Edgar Filing: LEE SARA CORP

Form 10-Q

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 April 1, 2006

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 1-3344

Sara Lee Corporation

(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.)

Three First National Plaza, Suite 4600, Chicago, Illinois 60602-4260

(Address of principal executive offices)

(Zip Code)

(312) 726-2600

(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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨

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 April 1, 2006, the registrant had 760,135,535 outstanding shares of common stock $.01 par value, which is the registrant’s only class of common stock.

SARA LEE CORPORATION AND SUBSIDIARIES

INDEX


PART I –

	ITEM 1 – FINANCIAL STATEMENTS
		Preface	3

		Condensed Consolidated Balance Sheets - At April 1, 2006 and July 2, 2005	4

		Consolidated Statements of Income - For the thirteen and thirty-nine weeks ended April 1, 2006 and April 2, 2005	5

		Consolidated Statements of Common Stockholders’ Equity - For the period July 3, 2004 to April 1, 2006	6

		Consolidated Statements of Cash Flows - For the thirty-nine weeks ended April 1, 2006 and April 2, 2005	7

		Notes to Consolidated Financial Statements	8

	ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION		28

	ITEM 4 – CONTROLS AND PROCEDURES		76

PART II –

	ITEM 1 - LEGAL PROCEEDINGS		77
	ITEM 1A - RISK FACTORS		78
	ITEM 2(c) - REPURCHASES OF EQUITY SECURITIES BY THE ISSUER		79
	ITEM 6 - EXHIBITS		79
	SIGNATURE		80

PART I

SARA LEE CORPORATION AND SUBSIDIARIES

Preface

The preparation of the Consolidated Financial Statements requires management to make use of estimates and assumptions that affect the reported amount of assets and liabilities, revenue and expenses and certain financial statement disclosures. Significant estimates in these Consolidated Financial Statements include allowances for doubtful accounts receivable, net realizable value of inventories, the cost of sales incentives, useful lives of property and identifiable intangible assets, the evaluation of impairments of property, identifiable intangible assets and goodwill, income tax and valuation reserves, the valuation of assets and liabilities acquired in business combinations, assumptions used in the determination of the funded status and annual expense of pension and postretirement employee benefit plans and the volatility, expected lives and forfeiture rates for stock compensation instruments granted to employees. Actual results could differ from these estimates.

The Consolidated Financial Statements for the thirteen and thirty-nine weeks ended April 1, 2006 and April 2, 2005 and the balance sheets as of April 1, 2006 and July 2, 2005 included herein have not been audited by an independent registered public accounting firm, but in the opinion of Sara Lee Corporation (“the corporation”), all adjustments (which include only normal recurring adjustments) necessary to make a fair statement of the financial position at April 1, 2006 and the results of operations and the cash flows for the periods presented herein have been made. The Condensed Consolidated Balance Sheet as of July 2, 2005 and the Consolidated Statement of Common Stockholders’ Equity for the period July 3, 2004 to July 2, 2005 have been derived from the corporation’s audited financial statements included in our annual report on Form 10-K for the fiscal year ended July 2, 2005. The results of operations for the thirteen and thirty-nine weeks ended April 1, 2006 are not necessarily indicative of the operating results to be expected for the full fiscal year.

The Consolidated Financial Statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Although the corporation believes the disclosures made are adequate to make the information presented not misleading, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These unaudited consolidated financial statements should be read in conjunction with the audited Consolidated Financial Statements and notes thereto included in the corporation’s Form 10-K for the year ended July 2, 2005 and other financial information filed with the Securities and Exchange Commission.

SARA LEE CORPORATION AND SUBSIDIARIES

Condensed Consolidated Balance Sheets at April 1, 2006 and July 2, 2005

(In millions)

Unaudited


	April 1, 2006		July 2, 2005
ASSETS
Cash and equivalents	$	1,972	$	533
Trade accounts receivable, less allowances		1,609		1,662
Inventories:
Finished goods		372		340
Work in process		226		218
Materials and supplies		1,589		1,593

		2,187		2,151
Other current assets		308		298
Assets of discontinued operations held for sale		461		1,172

Total current assets		6,537		5,816

Other non-current assets		170		117
Deferred tax asset		431		347
Property, net		2,813		2,836
Trademarks and other identifiable intangibles, net		1,336		1,395
Goodwill		3,067		3,018
Assets of discontinued operations held for sale		390		938

	$	14,744	$	14,467

LIABILITIES AND STOCKHOLDERS’ EQUITY
Notes payable	$	1,595	$	239
Accounts payable		1,107		1,115
Accrued liabilities		2,475		2,367
Current maturities of long-term debt		560		380
Liabilities of discontinued operations held for sale		413		916

Total current liabilities		6,150		5,017

Long-term debt		3,765		4,112
Pension obligation		858		858
Other liabilities		1,341		1,318
Liabilities of discontinued operations held for sale		56		163
Minority interests in subsidiaries		71		61
Common stockholders’ equity		2,503		2,938

	$	14,744	$	14,467

See accompanying Notes to Consolidated Financial Statements.

