Hillshire Brands Co 10-Q 2010
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended MARCH 27, 2010
Commission file number 1-3344
Sara Lee Corporation
(Exact name of registrant as specified in its charter)
3500 Lacey Road, Downers Grove, Illinois 60515
(Address of principal executive offices)
(Registrants 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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of accelerated filer, large accelerated filer, smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
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 March 27, 2010, the Registrant had 661,269,828 outstanding shares of common stock $.01 par value, which is the Registrants only class of common stock.
Condensed Consolidated Balance Sheets at March 27, 2010 and June 27, 2009
See accompanying Notes to Consolidated Financial Statements.
Consolidated Statements of Income
For the Quarter and Nine Months ended March 27, 2010 and March 28, 2009
See accompanying Notes to Consolidated Financial Statements.
Condensed Consolidated Statements of Equity
For the period June 28, 2008 to March 27, 2010
Total comprehensive loss was $432 million in the first nine months of 2009, of which $434 million was attributable to Sara Lee. The comprehensive income attributable to Sara Lee in the first nine months of 2010 was $343 million.
See accompanying Notes to Consolidated Financial Statements.
Consolidated Statements of Cash Flows
For the Nine Months ended March 27, 2010 and March 28, 2009
See accompanying Notes to Consolidated Financial Statements.
Notes to Consolidated Financial Statements
The consolidated financial statements for the quarter and nine months ended March 27, 2010 and March 28, 2009 have not been audited by an independent registered public accounting firm, but in the opinion of Sara Lee Corporation (corporation or company), these financial statements include all normal and recurring adjustments necessary for a fair presentation of our financial position, operating results, and cash flows. The results of operations for the nine months ended March 27, 2010 are not necessarily indicative of the operating results to be expected for the full fiscal year. The Condensed Consolidated Balance Sheet as of June 27, 2009 has been derived from the corporations audited financial statements included in our Annual Report on Form 10-K for the year ended June 27, 2009. The businesses comprising the former International Household and Body Care segment are presented as discontinued operations in the corporations consolidated financial statements. See Note 4 Discontinued Operations for additional information regarding these discontinued operations. Unless stated otherwise, any reference to income statement items in these financial statements refers to results from continuing operations.
The interim 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 annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the corporations Form 10-K for the year ended June 27, 2009 and other financial information filed with the Securities and Exchange Commission. These financial statements consider subsequent events through the date of filing with the Securities and Exchange Commission.
The corporations fiscal year ends on the Saturday closest to June 30. Fiscal 2010 ends on July 3, 2010. The third quarter and first nine months of fiscal 2010 ended on March 27, 2010 and the third quarter and first nine months of fiscal 2009 ended on March 28, 2009. Each of the quarters was a thirteen-week period and each of the nine month periods was a thirty-nine week period. Fiscal 2010 is a 53-week year, whereas fiscal 2009 was a 52-week year. Unless otherwise stated, references to years relate to fiscal years.
In 2010, the corporation retrospectively adopted new accounting guidance related to noncontrolling interests in consolidated financial statements. This guidance requires the classification of noncontrolling interests in subsidiaries, formerly referred to as minority interest, as a separate component of equity and the changes in ownership interest must be accounted for as equity transactions. It also requires that the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income. As a result, the Condensed Consolidated Balance Sheets, Consolidated Statements of Income, Condensed Consolidated Statements of Equity and Consolidated Statements of Cash Flows present the impact of noncontrolling interests on equity, net income and comprehensive income. Net income now includes earnings attributable to both Sara Lee and noncontrolling interests.
In 2010, the corporation adopted new accounting guidance related to business combinations, which requires changes in the accounting and reporting of business acquisitions. This guidance requires an acquirer to recognize and measure the identifiable assets acquired, liabilities assumed, contractual contingencies, contingent consideration and any noncontrolling interest in an acquired business at fair value on the acquisition date. In addition, it also requires that acquisition costs generally be expensed when incurred, restructuring costs generally be expensed in periods subsequent to the acquisition date and any adjustments to deferred tax asset valuation allowances and acquired uncertain tax positions after the measurement period to be reflected in income tax expense. The adoption of this guidance has not impacted the consolidated financial statements.
The computation of net income (loss) per share only includes results attributable to Sara Lee and does not include earnings related to noncontrolling interests. Net income per share basic is computed by dividing net income (loss) 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 fixed awards to be issued under stock-based compensation awards were converted into common stock. For the quarter and nine months ended March 27, 2010, options to purchase 21.4 million shares and 21.9 million shares, respectively, of the corporations 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 nine months ended March 28, 2009, options to purchase 28.3 million shares of the corporations common stock had exercise prices that were greater than the average market price of those shares during the respective reporting periods. These shares are excluded from the earnings per share calculation as they are anti-dilutive.
The average shares outstanding declined in the third quarter and first nine months of 2010 as compared to the third quarter and first nine months of 2009 as a result of shares repurchased under the corporations ongoing share repurchase program. The corporation repurchases common stock at times management deems appropriate, given current market valuations. Sara Lee announced on September 25, 2009 that its Board of Directors had authorized a $1.0 billion share repurchase program and on February 16, 2010 that its Board of Directors had increased this repurchase program by $2.0 billion shares (for a total authorization of $3.0 billion shares). In March of 2010, the corporation repurchased 36.4 million shares at a cost of $500 million under this program using an accelerated share repurchase program. During 2009, the corporation also repurchased 11.4 million shares of common stock, all of which were repurchased during the second quarter. As of March 27, 2010, the corporation was authorized to repurchase $2.5 billion of common stock under its existing share repurchase program, plus 13.5 million shares of common stock that remain authorized for repurchase under the corporations prior share repurchase program. The timing and amount of future share repurchases will be based upon the completion of the corporations sale of its household and body care businesses, market conditions and other factors.
The following is a reconciliation of net income to net income per share basic and diluted for the third quarter and first nine months of 2010 and 2009 (per share amounts are rounded and may not add to total):
Computation of Net Income (Loss) per Common Share
(In millions, except per share data)
The following is a general description of the corporations five business segments:
The results of the businesses comprising the corporations former International Household and Body Care segment are now being reported as discontinued operations for all periods presented. See Note 4 Discontinued Operations for additional information regarding these discontinued operations.
The corporation incurs various information technology (IT) and human resource (HR) costs related to its business segments. The IT costs include amortization of software used directly by the business segments, intranet website management costs, systems support, maintenance and project costs. The HR costs include benefits administration, organizational development, labor relations and recruiting costs incurred by the corporate human resource function on behalf of the business segments. Prior to 2010, these costs were included in Other general corporate expenses. Beginning in 2010, the corporation now includes these IT and HR costs in the operating results of the business segments. The reason for this change is that the integration of our operations over the past several years has resulted in more centralized services, which in many cases are conducted directly for the benefit of the business segments. Management believes these costs should be reflected in operating segment income in order to provide better information regarding the actual results of the business segment. Business segment information for 2009 has been revised to be consistent with the new basis of presentation.
