Sara Lee Reports Strong Third Quarter Operating Result from Beverage Segments

Our strong third quarter operating results, highlighted by the performance of our North American Retail and International Beverage businesses, reflect the foundation we’ve built over the past five years and the real momentum we’ve developed.

7 May 2010 --- Sara Lee Corp. reported a strong increase in operating income for the third quarter of fiscal 2010, driven by higher operating segment income in four of its five ongoing business segments. In particular, the North American Retail and International Beverage segments reported impressive operating results. The discontinued International Household and Body Care businesses also performed very well in the quarter. On a reported basis, the double-digit operating income growth for both continuing and discontinued operations was more than offset by the impact of significant items, most notably a tax charge for repatriation to support share repurchases, resulting in a net loss for the third quarter. On an adjusted basis, however, diluted earnings per share were up significantly in the third quarter. Net sales were unchanged versus the year-ago period and cash from operations continued to show strong year-over-year improvement.

“Our strong third quarter operating results, highlighted by the performance of our North American Retail and International Beverage businesses, reflect the foundation we’ve built over the past five years and the real momentum we’ve developed,” said Sara Lee Corp. chairman and chief executive officer Brenda C. Barnes. “By improving our sales mix, increasing market share, launching and supporting successful new products worldwide and driving efficiencies through our Project Accelerate initiative, we have the ability to raise our guidance for the third consecutive quarter.”

“To further build on the success in our core businesses, we plan to make a significant investment in marketing behind key new product launches in the fourth quarter. As we look to the future, we remain well-positioned for success and expect adjusted operating income from continuing operations to increase in fiscal 2011. I’ve never been more confident in our ability to deliver sustained, high-quality growth and increased shareholder value,” Barnes concluded.

Financial Review

Net Sales and Unit Volumes

Net sales for the third quarter of fiscal 2010 were $2.6 billion, unchanged versus the year-ago period as favorable foreign currency exchange rates and positive sales mix were offset by lower unit volumes, decreased prices and the impact of divestitures. The company’s adjusted net sales decreased 2.5%. Total Sara Lee unit volumes decreased 4.5% in the third quarter; however, excluding the impact of the planned exits from commodity and kosher meats in the North American Retail segment, total unit volumes were down 1.2%. The North American Retail business saw strong unit volume performance in its core retail business in the quarter with volumes up 8.6%, primarily driven by strong performance for the Jimmy Dean and Hillshire Farm brands. The term “adjusted EPS” and other “adjusted” financial measures are explained and reconciled to each item’s most
comparable U.S. generally accepted accounting principles measure at the end of this release.

Operating Income

Sara Lee reported third quarter operating income of $228 million, up 10.5% compared to $207 million in the prior-year period. Adjusted operating income was $257 million in the third quarter, up $32 million or 14.1%. The improvement in adjusted operating income included a $62 million increase in total adjusted operating segment income for the combined continuing business segments, partially offset by $26 million of unfavorable mark-to-market variances on commodity derivatives and an increase in other general corporate expenses, excluding significant items, of $4 million.

Discontinued Operations

Net sales for the International Household and Body Care businesses, which are being reported as discontinued operations, were $525 million in the third quarter of fiscal 2010, compared to $454 million in the prior-year period, a 15.6% increase. The sales growth was primarily driven by strength in the insecticides, shoe care and body care core categories, as well as favorable foreign currency exchange rates. Adjusted net sales rose 5.3%. Operating segment income in the third quarter was $79 million, an increase of $20 million or 33.0% compared to the year-ago period. The increase was driven by higher net sales, positive manufacturing results and favorable foreign currency exchange rates, which were partially offset by higher media advertising and promotion (MAP) spending and other selling, general and administrative (SG&A) costs. Adjusted operating segment income was up 20.6% in the third quarter.

Operating income was $74 million in the third quarter, up $19 million or 33.5%, helped by a $13 million benefit due to the cessation of depreciation and amortization in compliance with U.S. GAAP rules. Discontinued operations reported a net loss of $367 million in the period, due to $442 million in income tax expense. The increase in tax expense was related to the deemed repatriation of overseas earnings, primarily attributable to the cash and book value of the International Household and Body Care businesses.

