experienced higher costs for certain raw materials, commodities and energy, and transformation costs, and experienced pricing pressure from a competitive marketplace. The gross profit recognized in the first six months of fiscal 2007 was $91 million greater than in the first six months of fiscal 2006 primarily as a result of higher unit sales of lower margin products and changes in foreign currency exchange rates.

 

   

Selling, general and administrative (SG&A) expenses in the first six months of fiscal 2007 increased by $30 million over the comparable period of the prior year primarily as a result of the strengthening of foreign currencies versus the U.S. dollar offset in part by lower retirement plan costs, lower advertising and promotion costs and lower business transformation costs. SG&A expenses as a percentage of sales decreased from 34.0% in the first six months of fiscal 2006 to 32.6% in the first six months of fiscal 2007.

 

   

In the first six months of fiscal 2007, the corporation recognized $39 million of net charges for exit activities, asset and business dispositions, while in the first six months of fiscal 2006, the corporation reported $55 million of net charges.

 

   

The first six months of fiscal 2007 includes a pretax charge of $152 million to recognize the impairment of $92 million of goodwill and $26 million of trademarks in the International Beverage segment and $34 million of property in the North American Retail Meats segment. These actions are more fully described in Note 3 to the Consolidated Financial Statements titled, “Impairment Charges – Continuing Operations.”

 

   

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

The estimated annual effective tax rate related to ordinary income for the first six months of fiscal 2007 was 61.4%. This tax rate assumes the recognition of a $194 million cost to repatriate substantially all foreign earnings to the U.S. and 43 percentage points of the annual effective rate relates to this annual cost.

 

35


The tax expense and related effective tax rate on continuing operations, for the first six months of fiscal 2007 was determined by applying the 61.4% annual rate to pretax earnings and then recognizing the full impact of the following unusual and infrequently occurring items:

 

   

The corporation sold the shares of a subsidiary which resulted in a $158 million tax benefit that was recognized in the first quarter of fiscal 2007. The proceeds received and the net book value of the entity sold were less than $1 million.

 

   

After considering the lower future profit expectations of a Brazilian coffee operation, the corporation concluded that it was necessary to recognize a full $27 million valuation allowance on the deferred tax assets related to the Brazilian tax jurisdiction in the second quarter of fiscal 2007.

Income from continuing operations in the first six months of fiscal 2007 was $198 million, an increase of $54 million over the $144 million reported in the first six months of fiscal 2006. The increase in income from continuing operations was primarily due to the decline in income tax expense partially offset by the decrease in operating income. Diluted EPS from continuing operations increased from $0.19 in the first six months of fiscal 2006 to $0.26 in the first six months of fiscal 2007.

Discontinued Operations –

The corporation has reported its Direct Selling, U.S. Retail Coffee, European Branded Apparel, European Nuts and Snacks, U.K. Apparel, U.S. Meat Snacks, European Meats and Branded Apparel Americas/Asia businesses as discontinued operations. Further information regarding these operations is included in Note 4 to the Consolidated Financial Statements and below. The net income from discontinued operations in the first six months of fiscal 2007 was $62 million, as compared to net income of $146 million in the first six months of fiscal 2006, or a decrease of $84 million between the periods. Due to the timing of the sale of discontinued operations, the results of different businesses are included as follows: In the first six months of fiscal 2007, the results of discontinued operations include the results of the European Meats and the Branded Apparel Americas/Asia businesses. In the first six months of fiscal 2006, the results of the discontinued operations include the European Meats and Branded Apparel Americas/Asia businesses described above, plus the Direct Selling, European Branded Apparel, European Nuts and Snacks, U.S. Retail Coffee, U.K. Apparel and U.S. Meat Snacks businesses. The results of these businesses are included for the portion of the period in which they were owned by the corporation.

The first six months of fiscal 2006 includes a net gain on the sale of discontinued operations of $215 million which primarily relates to the sale of the Direct Selling and U.S. Retail Coffee businesses.

Net Income –

Net income in the first six months of fiscal 2007 was $271 million, a decrease of $234 million over the $505 million reported in the prior year first six months. Diluted EPS decreased from $0.65 in the first six months of fiscal 2006 to $0.36 in the first six months of fiscal 2007. A table which summarizes the significant items that impacted the first six months of fiscal 2007 and 2006 is presented below.

 

36


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

Amounts in millions

 

     Six Months Ended December 30, 2006     Six Months Ended December 31, 2005  

In millions, except per share data

   Pretax
Impact
    Tax (2)     Net Income     Diluted
EPS
Impact(1)
    Pretax
Impact
   

Tax (2)

    Net
Income
    Diluted
EPS
Impact (1)
 

Income from continuing operations

   $ 175     $ 23     $ 198     $ 0.26     $ 210     $ (66 )   $ 144     $ 0.19  
                                                                

Net income

       $ 271     $ 0.36         $ 505     $ 0.65  
                                        

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

                

Charges for exit activities, asset and business dispositions:

                

Charges for exit activities

   $ (52 )   $ 18     $ (34 )   $ (0.05 )   $ (71 )   $ 24     $ (47 )   $ (0.06 )

Income from business disposition activities

     13       (3 )     10       0.01       16