The following is a summary of net sales and operating segment income by business segment for the third quarter and first nine months of 2010 and 2009.
In 2010, the corporation is now presenting certain segment assets, principally consisting of cash, in corporate assets for all periods since these assets are primarily controlled by the corporate group. A summary of segment assets as of March 27, 2010 and June 27, 2009 is as follows:
In September 2009, the corporation announced that it had received a binding offer for the sale of its global body care and European detergents businesses for 1.275 billion euros. In December 2009, the corporation also announced that it received a binding offer for the sale of its air care business for 320 million euros. These proposed transactions are subject to certain customary closing conditions and regulatory approvals and are anticipated to close during calendar 2010. Together these businesses represent approximately 70% of the net sales of the international household and body care businesses. The corporation is also actively marketing for sale its remaining household and body care businesses and, as a result, the businesses that formerly comprised the International Household and Body Care segment air care, body care, shoe care and insecticidesare classified as discontinued operations and are presented in a separate line in the Consolidated Statements of Income for all periods presented. The assets and liabilities of these businesses to be sold meet the accounting criteria to be classified as held for sale and have been aggregated and reported on separate lines of the Condensed Consolidated Balance Sheets for all periods presented.
The following is a summary of the operating results of the corporations discontinued operations:
The $404 million tax expense reported in the first nine months of 2010 includes the following significant tax amounts: (i) a $416 million tax charge related to the companys third quarter decision to no longer reinvest overseas earnings attributable to overseas cash and the net assets of the household and body care businesses; (ii) a $53 million tax benefit related to the reversal of a tax valuation allowance on United Kingdom net operating loss carryforwards as a result of the anticipated gain from the household and body care business disposition; and (iii) a $27 million tax benefit related to the anticipated utilization of U.S. capital loss carryforwards available to offset the capital gain resulting from the household and body care business disposition.
The following is a summary of the net assets held for sale as of March 27, 2010 and June 27, 2009, which consists of the net assets of the international household and body care businesses.
Certain tax related revisions have been made to the June 27, 2009 balance sheet presented at the end of our 2010 second quarter to reflect the deal structure associated with the binding offers announced for the household and body care businesses. The most significant change relates to $51 million of long-term deferred tax liabilities which have been reclassified into continuing operations as those tax attributes will remain with the continuing operations.
The discontinued operations cash flows are summarized in the table below:
The cash used in financing operations primarily represents the net transfers of cash with the corporate office. The net assets of the discontinued operations includes only the cash noted above as most of the cash of those businesses has been retained as a corporate asset.
The corporation tests goodwill for impairments in the second quarter of each fiscal year and whenever a significant event occurs or circumstances change that would more likely than not reduce the fair value of these intangible assets.
As a result of the review performed in the second quarter of 2010, the corporation determined that no goodwill impairment was required to be recognized as the carrying amounts of the reporting units did not exceed their fair values. The change in the goodwill balance from June 27, 2009 is due to the impact of changes in foreign currency exchange rates on foreign denominated goodwill. In the second quarter of 2009, a $107 million goodwill impairment charge was recognized in the foodservice beverage reporting unit after it was determined the carrying value of assets exceeded their fair value. The foodservice beverage reporting unit had experienced a significant decline in profitability due to a highly competitive marketplace and difficult economic conditions which led to the impairment charge. The impairment charge recognized equaled the entire remaining amount of goodwill in the foodservice beverage reporting unit and no tax benefit was recognized on the charge. The corporation intends to move the testing for impairments to the fourth quarter of each fiscal year in order to better align the impairment review with the companys long-range planning process.
In the first nine months of 2010, the corporation recognized a $17 million impairment charge related to fixed assets. Thirteen million related to the writedown of manufacturing equipment associated with the North American foodservice bakery reporting unit due to the loss of a customer contract. The remaining $4 million related to the writedown of bakery equipment associated with the Spanish bakery reporting unit.
For the 2010 goodwill impairment test, the fair value of the reporting units was estimated based on a weighting of two modelsa discounted cash flow model and a market multiple model. The discounted cash flow model uses managements business plans and projections as the basis for expected future cash flows for the first ten years and a 2% residual growth rate thereafter. A separate discount rate derived from published sources was utilized for each reporting unit and, on a weighted average basis, the discount rate used was 9.3%. The market multiple approach employs market multiples of revenues or earnings for companies comparable to the corporations reporting units. Management believes the assumptions used for the impairment test are consistent with those utilized by a market participant performing similar valuations for our reporting units.
The majority of goodwill impairments recognized by the corporation in the past several years relate to goodwill attributable to the Earthgrains bakery acquisition in 2002. Three reporting units that continue to carry significant Earthgrains goodwill balances at March 27, 2010 include North American foodservice bakery with $476 million, North American fresh bakery with $270 million and international bakery France with $172 million. Although the corporation currently believes the operations support the value of goodwill reported, these entities are the most sensitive to changes in inherent assumptions and estimates used in determining fair value. These three reporting units represent approximately 74% of goodwill remaining in continuing operations. Holding all other assumptions constant at the test date for both models, a 100
basis point increase in the discount rate used for these three reporting units would reduce the enterprise value approximately 10% indicating no potential impairment. These three reporting units have estimated fair values in excess of net asset carrying values in the range of 21% to 33% as of the test date.
As part of its ongoing efforts to improve its operational performance and reduce costs, the corporation initiated Project Accelerate (Accelerate) in 2009, which is a series of global initiatives designed to drive significant savings in the next three years. It is anticipated that the overall cost of the initiatives will include severance costs as well as transition costs associated with transferring services to an outside third party. An important component of Accelerate involves outsourcing pieces of the North American and European Finance (transaction processing) and Global Information Services (applications development and maintenance) groups as well as the companys global indirect procurement activities. In addition to cost savings, this business process outsourcing will help the corporation drive standardization, increase efficiency and provide flexibility. The corporation began implementation of the initiative in North America and Europe in the second quarter of 2009 and plans to complete global implementation within three years.
The company announced a transformation plan in February 2005 designed to improve performance and better position the company for long-term growth. The plan involved significant changes in the companys organizational structure, portfolio changes involving the disposition of a significant portion of the corporations business, and a number of actions to improve operational efficiency. The corporation continues to recognize certain trailing costs related to these transformation actions, including the impact of certain activities that were completed for amounts more favorable than previously estimated.
