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Hillshire Brands Co 10-Q 2014

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
HSH-10Q-12.28.2013

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 FORM 10-Q
 
   
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 28, 2013
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 1-3344
 
 
 
The Hillshire Brands Company
(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.)
 
 
400 South Jefferson Street, Chicago, Illinois
 
60607
(Address of principal executive offices)
 
(Zip Code)
(312) 614-6000
(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 December 28, 2013, the Registrant had 122,424,923 outstanding shares of common stock, par value $.01 per share.


1


The Hillshire Brands Company
INDEX
 
PART I -
 
ITEM 1 –
FINANCIAL STATEMENTS (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
ITEM 2 –
 
 
 
ITEM 4 –
 
 
 
PART II –
 
 
 
 
 
ITEM 1A –
 
 
 
ITEM 2 –
 
 
 
ITEM 6 –
 
 



2




THE HILLSHIRE BRANDS COMPANY
Condensed Consolidated Balance Sheets at December 28, 2013 and June 29, 2013
(Unaudited)
 
In millions
December 28, 2013
 
June 29, 2013
Assets
 
 
 
Cash and equivalents
$
205

 
$
400

Short term investments
192

 

Trade accounts receivable, less allowances
221

 
219

Inventories
 
 
 
Finished goods
185

 
207

Work in process
14

 
15

Materials and supplies
77

 
91

 
276

 
313

Current deferred income taxes
98

 
71

Income tax receivable

 
18

Other current assets
80

 
85

Total current assets
1,072

 
1,106

Property, net of accumulated depreciation of $1,238 and $1,185, respectively
811

 
818

Trademarks and other identifiable intangibles, net
136

 
121

Goodwill
371

 
348

Deferred income taxes
62

 
20

Other noncurrent assets
22

 
21

 
$
2,474

 
$
2,434

Liabilities and Equity
 
 
 
Accounts payable
$
266

 
$
295

Accrued liabilities
324

 
357

Current maturities of long-term debt
108

 
19

Total current liabilities
698

 
671

Long-term debt
840

 
932

Pension obligation
112

 
119

Other liabilities
256

 
228

Contingencies and commitments (Note 10)

 

Equity
 
 
 
Hillshire Brands common stockholders’ equity
568

 
484

 
$
2,474

 
$
2,434

See accompanying Notes to Condensed Consolidated Financial Statements.



3





THE HILLSHIRE BRANDS COMPANY
Consolidated Statements of Income
For the Quarter and Six Months ended December 28, 2013 and December 29, 2012
(Unaudited)
 
 
Quarter Ended
 
Six Months ended
In millions, except per share data
December 28, 2013
 
December 29, 2012
 
December 28, 2013
 
December 29, 2012
Continuing Operations
 
 
 
 
 
 
 
Net sales
$
1,082

 
$
1,060

 
$
2,066

 
$
2,034

Cost of sales
757

 
728

 
1,476

 
1,408

Selling, general and administrative expenses
202

 
224

 
409

 
437

Net charges for exit activities, asset and business dispositions
7

 
9

 
10

 
6

Operating income
116

 
99

 
171

 
183

Interest expense
12

 
11

 
25

 
22

Interest income
(3
)
 
(1
)
 
(5
)
 
(3
)
Income from continuing operations before income taxes
107

 
89

 
151

 
164

Income tax expense (benefit)
(7
)
 
31

 
8

 
57

Income from continuing operations
114

 
58

 
143

 
107

Discontinued operations
 
 
 
 
 
 
 
Income from discontinued operations, net of tax expense (benefit) of $1, $(3), $1 and $(2)
1

 
7

 
1

 
9

Gain on sale of discontinued operations, net of tax expense of nil, nil, nil and $1

 

 

 
2

Net income from discontinued operations
1

 
7

 
1

 
11

Net income
115

 
65

 
144

 
118

Net income from continuing operations
114

 
58

 
143

 
107

Net income from discontinued operations
1

 
7

 
1

 
11

Net income
$
115

 
$
65

 
$
144

 
$
118

Earnings per share of common stock
 
 
 
 
 
 
 
Basic
 
 
 
 
 
 
 
Income from continuing operations
$0.92
 
$0.47
 
$
1.16

 
$
0.88

Net income
$0.93
 
$0.53
 
$
1.17

 
$
0.97

Average shares outstanding
123

 
123

 
123

 
122

Diluted
 
 
 
 
 
 
 
Income from continuing operations
$0.91
 
$0.47
 
$
1.15

 
$
0.87

Net income
$0.92
 
$0.53
 
$
1.16

 
$
0.96

Average shares outstanding
124

 
123

 
124

 
123

Cash dividends declared per share of common stock
$0.175
 
$
0.125

 
$
0.350

 
$
0.250

See accompanying Notes to Condensed Consolidated Financial Statements.

4


THE HILLSHIRE BRANDS COMPANY
Consolidated Statements of Comprehensive Income
For the Quarter and Six Months ended December 28, 2013 and December 29, 2012
(Unaudited)
 
 
Quarter Ended
 
Six Months ended
In millions
December 28, 2013
 
December 29, 2012
 
December 28, 2013
 
December 29, 2012
Net income
$
115

 
$
65

 
$
144

 
$
118

Translation adjustments, net of tax
(1
)
 

 
(1
)
 
1

Net unrealized gain on qualifying cash flow hedges, net of tax
(1
)
 
(11
)
 
(1
)
 
(4
)
Pension/Postretirement activity, net of tax
1

 

 

 

Comprehensive income
$
114

 
$
54

 
$
142

 
$
115

See accompanying Notes to Condensed Consolidated Financial Statements.



