Sara Lee: Reports First Quarter 2011 Earnings

Downers Grove / IL. (slc) Sara Lee Corporation reported lower operating income and diluted earnings per share from continuing operations for the first quarter of fiscal 2011, primarily due to higher commodity costs net of pricing, increased marketing spending and receipt of the final installment of contingent sale proceeds in the year-ago quarter. First quarter results compare to a strong year-ago period, when decreasing commodity costs provided a significant benefit to the company. Net sales from continuing operations were slightly down for the quarter on a reported basis, primarily due to the weaker Euro, as adjusted net sales were up driven by strength in the company´s two growth businesses, North American Retail and International Beverage.

The company also announced that it has agreed to sell its North American Fresh Bakery business to Grupo Bimbo S.A.B. de C.V. for 959 million USD. The proposed deal, which is subject to customary closing conditions and regulatory clearances, is anticipated to close in the first half of calendar year 2011. The combination of Sara Lee´s North American Fresh Bakery business with Bimbo Bakeries USA creates a leading national fresh bakery company in the United States. For additional information on the divestiture of the North American Fresh Bakery business, please see the separate news release that is posted on Sara Lee´s website.

«The sale of the North American Fresh Bakery business will allow us to aggressively invest in our core protein and coffee businesses. In both categories, we are a leading player, with healthy margins and a strong track record of innovation. We are actively pursuing growth here, organically and through acquisitions», said Sara Lee Corporation interim chief executive officer Marcel Smits.

«As anticipated, our first quarter operating income came in below the prior-year period. We see our price increases coming through across the board, but in the first quarter they still lagged sharply increasing commodity prices. We are confident that the additional price increases we have announced will mitigate commodity inflation for the full year. We also continue to execute against our capital plans with further share repurchases and the successful refinancing of 800 million USD of debt at an attractive rate in the first quarter».

«We are confident that the full year will reflect an acceleration of growth in our top-line and a further bottom-line improvement in our business, building on the past several strong years», Smits concluded.

First Quarter Review

Net Sales and Unit Volumes: Net sales for the first quarter of fiscal 2011 were 2,6 billion USD, down 0,5 percent versus the year-ago period as a favourable shift in sales mix and higher prices were offset by lower unit volumes and unfavourable foreign currencyexchange rates. The company´s adjusted net sales rose 1,5 percent in the quarter. This increase was driven by strong adjusted net sales growth in the North American Retail (sales up 7,3 percent, volume up 4,4 percent, mix up 1,3 percent) and International Beverage segments (sales up 4,6 percent, volume up 1,7 percent, mix down 0,3 percent). The North American Fresh Bakery and International Bakery segments saw sales and volume decline, while North American Food Service was impacted by the loss of a high volume, low margin food service bakery contract in the third quarter of last year. Overall, total Sara Lee unit volumes decreased 2,0 percent in the first quarter of fiscal 2011, while sales mix improved 2,0 percent.

Operating Income: In the first quarter of fiscal 2011, operating income was 169 million USD, compared to 326 million USD in the year-agoperiod, a decrease of 48,1 percent, primarily resulting from no longer receiving 95 million EUR (133 million USD in the year-ago period) in contingent sale proceeds in the first quarter, as well as lower operating segment income. Adjusted operating income was 179 million USD, compared to 209 million USD in the first quarter of fiscal 2010, a decrease of 30 million USD, or 14,4 percent, despite a 28 million USD decline in general corporate expenses, 17 million USD of favourable mark-to-market variances on unrealized commodity derivatives and a favourable sales mix shift. These positive factors could not fully offset the negative impact of 62 million USD of higher commodity costs net of pricing and 13 million USD of higher media advertising and promotion (MAP) investment. Operating income from discontinued operations was 58 million USD in the first quarter, down seven million USD, or 10,3 percent, versus the year-ago period, entirely due to the impact of dispositions. Adjusted operating income from discontinued operations was 69 million USD in the quarter, up 17 million USD, or 35,5 percent. At the net income level, discontinued operations reported income of 126 million USD in the first quarter versus 96 million USD in the year-ago period, driven by an 89 million USD net gain on the divestiture of the air care business, partially offset by 52 million USD of higher income tax expense.

Earnings Per Share: Diluted EPS as reported were 0,29 USD in the first quarter of fiscal 2011, compared to 0,41 USD per share in the year-ago period. Adjusted EPS were 0,21 USD in the first quarter, compared to 0,23 USD per share in the year-ago quarter.

Cash from Operations: Net cash from operating activities was 28 million USD in the first quarter of fiscal 2011, compared to 187 million USD in the prior year period. The decrease was primarily due to lower operating income, higher cash taxes and higher cash contributions to its pension plans. The first quarter cash from operations reflects seasonality in working capital outflow in line with the year-ago period, despite higher commodity prices that impacted inventory levels in the quarter. Sara Lee is targeting a substantial decrease in average working capital in the fiscal 2010 to 2013 timeframe. Various components of the working capital reduction program are being implemented and results are in line with expectations.