The nature of the costs incurred under these plans includes the following:
1) Exit Activities, Asset and Business Disposition Actions These amounts primarily relate to:
2) Transformation/Accelerate Costs recognized in Cost of sales and Selling, general and administrative expenses primarily relate to:
Transformation/Accelerate costs are recognized in Cost of sales or Selling, general and administrative expenses in the Consolidated Statements of Income as they do not qualify for treatment as an exit activity or asset and business disposition under the accounting rules for exit and disposal activities. However, management believes the disclosure of these transformation/Accelerate related charges provides the reader greater transparency to the total cost of the initiatives.
The following is a summary of the (income) expense associated with new and ongoing actions, which also highlights where the costs are reflected in the Consolidated Statements of Income along with the impact on diluted EPS:
The impact of these actions on the corporations business segments and general corporate expenses is summarized as follows:
The following discussion provides information concerning the exit, disposal and transformation/Accelerate activities for each year where actions were initiated and material reserves exist.
During 2010, the corporation approved certain actions related to exit, disposal, and Accelerate activities and recognized charges of $82 million related to these actions. Each of these activities is to be completed within a 12-month period after being approved and include the following:
The following table summarizes the net charges taken for the exit, disposal and Accelerate activities approved during 2010 and the related status as of March 27, 2010. The accrued amounts remaining represent those cash expenditures necessary to satisfy remaining obligations. The majority of the cash payments to satisfy the accrued costs are expected to be paid in the next 12 months. The composition of these charges and the remaining accruals are summarized below. Approximately $30 million of additional charges are expected to be recognized in the remainder of 2010.
During 2009, the corporation approved certain actions related to exit, disposal, transformation and Accelerate activities and recognized cumulative charges of $125 million related to these actions. Each of these activities is to be completed within a 12-month period after being approved and include the following:
Significant actions completed during the first nine months of 2010 and the status of the remaining elements of the 2009 actions, along with the remaining accruals, is described below. The accrued amounts remaining represent those cash expenditures necessary to satisfy remaining obligations. The majority of the cash payments to satisfy the accrued costs are expected to be paid in the next 12 months. The corporation does not anticipate any additional material future charges related to the 2009 actions. The composition of these charges and the remaining accruals are summarized below.
During 2008, the corporation approved certain actions related to exit, disposal and transformation activities and recognized cumulative charges of $89 million related to these actions. Each of these activities was completed within a 12-month period after being approved and included the following:
The status of the remaining elements of the 2008 actions, along with the remaining accruals, is described below. The accrued amounts remaining represent those cash expenditures necessary to satisfy remaining obligations. The majority of the cash payments to satisfy the accrued costs are expected to be paid in the next 12 months. The corporation does not anticipate any additional material future charges related to the 2008 actions. The composition of these charges and the remaining accruals are summarized below.
In periods prior to 2008, the corporation had approved and completed various actions to exit certain defined business activities and lower its cost structure and these actions have had minimal impact on current year results. As of March 27, 2010, the accrued liabilities remaining in the Condensed Consolidated Balance Sheet related to these completed actions total $24 million and primarily represent certain severance obligations. These accrued amounts are expected to be satisfied in cash and will be funded from operations.
The corporation uses derivative financial instruments, including forward exchange, futures, options and swap contracts, to manage its exposures to foreign exchange, commodity prices and interest rate risks. The use of these derivative financial instruments modifies the exposure of these risks with the intent to reduce the risk or cost to the corporation. The corporation does not use derivatives for trading or speculative purposes and is not a party to leveraged derivatives.
The corporation recognizes all derivative instruments as either assets or liabilities at fair value in the consolidated balance sheet. The corporation uses either hedge accounting or mark-to-market accounting for its derivative instruments. For derivatives that qualify for hedge accounting, the corporation designates these derivatives as fair value, cash flow or net investment hedges by formally documenting the hedge relationships, including identification of the hedging instruments and the hedged items, as well as its risk management objectives and strategies for undertaking the hedge transaction. The process includes linking derivatives that are designated as hedges of specific assets, liabilities, firm commitments or forecasted transactions.
As noted above, the corporation uses derivative financial instruments to manage some of its exposure to commodity prices. A commodity derivative not declared a hedge in accordance with the accounting rules related to derivative instruments and hedging activities is accounted for under mark-to-market accounting with changes in fair value recorded in the Consolidated Statements of Income. The corporation includes these unrealized mark-to-market gains and losses in general corporate expenses until the derivative instrument is settled. At that time, the cumulative gain or loss previously recorded in general corporate expenses for the derivative instrument will be reclassified into the business segments results.
On the date the derivative is entered into, the corporation designates the derivative as one of the following types of hedging instruments and accounts for the derivative as follows:
Fair Value Hedge A hedge of a recognized asset or liability or an unrecognized firm commitment is declared as a fair value hedge which qualifies for hedge accounting. For fair value hedges, both the effective and ineffective portions of the changes in the fair value of the derivative, along with the gain or loss on the hedged item that is attributable to the hedged risk, are recorded in earnings and are reported in the Consolidated Statements of Income on the same line as the hedged item.
Cash Flow Hedge A hedge of a forecasted transaction, firm commitment or of the variability of cash flows to be received or paid related to a recognized asset or liability is declared a cash flow hedge. Cash flow hedges qualify for hedge accounting. The effective portion of the change in the fair value of the derivative that is declared as a cash flow hedge is recorded in accumulated other comprehensive income (within common stockholders equity) and later reclassified to the income statement at the same time the underlying hedged item impacts the income statement. In addition, both the fair value of changes excluded from the corporations effectiveness assessments and the ineffective portion of the changes in the fair value of derivatives used as cash flow hedges are reported in Selling, general and administrative expenses in the Consolidated Statements of Income.
At March 27, 2010 the maximum maturity date of any cash flow hedge was approximately three years principally related to two cross currency swaps that mature in 2012 and 2013. The corporation expects to reclassify into earnings during the next twelve months net gains from Accumulated Other Comprehensive Income of approximately $1 million at the time the underlying hedged transaction is recognized in the Consolidated Statement of Income.
Net Investment Hedge A hedge of the exposure of changes in the underlying foreign currency denominated subsidiary net assets is declared as a net investment hedge. Net investment hedges qualify for hedge accounting. Net investment hedges can include either derivative or non-derivative instruments such as, non-U.S. dollar financing transactions or non-U.S. dollar assets or liabilities, including intercompany loans. The effective portion of the change in the fair value of net investment hedges is recorded in the cumulative translation adjustment account within common stockholders equity. At March 27, 2010, the U.S. dollar equivalent of intercompany loans and forward exchange contracts designated as net investment hedges was $4.7 billion. The corporation increased its net investment hedges in the third quarter in order to hedge 1.6 billion of proceeds anticipated to be generated by the divestiture of its air care and body care businesses.
