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Hillshire Brands Co 10-Q 2011

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.2
  6. Ex-32.2
Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

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

For the quarterly period ended April 2, 2011

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 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):

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   ¨

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 April 2, 2011, the Registrant had 585,100,721 outstanding shares of common stock $.01 par value, which is the Registrant’s only class of common stock.


Table of Contents

SARA LEE CORPORATION AND SUBSIDIARIES

INDEX

 

PART I

 

     

ITEM 1

 

   FINANCIAL STATEMENTS (Unaudited)   
     Condensed Consolidated Balance Sheets - At April 2, 2011 and July 3, 2010      3   
     Consolidated Statements of Income - For the Quarters and Nine Months ended April 2, 2011 and
March 27, 2010
     4   
     Condensed Consolidated Statements of Equity - For the period June 27, 2009 to April 2, 2011      5   
     Consolidated Statements of Cash Flows - For the Nine Months ended April 2, 2011 and
March 27, 2010
     6   
     Notes to Consolidated Financial Statements      7   

ITEM 2

 

   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS      28   

ITEM 4

 

   CONTROLS AND PROCEDURES      56   

PART II

 

     

ITEM 1A

 

   RISK FACTORS      57   

ITEM 2(c)

 

   REPURCHASES OF EQUITY SECURITIES BY THE ISSUER      57   

ITEM 6

 

   EXHIBITS      58   

SIGNATURE

          59   

 

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SARA LEE CORPORATION AND SUBSIDIARIES

Condensed Consolidated Balance Sheets at April 2, 2011 and July 3, 2010

(Unaudited)

 

In millions

   April 2,
2011
     July 3,
2010
 

Assets

     

Cash and equivalents

   $ 2,132       $ 955   

Trade accounts receivable, less allowances

     925         1,047   

Inventories

     

Finished goods

     504         397   

Work in process

     32         31   

Materials and supplies

     505         284   
                 
     1,041         712   

Current deferred income taxes

     75         241   

Other current assets

     314         364   

Assets held for sale

     308         461   
                 

Total current assets

     4,795         3,780   

Property, net of accumulated depreciation of $2,519 and $2,330, respectively

     1,730         1,672   

Trademarks and other identifiable intangibles, net

     272         254   

Goodwill

     1,019         974   

Deferred income taxes

     345         225   

Other noncurrent assets

     240         150   

Noncurrent assets held for sale

     1,211         1,781   
                 
   $ 9,612       $ 8,836   
                 

Liabilities and Equity

     

Notes payable

   $ 605       $ 47   

Accounts payable

     856         912   

Income taxes payable and current deferred taxes

     482         8   

Other accrued liabilities

     1,730         1,179   

Current maturities of long-term debt

     462         2   

Liabilities held for sale

     318         436   
                 

Total current liabilities

     4,453         2,584   
                 

Long-term debt

     1,932         2,627   

Pension obligation

     370         448   

Deferred income taxes

     93         492   

Other liabilities

     857         762   

Noncurrent liabilities held for sale

     333         408   

Equity

     

Sara Lee common stockholders’ equity

     1,546         1,487   

Noncontrolling interest

     28         28   
                 

Total Equity

     1,574         1,515   
                 
   $ 9,612       $ 8,836   
                 

See accompanying Notes to Consolidated Financial Statements.

 

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SARA LEE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income

For the Quarter and Nine Months ended April 2, 2011 and March 27, 2010

(Unaudited)

 

     Quarter ended     Nine Months ended  

In millions, except per share data

   Apr. 2,
2011
    Mar. 27,
2010
    Apr. 2,
2011
    Mar. 27,
2010
 

Continuing Operations

        

Net sales

   $ 2,220      $ 2,077      $ 6,628      $ 6,483   
                                

Cost of sales

     1,484        1,296        4,427        4,121   

Selling, general and administrative expenses

     518        531        1,564        1,620   

Net charges for exit activities, asset and business dispositions

     5        25        48        52   

Impairment charges

     —          —          —          17   

Contingent sale proceeds

     —          —          —          (133
                                

Operating income

     213        225        589        806   

Interest expense

     25        35        87        103   

Interest income

     (9     (7     (22     (19

Debt extinguishment costs

     —          —          55        —     
                                

Income from continuing operations before income taxes

     197        197        469        722   

Income tax expense

     60        174        155        217   
                                

Income from continuing operations

     137        23        314        505   
                                

Discontinued operations

        

Income (loss) from discontinued operations net of tax expense (benefit) of $2, $440, $(189) and $411

     (10     (357     261        (176

Gain on sale of discontinued operations, net of tax expense of $14, $2, $576 and $2

     29        6        608        6   
                                

Net income (loss) from discontinued operations

     19        (351     869        (170
                                

Net income (loss)

     156        (328     1,183        335   

Less: Income from noncontrolling interests, net of tax

        

Discontinued operations

     3        8        7        16   
                                

Net income (loss) attributable to Sara Lee

   $ 153      $ (336   $ 1,176      $ 319   
                                

Amounts attributable to Sara Lee:

        

Net income from continuing operations

   $ 137      $ 23      $ 314      $ 505   

Net income (loss) from discontinued operations

     16        (359     862        (186
                                

Net income (loss) attributable to Sara Lee

   $ 153      $ (336   $ 1,176      $ 319   
                                

Earnings per share of common stock

        

Basic

        

Income from continuing operations

   $ 0.23      $ 0.03      $ 0.50      $ 0.73   
                                

Net income (loss)

   $ 0.25      $ (0.49   $ 1.86      $ 0.46   
                                

Average shares outstanding

     605        691        632        695   
                                

Diluted

        

Income from continuing operations

   $ 0.22      $ 0.03      $ 0.49      $ 0.72   
                                

Net income (loss)

   $ 0.25      $ (0.49   $ 1.85      $ 0.46   
                                

Average shares outstanding

     609        693        635        697   
                                

Cash dividends declared per share of common stock

   $ 0.115      $ 0.11      $ 0.23      $ 0.22   
                                

See accompanying Notes to Consolidated Financial Statements.

 

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SARA LEE CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Equity

For the period June 27, 2009 to April 2, 2011

(Unaudited)

 

           Sara Lee Common Stockholders’ Equity        

In millions

   Total     Common
Stock
    Capital
Surplus
    Retained
Earnings
    Unearned
Stock
    Accumulated
Other
Comprehensive
Income (Loss)
    Noncontrolling
Interest
 

Balances at June 27, 2009

   $ 2,070      $ 7      $ 17      $ 2,721      $ (104   $ (605   $ 34   

Net income

     527        —          —          506        —          —          21   

Translation adjustments, net of tax

     (82     —          —          —          —          (82     —     

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

     8        —          —          —          —          8        —     

Pension/Postretirement activity, net of tax

     (235     —          —          —          —          (235     —     

Other comprehensive income activity, net of tax

     2        —          —          —          —          2        —     
                          

Comprehensive income

   $ 220                $ 21   
                          

Dividends on common stock

     (302     —          —          (302     —          —          —     

Dividends paid on noncontrolling interest/Other

     (2     —          —          —          —          —          (2

Disposition of noncontrolling interest

     (25     —          —          —          —          —          (25

Stock issuances—

              

Restricted stock

     27        —          27        —          —          —          —     

Stock option and benefit plans

     19        —          19        —          —          —          —     

Share repurchases and retirement

     (500     —          (47     (453     —          —          —     

ESOP tax benefit, redemptions and other

     8        —          1        —          7        —          —     
                                                        

Balances at July 3, 2010

     1,515        7        17        2,472        (97     (912     28   

Net income (loss)

     1,183        —          —          1,176        —          —          7   

Translation adjustments, net of tax

     283        —          —          —          —          283        —     

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

     19        —          —          —          —          19        —     

Pension/Postretirement activity, net of tax

     (15     —          —          —          —          (15     —     
                          

Comprehensive income

   $ 1,470                $ 7   
                          

Dividends on common stock

     (142     —          —          (142     —          —          —     

Dividends paid on noncontrolling interest

     (4     —          —          —          —          —          (4

Disposition of noncontrolling interest

     (3     —          —          —          —          —          (3

Stock issuances—

              

Restricted stock

     23        —          14        9        —          —          —     

Stock option and benefit plans

     28        —          28        —          —          —          —     

Share repurchases and retirement

     (1,313     (1     (55     (1,257     —          —          —     

ESOP tax benefit, redemptions and other

     —          —          (4     —          4        —          —     
                                                        

Balances at April 2, 2011

   $ 1,574      $ 6      $ —        $ 2,258      $ (93   $ (625   $ 28   
                                                        

Total comprehensive income was $361 million in the first nine months of 2010, of which $343 million was attributable to Sara Lee.