5


THE HILLSHIRE BRANDS COMPANY
Consolidated Statements of Equity
For the period June 30, 2012 to December 28, 2013

(Unaudited)
 
 
 
 
Hillshire Brands Common Stockholders’ Equity
In millions
Total
 
Common
Stock
 
Capital
Surplus
 
Retained
Earnings
 
Unearned
Stock
 
Accumulated
Other
Comprehensive
Income (Loss)
Balances at June 30, 2012
$
235

 
$
1

 
$
144

 
$
295

 
$
(61
)
 
$
(144
)
Net income
252

 

 

 
252

 

 

Translation adjustments, net of tax
(21
)
 

 

 

 

 
(21
)
Net unrealized loss on qualifying cash flow hedges, net of tax
(8
)
 

 

 

 

 
(8
)
Pension/Postretirement activity, net of tax
26

 

 

 

 

 
26

Dividends on common stock
(61
)
 

 

 
(61
)
 

 

Spin-off of international coffee and tea business
(3
)
 

 

 
(9
)
 

 
6

Stock issuances -
 
 
 
 
 
 
 
 
 
 
 
Restricted stock
3

 

 
3

 

 

 

Stock option and benefit plans
52

 

 
52

 

 

 

ESOP activity and other
9

 

 
1

 

 
8

 

Balances at June 29, 2013
484

 
1

 
200

 
477

 
(53
)
 
(141
)
Net income
144

 

 

 
144

 

 

Translation adjustments, net of tax
(1
)
 

 

 

 

 
(1
)
Net unrealized gain (loss) on qualifying cash flow hedges, net of tax
(1
)
 

 

 

 

 
(1
)
Pension/Postretirement activity, net of tax

 

 

 

 

 

Dividends on common stock
(44
)
 

 

 
(44
)
 

 

Spin-off of international coffee and tea business
5

 

 

 
5

 

 

Stock issuances -
 
 
 
 
 
 
 
 
 
 
 
Restricted stock
4

 

 
4

 

 

 

Stock option and benefit plans
5

 

 
5

 

 

 

Share repurchases and retirements
(30
)
 

 
(30
)
 

 

 

ESOP activity and other
2

 

 

 

 
2

 

Balance at December 28, 2013
$
568

 
$
1

 
$
179

 
$
582

 
$
(51
)
 
$
(143
)
See accompanying Notes to Condensed Consolidated Financial Statements.



6


THE HILLSHIRE BRANDS COMPANY
Consolidated Statements of Cash Flows
For the Six Months ended December 28, 2013 and December 29, 2012
(Unaudited)
 
 
Six Months Ended
In millions
December 28, 2013
 
December 29, 2012
OPERATING ACTIVITIES -
 
 
 
Net income
$
144

 
$
118

Adjustments to reconcile net income to net cash from operating activities:
 
 
 
Depreciation
67

 
78

Amortization
11

 
8

Net gain on business dispositions

 
(9
)
Increase (decrease) in deferred income taxes
(74
)
 
18

Other
16

 
(6
)
Changes in current assets and liabilities, net of businesses acquired and sold:
 
 
 
Trade accounts receivable
(2
)
 
6

Inventories
38

 
(18
)
Other current assets
5

 
16

Accounts payable
(36
)
 
(57
)
Accrued liabilities
(33
)
 
(57
)
Accrued taxes
38

 
32

Net cash from operating activities
174

 
129

INVESTING ACTIVITIES -
 
 
 
Purchases of property and equipment
(59
)
 
(79
)
Purchases of software and other intangibles
(6
)
 
(3
)
Acquisition of businesses
(35
)
 

Dispositions of businesses and investments

 
16

Cash from (used in) derivative transactions
(1
)
 
3

Cash used to invest in short-term investments
(269
)
 

Cash received from maturing short-term investments
76

 

Sales of assets

 
1

Net cash used in investing activities
(294
)
 
(62
)
FINANCING ACTIVITIES -
 
 
 
Issuances of common stock
2

 
39

Purchase of common stock
(30
)
 

Repayments of other debt and derivatives
(10
)
 
(5
)
Payments of dividends
(37
)
 
(31
)
Net cash from (used in) financing activities
(75
)
 
3

(Decrease) / Increase in cash and equivalents
(195
)
 
70

Less: Cash balances of discontinued operations at end of period

 
(6
)
Cash and equivalents at beginning of year
400

 
235

Cash and equivalents at end of period
$
205

 
$
299

Supplemental Cash Flow Data:
 
 
 
Cash paid for restructuring actions
$
43

 
$
48

Cash contributions to pension plans
3

 
3

Cash paid for income taxes
44

 
6

See accompanying Notes to Condensed Consolidated Financial Statements.