Earnings Per Share

During the third quarter, reported diluted EPS were impacted by a number of significant items, which reduced earnings by $547 million, or $0.79 per share. Included in these significant items, and as indicated in Sara Lee’s announcements of February 16 and March 2, 2010, was a charge of $518 million, or $0.75 per share, for taxes on the deemed repatriation of overseas earnings, primarily attributable to the cash and book value of the International Household and Body Care businesses. As a result, diluted EPS as reported were a loss of $(0.49) per diluted share in the third quarter compared to income of $0.24 per share in the year-ago period. Adjusted EPS were $0.29 in the third quarter, compared to $0.22 per share in the year-ago period, demonstrating ongoing strong underlying business performance for continuing and discontinued operations.

Cash from Operations

Net cash from operating activities was $335 million in the third quarter, compared to $89 million in the comparable period last year. The increase was primarily driven by higher operating income, better working capital management and lower cash contributions to pension plans versus the prior year.

Financial Highlights

- Project Accelerate is a company-wide cost saving and productivity initiative focused on outsourcing actions, supply chain efficiencies, SKU rationalization and organizational simplification. The company revisited its initial expectations for Project Accelerate costs and benefits in the fiscal 2009 – 2012 timeframe and excluded projects in discontinued operations. Focusing on Project Accelerate initiatives in continuing operations only, the company still expects annualized project benefits of $350 - $400 million by the end of fiscal 2012, and cumulative costs of $300+ million in that timeframe. In fiscal 2010, the project is expected to generate between $120 million and $140 million of incremental benefits, of which $89 million has already been realized in the first nine months of the year. In fiscal 2009, the benefits in continuing operations were $49 million.
- MAP spending increased 16.9% in the third quarter, primarily driven by an increase in spending at the North American Retail segment behind category-leading brands such as Jimmy Dean and Hillshire Farm, as well as in the North American Fresh Bakery segment in support of new product launches for the Sara Lee and EarthGrains brands.
- Net interest expense was $30 million in the third quarter, compared to $35 million in last year’s period, due to lower interest rates and less average debt outstanding.
- General corporate expense rose $51 million, from $14 million to $65 million, as a result of a $26 million unfavorable mark-to-market impact from commodity derivatives and a number of one-time items. These one-time items included a $15 million charge related to a tax indemnification, higher year-over-year charges related to the successful Project Accelerate and the year-over-year negative impact of nonrecurring prior-year gains.
- The effective tax rate for continuing operations in the third quarter was 87.1%, compared to 22.5% in the year-ago period, an increase primarily driven by the impact of significant items in the quarter. Excluding significant items, the effective tax rate would have been 29.9%.
- On February 16, 2010, Sara Lee announced a revised capital plan that focuses on share repurchase, dividend pay-out and the funded status of the company’s pension plans, while maintaining a solid investment grade credit profile. The company plans to buy back $2.5 to $3 billion of shares over a threeyear period, with approximately $1.0 to $1.3 billion of the shares anticipated to be repurchased in calendar year 2010. Sara Lee expects to maintain and gradually increase its current $0.44 per share annual dividend and also anticipates making an additional $200 million cash contribution to its pension plans. The company continues to evaluate the best opportunities for value creation and investment of cash, including potential acquisitions or other investments in the company’s growth.
- On March 2, 2010, the company announced that, as part of its share repurchase plan, it had executed an accelerated share repurchase program under which it repurchased $500 million, or approximately 36 million shares, of common stock. At the end of the third quarter, $2.5 billion remained authorized for share repurchase by the board of directors, in addition to the 13.5 million share authorization remaining under the prior program.

Business Performance Review

North American Retail

The North American Retail segment delivered another strong quarter, building on the past two years of improvements. Very strong operating segment income growth was accompanied by higher net sales, increased MAP spending and market share gains in almost every category, demonstrating the health of the business. The segment continues to focus on its three key brands – Hillshire Farm, Jimmy Dean and Ball Park – with new product introductions and effective marketing campaigns. In the fourth quarter, commodity headwinds and significant MAP investment in the base business behind consumer and shopper marketing campaigns, as well as trade spending to support seasonal promotions and distribution for new products, are expected to result in lower operating segment income. The reinvestment will help set the stage for another year of growth in fiscal 2011, in
spite of tough year-over-year comparisons in the first half and likely rising commodity costs.