See accompanying Notes to Consolidated Financial Statements.

 

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SARA LEE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the Nine Months ended April 2, 2011 and March 27, 2010

(Unaudited)

 

     Nine Months ended  

In millions

   Apr. 2,
2011
    Mar. 27,
2010
 

OPERATING ACTIVITIES—

    

Net income (loss)

   $ 1,183      $ 335   

Less: Cash received from contingent sale proceeds

     —          (133

Adjustments to reconcile net income to net cash from operating activities:

    

Depreciation

     225        265   

Amortization

     62        67   

Impairment charges

     —          17   

Net (gain) loss on business dispositions

     (1,184     13   

Pension contributions, net of expense

     (76     (2

Increase in deferred income taxes for unremitted earnings

     234        518   

Tax benefit on Fresh Bakery disposition

     (227     —     

Debt extinguishment costs

     55        —     

Other

     35        (55

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

    

Trade accounts receivable

     136        14   

Inventories

     (268     (9

Other current assets

     (105     37   

Accounts payable

     (10     (27

Accrued liabilities

     (83     (103

Accrued taxes

     315        (130
                

Net cash from operating activities

     292        807   
                

INVESTING ACTIVITIES—

    

Purchases of property and equipment

     (238     (215

Purchases of software and other intangibles

     (14     (11

Acquisition of businesses and investments

     (32     —     

Dispositions of businesses and investments

     2,182        6   

Cash received from contingent sale proceeds

     —          133   

Cash received from derivative transactions

     72        61   

Sales of assets

     10        13   
                

Net cash received from (used in) investing activities

     1,980        (13
                

FINANCING ACTIVITIES—

    

Issuances of common stock

     20        2   

Purchases of common stock

     (1,313     (500

Borrowings of other debt

     1,032        45   

Repayments of other debt

     (1,352     (73

Net change in financing with less than 90-day maturities

     483        (3

Payments of dividends

     (217     (232
                

Net cash used in financing activities

     (1,347     (761
                

Effect of changes in foreign exchange rates on cash

     252        (20
                

Increase (decrease) in cash and equivalents

     1,177        13   

Add: Cash balances of discontinued operations at beginning of year

     —          8   

Less: Cash balances of discontinued operations at end of period

     —          (37

Cash and equivalents at beginning of year

     955        951   
                

Cash and equivalents at end of quarter

   $ 2,132      $ 935   
                

Supplemental Cash Flow Data:

    

Cash paid for restructuring actions

   $ 82      $ 107   

Cash contributions to pension plans

     115        100   

Cash paid for income taxes

     219        241   

See accompanying Notes to Consolidated Financial Statements.

 

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Table of Contents

SARA LEE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

 

  1. Basis of Presentation

The consolidated financial statements for the quarter and nine months ended April 2, 2011 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 April 2, 2011 are not necessarily indicative of the operating results to be expected for the full fiscal year. The Condensed Consolidated Balance Sheet as of July 3, 2010 has been derived from the corporation’s audited financial statements included in our Annual Report on Form 10-K for the year ended July 3, 2010. The businesses comprising the former Fresh Bakery and International Household and Body Care segments are presented as discontinued operations in the corporation’s 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 corporation’s Form 10-K for the year ended July 3, 2010 and other financial information filed with the Securities and Exchange Commission.

The corporation’s fiscal year ends on the Saturday closest to June 30. Fiscal 2011 ends on July 2, 2011. The third quarter and first nine months of fiscal 2011 ended on April 2, 2011 and the third quarter and first nine months of fiscal 2010 ended on March 27, 2010. Each of the quarters was a thirteen-week period and each of the nine month periods was a thirty-nine week period. Fiscal 2011 is a 52-week year, whereas fiscal 2010 was a 53-week year. Unless otherwise stated, references to years relate to fiscal years.

In January 2011, the corporation announced that its board of directors has agreed in principle to divide the company into two separate, publicly traded companies which is expected to be completed in early calendar 2012. Under this plan, Sara Lee’s North American Retail and North American Foodservice businesses (excluding the North American Beverage business) will be spun off, tax-free, into a new public company that will retain the “Sara Lee” name. The other company will consist of Sara Lee’s current International Beverage and International Bakery businesses, as well as the North American beverage business. The separation plan is subject to final approval by the board of directors, other customary approvals and the receipt of an IRS tax ruling.

In conjunction with this planned separation, the board of directors intends to declare a $3.00 per share dividend on the corporation’s common stock, the majority of which will be funded from proceeds from the sale of the North American Fresh Bakery business. This special dividend is expected to be declared and paid in fiscal 2012 before the completion of the spin off.

 

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Income statement correction – The corporation identified errors related to the gain on disposition of the global body care and European detergents business previously recognized in the second quarter of 2011 as part of the net income from discontinued operations in the Consolidated Statement of Income. As a result of these errors, the total after tax gain on disposition of businesses for the quarter and six months ended January 1, 2011 was overstated by $49 million, of which $17 million related to the net assets sold and $32 million related to the tax provision on the gain. The corporation has concluded that these errors did not materially misstate the second quarter 2011 financial statements. The year-to-date and quarterly amounts reported in the Consolidated Statement of Income for the third quarter of 2011 reflect the correction of the errors as of the end of the second quarter of 2011. The following table summarizes the second quarter 2011 results on an as reported and as adjusted basis:

 

     Quarter ended
Jan. 1, 2011
     Six Months ended
Jan. 1, 2011
 
     As
Reported
     As
Adjusted
     As
Reported
     As
Adjusted
 

Income from continuing operations

   $ 107       $ 107       $ 177       $ 177   

Discontinued Operations

           

Income from discontinued operations, net of tax expense

   $ 236       $ 236       $ 271       $ 271   

Gain on sale of discontinued operations, net of tax expense

     539         490         628         579   
                                   

Net income from discontinued operations

     775         726         899         850   
                                   

Net income

     882         833         1,076         1,027   

Less: Income from noncontrolling interests, net of tax – Discontinued Op.

     2         2         4         4   
                                   

Net income attributable to Sara Lee

   $ 880       $ 831       $ 1,072       $ 1,023   
                                   

Amounts attributable to Sara Lee

           

Net income from continuing operations

     107         107         177         177   

Net income from discontinued operations

     773         724         895         846   
                                   

Net income attributable to Sara Lee

   $ 880       $ 831       $ 1,072       $ 1,023   
                                   

Earnings per common share – Basic

           

Income from continuing operations

   $ 0.17       $ 0.17       $ 0.27       $ 0.27   

Income (loss) from discontinued operations

     1.21         1.14         1.38         1.31   
                                   

Net income

   $ 1.38       $ 1.30       $ 1.66       $ 1.58   
                                   

Earnings per common share – Diluted

           

Income from continuing operations

   $ 0.17       $ 0.17       $ 0.27       $ 0.27   

Income (loss) from discontinued operations

     1.20         1.13         1.38         1.30   
                                   

Net income

   $ 1.37       $ 1.30       $ 1.65       $ 1.58   
                                   

Balance sheet correction – During the first quarter of 2011, the corporation corrected an error in the classification of certain asset and liability balances in the 2010 balance sheet associated with casualty losses from workers’ compensation, auto liability and general liability claims by recording a portion of the liability for these losses and the related insurance receivable as long-term. The correction of this error has resulted in a $15 million reduction to “other current assets” and a corresponding increase in “other noncurrent assets” in the 2010 balance sheet. In addition, “other accrued liabilities” was reduced by $60 million with a corresponding increase in “other liabilities” (long-term). The correction of this error had a similar impact on the assets and liabilities of the former North American Fresh Bakery segment, which are now classified as held for sale on the balance sheet for all periods presented. The impact of the error on the assets and liabilities held for sale was $15 million and $79 million, respectively. The corporation has concluded that this error did not materially misstate previously issued financial statements.

As noted in the Summary of Significant Accounting Policies note to the company’s 2010 annual report, the majority of the corporation’s shipping and handling costs is being recognized in the Selling, general and administrative expenses (SG&A) line of the Consolidated Income Statement. Beginning in 2011, the corporation has begun reporting all shipping and handling costs incurred after a product is considered complete and ready for sale in SG&A. Previously, the North American Foodservice and International Beverage business segments were recognizing a portion of these costs in Cost of sales. The impact of this change is considered to be immaterial to both the consolidated quarterly and annual financial statements.