7


THE HILLSHIRE BRANDS COMPANY
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation

The Hillshire Brands Company is a U.S.-based company that primarily focuses on meat and meat-centric food products. The company's principal product lines are branded packaged meat products and frozen bakery products. Sales are made in both the retail channel, to supermarkets, warehouse clubs and national chains, and the foodservice channel. References to “we”, “our”, “us”, “Hillshire Brands” and “the company” refer to The Hillshire Brands Company and its consolidated subsidiaries as a whole, unless the context otherwise requires. The company’s reportable segments are Retail and Foodservice/Other.
The consolidated financial statements for the second quarter ended December 28, 2013 and December 29, 2012 have not been audited by an independent registered public accounting firm, but in the opinion of management, these financial statements include all normal and recurring adjustments necessary for a fair presentation of our financial statements in accordance with U.S. generally accepted accounting principles (GAAP). The results of operations for the second quarter ended December 28, 2013 are not necessarily indicative of the operating results to be expected for the full fiscal year.
The interim consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Although management 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 GAAP have been condensed or omitted pursuant to such rules and regulations. The preparation of the consolidated financial statements in conformity with GAAP requires management to make use of estimates and assumptions that affect the reported amounts and related disclosures. Actual results could differ from these estimates. These unaudited interim consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes thereto included in the company’s Annual Report on Form 10-K for the year ended June 29, 2013 and other financial information filed with the SEC.
The company’s fiscal year ends on the Saturday closest to June 30. Fiscal 2014 ends on June 28, 2014. The second quarter of fiscal 2014 ended on December 28, 2013, and the second quarter of fiscal 2013 ended on December 29, 2012. Each of the quarters was a thirteen-week period. Fiscal 2014 and fiscal 2013 are both 52-week years. Unless otherwise stated, references to years relate to fiscal years.
The condensed consolidated balance sheet as of June 29, 2013 has been derived from the company’s audited financial statements included in our Annual Report on Form 10-K for the year ended June 29, 2013. The Australian bakery business, North American Fresh Bakery and North American Foodservice Beverage are presented as discontinued operations in the company’s consolidated income statements. See Note 5 – “Discontinued Operations” for additional information regarding this discontinued operation. Unless stated otherwise, any reference to income statement items in these financial statements refers to results from continuing operations.
2. Net Income Per Share

Net income per share - basic is computed by dividing income by the weighted average number of common shares outstanding for the period. Net income per share - diluted reflects the potential dilution that could occur if options and fixed awards to be issued under stock-based compensation arrangements were converted into common stock. For the quarter and six months ended December 28, 2013, options to purchase 0.2 million shares of the company’s common stock had exercise prices that were greater than the average market price of those shares during the respective reporting periods. For the quarter and six months ended December 29, 2012, options to purchase 3.2 million of the company’s common stock had exercise prices that were greater than the average market price of those shares during the respective reporting periods.

The average shares outstanding increased in the first six months of 2014 as compared to the first six months of 2013 as a result of stock issuances related to the exercise of stock options and the vesting of restricted stock units (RSUs). During the first six months of 2014, the company repurchased 0.9 million shares at a cost of $30 million under an existing share repurchase program which authorized the company to repurchase $1.2 billion of common stock.

As of December 28, 2013, the remaining amount authorized for repurchase is approximately $1.2 billion of common stock under one of its existing share repurchase programs, plus 2.7 million shares of common stock that remain authorized for repurchase under the company's other share repurchase program.

8


The following is a reconciliation of net income to net income per share – basic and diluted – for the second quarter and first six months of 2014 and 2013 (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
 
Six Months ended
 
December 28, 2013
 
December 29, 2012
 
December 28, 2013
 
December 29, 2012
 
 
 
 
 
 
 
 
Income from continuing operations
$
114

 
$
58

 
$
143

 
$
107

Income from discontinued operations, net of tax
1

 
7

 
1

 
11

Net income
$
115

 
$
65

 
$
144

 
$
118

Average shares outstanding – Basic
123

 
123

 
123

 
122

Dilutive effect of stock option and award plans
1

 

 
1

 
1

Diluted shares outstanding
124

 
123

 
124

 
123

Earnings per common share—Basic
 
 
 
 
 
 
 
Income from continuing operations
$
0.92

 
$
0.47

 
$
1.16

 
$
0.88

Income from discontinued operations
0.01

 
0.06

 
0.01

 
0.09

Net income
$
0.93

 
$
0.53

 
$
1.17

 
$
0.97

Earnings per common share – Diluted
 
 
 
 
 
 
 
Income from continuing operations
$
0.91

 
$
0.47

 
$
1.15

 
$
0.87

Income from discontinued operations
0.01

 
0.06

 
0.01

 
0.09

Net income
$
0.92

 
$
0.53

 
$
1.16

 
$
0.96




9


3. Accumulated Other Comprehensive Income

The changes in accumulated other comprehensive income (AOCI) by component for the six months ended December 28, 2013 and December 29, 2012 are as follows:
 
Net Unrealized Gain (loss) on Qualifying Cash Flow Hedges
 
Pension/ Post-retirement Activity
 
Translation Adjustments
 
Total
Beginning Balance as of June 29, 2013
$

 
$
(142
)
 
$
1

 
$
(141
)
 
Other comprehensive loss before reclassifications
(2
)
 

 
(1
)
 
(3
)
 
Amounts reclassified from accumulated other comprehensive income:
 
 
 
 
 
 
 
 
   Prior-service benefit

 
(4
)
 (b)

 
(4
)
 
   Net actuarial loss

 
2

 (b)

 
2

 
   Loss realized from derivatives
1

 (a)

 

 
1

 
Tax expense

 
2

(c)

 
2

Net current-period other comprehensive loss
(1
)
 

 
(1
)
 
(2
)
Ending Balance as of December 28, 2013
$
(1
)
 
$
(142
)
 
$

 
$
(143
)
 
 
 
 
 
 
 
 
 
Beginning Balance as of June 30, 2012
$
8

 
$
(168
)
 
$
16

 
$
(144
)
 
Other comprehensive income before reclassifications
8

 

 
1

 
9

 
Amounts reclassified from accumulated other comprehensive income:
 
 
 
 
 
 
 
 
   Prior-service benefit

 
(4
)
 (b)