Financial and Business Highlights

• MAP spending increased 13 million USD, or 18 percent, in the first quarter of fiscal 2011, driven by an increase in spending at the North American Retail and International Beverage segments. The North American Retail segment invested primarily behind two of its core retail brands, Hillshire Farm and Jimmy Dean, for the latter partly in support of the new Jimmy D´s product line. The International Beverage segment supported important new products, such as L´OR Espresso in France and Douwe Egberts Aromettes in Belgium, and invested behind the Café Pilão brand in Brazil.
• In the first quarter, commodity costs (excluding commodity mark-to-market), increased by about 90 million USD, which included 31 million USD of currency mark-to-market losses related to the purchase of commodities in the International Beverage segment. The 90 million USD commodity cost increase was partially offset by approximately 28 million USD in higher prices, resulting in a net unfavourable commodity cost impact of about 62 million USD in the first quarter.
• Net interest expense was 30 million USD in the first quarter, compared to 29 million USD in the year-ago period. In the quarter, the company successfully issued two 400 million USD bonds with a blended interest rate of 3,4 percent. The bonds were issued to help refinance Sara Lee´s 6,25 percent notes, which were due on September 15, 2011. The lower interest rate on the new bonds will reduce annual interest cost by approximately twenty million USD. The company incurred thirty million USD of debt extinguishment costs in the first quarter related to the early redemption of the 6,25 percent notes and expects another 25 million USD of debt extinguishment costs in the second quarter.
• General corporate expenses were 25 million USD in the first quarter compared to 55 million USD in the year-ago period; a decrease of thirty million USD. Excluding significant items, general corporate expenses decreased 28 million USD in the quarter, from 49 million USD to 21 million USD, primarily driven by lower IT costs, lower employee benefit costs and several smaller items. For the full year, general corporate expenses excluding significant items are expected to decrease about 50 million USD versus fiscal 2010.
• Mark-to-market gains from unrealized commodity derivatives amounted to 14 million USD in the first quarter; an improvement of 17 million USD compared to losses of three million USD in the year-ago period.
• The effective tax rate for continuing operations in the first quarter, on an as reported basis, was 37,1 percent, compared to 35,5 percent in the year-ago quarter. The year-over-year increase in the tax rate was due to impact of the receipt of the final installment of tax-free contingent sale proceeds in the year-ago quarter and the impact of various discrete tax items in the current quarter, which are not material individually or in the aggregate. Sara Lee expects that the tax rate for continuing operations, excluding significant items, will be between 33 percent and 35 percent for fiscal 2011.
• Project Accelerate is a company-wide cost savings and productivity initiative focused on outsourcing actions, supply chain efficiencies and organizational simplification. The company expects annualized project benefits in continuing operations of 350 to 400 million USD by the end of fiscal 2012, and cumulative costs of 300+ million USD in the fiscal 2009 to 2012 timeframe. In the first quarter of fiscal 2011, the project generated 29 million USD of additional benefits in continuing operations. The company expects cumulative project benefits of 270 to 290 million USD in fiscal 2011, compared to 180 million USD of cumulative savings at the end of fiscal 2010. The company expects Project Accelerate costs in fiscal 2011 to be approximately 30 to 50 million USD; Project Accelerate costs were ten million USD in the first quarter.
• Progress toward divesting the international household and body care businesses continues. In the first quarter, the company closed on the majority of the air care business being sold to Procter + Gamble and received 355 million USD of the total proceeds to be received on the sale. The company is working on the close of the proposed transactions of the global body care business to Unilever for 1’275 million EUR and the non-Indian insecticides business to SC Johnson for 153,5 million EUR. Both proposed transactions are expected to close in calendar year 2010, and are subject to customary closing conditions and regulatory clearances. Sara Lee is confident it will beable to successfully divest the remaining household businesses, primarily its global shoe care and Asian cleaning businesses, based on interest from various parties.

Capital Plan Initiatives

Sara Lee is in the process of executing a balanced capital plan that focuses on share repurchases, 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 3,0 billion USD of shares over a three-year period. As a result of the divestiture of the North American Fresh Bakery business announced this week, Sara Lee plans to accelerate its share repurchase program; the company now expects to complete the program by the end of fiscal 2012 (July 2012). 500 million USD of the share repurchase was executed in fiscal 2010 and the expectation is to repurchase another 1,0 to 1,5 billion USD in fiscal 2011. In the first quarter of fiscal 2011, Sara Lee bought back approximately 24 million USD shares of common stock in the open market. The total cost for share repurchases in the first quarter was 373 million USD. Outstanding board authorizations for buybacks are 2,1 billion USD in addition to a 13,5 million USD share authorization remaining under a prior program.
• On October 28, Sara Lee announced that it increased its quarterly dividend by 4,5 percent to 0,115 USD per common share, payable on December 31, 2010, resulting in an annualized dividend of 0,46 USD per share. No change in Sara Lee´s dividend amount is expected as a result of the divestiture of the North American Fresh Bakery business.
• 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.