 

  2. Net Income (Loss) Per Share

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) attributable to Sara Lee 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 April 2, 2011, options to purchase 6.9 million

 

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shares and 11.9 million shares, respectively, 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 nine months ended March 27, 2010, options to purchase 21.4 million shares and 21.9 million shares, respectively, 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. 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 2011 as compared to the third quarter and first nine months of 2010 as a result of shares repurchased under the corporation’s ongoing share repurchase program. During the first nine months of 2011, the corporation repurchased 80.2 million shares of common stock for $1.3 billion. The corporation also paid $13 million as a final settlement on the accelerated share repurchase program (ASR) initiated in 2010. The ASR provided for a final settlement adjustment at termination based on the final volume weighted average stock price. As of April 2, 2011, the corporation was authorized to repurchase approximately $1.2 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 corporation’s prior share repurchase program. The corporation repurchases common stock at times management deems appropriate.

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 2011 and 2010 (per share amounts are rounded and may not add to total):

Computation of Net Income per Common Share

(In millions, except per share data)

 

     Quarter ended     Nine Months ended  
     Apr. 2,
2011
     Mar. 27,
2010
    Apr. 2,
2011
     Mar. 27,
2010
 

Amounts attributable to Sara Lee

          

Income from continuing operations

   $ 137       $ 23      $ 314       $ 505   

Income (loss) from discontinued operations, net of tax

     16         (359     862         (186
                                  

Net income (loss)

   $ 153       $ (336   $ 1,176       $ 319   
                                  

Average shares outstanding – Basic

     605         691        632         695   

Dilutive effect of stock option and award plans

     4         2        3         2   
                                  

Diluted shares outstanding

     609         693        635         697   
                                  

Earnings per common share – Basic

          

Income from continuing operations

   $ 0.23       $ 0.03      $ 0.50       $ 0.73   

Income (loss) from discontinued operations

     0.03         (0.52     1.36         (0.27
                                  

Net income (loss)

   $ 0.25       $ (0.49   $ 1.86       $ 0.46   
                                  

Earnings per common share – Diluted

          

Income from continuing operations

   $ 0.22       $ 0.03      $ 0.49       $ 0.72   

Income (loss) from discontinued operations

     0.03         (0.52     1.36         (0.27
                                  

Net income (loss)

   $ 0.25       $ (0.49   $ 1.85       $ 0.46   
                                  

 

  3. Segment Information

The following is a general description of the corporation’s four business segments:

 

 

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

 

 

North American Foodservice – sells a variety of meat, bakery, and beverage products to foodservice customers in North America.

 

 

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.

 

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The results of the operations comprising the corporation’s former North American Fresh Bakery segment are now being reported as discontinued operations for all periods presented. See Note 4 - “Discontinued Operations” for additional information.

The following is a summary of net sales and operating segment income by business segment for the third quarter and first nine months of 2011 and 2010.

 

     Net Sales  

(In millions)

   Third
Quarter
2011
    Third
Quarter
2010
    Nine
Months
2011
    Nine
Months
2010
 

North American Retail

   $ 681      $ 672      $ 2,142      $ 2,076   

North American Foodservice

     448        427        1,410        1,413   

International Beverage

     925        799        2,552        2,417   

International Bakery

     173        186        544        601   
                                

Total business segments

     2,227        2,084        6,648        6,507   

Intersegment sales

     (7     (7     (20     (24
                                

Net sales

   $ 2,220      $ 2,077      $ 6,628      $ 6,483   
                                
     Income (Loss) Before Income Taxes  

(In millions)

   Third
Quarter
2011
    Third
Quarter
2010
    Nine
Months
2011
    Nine
Months
2010
 

North American Retail

   $ 85      $ 101      $ 236      $ 303   

North American Foodservice

     33        26        121        109   

International Beverage

     134        173        333        468   

International Bakery

     3        (1     16        4   
                                

Total operating segment income

     255        299        706        884   

General corporate expenses

     (42     (61     (112     (183

Mark-to-market derivative gains/(losses)

     8        (5     19        (4

Amortization of intangibles

     (8     (8     (24     (24

Contingent sale proceeds

     —          —          —          133   
                                

Operating income

     213        225        589        806   

Net interest expense

     (16     (28     (65     (84

Debt extinguishment costs

     —          —          (55     —     
                                

Income before income taxes

   $ 197      $ 197      $ 469      $ 722   
                                

 

  4. Discontinued Operations

In November 2010, the corporation signed an agreement to sell its North American fresh bakery operations to Grupo Bimbo for $959 million. As of the end of the third quarter of 2011, the corporation has closed or received binding offers for virtually all of its household and body care businesses. Subsequent to the end of the third quarter, the corporation closed on the disposition of a majority of its shoe care business. The corporation has also agreed to sell its non-Indian insecticides business for €154 million. Sara Lee received a deposit of €149 million on the sale of this business. The deposit was recognized as unrestricted cash, with an offsetting liability to the buyer of $211 million, which will be reported in Other accrued liabilities in the Condensed Consolidated Balance Sheet until the deal closes. The sale of this business is currently under regulatory review.

The businesses that formerly comprised the North American Fresh Bakery and International Household and Body Care segments are 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.

 

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In December 2010, the corporation completed the disposition of its global body care and European detergents business and, through the third quarter of 2011, completed the disposition of the majority of its air care business, as well as, its Australia/New Zealand bleach business.

As noted above, on November 9, 2010, the corporation signed an agreement to sell its North American fresh bakery business to Grupo Bimbo for $959 million. The purchase price is subject to various adjustments, including reduction by up to $140 million if and to the extent that Grupo Bimbo is required to divest certain amounts of assets in connection with obtaining regulatory approval. The agreement will enable Grupo Bimbo to use the Sara Lee brand in the fresh bakery category throughout the world, except Western Europe, Australia and New Zealand, while the corporation retains the brand for all other categories and geographies. The sale also includes a small portion of business that is currently part of the North American Foodservice segment which is not reflected as discontinued operations as it does not meet the definition of a component pursuant to the accounting rules. The transaction, which is subject to customary closing conditions and regulatory clearances, is anticipated to close before the end of 2011.

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

 

     Third Quarter 2011     Third Quarter 2010  

(In millions)

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

North American Fresh Bakery Businesses

   $ 491       $ 21      $ 14      $ 501       $ 3       $ 5   

International Household and Body Care Businesses

     197         (29     (24     525         80         (362
                                                   

Total

   $ 688       $ (8   $ (10   $ 1,026       $ 83       $ (357
                                                   

 

     First Nine Months 2011      First Nine Months 2010  

(In millions)

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

North American Fresh Bakery Businesses

   $ 1,494       $ 20       $ 242       $ 1,541       $ 26       $ 19   

International Household and Body Care Businesses

     970         52         19         1,611         209         (195
                                                     

Total

   $ 2,464       $ 72       $ 261       $ 3,152       $ 235       $ (176
                                                     

The North American fresh bakery tax provision for the first nine months of 2011 includes a $227 million income tax benefit associated with the excess tax basis related to these assets. This excess tax basis gives rise to a deferred tax asset, which will reverse upon the finalization of the sale of this business.

In the first nine months of 2010, the international household and body care businesses reported tax expense of $404 million. The net tax expense resulted from the recognition of the following significant tax amounts: (i) a $416 million tax charge related to the company’s 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 net 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 disposition of the household and body care businesses in that country; 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.

Gain on the Sale of Discontinued Operations

In February of 2011, the corporation closed on the sale of its Australia/New Zealand bleach business. Using foreign exchange rates on the date of the transaction, the corporation has received cash proceeds of $51 million and reported an after tax gain of $29 million.

The global body care and European detergents businesses were sold in December 2010. Using foreign exchange rates on the date of the transaction, the corporation received cash proceeds of $1.5 billion, and reported an after tax gain on disposition of $486 million. The corporation entered into a customary transitional services agreement with the purchaser of this business to provide for the orderly separation of

 

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the business and the orderly transition of various functions and processes. The terms of the agreement apply to specific functions or actions including sales, marketing and supply chain functions as well as 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 six months. The net amount recorded under the transition services agreement, including the service fee charged by the corporation, is a receivable which has been recorded in Other current assets in the Condensed Consolidated Balance Sheet.

