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| SLE > SEC Filings for SLE > Form 10-Q on 4-Feb-2009 | All Recent SEC Filings |
4-Feb-2009
Quarterly Report
Introduction
The following is management's discussion and analysis of the results of operations for the second quarter and first six months of 2009 compared with the second quarter and first six months of 2008 and a discussion of the changes in financial condition and liquidity during the first six months of 2009. Below is an outline of the analyses included herein:
• Business Overview
• Consolidated Results - Second Quarter and First Six Months of 2009
• Operating Results by Business Segment
• Financial Condition
• Liquidity
• Significant Accounting Policies and Critical Estimates
• 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 meats, bakery, beverage, and household products categories. Our brands include Ambi Pur, Ball Park, Douwe Egberts, Hillshire Farm, Jimmy Dean, Kiwi, Sanex, Senseo and our namesake, Sara Lee.
In North America, the company sells a variety of packaged meat products that include hot dogs, corn dogs, breakfast sausages, dinner sausages and deli meats as well as a variety of fresh and frozen baked products and specialty items that include bread, buns, bagels, cakes and cheesecakes. These products are sold through the retail channel to supermarkets, warehouse clubs and national chains. The company also sells a variety of meat, bakery and beverage products to foodservice customers in North America. Internationally, the company sells coffee and tea products in Europe, Brazil, Australia and Asia through both the retail and foodservice channels as well as a variety of bakery and dough products to retail and foodservice customers in Europe and Australia. It also sells body care, air care, shoe care and insecticides to retail customers primarily in the U.S., Europe, India and the Asia Pacific region.
Challenges and Risks
As an international consumer products company, we face certain risks and challenges that impact our business and financial performance. 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. The commodities we use, including beef, pork, coffee, wheat, corn, corn syrup, soybean and corn oils, butter, sugar and fuel, may experience price volatility due to factors beyond our control. The company's objective is to be able to offset commodity price increases with pricing actions and to offset any operating costs increases with continuous improvement savings. During the first six months of 2009, the corporation estimates that commodity cost increases of approximately $350 million over the first six months of the prior year, including the impact of commodity derivatives were offset by favorable pricing actions of approximately $345 million.
The company's business results are also heavily influenced by changes in foreign currency exchange rates. For the most recently completed fiscal year, nearly 50% of net sales and significantly more than 50% of operating segment income were generated outside of the U.S. As a result, changes in foreign currency exchange rates, particularly the European euro, can have a significant impact on the reported results. Changes in foreign currency exchange rates decreased net sales by $72 million and decreased operating income by $7 million for the first six months of 2009.
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 greater 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.
The corporation believes that, based on its current cash balance and continued access to financing, the recent turmoil and decreased liquidity in the financial markets will not have a material adverse impact on our liquidity or cash flow. In light of the current credit market instability, however, the corporation has taken certain actions to maintain its liquidity and preserve operating flexibility. Although the corporation continues to regularly access the commercial paper market, it has shortened maturities on its commercial paper and reduced the total amount of its commercial paper that matures each day in response to reduced market liquidity.
The turmoil in the financial markets has led to general economic weakness, which has negatively impacted our business. Continued economic uncertainly may 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. In addition, certain reporting units of the corporation, especially those carrying significant goodwill balances, could experience reduced profitability which potentially could trigger a goodwill impairment.
Significant Items Affecting Comparability
The reported results for 2009 and 2008 reflect amounts recognized for actions associated with the corporation's ongoing business transformation program, Project Accelerate and other significant amounts that impact comparability. More information on these costs can be found in Note 6 to the Consolidated Financial Statements, "Exit, Disposal and Transformation/Accelerate Activities." The nature of these items includes the following:
Exit Activities, Asset and Business Dispositions - These costs are reported on a separate line of the Consolidated Statements of Income. Exit activities primarily relate to charges taken to recognize severance actions approved by the 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.
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.