CEO Position

Sara Lee´s board is in the process of selecting a new chief executive officer, to replace Brenda C. Barnes who stepped down for health reasons on August 09. The board is considering both internal and external candidates for the CEO position. Pending the appointment of a permanent CEO, Marcel Smits acts as the interim chief executive officer, Mark Garvey as the interim chief financial officer and James S. Crown, an independent director, as the chairman of the board. Mr. Crown leads the Office of the Chairman, comprised of Crown, Smits and CJ Fraleigh, chief executive officer Sara Lee North America.

Business Performance Review

North American Fresh Bakery: The segment´s first quarter bottom-line results were impacted by lower prices and decreased unit volumes. However, unit volumes for Sara Lee branded fresh bakery products were up, resulting in a favourable sales mixshift (up 1,0 percent) for the segment in the quarter. Branded volumes increased following price recalibration actions in the second half of fiscal 2010 and were helped by the successful reformulation of certain top-selling Sara Lee brand breads. The segment also improved its total branded fresh bakery share by 0,7 points to 9,6 percent (IRI sharedata, volume share, FDMx, twelve weeks, ending September 19, 2010).

Private label volume was down in the first quarter, but is expected to improve going forward on the back of new business bids won. Overall, unit volume in the first quarter was down 2,4 percent compared to the prior year. It should be noted that the majority of the volume decline is attributable to the timing of the 04th of July holiday, as the ‘sellin’ week for the holiday fell in the fourth quarter of fiscal 2010. Net sales decreased 4,6 percent to 516 million USD in the first quarter, on a reported and adjusted basis, primarily due to lower unit volumes and lower prices, partially offset by favourable sales mix into branded business.

The segment reported an operating loss of one million USD in the first quarter, compared to income of 14 million USD in the year-ago period, a decrease primarily due to lower prices and volumes. These factors were partially offset by lower commodity costs and a decrease in operating costs driven by Project Accelerate initiatives and other continuous improvement savings. The adjusted operating segment income in the first quarter was nil versus 22 million USD of income in the year-ago period.

North American Food Service: The North American Food Service segment reported lower top- and bottom-line results for the first quarter of fiscal 2011, compared to a very strong year-ago period. As communicated previously, the segment lost two accounts in the second half of fiscal 2010. The first was a high volume, but low margin bakery contract, which will impact unit volumes in the first half of fiscal 2011. The second was a low volume, but high margin liquid coffee concentrate contract, which will impact the segment´s year-over-year comparisons for most of fiscal 2011.

The food service segment reported operating segment income of 29 million USD in the first quarter compared to 38 million USD in the year-ago period, a 23,2 percent decrease primarily due to the loss of the above mentioned liquid coffee concentrate contract, market-driven demand weakness and higher commodity costs. These impacts were partially offset by higher prices, growth with key customers, savings from Project Accelerate and continuous improvement initiatives and a favourable sales mix shift (up 10,6 percent). Adjusted operating segment income decreased by seven million USD, or 20,1 percent, to 31 million USD in the first quarter.

Net sales decreased 2,6 percent to 445 million USD on a reported basis and 2,7 percent on an adjusted basis in the first quarter, primarily driven by significantly lower unit volumes, which was partially offset by the favourable sales mix shift and higher prices. The loss of the two large contracts in fiscal 2010, as well as ongoing market driven demand weakness, resulted in 17,6 percent lower unit volumes in the quarter.

While food service industry trends are expected to remain challenging for the foreseeable future, the business segment anticipates having another year of bottom-line improvement in fiscal 2011 behind new business with keycustomers, the impact of strategic pricing actions, favourable sales mix and further improvements in its cost structure.

International Bakery: The International Bakery segment is still facing macro-economic and competitive headwinds in its core Spanish fresh bakery market. In this market, while unit volumes were still under pressure from private label competition, the business continued to work diligently on improving its cost structure and introduced various value-added new products. The French refrigerated dough business continued to perform well in the first quarter of fiscal 2011.

The segment reported operating segment income of eight million USD in the first quarter, up from six million USD in the year-ago period. Adjusted operating segment income was eight million USD, compared to twelve million USD in the prior-year quarter, or down 27,4 percent, largely due to reduced prices and lower unit volumes, partially offset by Project Accelerate and continuous improvement savings.

Net sales decreased 9,0 percent to 186 million USD in the quarter, due to lower prices, unfavourable foreign currency exchange rates, lower unit volumes and a slightly unfavourable sales mix (down 0,1 percent). Adjusted net sales decreased 2,8 percent. Unit volumes declined 3,7 percent as strong volumes for refrigerated dough products in France and strong export volume to Italy and Scandinavia, could not fully offset volume weakness in the Spanish bakery business.

Although the segment expects to benefit from the strong performance of its European refrigerated dough and Australian frozen bakery businesses, due to the still challenging Spanish fresh bakery market, adjusted operating segment income is expected to be flat in fiscal 2011.

Info: Sara Lee Reports First Quarter Earnings and Announces Divestiture of North American Fresh Bakery Business to Grupo Bimbo; press release (PDF, 24 pages).