A majority of the air care business was sold in July 2010. Using foreign exchange rates on the date of the transaction, the corporation has received cash proceeds of $410 million to date, which represents a majority of the proceeds to be received, and reported an after tax gain on disposition of $92 million. When this business was sold, certain operations were retained, primarily in Spain, until production related to non-air care businesses ceases at the facility. Sara Lee will continue to manufacture air care products for the buyer for a period of approximately 8 months, at which point the production facility will be sold to the buyer and the final gain on the sale will be recognized. The corporation entered into a customary transition services agreement with the purchaser of this business to provide for the orderly separation of the business and the orderly transition of various functions and processes which were completed by the end of the second quarter.

 

     Third Quarter 2011      First Nine Months 2011  

(In millions)

   Pretax
Gain
(Loss)
on Sale
    Tax
(Expense)
Benefit
    After
Tax
Gain
     Pretax Gain
on Sale
     Tax
(Expense)
Benefit
    After Tax
Gain
 

Air Care Products

   $ —        $ —        $ —         $ 271       $ (179   $ 92   

Global Body Care and European Detergents

     (3     3        —           866         (380     486   

Australia/New Zealand bleach

     46        (17     29         46         (17     29   

Other Household and Body Care Businesses

     —          —          —           1         —          1   
                                                  

Total

   $ 43      $ (14   $ 29       $ 1,184       $ (576   $ 608   
                                                  

The tax expense recognized on the sale of household and body care businesses in the first nine months of 2011 includes a $234 million charge related to the anticipated repatriation of the cash proceeds received on the disposition of these businesses.

The following is a summary of the net assets held for sale as of April 2, 2011 and July 3, 2010, which primarily consists of the net assets of the North American fresh bakery and international household and body care businesses.

 

(In millions)

   April 2,
2011
    July 3,
2010
 

Trade accounts receivable

   $ 167      $ 188   

Inventories

     114        221   

Other current assets

     27        52   
                

Total current assets held for sale

     308        461   
                

Property

     486        542   

Trademarks and other intangibles

     306        438   

Goodwill

     447        784   

Other assets

     (28     17   
                

Assets held for sale

   $ 1,519      $ 2,242   
                

Accounts payable

   $ 115      $ 121   

Accrued expenses and other current liabilities

     187        295   

Current maturities of long-term debt

     16        20   
                

Total current liabilities held for sale

     318        436   

Long-term debt

     83        92   

Other liabilities

     250        316   
                

Liabilities held for sale

   $ 651      $ 844   
                

Noncontrolling interest

   $ 28      $ 28   
                

The corporation enters into franchise agreements with independent third party contractors (“Independent Operators”) representing distribution rights to sell and distribute fresh bakery products via direct-store-delivery

 

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to retail outlets in defined sales territories. The corporation does not hold equity interests in any of the Independent Operator entities. The corporation determined that all Independent Operators are variable interest entities (VIE) of which it is the primary beneficiary, primarily as a result of Sara Lee’s debt guarantee and other route maintenance obligations. The balance sheet amounts resulting from the consolidation of these VIE’s are included in the assets and liabilities held for sale in the table above. The noncontrolling interest associated with these VIE’s were $26 million at April 2, 2011 and $23 million at July 3, 2010.

Lease obligations associated with the VIE’s are secured by the vehicles subject to lease and do not represent additional claims on the corporation’s general assets. The corporation’s maximum exposure for loss associated with the Independent Operator entities is limited to $50 million of long-term debt of the Independent Operators as of April 2, 2011.

The discontinued operations cash flows are summarized in the table below:

 

(In millions) – Increase / (Decrease)

   Nine Months
ended

Apr. 2, 2011
    Nine Months
ended

Mar.  27, 2010
 

Cash flow from operating activities

   $ 167      $ 312   

Cash flow from (used in) investing activities

     2,145        (41

Cash flow used in financing activities

     (2,312     (242
                

Increase (decrease) in net cash of discontinued operations

     —          29   

Cash and cash equivalents at beginning of year

     —          8   
                

Cash and cash equivalents at end of period

   $ —        $ 37   
                

The net cash received from investing activities primarily represents the cash proceeds received on the sale of the global body care and European detergents and air care businesses. 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.

 

  5. Debt Issuances and Redemptions

On September 7, 2010, the corporation completed a tender offer for any and all of its 6 1/4 % Notes due September 15, 2011, of which $1.11 billion aggregate principal amount was outstanding. At the time of expiration of the tender offer, $653.3 million of the 6  1/4% notes had been validly tendered. On September 8, 2010, the corporation announced that it was redeeming the remaining $456.7 million of aggregate principal outstanding of the 6 1/4% Notes. This debt was redeemed on October 8, 2010. The corporation recognized a total charge of $55 million in 2011 associated with the early extinguishment of this debt. This charge is reported on the Debt extinguishment costs line of the Consolidated Income Statement.

In September 2010, the company issued $400 million 2.75% Notes due in September 2015 and $400 million 4.1% Notes due in September 2020, the proceeds of which were used to fund a portion of the redemption of the 6 1/4% Notes. The remaining portion of the redemption of the 6 1/4% Notes in the second quarter of 2011 was funded by cash on hand and the net proceeds from commercial paper issuances.

 

  6. Exit, Disposal and Project Accelerate Activities

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 company’s 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 plans to complete global implementation in 2012.

The company announced a transformation plan in 2005 that involved significant changes in the company’s organizational structure, portfolio changes involving the disposition of a significant portion of the corporation’s 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.

 

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In January 2011, the corporation announced that its board of directors has agreed in principle to divide the company into two separate, publicly traded companies which is expected to be completed in early calendar 2012. Under this plan, a portion of the company’s North American operations will be spun off, tax-free, into a new public company. As the company prepares for the spin off, it will incur certain spin off related costs. Spin off related costs include third party professional fees for consulting and other services that are directly related to the spin off. It also includes the costs of employees solely dedicated to activities directly related to the spin off.

The corporation also incurs exit, disposition and restructuring charges for initiatives to eliminate the stranded overhead associated with the disposition of the international household and body care businesses and other initiatives outside of the scope of the projects noted above.

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:

 

   

Employee termination costs

 

   

Lease exit costs

 

   

Gains or losses on the disposition of assets or asset groupings that do not qualify as discontinued operations

2) Transformation/Accelerate/Spin off Costs recognized in Cost of sales and Selling, general and administrative expenses primarily relate to:

 

   

Expenses associated with the installation of new information systems

 

   

Costs to retain and relocate employees

 

   

Consulting costs

 

   

Costs associated with the transition of services to an outside third party vendor as part of a business process outsourcing initiative

Transformation/Accelerate/Spin off 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/spin off 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:

 

     Quarter ended     Nine Months ended  

(In millions)

   Apr. 2,
2011
    Mar. 27,
2010
    Apr. 2,
2011
    Mar. 27,
2010
 

Selling, general and administrative expenses:

        

Accelerate charges

   $ 3      $ 11      $ 10      $ 21   

Spin off related costs

     10        —          10        —     

Net charges for (income from):

        

Exit activities

     5        14        48        32   

Asset and business dispositions

     —          11        —          20   
                                

Decrease in income from continuing operations before income taxes

     18        36        68        73   

Income tax benefit (at applicable statutory rates)

     (7     (11     (21     (23
                                

Decrease in income from continuing operations

   $ 11      $ 25      $ 47      $ 50   
                                

Impact on diluted EPS

   $ 0.02      $ 0.04      $ 0.07      $ 0.07   
                                

 

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

 

     Quarter ended      Nine Months ended  

(In millions)

   Apr. 2,
2011
     Mar. 27,
2010
     Apr. 2,
2011
     Mar. 27,
2010
 

North American Retail

   $ 1       $ —         $ 2       $ 3   

North American Foodservice

     2         8         2         10   

International Beverage

     1         4         36         4   

International Bakery

     —           10         —           26   
                                   

Decrease in operating segment income

     4         22         40         43   

Increase in general corporate expenses

     14         14         28         30   
                                   

Total

   $ 18       $ 36       $ 68       $ 73   
                                   

The following discussion provides information concerning the exit, disposal and transformation/Accelerate activities for each year where actions were initiated and material reserves exist.

2011 Actions

During 2011, the corporation approved certain actions related to exit, disposal, and Accelerate activities and recognized charges of $72 million related to these actions. Each of these activities is expected to be completed within a 12-month period after being approved and include the following:

 

   

Recognized a charge to implement a plan to terminate 411 employees, related to the European beverage and corporate office operations and provide them with severance benefits in accordance with benefit plans previously communicated to the affected employee group or with local employment laws. Of the 411 targeted employees, 388 employees have not yet been terminated, but are expected to be terminated within the next 12 months.