Business Transformation Costs - These include costs to retain and relocate existing employees, recruit new employees, third-party consulting costs associated with transformation efforts, and amortization costs for new enterprise-wide software. In addition, these costs include incremental depreciation associated with decisions to close facilities at dates sooner than originally anticipated, pursuant to an exit plan. These costs are recognized in the Consolidated Statements of Income in Selling, General and Administrative Expenses or Cost of Sales. Employee termination costs, lease exit costs and gains or losses on the disposition of assets or asset groupings that do not qualify as discontinued operations associated with these initiatives are reported as part of exit activities, asset and business dispositions.
Other Significant Items - The reported results are also impacted by other items that affect comparability. These items may include impairment charges, pension partial withdrawal liability charges, curtailment gains and certain discrete tax matters, which include contingent tax obligation and valuation allowance adjustments and various other tax matters.
Impact of Significant Items on Net Income (Loss) and Diluted Earnings per Share
Quarter ended Quarter ended
December 27, 2008 December 29, 2007
Net Net Diluted
Pretax Income Diluted EPS Pretax Income EPS
In millions, except per share data Impact (Loss) (2) Impact (1) Impact (Loss) (2) Impact (1)
Net income (loss) $ (2 ) $ (17 ) $ (0.02 ) $ 204 $ 182 $ 0.25
Significant items affecting comparability of net
income (loss):
Charges for exit activities, asset and business
dispositions:
Income from (charges for) exit activities $ (40 ) $ (28 ) $ (0.04 ) $ (7 ) $ (5 ) $ (0.01 )
Income from (charges for) business disposition
activities - (2 ) - - - -
Subtotal (40 ) (30 ) (0.04 ) (7 ) (5 ) (0.01 )
Charges to cost of sales:
Transformation charges - IT costs (1 ) (1 ) - (2 ) (1 ) -
Pension partial withdrawal liability charge (12 ) (8 ) (0.01 ) - - -
Accelerated depreciation - - - (1 ) (1 ) -
Charges to SG&A expenses:
Transformation charges - IT costs (4 ) (3 ) - (10 ) (6 ) (0.01 )
Transformation/Accelerate charges - Other (2 ) (1 ) - - - -
Pension partial withdrawal liability charge (18 ) (11 ) (0.02 ) - - -
Impairment charge (107 ) (107 ) (0.15 ) - - -
Impact of significant items on income (loss)
before income taxes (184 ) (161 ) (0.23 ) (20 ) (13 ) (0.02 )
Significant tax matters affecting comparability:
Deferred tax valuation allowance adjustment - - - - 37 0.05
Transformation charges - disc'd. operations (3) - - - (1 ) (1 ) -
Impact of significant items on net income (loss) $ (184 ) $ (161 ) $ (0.23 ) $ (21 ) $ 23 $ 0.03
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Notes:
(1) EPS amounts are rounded to the nearest $0.01 and may not add to the total.
(2) Taxes computed at applicable statutory rates.
(3) Impact on discontinued operations, which is included in net income (loss).
Impact of Significant Items on Net Income and Diluted Earnings per Share
Six Months ended Six Months ended
December 27, 2008 December 29, 2007
Diluted
Pretax Net Diluted EPS Pretax Net EPS
In millions, except per share data Impact Income (5) Impact (4) Impact Income (5) Impact (4)
Net income $ 326 $ 213 $ 0.30 $ 469 $ 382 $ 0.53
Significant items affecting comparability of
net income:
Charges for exit activities, asset and
business dispositions:
Income from (charges for) exit activities $ (39 ) $ (28 ) $ (0.04 ) $ (10 ) $ (7 ) $ (0.01 )
Income from (charges for) business
disposition activities 3 - - (1 ) (1 ) -
Subtotal (36 ) (28 ) (0.04 ) (11 ) (8 ) (0.01 )
Charges to cost of sales:
Transformation charges - IT costs (3 ) (2 ) - (6 ) (3 ) -
Accelerated depreciation - - - (1 ) (1 ) -
Curtailment gain 7 5 0.01 - - -
Pension partial withdrawal liability charge (12 ) (8 ) (0.01 ) - - -
Charges to SG&A expenses:
Transformation charges - IT costs (12 ) (9 ) (0.01 ) (22 ) (14 ) (0.02 )
Transformation/Accelerate charges - Other (2 ) (1 ) - (2 ) (1 ) -
Curtailment gain 10 7 0.01 - - -
Pension partial withdrawal liability charge (18 ) (11 ) (0.02 ) - - -
Impairment charge (107 ) (107 ) (0.15 ) - - -
Impact of significant items on income before
income taxes (173 ) (154 ) (0.22 ) (42 ) (27 ) (0.04 )
Significant tax matters affecting
comparability:
Deferred tax valuation allowance adjustment - - - - 37 0.05
Contingent tax obligation adjustment - - - - 14 0.02
Other tax adjustments - - - - (1 ) -
Transformation charges - disc'd.