Mark-to-Market Hedge A derivative that does not qualify for hedge accounting in one of the categories above is accounted for under mark-to-market accounting and referred to as a mark-to-market hedge. Changes in the fair value of a mark-to-market hedge are recognized in the Consolidated Statements of Income to act as an economic hedge against the changes in the values of another item or transaction. Changes in the fair value of derivatives classified as mark-to-market hedges are reported in earnings in either the Cost of sales or Selling, general and administrative expenses lines of the Consolidated Statements of Income where the change in value of the underlying transaction is recorded.
Types of Derivative Instruments
Interest Rate and Cross Currency Swaps To manage interest rate risk, the corporation has entered into interest rate swaps that effectively convert certain fixed-rate debt instruments into floating-rate debt instruments. Interest rate swap agreements that are effective at hedging the fair value of fixed-rate debt agreements are designated and accounted for as fair value hedges. The corporation utilizes interest rate swap derivatives in order to maintain a targeted amount of both fixed-rate and floating-rate long term debt and notes payable. Currently, the corporation has a fixed interest rate on approximately 70% of long-term debt and notes payable issued.
The corporation has issued certain foreign-denominated debt instruments and utilizes cross currency swaps to reduce the variability of functional currency cash flows related to the foreign currency debt. Cross currency swap agreements that are effective at hedging the variability of foreign-denominated cash flows are designated and accounted for as cash flow hedges. As of March 27, 2010, the total notional amount of the corporations interest rate swaps and cross currency swaps were $385 million and $746 million, respectively. The notional value of the cross currency swaps is calculated by multiplying the euro value swapped by the exchange rate at the reporting date.
In connection with the funding of the anticipated retirement of the 6.25% notes in September 2011, the corporation maintains a $50 million forward starting swap to effectively fix the cash flows related to interest payments on the anticipated debt issuance.
Currency Forward Exchange, Futures and Option Contracts The corporation uses forward exchange and option contracts to reduce the effect of fluctuating foreign currencies on short-term foreign-currency-denominated intercompany transactions, third-party product-sourcing transactions, foreign-denominated investments (including subsidiary net assets) and other known foreign currency exposures. Gains and losses on the derivative instruments are intended to offset losses and gains on the hedged transaction in an effort to reduce the earnings volatility resulting from fluctuating foreign currency exchange rates. Forward currency exchange contracts mature at the anticipated cash requirement date of the hedged transaction, generally within one year to eighteen months. Forward currency exchange contracts which are effective at hedging the fair value of a recognized asset or liability are designated and accounted for as fair value hedges. Forward currency contracts that act as a hedge of changes in the underlying foreign currency denominated subsidiary net assets are accounted for as net investment hedges. All remaining currency forward and options contracts are accounted for as mark-to-market hedges.
The principal currencies hedged by the corporation include the European euro, British pound, Danish krone, Hungarian forint, U.S. dollar, Swiss franc and Brazilian real. As of March 27, 2010, the net U.S. dollar equivalent of commitments to purchase and sell foreign currencies is $4,565 million and $4,551 million, respectively, using the exchange rate at the reporting date. The corporation hedges virtually all foreign exchange risk derived from recorded transactions and firm commitments and only hedges foreign exchange risk related to anticipated transactions where the exposure is potentially significant.
The corporation did not have any foreign exchange option contracts outstanding as of March 27, 2010.
Commodity Futures and Options Contracts The corporation uses commodity futures and options to hedge a portion of its commodity price risk. The principal commodities hedged by the corporation include hogs, beef, natural gas, diesel fuel, coffee, corn, wheat and other ingredients. The corporation does not use significant levels of commodity financial instruments to hedge commodity prices and primarily relies upon fixed rate supplier contracts to determine commodity pricing. In circumstances where commodity-derivative instruments are used, there is a high correlation between the commodity costs and the derivative instruments. For those instruments where the commodity instrument and underlying hedged item correlate between 80-125%, the corporation accounts for those contracts as cash flow hedges. However, the majority of commodity derivative instruments are accounted for as mark-to-market hedges.
As of March 27, 2010, the total notional amount of commodity futures and option contracts was $121 million and $27 million, respectively. The notional amount of commodity futures contracts is determined by the initial cost of the contracts while the notional amount of options contracts is determined by the delta adjusted value as of period end.
The corporation only enters into futures and options contracts that are traded on established, well-recognized exchanges that offer high liquidity, transparent pricing, daily cash settlement and collateralization through margin requirements.
Cash Flow Presentation
The settlement of derivative contracts related to the purchase of inventory, commodities or other hedged items that utilize hedge accounting are reported in the Consolidated Statements of Cash Flows as an operating cash flow, while those derivatives that utilize the mark-to-market hedge accounting model are reported in investing activities when those contracts are realized in cash. Fixed to floating rate swaps are reported as a component of interest expense and therefore are reported in cash flow from operating activities similar to how cash interest payments are reported. The portion of the gain or loss on a cross currency swap that offsets the change in the value of interest expense is recognized in cash flow from operations, while the gain or loss on the swap that is offsetting the change in value of the debt is classified as a financing activity in the Consolidated Statement of Cash Flows.
Contingent Features/Concentration of Credit Risk
All of the corporations derivative instruments are governed by International Swaps and Derivatives Association (i.e. ISDA) master agreements, requiring the corporation to maintain an investment grade credit rating from both Moodys and Standard & Poors credit rating agencies. If the corporations debt were to fall below investment grade, it would be in violation of these provisions, and the counterparties to the derivative instruments could request immediate payment or demand immediate collateralization on the derivative instruments in net liability positions. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that are in a liability position on March 27, 2010, is $251 million for which the corporation has posted no collateral. If the credit-risk-related contingent features underlying these agreements were triggered on March 27, 2010, the corporation would be required to post collateral of, at most, $251 million with its counterparties.
A large number of major international financial institutions are counterparties to the corporations financial instruments including cross currency swaps, interest rate swaps, and currency exchange forwards and swaps. The corporation enters into financial instrument agreements only with counterparties meeting very stringent credit standards (a credit rating of A-/A3 or better), limiting the amount of agreements or contracts it enters into with any one party and, where legally available, executing master netting agreements. These positions are continually monitored. While the corporation may be exposed to credit losses in the event of nonperformance by individual counterparties of the entire group of counterparties, it has not recognized any losses with these counterparties in the past and does not anticipate material losses in the future.
Fair Value Measurements
Effective the beginning of 2009, the corporation implemented new accounting guidance related to the fair value of financial assets and liabilities while in 2010 new fair value accounting rules were adopted for non-financial assets and liabilities. The adoption of these rules did not have a significant impact on the measurement of the corporations assets and liabilities.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., exit price) in an orderly transaction between market participants at the measurement date. Assets and liabilities measured at fair value must be categorized into one of three different levels depending on the assumptions (i.e., inputs) used in the valuation. Level 1 provides the most reliable measure of fair value while level 3 generally requires significant management judgment. Assets and liabilities are classified in their entirety based on the lowest level of input significant to the fair value measurement. The fair value hierarchy is defined as follows:
Level 1 Unadjusted Quoted Prices Valuations are based on unadjusted quoted prices in active markets for identical assets or liabilities. An example would be a marketable equity security that is traded on a major stock exchange.