 

   

Recognized costs associated with the transition of services to an outside third party vendor as part of a business process outsourcing initiative.

 

   

Recognized third party and employee costs associated with the planned spin off of the company’s North American operations

The corporation also recognized $78 million of charges in discontinued operations primarily related to restructuring actions taken to eliminate stranded overhead associated with the household and body care businesses.

The following table summarizes the net charges taken for the exit, disposal, Project Accelerate and other restructuring activities approved during 2011 and the related status as of April 2, 2011. 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 $130 million of charges related to continuing operations are expected to be recognized in 2011.

 

(In millions)

   Employee
termination and
other benefits
    IT and other
costs
    Total  

Exit, disposal and other costs recognized during 2011

   $ 52      $ 20      $ 72   

Charges recognized in discontinued operations

     56        22        78   

Cash payments

     (18     (24     (42

Foreign exchange

     5        —          5   
                        

Accrued costs as of April 2, 2011

   $ 95      $ 18      $ 113   
                        

 

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2010 Actions

During 2010, the corporation approved certain actions related to exit, disposal, and Accelerate activities and recognized charges of $117 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:

 

   

Recognized a charge to implement a plan to terminate 1,130 employees, related to European beverage, European bakery and North American foodservice operations, and provide them with severance benefits in accordance with benefit plans previously communicated to the affected employee group or with local employment laws. Of the 1,130 targeted employees, 204 employees have not yet been terminated, but are expected to be terminated within the next 12 months.

 

   

Recognized costs associated with the transition of services to an outside third party vendor as part of a business process outsourcing initiative.

 

   

Recognized a $20 million net loss associated with the disposition of certain bakery manufacturing facilities in Spain.

The following table summarizes the significant actions completed during the first nine months of 2011 and the status of the remaining accruals related to the 2010 actions as of April 2, 2011. 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 2010 actions. The composition of these charges and the remaining accruals are summarized below.

 

(In millions)

   Employee
termination and
other benefits
    IT
and  other
costs
    Non-
cancellable
Leases
    Total  

Accrued costs as of July 3, 2010

   $ 40      $ 9      $ 13      $ 62   

Cash payments

     (19     (9     (6     (34

Change in estimate

     (6     —          3        (3

Foreign exchange impacts

     5        —          —          5   
                                

Accrued costs as of April 2, 2011

   $ 20      $ —        $ 10      $ 30   
                                

2009 Actions

During 2009, the corporation approved certain actions related to exit, disposal, transformation and Accelerate activities and recognized charges of $120 million related to these actions. Each of these activities was to be completed within a 12-month period after being approved and include the following:

 

   

Implemented a plan to terminate 984 employees, related to the European beverage and bakery operations and the corporate office group in North America, and provide them with severance benefits in accordance with benefit plans previously communicated to the affected employee group or with local employment laws. Of the 984 targeted employees, 7 employees have not yet been terminated, but are expected to be terminated within the next 12 months.

 

   

Recognized costs related to the implementation of common information systems across the organization in order to improve operational efficiencies. These costs primarily relate to the amortization of certain capitalized software costs.

 

   

Recognized costs associated with the transition of business support services to an outside third party vendor as part of a business process outsourcing initiative.

Significant actions completed during the first nine months of 2011 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 in the following table:

 

(In millions)

   Employee
termination and
other benefits
    IT
and  other
costs
     Total  

Accrued costs as of July 3, 2010

   $ 22      $ 3       $ 25   

Cash payments

     (8     —           (8

Change in estimate

     (3     —           (3

Foreign exchange impacts

     2        —           2   
                         

Accrued costs as of April 2, 2011

   $ 13      $ 3       $ 16   
                         

 

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In periods prior to 2009, 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 April 2, 2011, the accrued liabilities remaining in the Condensed Consolidated Balance Sheet related to these completed actions total $15 million and primarily represent certain severance obligations. These accrued amounts are expected to be satisfied in cash and will be funded from operations.

 

  7. Financial Instruments

Background Information

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 segment’s 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

 

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underlying hedged item impacts the income statement. In addition, both the fair value of changes excluded from the corporation’s 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 April 2, 2011 the maximum maturity date of any cash flow hedge was approximately two years principally related to a cross currency swap that matures in 2013. The corporation expects to reclassify into earnings during the next twelve months net gains from Accumulated Other Comprehensive Income of approximately $5 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 April 2, 2011 and July 3, 2010, the U.S. dollar equivalent of intercompany loans and forward exchange contracts designated as net investment hedges was $4.0 billion and $4.5 billion, respectively.

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. In the first nine months of 2011, the corporation settled $285 million of interest rate swaps, including a $50 million forward starting swap. Currently, the corporation has a fixed interest rate on approximately 60% 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 April 2, 2011 and July 3, 2010, the total notional amount of the corporation’s interest rate swaps was $576 million and $761 million, respectively and the total notional amount of cross currency swaps was $798 million and $704 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.

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.

 

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The principal currencies hedged by the corporation include the European euro, British pound, Danish krone, Hungarian forint, U.S. dollar, Swiss franc, Australian dollar and Brazilian real. The net U.S. dollar equivalent of commitments to purchase and sell foreign currencies is $2.886 billion and $2.876 billion, respectively as of April 2, 2011 and $4.211 billion and $4.066 billion, respectively as of July 3, 2010, using the exchange rates as of the reporting dates. 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 notional value of foreign exchange options contracts outstanding was $1 million as of April 2, 2011 and $9 million as of July 3, 2010 as determined by the ratio of the change in option value to the change in the underlying hedged item.

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 April 2, 2011 and July 3, 2010, the total notional amount of commodity futures contracts was $190 million and $143 million, respectively, and the total notional amount of option contracts was $36 million and $3 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 ratio of the change in option value to the change in the underlying hedged item.

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.

Contingent Features/Concentration of Credit Risk

All of the corporation’s 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 Moody’s and Standard & Poor’s credit rating agencies. If the corporation’s 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 April 2, 2011, is $278 million for which the corporation has posted no collateral. If the credit-risk-related contingent features underlying these agreements were triggered on April 2, 2011, the corporation would be required to post collateral of, at most, $278 million with its counterparties.

 

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A large number of major international financial institutions are counterparties to the corporation’s 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

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 management’s 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 April 2, 2011 were $2.4 billion and $2.4 billion, and at July 3, 2010 were $2.8 billion and $2.6 billion, respectively. The fair value of the corporation’s long-term debt, including the current portion, is estimated using discounted cash flows based on the corporation’s current incremental borrowing rates for similar types of borrowing arrangements.

 

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Information on the location and amounts of derivative fair values in the Condensed Consolidated Balance Sheet at April 2, 2011 and July 3, 2010 is as follows:

 

     Assets      Liabilities  
     Other Current
Assets
     Other Non-
Current Assets
     Accrued
Liabilities - Other
     Other  
(In millions)    Apr. 2,
2011
     July 3,
2010
     Apr. 2,
2011
     July 3,
2010
     Apr. 2,
2011
     July 3,
2010
     Apr. 2,
2011
     July 3,
2010
 

Derivatives designated as hedging instruments:

                       

Interest rate contracts (b)

   $ 2       $ 4       $ 12       $ 27       $ 2       $ —         $ —         $ —     

Foreign exchange contracts (b)

     —           143         —           —           189         2         59         153   

Commodity contracts (a)

     —           —           —           —           —           —           —           —     
                                                                       

Total derivatives designated as hedging instruments

     2         147         12         27         191         2         59         153   
                                                                       

Derivatives not designated as hedging instruments:

                       

Foreign exchange contracts (b)

     45         42         —           —           28         42         —           —     

Commodity contracts (a)

     2         —           —           —           —           —           —           —     
                                                                       

Total derivatives not designated as Hedging instruments

     47         42         —           —           28         42         —           —     
                                                                       

Total derivatives

   $ 49       $ 189       $ 12       $ 27       $ 219       $ 44       $ 59       $ 153   
                                                                       

 

(a) Categorized as level 1: Fair value of level 1 assets and liabilities as of April 2, 2011 are $2 and nil and at July 3, 2010 are nil and nil, respectively.
(b) Categorized as level 2: Fair value of level 2 assets and liabilities as of April 2, 2011 are $59 million and $278 million and at July 3, 2010 are $216 million and $197 million, respectively.

