Sara Lee Corp. Reports Weak Second Quarter Net Sales

Sara Lee Corp. reported a 1.8 percent increase in second quarter fiscal 2011 adjusted net sales from continuing operations, driven by gains in the company's two strategic growth businesses, North American retail and international beverage. On a reported basis net sales were essentially flat (-0.4 percent), due to the impact of a weaker euro.

The company reported lower operating income and diluted earnings per share from continuing operations for the second quarter of fiscal 2011, primarily due to higher commodity costs net of pricing. Second quarter results compare to a very strong year-ago period, when decreasing commodity costs provided a benefit to the company. Sara Lee's North American fresh bakery segment is now reported as a discontinued operation, following the agreement to sell the business to Grupo Bimbo.

On Jan. 28, 2011, Sara Lee announced that its board of directors agreed in principle to divide the company into two separate, publicly-traded companies. The separation is expected to be completed in early calendar year 2012.

The North American retail and North American foodservice businesses (excluding the North American beverage business) are planned to be spun off, tax-free, into a new public company that will assume the "Sara Lee" name.

The yet to be named other company will consist of Sara Lee's current international beverage and bakery businesses, as well as the North American beverage business. Each company will have leading consumer brands and compelling growth prospects.

"We are excited to move forward with the implementation of our strategic initiative to create two pure-play companies. We are confident that this plan offers the best opportunity to deliver long-term value to our shareholders," said Sara Lee Corp. chief executive officer Marcel Smits.
"At $0.24, our second quarter adjusted EPS from continuing operations showed good improvement from the $0.14 earned in the first quarter. As we focus on driving operational improvement in our two growth businesses, we are well positioned to finish the year with a strong second half. The North American Retail segment will benefit from first half pricing actions and MAP investments. In the international beverage business, we continue to push through pricing to offset commodity increases and we expect further benefits from successful innovation.

We are confident in our ability to drive top-line and bottom-line growth for the fiscal year," Smits concluded.

Net sales from continuing operations for the second quarter of fiscal 2011 were $2.3 billion, down 0.4 percent versus the year-ago period, as a favorable shift in sales mix and higher prices were offset by lower unit volumes and unfavorable foreign currency exchange rates. The company's adjusted net sales rose 1.8 percent in the quarter, as growth in international beverage and North American retail more than offset expected declines in North American foodservice and international bakery. In the first half, reported net sales from continuing operations were $4.4 billion, up 0.1 percent versus the year ago period. Adjusted net sales grew 2.4 percent in the first half.

The first half of fiscal 2011 compares to a very strong year-ago period. In the prior year, favorable commodity costs and pricing contributed to a strong first quarter and even stronger second quarter. This year, in contrast, operating segment income will be more heavily weighted toward the second half of the year. The second quarter of fiscal 2011 delivered $294 million of adjusted operating segment income versus $195 million in the first quarter.

Reported operating income from continuing operations for the second quarter of fiscal 2011 was $206 million, compared to $269 million in the year-ago period, a decrease of $63 million, or 23 percent. The decline was primarily driven by higher commodity costs net of pricing (-$54 million), as well as volume declines net of mix improvements, higher MAP spending, unfavorable exchange rates and the impact of commodity mark-to market, partially offset by savings from corporate and continuous improvement net of inflation. Adjusted operating income from continuing operations was $249 million, compared to $296 million in the second quarter of fiscal 2010, a decrease of $47 million, or 16 percent.

Reported operating income from continuing operations for the first half of fiscal 2011 was $376 million, compared to $581 million in the year-ago period, a decrease of $205 million, or 35 percent. The decline was primarily the result of no longer receiving contingent sale proceeds from the sale of its tobacco business ($133 million in the year-ago period), as well as higher commodity costs net of pricing (-$96 million), increased investment in MAP and unfavorable exchange rates, partially offset by savings from corporate and continuous improvement net of inflation, a commodity mark-to-market benefit and mix improvement net of volume declines. Adjusted operating income from continuing operations was $ 428 million, compared to $483 million in the first half of fiscal 2010, a decrease of $55 million, or 11 percent.

Sara Lee reported a gain on the sale of household and body care discontinued operations of $0.84 in the second quarter and $0.97 in the first half. As a result of entering into an agreement to sell the North American fresh bakery operations, Sara Lee is required to record a deferred tax asset and related tax benefit associated with the excess tax over book basis. This tax benefit is $0.35 in the second quarter. Upon the close of the sale of the North American fresh bakery business, this benefit will reverse.

Net cash from operating activities was $233 million for the first half of fiscal 2011, compared to $472 million in the prior-year period. The $239 million decline is mainly due to a $112 million increase in inventory balances primarily due to higher commodity input costs, a $55 million decline in adjusted operating income from continuing operations and a $29 million decline in operating cash flow from discontinued operations.