Level 2 Pricing Models with Significant Observable Inputs Valuations are based on information derived from either an active market quoted price, which may require further adjustment based on the attributes of the asset or liability being measured, or an inactive market transaction. Circumstances when adjustments to market quoted prices may be appropriate include (i) a quoted price for an actively traded equity investment that is adjusted for a contractual trading restriction, or (ii) the fair value derived from a trade of an identical or similar security in an inactive market. An interest rate swap derivative valued based on a LIBOR swap curve is an example of a level 2 asset or liability.
Level 3 Pricing Models with Significant Unobservable Inputs Valuations are based on internally derived assumptions surrounding the timing and amount of expected cash flows for the financial instrument, which are significant to the overall fair value measurement. These assumptions are unobservable in either an active or inactive market. The inputs reflect managements best estimate of what market participants would use in valuing the asset or liability at the measurement date. A goodwill impairment test that utilizes an internally developed discounted cash flow model is an example of a level 3 asset or liability.
The carrying amounts of cash and equivalents, trade accounts receivables, accounts payable, derivative instruments and notes payable approximate fair values.
The fair values and carrying amounts of long-term debt, including the current portion, at March 27, 2010 were $2,822 million and $2,734 million, and at June 27, 2009 were $2,780 million and $2,784 million, respectively. The fair value of the corporations long-term debt, including the current portion, is estimated using discounted cash flows based on the corporations current incremental borrowing rates for similar types of borrowing arrangements.
Information on the location and amounts of derivative fair values in the Condensed Consolidated Balance Sheet at March 27, 2010 and June 27, 2009 is as follows:
Information related to our cash flow hedges, net investment hedges, fair value hedges and other derivatives not designated as hedging instruments for the quarterly and nine-month periods ended March 27, 2010, and March 28, 2009, follows:
8. Pension and Other Postretirement Benefit Plans
The components of the net periodic pension cost and the postretirement medical cost (income) for the third quarter and first nine months of 2010 and 2009 are as follows:
The net periodic benefit cost of the corporations defined benefit pension plans in the first nine months of 2010 was $43 million higher than in 2009 as a result of the following:
In 2010, the corporation classified the international household and body care businesses as discontinued operations and anticipates retaining the pension and postretirement medical obligations related to those businesses. The corporation no longer anticipates incurring service cost for the participants in those plans after these businesses are sold and this cost component is recognized in discontinued operations while the remainder of net periodic benefit cost is recognized in continuing operations.
During the first nine months of 2010 and 2009, the corporation contributed $100 million and $235 million, respectively, to its defined benefit pension plans. At the present time, the corporation expects to contribute approximately $130 million of cash to its defined benefit pension plans in 2010, or $30 million additional in the fourth quarter, as part of its normal funding requirements. However, in February 2010, the corporation announced that it intends to make an additional $200 million dollar contribution to its pension plans, which is not included in the $130 million estimate above. 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 2010 may differ from the current estimate.
In March 2010, the corporation announced changes to its U.S. defined benefit pension plans for salaried employees whereby participants will no longer accrue benefits under these plans. All future retirement benefits will be provided through a defined contribution plan. The benefit plan changes resulted in the elimination of any expected years of future service associated with these plans. As a result, a pretax curtailment gain of $25 million was recognized, of which $24 million impacted continuing operations and $1 million impacted discontinued operations. The curtailment gain resulted from the recognition of $3 million of previously unamortized net prior service credits associated with these benefit plans as well as a $22 million reduction in the projected benefit obligation associated with one of the plans. As a result of the significant benefit plan changes, the plan assets and liabilities of the two U.S. defined benefit plans were remeasured. Based on the results of the remeasurement, the net underfunded position of these plans decreased by approximately $13 million, which was recognized as a decrease in noncurrent pension liabilities with an offsetting decrease in the unamortized actuarial loss in accumulated other comprehensive income (AOCI). The reduction in the net underfunded position related to an increase in assets due to improved investment performance partially offset by an increase in the projected benefit obligation due to a decrease in discount rates.
During 2009, the corporation entered into a new collective labor agreement in the Netherlands which eliminated postretirement health care benefits for certain employee groups, while also reducing benefits provided to others. The elimination of benefits resulted in the recognition of a curtailment gain of $17 million, of which $12 million impacted continuing operations, related to a portion of the unamortized prior service cost credit which was reported in accumulated other comprehensive income. The plan changes also resulted in a $32 million reduction in the accumulated postretirement benefit obligation with an offset to AOCI.
As discussed in footnote 4, Discontinued Operations, the corporation received a binding offer for the sale of the corporations body care and European detergents businesses in the first quarter of 2010 and a binding offer for the air care business in the second quarter of 2010. Based on the proposed terms of the sales agreements, the corporation anticipates a significant reduction in the expected years of future service for the employees associated with a defined benefit pension plan in the Netherlands. Although the business dispositions have not yet been completed, a pretax curtailment loss of $11 million has been recognized because the loss is both probable and reasonably estimable. The curtailment loss, which relates to the previously unamortized prior service cost associated with this benefit plan, was recognized in the results of discontinued operations. In conjunction with the curtailment, the plan assets and liabilities of the Netherlands defined benefit plan were remeasured as of the end of December 2009. Based on the results of the remeasurement, the net funded position of this plan declined by approximately $81 million, which was recognized as a decrease in noncurrent pension assets with an offsetting increase in the unamortized actuarial loss in AOCI. This reduction in net funded position primarily related to a reduction in the discount rate used to determine the projected benefit obligation.
The corporation recognized a $7 million charge to income during the first quarter of 2010 to establish the estimated partial withdrawal liability for certain multi-employer pension plans. The charges were all recognized in Selling, general and administrative expenses in the Consolidated Statements of Income and related to the North American Fresh Bakery segment.
The corporation sold its European cut tobacco business in 1999. Under the terms of that agreement, the corporation was to receive an annual cash payment of 95 million euros if tobacco continued to be a legal product in the Netherlands, Germany and Belgium through July 15, 2009. The contingencies associated with the 2010 and 2009 payments passed in the first quarter of each fiscal year and the corporation received the annual payments and recorded income in the Contingent sales proceeds line in the Consolidated Statements of Income. The payment received in 2009 increased annual diluted earnings per share by $0.21 and the payment received in 2010 is expected to increase annual diluted earnings per share by $0.19. The payment received in 2010 represents the final payment to be received under the terms of the sale agreement.