Information related to our cash flow hedges, net investment hedges, fair value hedges and other derivatives not designated as hedging instruments for the quarter and nine months ended April 2, 2011, and March 27, 2010, follows:

 

     Interest Rate
Contracts
    Foreign Exchange
Contracts
    Commodity
Contracts
    Total  
     Quarter ended     Quarter ended     Quarter ended     Quarter ended  
(In millions)    Apr. 2,
2011
    Mar. 27,
2010
    Apr. 2,
2011
    Mar. 27,
2010
    Apr. 2,
2011
    Mar. 27,
2010
    Apr. 2,
2011
    Mar. 27,
2010
 

Cash Flow Derivatives:

                

Amount of gain (loss) recognized in other comprehensive income (OCI) (a)

   $ 1      $ (1   $ (27   $ 39      $ 2      $ (3   $ (24   $ 35   

Amount of gain (loss) reclassified from AOCI into
earnings (a) (b)

     5        —          (37     45        7        —          (25     45   

Amount of ineffectiveness recognized in earnings (c) (d)

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

Net Investment Derivatives:

                

Amount of gain (loss) recognized in OCI (a)

     —          —          (374     232        —          —          (374     232   

Amount of gain (loss) recognized from OCI into earnings (f)

     —          —          (10     —          —          —          (10     —     

Fair Value Derivatives:

                

Amount of derivative gain (loss) recognized in earnings (e)

     (4     5        —          —          —          —          (4     5   

Amount of Hedged Item gain (loss) recognized in earnings (e)

     4        —          —          —          —          —          4        —     

Derivatives Not Designated as Hedging Instruments:

                

Amount of gain (loss) recognized in Cost of Sales

     —          —          (13     13        8        1        (5     14   

Amount of gain (loss) recognized in SG&A

     —          —          34        (39     5        —          39        (39

 

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Table of Contents
     Interest Rate
Contracts
     Foreign Exchange
Contracts
    Commodity
Contracts
    Total  
     Nine Months ended      Nine Months ended     Nine Months ended     Nine Months ended  
(In millions)    Apr. 2,
2011
     Mar. 27,
2010
     Apr. 2,
2011
    Mar. 27,
2010
    Apr. 2,
2011
     Mar. 27,
2010
    Apr. 2,
2011
    Mar. 27,
2010
 

Cash Flow Derivatives:

                   

Amount of gain (loss) recognized in other comprehensive income (OCI) (a)

   $ 2       $ —         $ (58   $ 33      $ 19       $ (1   $ (37   $ 32   

Amount of gain (loss) reclassified from AOCI into earnings (a) (b)

     3         —           (71     31        10         (3     (58     28   

Amount of ineffectiveness recognized in earnings (c) (d)

     —           —           (6     (8     —           —          (6     (8

Net Investment Derivatives:

                   

Amount of gain (loss) recognized in OCI (a)

     —           —           (601     145        —           —          (601     145   

Amount of gain (loss) recognized from OCI into earnings (f)

     —           —           41        —          —           —          41        —     

Fair Value Derivatives:

                   

Amount of derivative gain (loss) recognized in earnings (e)

     —           12         —          —          —           —          —          12   

Amount of Hedged Item gain (loss) recognized in earnings (e)

     7         1         —          —          —           —          7        1   

Derivatives Not Designated as Hedging Instruments:

                   

Amount of gain (loss) recognized in Cost of Sales

     —           —           (31     14        9         4        (22     18   

Amount of gain (loss) recognized in SG&A

     —           —           65        2        8         —          73        2   

 

(a) Effective portion. For net investment derivatives, the gain/loss flows through currency translation.
(b) Gain (loss) reclassified from AOCI into earnings is reported in interest, for interest rate swaps, in selling, general, and administrative (SG&A) expenses for foreign exchange contracts and in cost of sales for commodity contracts.
(c) Gain (loss) recognized in earnings is related to the ineffective portion and amounts excluded from the assessment of hedge effectiveness.
(d) Gain (loss) recognized in earnings is reported in interest expense for foreign exchange contracts and SG&A expenses for commodity contracts.
(e) The amount of gain (loss) recognized in earnings on the derivative contracts and the related hedged item is reported in interest expense.
(f) The gain (loss) recognized from OCI into earnings is reported in gain on sale of discontinued operations.

 

  8. Pension and Other Postretirement Benefit Plans

The components of the net periodic pension cost and the postretirement medical cost (benefit) for the third quarter and first nine months of 2011 and 2010 are as follows:

 

     Pension     Postretirement Medical  and
Life Insurance
 

(In millions)

   Third
Quarter
2011
    Third
Quarter
2010
    Third Quarter
2011
    Third Quarter
2010
 

Service cost

   $ 10      $ 13      $ —        $ —     

Interest cost

     59        59        1        1   

Expected return on plan assets

     (69     (60     —          —     

Amortization of:

        

Prior service cost (benefit)

     1        1        (4     (2

Net actuarial loss

     10        12        1        —     
                                

Net periodic benefit cost (benefit)

   $ 11      $ 25      $ (2   $ (1
                                
     Pension     Postretirement Medical  and
Life Insurance
 

(In millions)

   Nine
Months
2011
    Nine
Months
2010
    Nine Months
2011
    Nine Months
2010
 

Service cost

   $ 30      $ 36      $ 1      $ 1   

Interest cost

     174        181        4        4   

Expected return on plan assets

     (206     (179     —          —     

Amortization of:

        

Prior service cost (benefit)

     5        4        (11     (9

Net actuarial loss

     30        38        1        —     
                                

Net periodic benefit cost (benefit)

   $ 33      $ 80      $ (5   $ (4
                                

 

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The net periodic benefit cost of the corporation’s defined benefit pension plans in the first nine months of 2011 was $47 million lower than in 2010 as a result of the following:

 

   

An increase in the expected return on plan assets as a result of a larger amount of plan assets as of the beginning of this fiscal year as compared to the prior year due to improved asset returns during 2010 as well as a $200 million contribution into the U.S. pension plans in the fourth quarter of 2010.

 

   

A reduction in service cost and interest cost as a result of freezing the pension benefits under the U.S. salaried pension plans during the third quarter of 2010 as well as a reduction in interest rates.

 

   

The amortization of net actuarial losses decreased in 2011 despite an increase in the total amount of unamortized actuarial losses at the end of 2010 as compared to 2009. Amortization of actuarial losses declined as the total amount of unamortized actuarial losses associated with the U.S. plans was reduced due to the freezing of the U.S. salaried pension plans, which also extended the amortization period. This decline in amortization was partially offset by an increase in amortization associated with the non-U.S. plans.

In 2011, the corporation disposed of a majority of the international household and body care businesses but retained a significant portion of the pension and postretirement medical obligations related to those businesses. As the corporation will no longer incur service cost for the participants in those plans after the businesses were sold, this cost component is recognized in discontinued operations, while the remainder of net periodic benefit cost associated with these plans is being recognized in continuing operations.

As discussed in footnote 4, Discontinued Operations, the corporation signed an agreement for the sale of the corporation’s North American fresh bakery businesses in the second quarter of 2011 which has triggered a $5 million curtailment loss to be recognized in discontinued operations. In conjunction with the curtailment, the plan assets and liabilities of this U.S. defined benefit plan were remeasured as of the date of the agreement. Based on the results of the remeasurement, the net funded position of this plan increased by approximately $30 million, which was recognized as a decrease in noncurrent pension liabilities with an offsetting decrease in the unamortized actuarial loss in AOCI. This improvement in the net funded position primarily related to an improvement in asset returns.

Beginning in the second quarter of 2011, the corporation has classified the North American fresh bakery businesses as discontinued operations and per the sale agreement, the purchaser will assume the pension and postretirement medical obligations related to those businesses. As such, the total net periodic benefit cost associated with the participants in those plans has been included in discontinued operations as these costs will not be retained after these businesses are sold and the related pension and postretirement benefit plan net liabilities have been included in assets and/or liabilities held for sale.

During the first nine months of 2011 and 2010, the corporation contributed $115 million and $100 million, respectively, to its defined benefit pension plans. At the present time, the corporation expects to contribute approximately $120 million of cash to its defined benefit pension plans in 2011. Previously, the company estimated that its 2011 contributions would include approximately $80 million of additional contributions to the company’s Dutch pension plan, subject to reaching an agreement with the Dutch unions to restructure this plan. It is now expected that this contribution will be made in the first half of 2012. 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 2011 may differ from the current estimate.