MAP spending increased 2 percent in the second quarter of fiscal 2011. In the first half MAP increased 10 percent, driven by greater investment behind the core growth brands, Jimmy Dean and Hillshire Farm, in North American retail and the launch of innovative new products, such as L'Or EspressO, in international beverage.

In the second quarter, commodity costs (excluding commodity mark-to-market) increased by approximately $127 million, partially offset by approximately $73 million in higher prices, resulting in a net unfavorable commodity cost impact of approximately $54 million. In the first half of fiscal 2011, commodity costs increased by approximately $219 million, partially offset by approximately $123 million in price increases, resulting in a net unfavorable commodity cost impact of $96 million. Included in the above commodity cost increases were currency mark-to-market losses, related to the purchase of commodities in the international beverage segment, of $2 million in the quarter and $33 million year-to-date.

  • Net interest expense was $21 million in the quarter, compared to $29 million in the year-ago period. In the second quarter the company incurred $25 million of debt extinguishment costs related to the early redemption of debt. This is the final extinguishment charge bringing the full year total to $55 million. The lower interest rate on the new bonds will reduce annual interest expense by approximately $20 million.

General corporate expenses declined $18 million to $45 million in the second quarter compared to $63 million in the year-ago period, due to a reduction in information technology costs and lower employee benefit costs.

Mark-to-market adjustments from unrealized commodity derivatives amounted to a loss of $2 million in the quarter compared to a gain of $2 million in the second quarter last year. The effective tax rate for continuing operations in the second quarter, on an as reported basis, was 32.7 percent, compared to (24.4) percent in the year-ago quarter. Sara Lee expects the tax rate for continuing operations, excluding significant items, to be between 34 percent and 35 percent for fiscal 2011. For further detail on the tax rate, see pages 18 and 19 of this release.

·Project Accelerate is a company-wide cost savings and productivity initiative focused on outsourcing actions,\ supply chain efficiencies and organizational simplification. The company has revised Project Accelerate benefits and costs to exclude the North American fresh bakery business. Ongoing cumulative benefits realized from the beginning of fiscal 2009 to date are $194 million, of which approximately $50 million are incremental in the first half of fiscal 2011. At the end of fiscal 2011, Sara Lee expects cumulative ongoing benefits of $220 to $240 million. By the end of fiscal 2012, the company expects annualized benefits in continuing operations of $300 to $350 million. The company expects Project Accelerate costs in fiscal 2011 to be approximately $30 to $40 million and minimal charges in fiscal 2012. In total, project charges will amount to approximately $280 million from 2009 to 2012.

The company's global body care and European detergents businesses were sold in December 2010. The company received cash proceeds of $1.6 billion and recognized an after-tax gain of $539 million on the dispositions in the quarter.

In the second quarter, the North American retail segment focused on its core brands and pricing to offset commodity increases. This resulted in 4.5 percent of sales growth attributed to pricing, versus 2.3 percent in the first quarter. Net sales increased 1 percent in the second quarter, on a reported and adjusted basis, to $754 million.

Volume declined by 4.9 percent while sales mix added 2.9 percent, driven by strength in the key strategic brands Jimmy Dean, Hillshire Farm and Ball Park. Despite taking pricing actions, the segment grew share in six of 12 core categories. Jimmy Dean increased its leading market share in the frozen protein breakfast category by 3.0 points versus last year to 59.8 percent, while Hillshire Farm smoked sausage increased market share by 0.5 points to 29.6 percent (IRI share data, 12 week ending Dec. 12, 2010).

This quarter compares to a very strong year-ago period, during which adjusted operating segment income increased significantly with the benefit of lower commodity costs. In the quarter, the segment reported an adjusted operating margin of 11.6 percent versus 16.4 percent last year, which was well above the segment's trend line of gradual improvement. Operating segment income declined 28 percent in the second quarter, on a reported and adjusted basis, to $88 million. Despite a favorable sales mix shift into higher margin products, operating segment income declined versus a favorable prior-year period driven by higher commodity costs net of pricing, volume declines, increases in MAP spending behind core brands along with continued investment in infrastructure and systems, particularly the new Kansas City sliced meat plant which will become operational in the third quarter of fiscal 2011.

While pricing lagged significant commodity cost increases in the first half, the second half will benefit from the pricing actions taken in the first half, along with additional actions planned for the third quarter. The segment will also benefit from the timing of key brand and infrastructure investments, both of which were weighted more heavily toward the first half of the year. As a result of active price management, continued focus on cost savings and efficiencies and strong growth prospects, the segment expects to report improved top-line and bottom-line results for fiscal 2011.