 
(4
)
 
   Net actuarial loss

 
2

 (b)

 
2

 
   Gain realized from derivatives
(11
)
 (a)

 

 
(11
)
 
Tax expense (benefit)
(1
)
(c)
2

 (c)

 
1

Net current-period other comprehensive income (loss)
(4
)
 

 
1

 
(3
)
Ending Balance as of December 29, 2012
$
4

 
$
(168
)
 
$
17

 
$
(147
)

(a) Included as Cost of sales in the Consolidated Statements of Income
(b) These accumulated other comprehensive income components are included in the computation of net periodic pension cost (see Note 8 - "Pension and Other Postretirement Benefit Plans" for additional details)
(c) Included as Income tax expense (benefit) in the Consolidated Statements of Income

4. Segment Information
The following is a general description of the company’s two business segments:
Retail – sells a variety of packaged meat and frozen bakery products to retail customers in North America. It also includes gourmet artisanal sausage, salami and jerky products.
Foodservice/Other – sells a variety of meats and bakery products to foodservice customers in North America such as broad-line foodservice distributors, restaurants, hospitals and other large institutions and includes commodity meat products.


10


The following is a summary of net sales and operating income by business segment:
 
 
Net Sales
 
Quarter Ended
 
Six Months Ended
(In millions)
December 28, 2013
 
December 29, 2012
 
December 28, 2013
 
December 29, 2012
Retail
$
799

 
$
777

 
$
1,513

 
$
1,496

Foodservice/Other
283

 
283

 
553

 
538

Net sales
$
1,082

 
$
1,060

 
$
2,066

 
$
2,034

 
 
 
 
 
 
 
 
 
Income from Continuing Operations Before Income Taxes
 
Quarter Ended
 
Six Months Ended
(In millions)
December 28, 2013
 
December 29, 2012
 
December 28, 2013
 
December 29, 2012
Retail
$
115

 
$
112

 
$
175

 
$
196

Foodservice/Other
31

 
28

 
56

 
53

Total operating segment income
146

 
140

 
231

 
249

General corporate expense
(9
)
 
(8
)
 
(19
)
 
(20
)
Mark-to-market derivative gains (losses)
3

 
(4
)
 
5

 
1

Amortization of intangibles
(1
)
 
(1
)
 
(2
)
 
(2
)
Significant items
(23
)
 
(28
)
 
(44
)
 
(45
)
Total operating income
116

 
99

 
171

 
183

Net interest expense
(9
)
 
(10
)
 
(20
)
 
(19
)
Income from continuing operations before income taxes
$
107

 
$
89

 
$
151

 
$
164


Significant items primarily consist of restructuring charges and accelerated depreciation.

5. Discontinued Operations

During the second quarter of 2014, the company received a tax refund of approximately AUD 2.0 million ($1.9 million USD) related to Australian bakery discontinued operations. The disposition of the Australian bakery business was completed prior to the end of fiscal 2013. The results of the Australian bakery business are classified as discontinued operations and are presented as discontinued operations in the consolidated statements of income for all periods presented.
On December 19, 2012, the company signed an agreement to sell its Australian bakery business to McCain Foods Limited. The results of this business were previously reported as the Australian Bakery business segment. Also included in the transaction were the license rights to certain intellectual property used by the Australian bakery business in the Asia-Pacific region. In February 2013, the company completed the sale of its Australian Bakery business. Using foreign currency exchange rates on the date of the transaction, the company received cash proceeds of $85 million and reported an after tax gain on disposition of $42 million.

The results of the fresh bakery and foodservice beverage operations in North America, which were disposed of prior to the end of fiscal 2012, are classified as discontinued operations and are presented as discontinued operations in the consolidated statements of income for all periods presented.


11


The following is a summary of the operating results of the company’s discontinued operations for the second quarter and first six months of 2014 and 2013: 
 
Second Quarter 2014
 
First Six Months of 2014
(In millions)
Net
Sales
 
Pretax
Income
 
Net
Income
 
Net
Sales
 
Pretax
Income
 
Net
Income
Australian Bakery
$

 
$
2

 
$
1

 
$

 
$
2

 
$
1


 
Second Quarter 2013
 
First Six Months of 2013
(In millions)
Net
Sales
 
Pretax
Income
 
Net
Income
 
Net
Sales
 
Pretax
Income
 
Net
Income
Australian Bakery
$
34

 
$
2

 
$
6

 
$
71

 
$
5

 
$
8

North American Foodservice Beverage

 
2

 
1

 

 
2

 
1

Total
$
34

 
$
4

 
$
7

 
$
71

 
$
7

 
$
9


The following is a summary of the gain on sale of the company’s discontinued operations for the second quarter and first six months of 2013: 
 
Second Quarter 2013
 
First Six Months of 2013
(In millions)
Pretax Gain
on Sale
 
Tax
Expense
 
After Tax
Gain
 
Pretax Gain
on Sale
 
Tax
Expense
 
After Tax
Gain
North American Fresh Bakery
$

 
$

 
$

 
$
1

 
$

 
$
1

North American Foodservice Beverage

 

 

 
2

 
(1
)
 
1

Total
$

 
$

 
$

 
$
3

 
$
(1
)
 
$
2


The gain on sale of discontinued operations reported in fiscal 2013 represents the impact of a final purchase price adjustment related to the North American fresh bakery disposition and gain related to the disposition of two manufacturing facilities related to the North American foodservice beverage operations.
The cash flows related to the discontinued operations for the first six months of 2014 and 2013 are summarized in the table below:
 
 
Six Months Ended
Six Months Ended
(In millions) – Increase / (Decrease)
December 28, 2013
December 29, 2012
Cash flow from operating activities
$
1

$
13

Cash flow from investing activities

6

Cash flow used in financing activities
(1
)
(13
)
Increase in net cash of discontinued operations

6

Cash and cash equivalents at beginning of year


Cash and cash equivalents at end of period
$

$
6

The cash used in financing activities primarily represents the net transfers of cash with the corporate office. The net assets of the discontinued operations assumed that the cash of those businesses has been retained as a corporate asset.