Operating segment income was $101 million in the third quarter, compared to $64 million in the year-ago period, an increase of 60.0%. Adjusted operating segment income rose 47.9%. The increase in operating segment income was primarily driven by the strong performance of the segment’s core retail business, favorable supply chain performance, Project Accelerate savings and lower input costs, which were partially offset by higher brand support spending, primarily behind the Jimmy Dean and Hillshire Farm brands.

Unit volumes declined 4.0% in the third quarter due to significantly lower volumes for commodity meats, which the company is exiting, and the impact of the exit of the kosher meats business. Excluding these planned exits, unit volumes for the core retail business were up 8.6% in the third quarter, driven by an increase in the retail distribution of the segment’s best performing products, coupled with strong volume growth for Jimmy Dean breakfast sandwiches and sausage and Hillshire Farm lunchmeats, smoked sausage and cocktail sausage. Net sales of $672 million were up 4.1% in the quarter on a reported and adjusted basis, driven by a unit volume increase in the core branded business and favorable sales mix into higher-margin products, which were partially offset by the impact of trade spending and the earlier mentioned exits. The retail segment increased market share in ten of the twelve categories in which it competes, while maintaining its premium pricing positioning.

For instance, the Jimmy Dean brand increased its share of the frozen protein breakfast category by 3.5 points to 54.5% according to Information Resources, Inc. (IRI) share data, FDMx + Walmart, 12 weeks ending March 7, 2010. The Ball Park brand increased its leading share in hot dogs by 1.2 points to 21.5%, per the same IRI market share data. New product launches in the quarter included Hillshire Farm Ultra Thin Lower Sodium and Variety Pack lunchmeats and new varieties of Jimmy Dean breakfast sandwiches.

North American Fresh Bakery

Similar to the first half of fiscal 2010, the North American Fresh Bakery segment increased operating segment income and operating margin in the third quarter in a very competitive marketplace. While total unit volumes declined, branded volume rose as a result of pricing recalibration and the launch of new products, such as Sara Lee Soft & Smooth Plus bread made with Omega-3/DHA and EarthGrains 100% whole grain bread made with Eco-Grain. Preparing for the very important buns and rolls season, the segment continued to introduce new products, such as Sara Lee Soft & Smooth mini buns, Sara Lee Delightful hot dog buns and Sara Lee Hearty & Delicious ciabatta rolls, and will carefully manage its pricing.

Operating segment income was $6 million in the third quarter, compared to $2 million in the year-ago period. Adjusted operating segment income was $5 million, compared to $3 million in the prior-year quarter, resulting from lower commodity costs and a decrease in operating costs driven by Project Accelerate initiatives and other continuous improvement savings, partially offset by lower prices and higher MAP spending.

Net sales decreased 5.5% to $501 million in the third quarter of fiscal 2010, primarily due to lower unit volumes and lower prices, which was partially offset by favorable sales mix into branded business. Unit volumes decreased 2.5%, as higher unit volumes for branded breads could not fully offset volume weakness in private label bakery products as a result of intense price competition in the category.

North American Foodservice

At the beginning of the year, Sara Lee anticipated lower operating segment income for North American Foodservice in fiscal 2010. Helped by favorable commodities, sales mix improvements, new business with key customers and Project Accelerate savings, operating segment income is now anticipated to be up for the full year, even though the foodservice category is still very challenging.

The segment reported operating segment income of $26 million in the third quarter, compared to $25 million in the year-ago period. During the quarter, the segment booked $8 million in charges for exit activities and asset and business dispositions, which was partially offset by a $6 million pension curtailment gain. Adjusted operating segment income rose 16.2% to $28 million in the third quarter. The increase was primarily driven by improved sales mix, lower commodity costs, lower SG&A expense and savings from Project Accelerate and continuous improvement initiatives.

As communicated in the second quarter earnings release, earlier this fiscal year the segment lost a large bakery contract, which contributed 15% of the segment’s volume and 4% of its net sales, but had virtually no profit. The loss started to impact foodservice unit volumes in the third quarter and will continue to do so in the next three quarters. However, the discontinuation of this business will be accretive to the segment’s operating margin. In the third quarter, the segment lost a liquid coffee concentrate account that generated little volume, but meaningful profit. This will impact the segment’s year-over-year comparisons starting in the first quarter of fiscal 2011.