Effective Annual Tax Rate for Interim Reporting Generally accepted accounting principles require that the interim period tax provision be determined as follows:
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 corporations tax expense can be impacted by changes in tax rates or laws, the finalization of tax audits and reviews, as well as other factors that cannot be predicted with certainty. As such, there can be significant volatility in interim tax provisions.
The following table sets out the tax expense (benefit) and the effective tax rate for the corporation:
Third Quarter and First Nine Months of 2010
In the third quarter of 2010, the corporation recognized tax expense of $173 million on pretax income from continuing operations of $198 million, or an effective tax rate of 87.1%. The tax expense and related effective tax rate on continuing operations were impacted by recognizing $22 million of discrete tax expense related to the following items:
In the first nine months of 2010, the corporation recognized tax expense of $224 million on pretax income from continuing operations of $744 million, or an effective tax rate of 30.1%. The tax expense and related effective tax rate on continuing operations was determined by applying a 39.1% estimated annual effective tax rate to pretax earnings and then recognizing $67 million of discrete tax benefits. The discrete tax items relate to the following:
The corporations 2010 estimated annual effective tax rate increased from 25.7% to 39.1% primarily due to a one-time tax charge of $118 million related to current year foreign earnings that are no longer indefinitely reinvested. This tax charge is in connection with the companys third quarter decision, announced February 16, 2010, to no longer reinvest overseas earnings primarily attributable to existing overseas cash and the book value of the household and body care businesses. Herein after this tax charge may also be referred to as the tax on unremitted earnings. This tax charge increased the estimated annual effective tax rate by approximately 14%. The portion of this tax charge recognized in the first nine months of 2010 is $102 million, all of which was recognized in the third quarter. Additionally, for the same reasons as noted above, the first nine months of 2010 includes a $416 million charge in discontinued operations.
The 2010 estimated annual effective tax rate also includes $18 million of non-recurring tax benefits related to the utilization of United Kingdom net operating losses which lowered the estimated annual effective rate by approximately 2%. The portion of this tax benefit recognized in the first nine months of 2010 is $16 million, of which $4 million was recognized in the third quarter.
Third Quarter and First Nine Months of 2009
In the third quarter of 2009, the corporation recognized tax expense of $39 million on pretax income from continuing operations of $172 million, or an effective tax rate of 22.5%. The tax rate in the third quarter was impacted by $7 million of tax expense related to the following discrete tax items:
The estimated annual effective tax rate includes a charge of $53 million related to the expected repatriation of a portion of 2009 foreign earnings. The estimated charge increases the estimated annual effective tax rate by approximately 10%.
The tax expense and related effective tax rate on continuing operations, for the first nine months of 2009, were determined by applying a 26.9% estimated annual effective tax rate to pretax earnings and then recognizing the impact of $8 million of tax expense related to the following discrete tax items:
The corporations 2009 estimated annual effective tax rate decreased from 33.4% to 26.9% due to a $29 million non-recurring tax benefit from current year foreign exchange gains. A significant portion of this non-recurring tax benefit should have been reflected in prior quarters of 2009. Management believes this error is immaterial to the quarterly financial statements.
Unrecognized Tax Benefits
Each quarter, the corporation makes a determination of the tax liability needed for unrecognized tax benefits that should be recorded in the financial statements. For tax benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by the taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement.
The year-to-date net decrease in the liability for unrecognized tax benefits was $118 million, resulting in an ending balance of $434 million as of March 27, 2010. There was a decrease in the gross liability for uncertain tax positions of $142 million, of which $92 million relates to audit settlements, $24 million relates to the expiration of statutes of limitations, $9 million relates to prior year decreases, and $17 million relates to favorable foreign currency exchange translation. This decrease was offset by an increase in the gross liability for uncertain tax positions of $24 million, all of which relate to 2010 increases.
At this time, the corporation estimates that it is reasonably possible that the liability for unrecognized tax benefits will decrease between $90 $130 million in the next twelve months from a variety of uncertain tax positions as a result of the completion of various worldwide tax audits currently in process and the expiration of statutes of limitations in several jurisdictions.
The corporations tax returns are routinely audited by federal, state, and foreign tax authorities and these audits are at various stages of completion at any given time. The Internal Revenue Service (IRS) has completed examinations of the companys U.S. income tax returns through July 1, 2006. Fiscal years remaining open to examination in the Netherlands include 2003 and forward. Other foreign jurisdictions remain open to audits after 2000. With few exceptions, the company is no longer subject to state and local income tax examinations by tax authorities for years before June 28, 2003.
As expected, in October 2009, the Spanish tax administration upheld the challenge made by its local field examination team against tax positions taken by the corporations Spanish subsidiaries. In November 2009, the corporation filed an appeal against this claim with the Spanish Tax Court. In April 2010, the Spanish Chief Inspector upheld a portion of the claim raised by the Spanish tax authorities, which the corporation will appeal. The corporation believes it is adequately reserved for the claim upheld by the Spanish Chief Inspector. However, in order to continue its appeal, the corporation anticipates obtaining a bank guarantee in 2010 for up to $135 million as security against all allegations. The corporation continues to dispute the challenge and will continue to communicate with the Spanish tax authorities regarding this issue.
Aris This is a consolidation of cases filed by individual complainants with the Republic of the Philippines, Department of Labor and Employment and the National Labor Relations Commission (NLRC) from 1998 through July 1999. The complaint alleges unfair labor practices due to the termination of manufacturing operations in the Philippines by Aris Philippines, Inc. (Aris), a former subsidiary of the corporation. The complaint names the corporation as a party defendant. In 2006, the arbitrator ruled against the corporation and awarded the plaintiffs $60 million in damages and fees, and the corporation appealed this ruling. In December 2006, the NLRC set aside the arbitrators ruling, and remanded the case to the arbitrator for further proceedings. The complainants and the corporation have filed motions for reconsideration the corporation seeking a final judgment and outright dismissal of the case, and complainants seeking to reinstate the original arbitrators judgment against the defendants, including the corporation. The respective motions for reconsideration have been fully briefed and the parties await the NLRCs rulings.
In response to the arbitrators original ruling, the Court of Appeals required the corporation to post a bond of approximately $25 million. However, the corporation has appealed the decision to the Supreme Court and, as a result, no bond posting is required until all allowable appeals have been exhausted. The corporation continues to believe that the plaintiffs claims are without merit; however, it is reasonably possible that this case will be ruled against the corporation and have a material adverse impact on the corporations results of operations or cash flows.