12


6. Exit, Disposal and Other Restructuring Activities
The company has incurred exit, disposition and restructuring charges for initiatives designed to improve its operational performance and reduce cost. The nature of the costs incurred under these plans determine where they are classified in the financial statements. Our restructuring activities are recorded in one of two areas:
1. Exit Activities, Asset and Business Disposition Actions
These amounts primarily relate to:
Employee termination costs
Lease and contractual obligation exit costs
Gains or losses on the disposition of assets or asset groupings that do not qualify as discontinued operations
2. Costs recognized in Selling, general and administrative expenses
These costs are recognized in 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 charges provides the reader greater transparency to the total cost of the initiatives.
These amounts primarily relate to:
Expenses associated with the installation of information systems
Consulting costs
Costs associated with the renegotiation of contracts for services with outside third-party vendors as part of the spin-off of the international coffee and tea operations

The following is a summary of the (income) expense associated with ongoing actions, which also highlights where the costs are reflected in the Consolidated Statements of Income:
 
 
Quarter Ended
 
Six Months ended
(In millions)
December 28, 2013
 
December 29, 2012
 
December 28, 2013
 
December 29, 2012
Selling, general and administrative expenses
11

 
6

 
$
25

 
$
15

Net charges for exit activities, asset and business dispositions
7

 
9

 
10

 
6

Decrease in income from continuing operations before income taxes
18

 
15

 
35

 
21

The impact of these actions on the company’s business segments and general corporate expenses is summarized as follows:
 
 
Quarter Ended
 
Six Months ended
(In millions)
December 28, 2013
 
December 29, 2012
 
December 28, 2013
 
December 29, 2012
Retail
$
5

 
$

 
$
7

 
$
(3
)
Foodservice/Other
1

 

 
2

 
(2
)
Expense (income) in operating segments
6

 

 
9

 
(5
)
General corporate expenses
12

 
15

 
26

 
26

Total
$
18

 
$
15

 
$
35

 
$
21


13


The following table summarizes the activity for the first six months of 2014 related to exit, disposal and restructuring related actions and the status of the related accruals as of December 28, 2013. The 2014 exit, disposal and restructuring related actions include recognized third party consulting costs related to cost saving and efficiency process, IT initiatives and recognized severance charges associated with planned employee terminations. The accrued amounts remaining represent the estimated cash expenditures necessary to satisfy remaining obligations and the majority are expected to be paid in the next 12 months.
 
(In millions)
Employee termination and other benefits
 
IT and other costs
 
Non-cancellable leases/ Contractual obligations
 
Total
Accrued Costs as of June 29, 2013
$
10

 
$
5

 
$
23

 
$
38

Exit, disposal and other costs recognized during 2014
10

 
25

 

 
35

Cash payments
(12
)
 
(23
)
 
(8
)
 
(43
)
Accrued costs as of December 28, 2013
$
8

 
$
7

 
$
15

 
$
30


7. Financial Instruments
Investment Securities
Beginning in the first quarter of fiscal year 2014, the company purchased securities for investment purposes. Under the current investment policy, the company may invest in debt securities deemed to be investment grade at the time of purchase. The company determines the appropriate categorization of debt securities at the time of purchase and reevaluates such designation at each balance sheet date. The company typically categorizes all debt securities as available-for-sale, as the company has the intent to convert these investments into cash if needed. Classification of available-for-sale marketable securities as current or non-current is based on whether the conversion to cash is expected to be necessary for operations in the upcoming year, which is consistent with the security’s maturity date, if applicable.

Securities categorized as available-for-sale are stated at fair value, with unrealized gains and losses reported as a component of accumulated other comprehensive income (loss). The amortized cost, unrealized gains and losses, and fair market values of the company's investment securities available for sale at December 28, 2013 are summarized as follows:
 
December 28, 2013
(In millions)
Amortized Cost
 
Unrealized Gain/(Loss)
 
Fair Market Value
Available-for-sale:(1)
 
 
 
 
 
Commercial Paper
$
137

 
$

 
$
137

Corporate Note
149

 

 
149

Total
$
286

 
$

 
$
286

(1)
Categorized as Level 1: Observable input such as quoted prices in active markets for identical assets or liabilities
Derivative Instruments
The company uses derivative financial instruments, including futures, options and swap contracts to manage its exposures to 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 company. The company does not use derivatives for trading or speculative purposes and is not a party to leveraged derivatives. More information concerning accounting for financial instruments can be found in Note 2, Summary of Significant Accounting Policies in the company’s 2013 Annual Report.
Types of Derivative Instruments
Interest Rate Swaps
The company previously had utilized interest rate swap derivatives to manage interest rate risk in order to maintain a targeted amount of both fixed-rate and floating-rate long-term debt. 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 company has a fixed interest rate on virtually all of its long-term debt, and as of December 28, 2013 and June 29, 2013, the company is not a party to any interest rate swap agreements.