operations(6) - - - (1 ) (1 ) -
Impact of significant items on net income $ (173 ) $ (154 ) $ (0.22 ) $ (43 ) $ 22 $ 0.03
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Notes:
(4) EPS amounts are rounded to the nearest $0.01 and may not add to the total.
(5) Taxes computed at applicable statutory rates.
(6) Impact on discontinued operations, which is included in net income.
Consolidated Results - Second Quarter of 2009 Compared with Second Quarter of 2008
The following table summarizes net sales and operating income for the second quarter of 2009 and 2008 and certain items that affected the comparability of these amounts:
Quarter ended
December 27, December 29, Percent
Total Corporation Performance (In millions) 2008 2007 Change Change
Net sales $ 3,340 $ 3,408 $ (68 ) (2.0 )%
Increase / (Decrease) in net sales from:
Changes in foreign currency exchange rates $ - $ 190 $ (190 )
Acquisitions/Dispositions 9 20 (11 )
Total $ 9 $ 210 $ (201 )
Operating income $ 33 $ 231 $ (198 ) (85.8 )%
Increase / (Decrease) in operating income from:
Changes in foreign currency exchange rates $ - $ 22 $ (22 )
Exit activities, asset and business dispositions (40 ) (7 ) (33 )
Transformation/Accelerate charges (7 ) (12 ) 5
Impairment charge (107 ) - (107 )
Accelerated depreciation - (1 ) 1
Pension partial withdrawal liability charge (30 ) - (30 )
Acquisitions/dispositions 5 - 5
Total $ (179 ) $ 2 $ (181 )
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Net Sales
Net sales decreased by $68 million or 2.0%. The weakening of foreign currencies, particularly the European euro, Brazilian real, British pound sterling and Australian dollar decreased reported net sales by $190 million, or 5.9%. Sales were favorably impacted by pricing actions, taken across all business segments to offset increased commodity costs, which increased reported net sales by approximately 5% and a favorable shift in sales mix. These favorable impacts were partially offset by an overall decline in unit volumes of 3.7%. The following table summarizes the components of the percentage change in net sales as compared to the prior year:
Second Quarter 2009
Unit Price/ Acquisitions/ Foreign Net Sales
Net Sales Changes Volumes + Mix/Other + Divestitures + Exchange = Change
Total Corporation (3.7 )% 7.9 % (0.3 )% (5.9 )% (2.0 )%
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Operating Income
Operating income decreased by $198 million, or 85.8%. Of the decrease, $181 million was due to the items summarized in the previous table of operating income results, the most significant of which were a $107 million impairment charge; $22 million of unfavorable impacts related to changes in foreign currency exchange rates; a $30 million charge to recognize a pension partial withdrawal liability and a $33 million increase in exit activities, asset and business disposition charges. The remaining decline in operating income of $17 million, or 7.6%, was primarily due to $23 million of mark-to-market losses on derivative contracts related to commodities in the second quarter of 2009 as compared to $8 million of mark-to-market derivative gains in the second quarter of 2008. In addition, the negative impact of higher commodity and labor costs and lower unit volumes were partially offset by the favorable impact of pricing actions and cost savings from continuous improvement programs. The individual components that impacted operating income are discussed in more detail below.