Net sales decreased 12.4% to $427 million in the third quarter of fiscal 2010, primarily due to the divestiture of the direct store delivery (DSD) foodservice coffee business in February 2009, as well as lower unit volumes and lower pricing, which were partially offset by favorable sales mix. Adjusted net sales, which exclude the impact of the dispositions, decreased 6.3%. The loss of the high-volume, low-margin bakery contract mentioned above, the planned exit of low-margin meats business and demand weakness in other parts of the business, resulted in 13.7% lower unit volumes in the third quarter.

International Beverage

The International Beverage segment continues to invest in new markets and product innovation, without losing focus on its bottom-line. Operating segment income increased significantly in the third quarter, resulting in historically high operating margins for the segment. Unit volumes decreased marginally in the period, primarily due to softness in some European retail markets, which the business plans to address through trade and MAP spending initiatives in the fourth quarter and beyond. The International Beverage segment is expected to deliver a very strong fiscal 2010 and behind a significant increase in marketing investment is confident that business momentum will continue in fiscal 2011.

Reported operating segment income was $173 million, up 31.8% from $131 million in the third quarter of fiscal 2009. The increase was primarily driven by continuous improvement and Project Accelerate savings, lower green coffee prices and favorable foreign currency exchange rates. Adjusted operating segment income rose 19.7%. Both reported and adjusted operating segment income also benefited from a $9 million favorable foreign exchange variance in the quarter, largely from mark-to-market currency impacts related to the purchase of raw materials.

Net sales increased 7.8% to $799 million in the third quarter, driven by favorable foreign currency exchange rates. Adjusted net sales were down 3.3%. Unit volumes decreased 1.9% in the quarter, as continued volume strength in Brazil, instant coffee and foodservice coffee concentrates, was more than offset by lower volumes in retail coffee in Europe due to slight market contraction in some key markets, as well as competition from private label coffee.

At the beginning of the fourth quarter, the International Beverage segment launched an exciting addition to its successful single-serve coffee portfolio in France: L’OR Espresso, an espresso capsule that is compatible with coffee appliances from Nespresso− which is a registered trademark of Sociéte des Produits Nestlé S.A., a company not associated with Sara Lee. L’OR Espresso capsules come in four varieties that differ in intensity, smoothness and roundness. All varieties are made with 100% Arabica coffee and are fully UTZ-certified, guaranteeing that the coffee was grown and harvested in a socially and environmentally sustainable way.

International Bakery

The International Bakery segment continues to face macro-economic and competitive headwinds in its core Spanish market and has implemented numerous actions to deliver bottom-line improvement moving forward. While unit volumes are still under pressure from private label competition in Spain, the business model has been significantly improved over the past few years through cost reductions, restructuring and right-sizing of the manufacturing footprint. During the fiscal year, Sara Lee sold several bakeries to a third-party manufacturer, which helped improve the segment’s plant utilization rates and reduce its cost per unit. These actions have helped mitigate the impact of lower unit volumes on profitability. Going forward, the segment has a much improved foundation in its Spanish business to grow upon, while it also expects to benefit from strong
performance of its European refrigerated dough and Australian frozen bakery businesses.

The segment reported an operating segment loss of $1 million in the third quarter compared to income of $11 million in the year-ago period, a decrease primarily resulting from charges for exit activities, asset and business dispositions associated with the sale of two bakeries in Spain. Adjusted operating segment income was $9 million, compared to $13 million in the prior-year quarter, largely due to reduced prices and slightly lower unit volumes, partially offset by lower commodity costs and Project Accelerate and continuous improvementsavings.

Net sales increased 4.0% to $186 million in the third quarter, driven by favorable foreign currency exchange rates, partially offset by lower prices, unfavorable sales mix and a slight decline in unit volumes. Adjusted net sales decreased 5.0%. Strong volumes in the European refrigerated dough business, driven by growth in France, Italy and Scandinavia, could not fully offset volume weakness in Spain, resulting in 0.9% lower unit volumes for the segment. The Spanish fresh bakery business has planned various new product launches for the next few months to help improve its top-line trends.