The corporation recognized a $7 million charge in the prior year to establish the estimated partial withdrawal liability for certain multi-employer pension plans. The charge was recognized in discontinued operations in the Consolidated Statements of Income as it was related to the North American fresh bakery operations.

 

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  9. Receipt of Contingent Sale Proceeds

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 final payment associated with this contingency of $133 million, which increased diluted earnings per share for the full year by $0.19 per share, was received in the first quarter of 2010 and recorded as income on the Contingent sale proceeds line in the Consolidated Statements of Income.

 

  10. Income Taxes

The following table sets out the tax expense and the effective tax rate for the corporation from continuing operations:

 

     Third Quarter     Nine Months  

(In millions)

   2011     2010     2011     2010  

Continuing operations

        

Income before income taxes

   $ 197      $ 197      $ 469      $ 722   

Income tax expense (benefit)

     60        174        155        217   

Effective tax rate

     30.5     88.1     33.0     30.0

Third Quarter and First Nine Months of 2011

In the third quarter of 2011, the corporation recognized tax expense of $60 million on pretax income from continuing operations of $197 million, or an effective tax rate of 30.5%. The tax expense and related effective tax rate on continuing operations were impacted by recognizing various discrete tax items, none of which were material individually or in the aggregate.

In the first nine months of 2011, the corporation recognized tax expense of $155 million on pretax income from continuing operations of $469 million, or an effective tax rate of 33.0%. The tax expense and related effective tax rate on continuing operations was determined by applying a 35.0% estimated annual effective tax rate to pretax earnings and then recognizing various discrete tax items, none of which were material individually or in the aggregate. The expected repatriation of a portion of 2011 earnings increases the 2011 estimated annual effective tax rate by 3%.

Third Quarter and First Nine Months of 2010

In the third quarter of 2010, the corporation recognized tax expense of $174 million on pretax income from continuing operations of $197 million, or an effective tax rate of 88.1%. 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:

 

   

$43 million of tax expense related to a Belgian litigation proceeding that is expected to result in additional income tax expense. (See Note 11 – Contingencies and Commitments)

 

   

$19 million of tax benefit related to adjustment of taxes previously provided on 2009 earnings of the corporation, of which $18 million is an adjustment of a tax provision estimate related to a tax credit.

 

   

$9 million of tax benefit related to the settlement of tax audits and expiration of statutes of limitations in France, the Netherlands, Spain, and the United States, of which $1 million of tax benefit is from the settlement of tax audits, and $8 million of tax benefit is from the expiration of statutes of limitations.

 

   

$7 million of tax expense related to deferred tax adjustments, of which $3 million related to a change in the law on the deductibility of benefits reimbursed under the Medicare Part D retiree prescription drug program.

In the first nine months of 2010, the corporation recognized tax expense of $217 million on pretax income from continuing operations of $722 million, or an effective tax rate of 30.0%. The tax expense and related effective tax rate on continuing operations was determined by applying a 39.3% 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:

 

   

$103 million of tax benefit primarily from the settlement of tax audits and expiration of the statutes of limitations in the United Kingdom, Hungary, Spain, the United States, South Africa, France, the Netherlands, and various state and local jurisdictions, of which $95 million is primarily from the settlement of audits with the tax authorities, and $8 million is from the expiration of statutes of limitations.

 

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$43 million of tax expense related to a Belgian litigation proceeding that is expected to result in additional income tax expense. (See Note 11 – Contingencies and Commitments)

 

   

$25 million of tax expense to establish a valuation allowance on net operating losses and other deferred tax assets in Belgium.

 

   

$20 million of tax benefit from the release of a valuation allowance on the deferred tax assets of the corporation’s Brazilian subsidiaries.

 

   

$19 million of tax benefit primarily related to adjustment of taxes previously provided on 2009 earnings of the corporation, of which $18 million is an adjustment of a tax provision estimate related to a tax credit.

 

   

$7 million of tax expense related to deferred tax adjustments, of which $3 million related to a change in the law on the deductibility of benefits reimbursed under the Medicare Part D retiree prescription drug program,.

The corporation’s 2010 estimated annual effective tax rate increased from 25.7% to 39.3% primarily due to a one-time tax charge of $118 million related to foreign earnings in that year that were no longer considered to be indefinitely reinvested. This tax charge was in connection with the company’s 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 was $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.

Annual Effective Tax Rate

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 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.

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 increase in the liability for unrecognized tax benefits was $92 million, resulting in an ending balance of $459 million as of April 2, 2011. There was an increase in the gross liability for uncertain tax positions of $153 million, of which $107 million relates to 2011 increases, $8 million relates to prior year increases, and $38 million relates to unfavorable foreign currency exchange translation. This increase was offset by a decrease in the gross liability for uncertain tax positions of $61 million, of which $56 million relates to the expiration of statutes of limitation and $5 million relates to audit settlements.

 

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At this time, the corporation estimates that it is reasonably possible that the liability for unrecognized tax benefits will decrease by up to $25 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 corporation’s 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 company’s U.S. income tax returns through 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 prior to 2005.

 

  11. Contingencies and Commitments

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, an arbitrator ruled against the corporation and awarded the plaintiffs approximately $80 million in damages and fees. This ruling was appealed by the corporation and subsequently set aside by the NLRC in December 2006. Both the complainants and the corporation have filed motions for reconsideration. 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 corporation’s results of operations or cash flows. For further information, see Note 14 to the financial statements, “Contingencies and Commitments,” in the company’s 2010 Annual Report.

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 HBI’s claims are without merit and is vigorously contesting the matter. It is anticipated that the final decision by the arbitrator will occur in calendar 2011.

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. 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 corporation’s proportionate share of the unfunded vested benefits based on the year in which the 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 corporation’s 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 corporation’s future withdrawal liability, if any, or whether the corporation’s 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.

 

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The corporation’s regular scheduled contributions to MEPPs related to its continuing operations totaled approximately $7 million in 2010, 2009 and 2008, respectively.

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 Lee’s 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. Sara Lee has been imposed fines in three instances (a €4.0 million fine imposed by the Italian Cartel Authority in the second quarter of 2011; a €3.7 million fine imposed by the Spanish Competition Authorities in the second quarter of 2010; and a €5.5 million fine imposed by the German cartel authorities in February 2008), but no formal charges have been brought against Sara Lee concerning the substantive conduct that is the subject of these other 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 have been reflected in the Consolidated Statements of Income in the periods we were notified of the fines or it was probable that a loss was incurred. The total amount currently accrued for competition matters is €28 million, which represents an accrual for fines that have already been assessed and an estimate of additional fines that are probable of being imposed. Based on currently available information, it is reasonably possible the corporation may be subject to additional fines related to several of these investigations. Except for fines previously assessed or accrued by the corporation, 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 (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 corporation’s 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 has agreed to a settlement with the Belgian authorities, which is subject to final approval by the Belgian Judiciary, and has deposited €32 million into an escrow account for Belgian taxes, interest and penalties.

Nestec/Nespresso – In June 2010, Nestec/Nespresso (Nestle) filed a suit against Sara Lee Coffee and Tea France (SLCTF), a subsidiary of the corporation, alleging patent infringement related to Sara Lee’s sale and distribution of espresso capsules. In addition, on January 19, 2011, Nestle filed a similar suit against Sara Lee Coffee and Tea in the Netherlands (SLCT) after SLCT began selling espresso capsules in that country. In the lawsuit filed in France, Nestle claims that damages could be as high as €50 million. The corporation believes Nestle’s claims are without merit and is vigorously contesting the matter.

 

  12. Subsequent events

On May 5, 2011, the corporation announced that it had entered into an agreement to acquire Aidells, a premium meat business in the U.S., for $87 million. The acquisition is subject to customary closing conditions and regulatory approvals. In addition, the corporation announced that it is evaluating strategic options for its international bakery and North American refrigerated dough businesses.

 

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Item 2

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

Introduction

The following is management’s discussion and analysis of the results of operations for the third quarter and first nine months of 2011 compared with the third quarter and first nine months of 2010 and a discussion of the changes in financial condition and liquidity during the first nine months of 2011. Below is an outline of the analyses included herein:

 

   

Business Overview

 

   

Summary of Results

 

   

Consolidated Results – Third Quarter and First Nine Months of 2011

 

   

Operating Results by Business Segment

 

   

Financial Condition

 

   

Liquidity

 

   

Significant Accounting Policies and Critical Estimates

 

   

Issued but not yet Effective Accounting Standards

 

   

Forward-Looking Information

Business Overview

Our Business

Sara Lee is a global manufacturer and marketer of high-quality, brand name products for consumers throughout the world focused primarily in the meat 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 frozen baked products. 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 the retail and foodservice channels as well as a variety of bakery and dough products to retail and foodservice customers in Europe and Australia.