14


Commodity Futures and Options Contracts
The company uses commodity futures and options to hedge a portion of its commodity price risk. The principal commodities hedged by the company include pork, beef, natural gas, diesel fuel, corn, wheat and other ingredients. The company uses both commodity financial instruments and 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 company accounts for those contracts as cash flow hedges. However, the majority of commodity derivative instruments are accounted for as mark-to-market hedges. The company 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.

The notional values of the various derivative instruments used by the company are summarized in the following table:
 
Notional Values
(In millions)
December 28, 2013
 
June 29, 2013
 
Hedge Coverage (Number of months)
Commodity Contracts:
 
 
 
 
 
Commodity Future Contracts:(1)
 
 
 
 
 
Grains/Oilseed
$
42

 
$
34

 
6
Energy
$
26

 
$
29

 
14
Other commodities
$
9

 
$
20

 
7
 
(1) Commodity futures contracts are determined by the initial cost of the contract
Cash Flow Presentation

The cash receipts and payments from a derivative instrument are classified according to the nature of the instrument, when realized, generally in investing activities unless otherwise disclosed. However, cash flows from a derivative instrument that are accounted for as a fair value hedge or cash flow hedge are classified in the same category as the cash flows from the items being hedged provided the derivative does not include a financing element at inception. If a derivative instrument includes a financing element at inception, all cash inflows and outflows of the derivative instrument are considered cash flows from financing activities. If, for any reason, hedge accounting is discontinued, any remaining cash flows after that date will be classified consistent with mark-to-market instruments.
Contingent Features/Concentration of Credit Risk
All of the company’s derivative instruments are governed by International Swaps and Derivatives Association (ISDA) master agreements, requiring the company to maintain an investment grade credit rating from both Moody’s and Standard & Poor’s credit rating agencies. If the company’s credit rating 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. There are no derivative instruments with credit-risk-related contingent features that are in a liability position as of December 28, 2013 and June 29, 2013.
A large number of major international financial institutions are counterparties to the company’s financial instruments. The company 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. The company regularly monitors these positions. While the company may be exposed to credit losses in the event of non-performance by individual counterparties of the entire group of counterparties, the company 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.

15


The carrying amounts of cash and equivalents, trade accounts receivables, accounts payable, and derivative instruments approximate fair values due to their short-term nature and are considered Level 1 based on the valuation inputs. The carrying value of derivative instruments approximate fair value but may be considered Level 1 or Level 2 based on the valuation inputs used (see balance sheet classification and fair value determination in the table presented later in this disclosure). The fair value of the company’s long-term debt (considered Level 2 based on the valuation inputs used), including the current portion, is estimated using available market data. Marketable securities available for sale values are derived solely from Level 1 inputs.

 
 
December 28, 2013
 
June 29, 2013
(In millions)
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
Long-term debt, including current portion
$
972

 
$
948

 
$
981

 
$
951


Information related to our cash flow hedges and other derivatives not designated as hedging instruments for the quarters and six months ended December 28, 2013 and December 29, 2012 is as follows:
 
 
Commodity
Contracts
 
Quarter Ended
(In millions)
December 28, 2013
 
December 29, 2012
Cash Flow Derivatives:
 
 
 
Amount of loss recognized in other comprehensive income (OCI) (a)
$
(1
)
 
$
(4
)
Amount of gain (loss) reclassified from AOCI into earnings (a) (b)
(1
)
 
6

Amount of ineffectiveness recognized in earnings (c) (d)
1

 

Amount of loss expected to be reclassified into earnings during the next twelve months
(3
)
 
(6
)
Derivatives Not Designated as Hedging Instruments:
 
 
 
Amount of gain (loss) recognized in Cost of Sales
2

 
(1
)
Amount of gain (loss) recognized in SG&A
1

 
(1
)

(a) Effective portion
(b) Gain (loss) reclassified from AOCI into earnings is reported 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 SG&A expenses for commodity contracts


16


 
Foreign Exchange
Contracts
 
Commodity
Contracts
 
Total
 
Six Months Ended
 
Six Months Ended
 
Six Months Ended
(In millions)
December 28, 2013
 
December 29, 2012
 
December 28, 2013
 
December 29, 2012
 
December 28, 2013
 
December 29, 2012
Cash Flow Derivatives:
 
 
 
 
 
 
 
 
 
 
 
Amount of gain (loss) recognized in other comprehensive income (OCI) (a)

 

 
(2
)
 
8

 
(2
)
 
8

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

 

 
(2
)
 
11

 
(2
)
 
11

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

 

 
1

 

 
1

 

Amount of loss expected to be reclassified into earnings during the next twelve months

 

 
(3
)
 
(6
)
 
(3
)
 
(6
)
Derivatives Not Designated as Hedging Instruments:
 
 
 
 
 
 
 
 
 
 
 
Amount of gain recognized in Cost of Sales

 

 
1

 
3

 
1

 
3

Amount of gain (loss) recognized in SG&A

 
(1
)
 
2

 

 
2

 
(1
)

(a) Effective portion
(b) Gain (loss) reclassified from AOCI into earnings is reported 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 SG&A expenses for commodity contracts

8. Pension and Other Postretirement Benefit Plans
The components of the net periodic benefit cost (benefit) for the pension and postretirement benefit plans for the quarter and six months ended December 28, 2013 and December 29, 2012 are as follows:
 
 
Pension Plans
 
Quarter Ended
 
Six Months Ended
(In millions)
December 28, 2013
 
December 29, 2012
 
December 28, 2013
 
December 29, 2012
Service cost
2

 
$
3

 
4

 
$
6

Interest cost
18

 
18

 
37

 
35

Expected return on plan assets
(22
)
 