American Bakers Association Retirement Plan (ABA Plan) The corporation is a participating employer in the ABA 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 multiple employer plan. Under the express terms of the ABA Plans governing documents, the corporations contributions can only be used to pay for the benefits of its own employee-participants. In August 2006, the PBGC reversed its 1979 determination and concluded that the ABA Plan is and always has been a multiple employer plan in which the participating parties share responsibility for any plan liabilities (2006 Determination). If the 2006 Determination was upheld, it would have required the corporation to be responsible for a substantial portion of the ABA Plans underfunded liabilities. The corporation initiated litigation in the United States District Court for the District of Columbia seeking to overturn the 2006 Determination.
On December 1, 2009, the United States District Court upheld the 2006 Determination. However, the corporation moved the Court to alter or amend its Order to specifically state, among other things, that the 2006 Determination is prospective only and that the ABA Plan is deemed to have been, and shall for all purposes be treated as, an aggregate of single-employer pension plans from its establishment until the date of the 2006 Determination. On February 18, 2010, the Court granted the corporations motion, specifically stating that the 2006 Determination has prospective effect only. The time period for any party to appeal the Courts amended Order ended on April 19, 2010, and no appeals were filed.
Based on the Courts amended Order, the ABA Plan should be treated as an aggregate of single-employer pension plans prior to the 2006 Determination (i.e., the 2006 Determination would have no retroactive application) and as a multiple employer pension plan after the 2006 Determination. We are awaiting updated actuarial calculations; however, we believe that the amended Order significantly reduces the corporations responsibility for the ABA Plans underfunded liabilities prior to August 8, 2006.
As a result of the amended Order, the corporation began to recognize the obligations as if the ABA Plan was a multiple employer pension plan, with all future contributions to the plan immediately expensed in the consolidated statements of income. The corporation does not believe the resolution of this matter will have a material adverse impact on the corporations financial position, results of operations or cash flows.
Hanesbrands Inc. In September 2006, the corporation spun off its branded apparel business into an independent publicly-traded company named Hanesbrands Inc. (HBI). In connection with the spin off, the corporation and HBI entered into a tax sharing agreement that governs the allocation of tax assets and liabilities between the parties. HBI has initiated binding arbitration claiming that it is owed $72 million from the corporation under the tax sharing agreement. The corporation believes HBIs claims are without merit and is vigorously contesting the matter. The parties are engaging in discovery and the final hearing is scheduled for mid-June 2010. The corporation expects that this matter will be resolved by the end of August 2010.
Multi-Employer Pension Plans The corporation participates in various multi-employer pension plans that provide retirement benefits to certain employees covered by collective bargaining agreements (MEPP). Participating employers in a MEPP are jointly responsible for any plan underfunding. MEPP contributions are established by the applicable collective bargaining agreements; however, the MEPPs may impose increased contribution rates and surcharges based on the funded status of the plan and the provisions of the Pension Protection Act, which requires substantially underfunded MEPPs to implement rehabilitation plans to improve funded status. The corporation believes that its contributions to MEPPs may increase by approximately 12% to 15% through 2011 due to increased contribution rates and surcharges MEPPs are expected to impose under the Pension Protection Act. Factors that could impact funded status of a MEPP include investment performance, changes in the participant demographics, financial stability of contributing employers and changes in actuarial assumptions.
In addition to regular contributions, the corporation could be obligated to pay additional contributions (known as a complete or partial withdrawal liability) if a MEPP has unfunded vested benefits. These withdrawal liabilities, which would be triggered if the corporation ceases to make contributions to a MEPP with respect to one or more collective bargaining units, would equal the corporations proportionate share of the unfunded vested benefits based on the year in which liability is triggered. The corporation believes that certain of the MEPPs in which it participates have unfunded vested benefits, and some are significantly underfunded. Withdrawal liability triggers could include the corporations decision to close a plant or the dissolution of a collective bargaining unit. Due to uncertainty regarding future withdrawal liability triggers, we are unable to determine the amount and timing of the corporations future withdrawal liability, if any, or whether the corporations participation in these MEPPs could have any material adverse impact on its financial condition, results of operations or liquidity. Disagreements over potential withdrawal liability may lead to legal disputes. The corporation currently is involved in litigation with one MEPP and it is reasonably possible that the outcome of this litigation may result in an additional partial withdrawal liability of approximately $16 million.
The corporations regular scheduled contributions to MEPPs totaled $49 million in 2009, $48 million in 2008 and $47 million in 2007. The corporation recognized charges for partial withdrawal liabilities of approximately $7 million in 2010 to date, $31 million in 2009, and an immaterial amount in 2008.
Competition Law During the past few years, competition authorities in various European countries and the European Commission have initiated investigations into the conduct of consumer products companies. These investigations usually continue for several years and, if violations are found, may result in substantial fines. In connection with these investigations, Sara Lees household and body care business operating in Europe has received requests for information, made employees available for interviews, and been subjected to unannounced inspections by various competition authorities. In the second quarter of 2010, the corporation recognized a 3.7 million euro charge for a fine imposed by the Spanish Competition Authorities related to claims that the corporation engaged in inappropriate activities to indirectly increase prices of its shower gel products. To date, except for the Spanish fine and the previously disclosed 5.5 million euros fine imposed by the German cartel authorities in February 2008, no formal charges have been brought against Sara Lee concerning the substantive conduct that is the subject of these investigations. Our practice is to comply with all laws and regulations applicable to our business, including the antitrust laws, and to cooperate with relevant regulatory authorities.
Charges for fines that already have been imposed against the corporation, as noted above, have been reflected in the consolidated statements of income in the year we were notified of the fine. The corporation also recognized a charge of 4 million euros in the third quarter of 2010 as an estimate of additional fines that may be imposed. Based on currently available information, it is reasonably possible the corporation may be subject to additional fines related to several of these investigations and, with respect to one of these investigations, it is probable that a fine will be imposed. However, we are unable to estimate the impact on our financial statements of additional fines, if any, that may be imposed against the corporation.
Belgian tax matter In 1997, the corporation sold a Belgian subsidiary to an unrelated third party. At the time of the sale, the Belgian subsidiary owed a Belgian tax liability of approximately 30 million euros (resulting from an intercompany restructuring completed before the 1997 sale) and the third party buyer
assumed all assets and liabilities of the subsidiary. In 1999, the former Belgian subsidiary, then owned by the third party buyer, declared bankruptcy and did not pay the outstanding Belgian tax liability. In 2001, the Belgian Ministry of Finance launched an investigation into the 1997 sale. In November 2009, the corporation received from the Belgian state prosecutor a notice of intent to indict the third party buyer as well as several of the corporations international subsidiaries and several current and former directors and officers of such subsidiaries, in connection with the 1997 sale. The notice alleges various tax-related legal violations, some of which carry criminal penalties. The corporation is engaged in settlement discussions with the Belgian authorities. Although no settlement has been reached, based on currently available information the corporation accrued $43 million for Belgian taxes, interest, and penalties in the third quarter.