The results of the North American fresh bakery businesses and the international household and body care businesses, which were previously reported as separate business segments, are being reported as discontinued operations. See Note 4 – “Discontinued Operations” for additional information. Unless stated otherwise, any reference to income statement items in these financial statements refers to results from continuing operations.

In January 2011, the corporation announced that its board of directors has agreed in principle to divide the company into two separate, publicly traded companies which is expected to be completed in early calendar 2012. Under this plan, Sara Lee’s North American Retail and North American Foodservice businesses (excluding the North American Beverage business) will be spun off, tax-free, into a new public company that will retain the “Sara Lee” name. The other company will consist of Sara Lee’s current International Beverage and International Bakery businesses, as well as the North American beverage business. The separation plan is subject to final approval by the board of directors, other customary approvals and the receipt of an IRS tax ruling.

On May 5, 2011, the corporation announced that it had entered into an agreement to acquire Aidells, a premium meat business in the U.S., for $87 million. The acquisition is subject to customary closing conditions and regulatory approvals. In addition, the corporation announced that it is evaluating strategic options for its international bakery and North American refrigerated dough businesses.

 

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Summary of Results

The business highlights include the following:

 

   

Net sales for the third quarter of $2.2 billion were $143 million higher than the prior year due to pricing actions, an improved sales mix, higher green coffee export sales and the favorable impact of changes in foreign currency exchange rates partially offset by the negative impact of volume declines.

 

   

Reported operating income for the third quarter of 2011 was $213 million, a decrease of $12 million over the same period of the prior year. The decrease was due to a decline in business segment results for North American Retail and International Beverage, which was caused by a significant increase in commodity costs, including $28 million of foreign currency hedging losses related to raw material purchases. These declines were partially offset by a $19 million decrease in general corporate expenses due to a reduction in information systems implementation costs and lower employee benefit costs; and a $13 million year-over-year improvement in the mark-to-market gains/losses related to unrealized commodity derivatives.

 

   

Diluted earnings per share from continuing operations for the quarter increased from $0.03 to $0.22 due to the favorable impact of a $114 million decrease in tax expense as the income from continuing operations before income taxes of $197 million is unchanged from the prior year.

 

   

Total cash flow from operating activities of $292 million for the first nine months of 2011 showed a decline of $515 million over the prior year driven by an increase in cash used to fund certain working capital components, primarily inventories and other current assets, a decline in cash generated by discontinued operations and lower operating income from continuing operations. The cash used to fund inventories increased due in part to higher commodity costs. The cash flow from operating activities for discontinued operations declined $145 million, due in large part to the impact of business dispositions, while adjusted operating income from continuing operations declined $82 million.

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 previous 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 company’s objective is to offset commodity price increases with pricing actions and to offset any operating cost increases with continuous improvement savings. Commodity costs, excluding mark-to-market derivative gains/losses, increased by approximately $400 million in the first nine months of 2011. This increase in commodity costs was partially offset by approximately $250 million in pricing actions, resulting in a net unfavorable impact from commodities net of pricing of $150 million in the first nine months of 2011.

 

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The company’s business results are also heavily influenced by changes in foreign currency exchange rates. For the most recently completed fiscal year, approximately half of the company’s net sales and 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 decreased net sales by $98 million and decreased operating income by $17 million in the first nine months of 2011.

The company’s international operations also provide a significant portion of the company’s 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.

Non-GAAP Measures

Management measures and reports Sara Lee’s financial results in accordance with U.S. generally accepted accounting principles (“GAAP”). In this report, Sara Lee highlights certain items that have significantly impacted the corporation’s financial results and uses several non-GAAP financial measures to help investors understand the financial impact of these significant items. The non-GAAP financial measures used by Sara Lee in this report are adjusted net sales, adjusted operating segment income, and adjusted operating income, which exclude from a financial measure computed in accordance with GAAP the impact of significant items, the receipt of contingent sale proceeds, the impact of acquisitions and dispositions and changes in foreign currency exchange rates. Management believes that these non-GAAP financial measures reflect an additional way of viewing aspects of Sara Lee’s business that, when viewed together with Sara Lee’s financial results computed in accordance with GAAP, provide a more complete understanding of factors and trends affecting Sara Lee’s historical financial performance and projected future operating results, greater transparency of underlying profit trends and greater comparability of results across periods. These non-GAAP financial measures are not intended to be a substitute for the comparable GAAP measures and should be read only in conjunction with our consolidated financial statements prepared in accordance with GAAP.

In addition, investors frequently have requested information from management regarding significant items and the impact of the contingent sale proceeds. Management believes, based on feedback it has received during earnings calls and discussions with investors, that these non-GAAP measures enhance investors’ ability to assess Sara Lee’s historical and project future financial performance. Management also uses certain of these non-GAAP financial measures, in conjunction with the GAAP financial measures, to understand, manage and evaluate our businesses, in planning for and forecasting financial results for future periods, and as one factor in determining achievement of incentive compensation. Two of the three performance measures under Sara Lee’s annual incentive plan are net sales and operating income, which are the reported amounts as adjusted for significant items and possibly other items. Operating income, as adjusted for significant items, also may be used as a component of Sara Lee’s long-term incentive plans. Many of the significant items will recur in future periods; however, the amount and frequency of each significant item varies from period to period. See Non-GAAP Measures Definitions at the back of this report for additional information regarding these financial measures.

Significant Items Affecting Comparability

The reported results for 2011 and 2010 reflect amounts recognized for actions associated with the corporation’s ongoing 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 Project 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 corporation’s 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.

 

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The corporation is currently in the process of divesting the household and body care businesses but there is a significant amount of related overhead that is expected to remain after these businesses have been sold. The corporation has taken action to eliminate the majority of these costs but it is anticipated that approximately $25 million to $30 million will remain in our cost structure in 2011. The corporation estimates that the actions to eliminate this stranded overhead will result in charges of approximately $125 to $130 million in 2011, of which approximately $60-65 million will be recognized in continuing operations. The corporation also estimates that an additional $30 million of charges will be incurred in 2012.

Project 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 incremental savings resulting from Project Accelerate and other restructuring actions were approximately $60 million in the first nine months of 2011. The corporation anticipates annualized savings in 2011 of approximately $225-$235 million related to these actions, of which $80-$90 million is incremental to the $145 million of cumulative Project Accelerate savings in 2010. The company expects Project Accelerate costs in fiscal 2011 to be approximately $30 to $35 million.

Spin off related costs – As noted previously, the corporation announced that its board of directors has agreed in principle to divide the company into two separate, publicly traded companies. Spin off related costs include third party professional fees for consulting and other services that are directly related to the spin off. It also includes the costs of employees solely dedicated to activities directly related to the spin off.

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, debt extinguishment costs, 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.

 

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Impact of Significant Items on Net Income and Diluted Earnings per Share Attributable to Sara Lee

 

     Quarter ended Apr. 2, 2011     Quarter ended Mar. 27, 2010  

In millions, except per share data

   Pretax
Impact
    Net
Income
Attributable  to
Sara Lee (2)
    Diluted EPS
Impact (1)
    Pretax
Impact
    Net
Income
Attributable  to
Sara Lee (2)
    Diluted EPS
Impact (1)
 

Continuing operations:

            

Business outsourcing costs

   $ (6   $ (4   $ (0.01   $ (11   $ (7   $ (0.01

Severance charges

     (2     (2     —          (10     (7     (0.01

Lease exit costs

     —          —          —          (4     (2     —     

Business disposition costs

     2        1        —          (11     (8     (0.01
                                                

Total Project Accelerate charges

     (6     (5     (0.01     (36     (24     (0.04

Other:

            

International stranded overhead – severance

     (2     —          —          —          —          —     

Curtailment gain

     —          —          —          21        14        0.02   

Mexican tax indemnification

     —          —          —          (15     (10     (0.01

Spin off related costs

     (10     (6     (0.01     —          —          —     
                                                

Impact of significant items on income from continuing operations before significant tax matters

     (18     (11     (0.02     (30     (20     (0.03

Significant tax matters affecting comparability:

            

Tax on unremitted earnings

     —          —          —          —          (102     (0.15

Belgian tax proceeding

     —          —          —          —          (43     (0.06

U.K. net operating loss utilization

     —          —          —          —          4