(23
)
 
(44
)
 
(46
)
Amortization of:
 
 
 
 
 
 
 
     Net actuarial loss
1

 
1

 
2

 
2

Prior service cost

 

 

 

Settlement loss

 
1

 

 
1

Net periodic benefit
$
(1
)
 
$

 
$
(1
)
 
$
(2
)
 

17


 
Postretirement Benefit Plans
 
Quarter Ended
 
Six Months Ended
(In millions)
December 28, 2013
 
December 29, 2012
 
December 28, 2013
 
December 29, 2012
Service cost
$
1

 
$
1

 
$
1

 
$
1

Interest cost
1

 
1

 
2

 
2

Expected return on plan assets

 

 

 

Amortization of:
 
 
 
 
 
 
 
     Net actuarial loss

 

 

 

Prior service benefit
(2
)
 
(2
)
 
(4
)
 
(4
)
Settlement loss

 

 

 

Net periodic benefit
$

 
$

 
$
(1
)
 
$
(1
)
The company contributed approximately $3 million to its defined benefit pension plans related to continuing operations during the first six months of 2014 and 2013, respectively. At the present time, the company expects to contribute approximately $2 million to $3 million of additional cash to its defined benefit pension plans in the remainder of 2014. The exact amount of cash contributions made to pension plans in any year is dependent upon a number of factors including minimum funding requirements in the jurisdictions in which the company operates. As a result, the actual funding in 2014 may differ from the current estimate.
9. Income Taxes
The following table sets out the tax expense and the effective tax rate for the company from continuing operations: 
 
Quarter Ended
 
Six Months Ended
(In millions)
December 28, 2013
 
December 29, 2012
 
December 28, 2013
 
December 29, 2012
Continuing operations
 
 
 
 
 
 
 
Income before income taxes
$
107

 
$
89

 
$
151

 
$
164

Income tax expense (benefit)
(7
)
 
31

 
8

 
57

Effective tax rate
(6.4
)%
 
34.4
%
 
5.2
%
 
34.8
%
Second Quarter 2014
In the second quarter of 2014, the company recognized a tax benefit of $7 million on pretax income from continuing operations of $107 million, or an effective tax rate of (6.4)%. The tax expense and related effective tax rate on continuing operations were impacted by recognizing $45 million in tax benefits from discrete tax items, primarily resulting from the release of a valuation allowance on state deferred tax assets.
In the first six months of 2014, the company recognized a tax expense of $8 million on pretax income from continuing operations of $151 million, or an effective tax rate of 5.2%. The tax expense and related effective tax rate on continuing operations was determined by applying a 35.2% estimated annual effective tax rate to pretax earnings, and then recognizing $45 million of tax benefits from discrete tax items, primarily resulting from the release of a valuation allowance on state deferred tax assets.
Second Quarter 2013
In the second quarter of 2013, the company recognized a tax expense of $31 million on pretax income from continuing operations of $89 million, or an effective tax rate of 34.4%.
In the first six months of 2013, the company recognized a tax expense of $57 million on pretax income from continuing operations of $164 million, or an effective tax rate of 34.8%. The tax expense and related effective tax rate on continuing operations was determined by applying a 34.9% estimated annual effective tax rate to pretax earnings and recognizing various discrete items, none of which were material individually or in the aggregate.
Unrecognized Tax Benefits
Each quarter, the company 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

18


sustained upon examination by the taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement.

The year-to-date net decrease in the liability for unrecognized tax benefits was $4 million, resulting in a ending balance of $63 million as of December 28, 2013. The $4 million net decrease in the gross liability for uncertain tax positions is the result of a $6 million decrease for audit settlements, primarily offset by a $2 million increase related to prior years. At this time, the company estimates that it is reasonably possible that the liability for unrecognized tax benefits will decrease by $5 million to $30 million in the next twelve months from a variety of uncertain tax positions as a result of the completion of tax audits currently in process and the expiration of statutes of limitations.
The company’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 2010. With few exceptions, the company is no longer subject to state and local income tax examinations by tax authorities for years prior to 2005.
10. Contingencies and Commitments

The company is a party to various pending legal proceedings, claims and environmental actions by government agencies. The company records a provision with respect to a claim, suit, investigation or proceeding when it is probable that a liability has been incurred and the amount of the loss can reasonably be estimated. Any provisions are reviewed at least quarterly and are adjusted to reflect the impact and status of settlements, rulings, advice of counsel and other information pertinent to the particular matter.
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 company. The complaint names the company as a party defendant. In 2006, the arbitrator ruled against the company and awarded the plaintiffs approximately $80 million in damages and fees. This ruling was appealed by the company and subsequently set aside by the NLRC in December 2006. Both the complainants and the company have filed motions for reconsideration. The company continues to believe that the plaintiffs' claims are without merit; however, it is reasonably possible that this case will be ruled against the company and have a material adverse impact on the company's results of operations and cash flows. The company has initiated settlement discussions for this case and has established an accrual for the estimated settlement amount.
Multi-Employer Pension Plan – The company participates in one multi-employer pension plan that provides retirement benefits to certain employees covered by collective bargaining agreements (the MEPP). Participating employers in the MEPP are jointly responsible for any plan underfunding. The Pension Protection Act of 2006 (PPA) imposes minimum funding requirements on pension plans. Multi-employer pension plans that fail to meet certain funding standards (as defined by the PPA) are categorized as being either in critical or endangered status. The MEPP was certified by its actuary to be in critical status for the 2012 plan year; consequently, the trustees of the MEPP adopted a rehabilitation plan designed to improve the plan's funding within a prescribed period of time. The rehabilitation plan included increases in employer contributions and reductions in benefits. Unless otherwise agreed upon, any requirement to increase employer contributions will not take effect until the current collective bargaining agreements expire. However, a five percent surcharge for the initial critical year (increasing to ten percent for subsequent years) is imposed on contributions to the MEPP under the current collective bargaining agreement. Such surcharge remains in effect until the effective date of an adopted collective bargaining agreement which includes modifications consistent with the rehabilitation plan. Any surcharge assessed on an employer will also be included in the calculation of the compounded contribution rate increases required under the rehabilitation plan. In addition, the failure of the MEPP to meet funding improvement targets provided in its rehabilitation plan could result in the imposition of an excise tax on contributing employers.