Gross Margin
Gross margin dollars in the second quarter decreased $95 million over the prior year due to higher commodity, labor and energy costs, changes in foreign currency exchange rates and lower unit volumes, partially offset by the favorable impact of pricing actions and savings from continuous improvement programs. The corporation estimates that commodity cost increases of approximately $135 million in the second quarter of 2009 versus the second quarter of 2008, including the impact of commodity derivatives, were offset by favorable pricing actions of approximately $165 million. The gross margin percent in the second quarter of 2009 declined 2.1%, from 37.9% in the second quarter of 2008 to 35.8% in the second quarter of 2009 due to the negative impact of higher commodity costs.
Selling, General and Administrative Expenses
Quarter ended
December 27, December 29, Percent
(In millions) 2008 2007 Change Change
SG&A expenses in the business segment results:
Media advertising and promotion $ 144 $ 175 $ (31 ) (18.0 )%
Other 767 806 (39 ) (4.7 )
Total business segments 911 981 (70 ) (7.1 )
Amortization of identifiable intangibles 15 16 (1 ) (6.0 )
General corporate expenses:
Other 74 59 15 25.2
Mark-to-market derivative (gains) / losses 17 (2 ) 19 NM
Total SG&A Expenses $ 1,017 $ 1,054 $ (37 ) (3.5 )%
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Selling, general and administrative (SG&A) expenses decreased by $37 million, or 3.5%. Measured as a percent of sales, SG&A expenses decreased from 30.9% in 2008 to 30.4% in 2009. Changes in foreign currency exchange rates decreased SG&A costs by $61 million, or 5.9%. The remaining increase in SG&A expenses is $24 million, or 2.4%. SG&A expenses in the business segments decreased by $70 million, or 7.1%, due to the change in foreign currencies, a reduction in media advertising and promotion (MAP) spending, and the impact of cost containment actions partially offset by an $18 million charge related to a pension partial withdrawal liability. Other general corporate expenses increased $15 million versus the prior year due to an increase in employee benefit costs and increased professional fees for consulting and special project work. Derivative losses were $17 million in 2009 versus gains of $2 million in 2008, due to mark-to-market losses incurred on commodity related derivative contracts primarily related to energy.
Transformation/Accelerate Actions, Impairment Charges, Exit Activities and Other Significant Items
The reported results for the second quarter of 2009 and 2008 reflect amounts recognized for actions associated with the corporation's ongoing business transformation and Project Accelerate programs and other exit and disposal actions. The expense related to exit activities, asset and business dispositions was $40 million in the second quarter of 2009 versus $7 million in the second quarter of 2008. As discussed in Note 6 to the financial statements, "Exit, Disposal and Transformation/Accelerate Activities," $41 million of the charge in 2009 relates to the planned termination of 438 employees related to both European and North American operations as part of Project Accelerate.
Transformation costs related to information technology were down $7 million primarily due to a reduction in costs related to the implementation of new information technology systems. The transformation - IT costs in the second quarter of 2009 include $5 million of computer software amortization expense related to systems that were put into use in 2008. The total amortization expense for the year is expected to be $22 million.
The corporation recognized a $107 million impairment charge in the second quarter of 2009 related to goodwill associated with the foodservice beverage reporting unit. In the second quarter of 2009, the corporation determined that the carrying amount of its foodservice beverage reporting unit, which is reported in the North American Foodservice segment, exceeded its fair value. Management compared the implied fair value of the goodwill in the reporting unit with the carrying value and concluded that a $107 million impairment charge needed to be recognized. The impairment loss recognized equaled the entire remaining amount of goodwill in the foodservice beverage reporting unit. No tax benefit will be recognized on the goodwill impairment loss. For further information, see Note 5 to the Consolidated Financial Statements, "Impairment Review and Goodwill."
These actions are more fully described in the Exit, Disposal and Transformation/Accelerate Activities and Impairment Review and Goodwill Notes to the Consolidated Financial Statements.
Net Interest Expense
Net interest expense in the second quarter of 2009 was $35 million, an increase of $8 million over the second quarter of the prior year. Interest expense decreased by $7 million due to the repayment of debt using proceeds from prior business dispositions and cash on hand, while interest income declined by $15 million due to lower cash and cash equivalents.
Income Tax Expense
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