On March 30, 2010, a subsidiary of the corporation issued 300 million of euro denominated debt, which is scheduled to mature in March 2012. The notes were issued at a fixed rate of 2.25% but have effectively been converted into variable rate debt using interest rate swap instruments. The proceeds were used to retire 285 million euro of debt that was scheduled to mature in 2011.
Managements Discussion and Analysis of Financial Condition and Results of Operations
The following is managements discussion and analysis of the results of operations for the third quarter and first nine months of 2010 compared with the third quarter and first nine months of 2009 and a discussion of the changes in financial condition and liquidity during the first nine months of 2010. Below is an outline of the analyses included herein:
Sara Lee is a global manufacturer and marketer of high-quality, brand name products for consumers throughout the world focused primarily in the meat, bakery, and beverage products categories. Our brands include Ball Park, Douwe Egberts, Hillshire Farm, Jimmy Dean, Senseo and our namesake, Sara Lee.
In North America, the company sells a variety of packaged meat products that include hot dogs, corn dogs, breakfast sausages, dinner sausages and deli meats as well as a variety of fresh and frozen baked products and specialty items that include bread, buns, bagels, cakes and cheesecakes. These products are sold through the retail channel to supermarkets, warehouse clubs and national chains. The company also sells a variety of meat, bakery and beverage products to foodservice customers in North America. Internationally, the company sells coffee and tea products in Europe, Brazil, Australia and Asia through both the retail and foodservice channels as well as a variety of bakery and dough products to retail and foodservice customers in Europe and Australia.
In September 2009, the corporation announced that it had received a binding offer to acquire its global body care and European detergents businesses for 1.275 billion euros. In December 2009, the
corporation also announced that it had received a binding offer for the sale of its air care business for 320 million euros. Together these businesses represent approximately 70% of the net sales of the international household and body care businesses. The results of these businesses and the remaining household and body care businesses, which were previously reported as a separate business segment, are now being reported as discontinued operations. Prior period results have been revised to reflect these businesses as discontinued operations. See Note 4 Discontinued Operations for additional information regarding these discontinued operations. Unless stated otherwise, any reference to income statement items in these financial statements refers to results from continuing operations. The corporation intends to use the proceeds from the divestiture to, among other things, repurchase stock, make additional contributions to its pension plans and invest for growth in its core businesses.
Summary of Results
The business highlights include the following:
Challenges and Risks
As an international consumer products company, we face certain risks and challenges that impact our business and financial performance. The risks and challenges described below have impacted our performance and are likely to impact our future results as well.
The food businesses are highly competitive. In many product categories, we compete not only with widely advertised branded products, but also with private label products that are generally sold at lower prices. As a result, from time to time, we may need to reduce the prices for some of our products to respond to competitive pressures. In addition, the turmoil in the financial markets has led to general economic weakness, which has negatively impacted our business. The continued economic uncertainty may also result in increased pressure to reduce the prices for some of our products, limit our ability to increase or maintain prices or lead to a continued shift toward private label products. Any reduction in prices or our inability to increase prices could negatively impact profit margins and the overall profitability of our reporting units, which could potentially trigger a goodwill impairment.
Commodity prices directly impact our business because of their effect on the cost of raw materials used to make our products and the cost of inputs to manufacture, package and ship our products. In addition, under some of our contracts, the prices at which we sell our products are tied to increases and decreases in commodity costs. Many of the commodities we use, including coffee, wheat, beef, pork, corn, corn syrup, soybean and corn oils, butter, sugar and fuel, have experienced price volatility due to factors beyond our control. The companys objective is to offset commodity price increases with pricing actions and to offset any operating cost increases with continuous improvement savings.
The companys business results are also heavily influenced by changes in foreign currency exchange rates. For the most recently completed fiscal year, approximately 35% of net sales and 50% of operating segment income were generated outside of the U.S. As a result, changes in foreign currency exchange rates, particularly the European euro, can have a significant impact on the reported results. Changes in foreign currency exchange rates increased net sales by $162 million and increased operating income by $22 million for the first nine months of 2010.
The companys international operations also provide a significant portion of the companys cash flow from operating activities, which is expected to require the company to continue to repatriate a significant portion of cash generated outside of the U.S. The repatriation of these funds has and is expected to continue to result in a higher effective income tax rate and cash tax payments.
Significant Items Affecting Comparability
The reported results for 2010 and 2009 reflect amounts recognized for actions associated with the corporations ongoing business transformation program, Project Accelerate and other significant amounts that impact comparability. More information on these costs can be found in Note 6 to the Consolidated Financial Statements, Exit, Disposal and Transformation/Accelerate Activities. The nature of these items includes the following:
Exit Activities, Asset and Business Dispositions These costs are reported on a separate line of the Consolidated Statements of Income. Exit activities primarily relate to charges taken to recognize severance actions approved by the corporations management and the exit of leased facilities or other contractual arrangements. Asset and business disposition activities include costs associated with separating businesses targeted for sale, as well as gains and losses associated with the disposition of asset groups that do not qualify for discontinued operations reporting.
Project Accelerate (Accelerate) Costs These include costs associated with the transition of services to an outside third party vendor as part of a business process outsourcing initiative. The initiative includes the outsourcing of a portion of the North American and European finance processing functions, information systems application development and maintenance as well as indirect procurement activities. These costs are recognized in the Consolidated Statements of Income in Selling, general and administrative expenses or Cost of sales. Employee termination costs, lease exit costs and gains or losses on the disposition of assets or asset groupings that do not qualify as discontinued operations associated with these initiatives are reported as part of exit activities, asset and business dispositions.
For continuing operations, the savings resulting from Accelerate and other restructuring actions were approximately $127 million in the first nine months of 2010, of which $89 million is incremental to the prior year. The corporation anticipates annualized savings in 2010 of approximately $170-$190 million related to these actions, of which $120-$140 million is incremental to the Accelerate savings in 2009.
Business Transformation Costs These include costs to retain and relocate existing employees, recruit new employees, and third-party consulting costs associated with transformation efforts. These costs are recognized in the Consolidated Statements of Income in Selling, general and administrative expenses or Cost of sales. Employee termination costs, lease exit costs and gains or losses on the disposition of assets or asset groupings that do not qualify as discontinued operations associated with these initiatives are reported as part of exit activities, asset and business dispositions.
Other Significant Items The reported results are also impacted by other items that affect comparability. These items include, but are not limited to, impairment charges, pension partial withdrawal liability charges, curtailment gains (losses) and certain discrete tax matters, which include charges related to the tax on unremitted earnings, audit settlements/reserve adjustments, valuation allowance adjustments and various other tax matters.
Impact of Significant Items on Net Income and Diluted Earnings per Share Attributable to Sara Lee
Impact of Significant Items on Net Income and Diluted Earnings per Share Attributable to Sara Lee