Under the current law regarding multi-employer pension plans, a withdrawal or partial withdrawal from any multi-employer pension plan that was underfunded would render a withdrawing employer liable for its proportionate share of that underfunding. Such withdrawing employer is required to pay, in annual installment payments, a statutorily determined amount to satisfy the withdrawal liability. The annual installment payments for a complete withdrawal are capped at twenty years, except in the case of a mass withdrawal. In a mass withdrawal, the twenty-year payment cap does not apply. This potential unfunded pension liability also applies ratably to other contributing employers. Information regarding underfunding is generally not provided by plan administrators and trustees on a current basis and when provided, is difficult to independently validate. Any public information available relative to multi-employer pension plans may be dated as well. In the event a withdrawal or partial withdrawal was to occur with respect to the MEPP, the impact to the company's consolidated financial

19


statements could be material. Withdrawal liability triggers could include the company's decision to close a plant or the dissolution of a collective bargaining unit.

The company's regularly scheduled contributions to the MEPP are expected to be approximately $2 million in 2014, and totaled approximately $1 million in 2013.

Guarantees

The company is a party to a variety of agreements under which it may be obligated to indemnify a third party with respect to certain matters. Typically, these obligations arise as a result of contracts entered into by the company under which the company agrees to indemnify a third party against losses arising from a breach of representations and covenants related to matters such as title to assets sold, the collectibility of receivables, specified environmental matters, lease obligations assumed and certain tax matters. In each of these circumstances, payment by the company is conditioned on the other party making a claim pursuant to the procedures specified in the contract. These procedures allow the company to challenge the other party's claims. In addition, the company's obligations under these agreements may be limited in terms of time and/or amount, and in some cases the company may have recourse against third parties for certain payments made by the company. It is not possible to predict the maximum potential amount of future payments under certain agreements, due to the conditional nature of the company's obligations and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the company under these agreements have not had a material effect on the company's business, financial condition or results of operations. The company believes that if it were to incur a loss in any of these matters, such loss would not have a material effect on the company's business, financial condition or results of operations.

The material guarantees for which the maximum potential amount of future payments can be determined, are as follows:
Contingent Lease Obligations – The company is contingently liable for leases on property operated by others. At December 28, 2013, the maximum potential amount of future payments the company could be required to make, if all of the current operators default on the rental arrangements, is $13 million. The minimum annual rentals under these leases are $4 million in 2014, $8 million in 2015 and $1 million in 2016. The largest components of these amounts relate to a number of retail store leases assumed by Coach, Inc. Coach, Inc. has issued a guarantee to the company and agreed to indemnify and reimburse the company from and against any payments or performance that may be required with respect to any obligation or liability imposed under the retail store leases. The company has not recognized a liability for the contingent obligation on the Coach, Inc. leases it assumed.
Contingent Debt Obligations and Other – The company has guaranteed the payment of certain third-party debt. The maximum potential amount of future payments that the company could be required to make, in the event that these third parties default on their debt obligations, is $15 million. At the present time, the company does not believe it is probable that any of these third parties will default on the amount subject to guarantee.

20



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 second quarter and first six months of 2014 compared with the second quarter and first six months of 2013 and a discussion of the changes in financial condition and liquidity during the first six months of 2014. Below is an outline of the analyses included herein:
Business Overview
Summary of Results
Consolidated Results – Second Quarter of 2014 Compared with Second Quarter of 2013
Consolidated Results – First Six Months of 2014 Compared with First Six Months of 2013
Operating Results by Business Segment
Financial Condition
Liquidity
Non-GAAP Financial Measures Definitions
Significant Accounting Policies and Critical Estimates
Issued but not yet Effective Accounting Standards
Forward-Looking Information
Business Overview
Our Business
Hillshire Brands is a manufacturer and marketer of high-quality, brand name food products. Sales are principally in the United States, where it is a leader in branded, convenient foods for the retail and foodservice markets. In the retail channel, the company sells a variety of packaged meat products that include hot dogs, corn dogs, breakfast sandwiches, sausages and lunchmeats as well as a variety of frozen baked products and specialty items including cakes and cheesecakes. These products are sold primarily to supermarkets, warehouse clubs and national chains. The company also sells a variety of meat and bakery products to foodservice customers.

The company's portfolio of brands includes Jimmy Dean, Ball Park, Hillshire Farm, State Fair, Sara Lee frozen bakery and Chef Pierre, as well as artisanal brands Aidells, Gallo Salame and Golden Island.

Strategy

The company is focused on delivering long-term value creation through strengthening the core of its business through brand building and innovation; leveraging its heritage brand equities to extend into new adjacent categories; fueling growth by driving operating efficiencies; and evaluating opportunities to acquire on-trend brands that align with its strategy for value creation.