North American Foodservice segment results continue to be impacted by the loss of two large customer contracts in fiscal 2010: a high-volume, low-margin bakery contract lost in the third quarter and a low-volume, high-margin liquid coffee contract lost in the fourth quarter. The segment reported a 2 percent decline in net sales in the quarter, on a reported and adjusted basis, to $517 million. However, operating segment income, as reported, increased 29 percent in the second quarter to $59 million, with the prior year including $15 million of charges primarily for an asset impairment on the write-down of a manufacturing facility. Adjusted operating segment income declined by 2 percent.

Strong top-line performance in the company's meats, frozen bakery and liquid coffee categories was offset by volume declines attributed mostly to the bakery contract loss. As a result, segment unit volumes declined 16 percent but sales mix improved 8 percent. The segment offset the loss of the high-margin liquid coffee contract and higher commodity costs net of pricing with profitable new business, favorable sales mix and cost control initiatives, resulting in only a slight decline in adjusted operating segment income.

In the second half of fiscal 2011, the segment expects improving overall trends and continued momentum in meats and liquid coffee. The negative impacts of the two large customer contract losses will ease as the segment laps the quarters in which the contracts were lost. Volume improvement combined with the full realization of pricing actions and continued cost savings, will drive second half sales growth and full year profit growth.

The International beverage segment continues to push through pricing actions in the face of record increases in green coffee costs. Value-added innovation, such as L'Or EspressO, Douwe Egberts Aromettes and Marcilla C√°psulas Gran Aroma, has helped the segment maintain or grow share in most major markets. In particular, growth in France, Spain, and Brazil demonstrates the success of focused investments behind premium
innovation in these countries. L'Or EspressO has sold in excess of 115 million pods since its launch in France in April 2010 and sales are now expanding to other countries (launched in the Netherlands in December). On Nov. 30, 2010, Sara Lee finalized the acquisition of Damasco, a coffee company in Brazil, which contributed $3 million to net sales in the quarter.

The international beverage segment increased net sales 2 percent in the second quarter to $899 million, while adjusted net sales grew 7 percent. Reported operating segment income declined 36 percent to $109 million and adjusted operating segment income declined 11 percent to $142 million. Unit volumes were down 2 percent and sales mix was up 3 percent, as high single-digit growth in single-serve, tea and instants, was offset by low single-digit declines in multiserve and coffee concentrates. In addition, adjusted sales growth was driven by pricing actions implemented to offset increases in green coffee costs. The decline in adjusted operating segment income is mostly attributed to significant commodity cost increases which have outpaced pricing actions.

For the second half of the fiscal year, the business expects to see further improvement in volume and sales mix and anticipates strong top-line growth, driven by the continued roll-out and geographic expansion of successful innovations launched in recent quarters. While the business will continue to increase prices, it does not expect to completely offset increases in commodity costs and adjusted operating segment income is expected to be down in fiscal 2011 as a result of higher commodity costs net of pricing, approximately $10 million of stranded overhead related to the Household & Body Care divestiture and a $30 million unrealized mark-to-market currency gain in fiscal 2010.

Results for the international bakery segment came in below expectations. Earlier restructuring actions continue to benefit the Spanish bakery business but performance is still impacted by difficult macro-economic and competitive conditions in Spain. The Spanish business is reducing costs, narrowing price gaps to private label and launching innovative new products. Meanwhile, the French refrigerated dough business continues to perform well, reporting volume and sales growth versus last year.

The segment reported a net sales decline of 12 percent to $185 million and an adjusted net sales decline of 7 percent.

Reported operating segment income was $5 million versus a loss of $1 million in the prior year period, while adjusted operating segment income declined to $5 million from $11 million in the prior year. The declines in net sales and operating segment income were mostly attributed to lower unit volumes, a net reduction in prices and an unfavorable shift in sales mix.

The segment expects strong performance from its refrigerated dough business in the second half of the year and expects adjusted operating segment income to be roughly flat in fiscal 2011, due to the continued challenges in the Spanish fresh bakery market.

The company reported $852 million in net sales from discontinued operations in the second quarter. Operating income from discontinued operations was $26 million in the second quarter. Adjusted operating income from discontinued operations was $67 million in the quarter.

The North American Fresh Bakery operations reported a net sales decline of 2 percent, on a reported and adjusted basis, to $487 million in the second quarter. Operating segment income was $2 million compared to $19 million in the comparable quarter. Adjusted operating segment income was $8 million versus $19 million in the prior year, despite an $11 million benefit from halting depreciation in fiscal 2011 following the reclassification of the segment to discontinued operations. The decline in operating segment income was driven by flat volumes and lower pricing. Prices increased versus the first quarter but still remain below prior-year levels. Input costs continue to rise in the category and the company is preparing further price increases in the back half of the year to offset additional cost increases.

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