SARA LEE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income

For the Thirteen and Thirty-nine Weeks Ended April 1, 2006 and April 2, 2005

(In millions, except per share data)

Unaudited


	Thirteen Weeks Ended						Thirty-nine Weeks Ended
	April 1, 2006			April 2, 2005			April 1, 2006			April 2, 2005
Net sales	$	3,789		$	3,844		$	11,844		$	12,003

Cost of sales		2,383			2,416			7,461			7,513
Selling, general and administrative expenses		1,163			1,146			3,583			3,522
Charges for (income from) exit activities and business dispositions		(11	)		(16	)		43			(32	)
Contingent sale proceeds		—			—			(114	)		(117	)
Interest expense		76			76			226			213
Interest income		(19	)		(26	)		(58	)		(75	)

		3,592			3,596			11,141			11,024

Income from continuing operations before income taxes		197			248			703			979
Income taxes		60			97			182			213

Income from continuing operations		137			151			521			766

Discontinued operations
Net (loss) income from discontinued operations, net of tax		(162	)		38			(256	)		101

Gain on sale of discontinued operations, net of tax		67			—			282			—

Net income	$	42		$	189		$	547		$	867

Income from continuing operations per common share
Basic	$	0.18		$	0.19		$	0.68		$	0.97

Diluted	$	0.18		$	0.19		$	0.68		$	0.96

Net income per common share
Basic	$	0.06		$	0.24		$	0.71		$	1.10

Diluted	$	0.06		$	0.24		$	0.71		$	1.09

Average shares outstanding
Basic		761			791			768			790

Diluted		765			797			770			796

Cash dividends per common share	$	0.1975		$	0.1975		$	0.5925		$	0.5825

See accompanying Notes to Consolidated Financial Statements.

SARA LEE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Common Stockholders’ Equity

For the Period July 3, 2004 to April 1, 2006

(In millions, except per share data)


	TOTAL			COMMON STOCK		CAPITAL SURPLUS			RETAINED EARNINGS			UNEARNED STOCK			ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)			COMPREHENSIVE INCOME (LOSS)
Balances at July 3, 2004	$	2,985		$	8	$	104		$	4,437		$	(170	)	$	(1,394	)
Net income		867			—		—			867			—			—		$	867
Translation adjustments, net of tax		279			—		—			—			—			279			279
Net unrealized gain / (loss) on qualifying cash flow hedges, net of tax		(38	)		—		—			—			—			(38	)		(38	)

Comprehensive income																		$	1,108

Cash dividends - Common ($0.5825 per share)		(459	)		—		—			(459	)		—			—
Stock issuances (cancelations) -
Stock option and benefit plans		150			—		150			—			—			—
Restricted stock		33			—		33			—			—			—
Tax benefit related to stock-based compensation		5			—		5			—			—			—
Share repurchases and retirement		(346	)		—		(207	)		(139	)		—			—
ESOP contributions and other		9			—		3			—			6			—

Balances at April 2, 2005		3,485			8		88			4,706			(164	)		(1,153	)

Net income		(148	)		—		—			(148	)		—			—		$	(148	)
Translation adjustments, net of tax		(217	)		—		—			—			—			(217	)		(217	)
Minimum pension liability, net of tax		(70	)		—		—			—			—			(70	)		(70	)
Net unrealized gain / (loss) on qualifying cash flow hedges, net of tax		38			—		—			—			—			38			38

Comprehensive income (loss)																		$	(397	)

Cash dividends - Common ($0.1975 per share)		(155	)		—		—			(155	)		—			—
Stock issuances (cancelations) -
Stock option and benefit plans		11			—		11			—			—			—
Restricted stock		24			—		24			—			—			—
Tax benefit related to stock-based compensation		5			—		5			—			—			—
Share repurchases and retirement		(51	)		—		(51	)		—			—			—
ESOP contributions and other		16			—		2			5			9			—

Balances at July 2, 2005		2,938			8		79			4,408			(155	)		(1,402	)
Net income		547			—		—			547			—			—		$	547
Translation adjustments, net of tax		(15	)		—		—			—			—			(15	)		(15	)
Net unrealized gain / (loss) on qualifying cash flow hedges, net of tax		(31	)		—		—			—			—			(31	)		(31	)

Comprehensive income																		$	501

Cash dividends-Common ($0.5925 per share)		(454	)		—		—			(454	)		—			—
Stock issuances (cancelations) -
Stock option and benefit plans		28			—		28			—			—			—
Restricted stock		45			—		45			—			—			—
Tax benefit related to stock-based compensation		1			—		1			—			—			—
Share repurchases and retirement		(561	)		—		(107	)		(454	)		—			—
ESOP contributions and other		5			—		(1	)		—			6			—

Balances at April 1, 2006	$	2,503		$	8	$	45		$	4,047		$	(149	)	$	(1,448	)

Interim period balances are unaudited.

See accompanying Notes to Consolidated Financial Statements.

SARA LEE CORPORATION AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the Thirty-nine Weeks Ended April 1, 2006 and April 2, 2005

(In millions)

Unaudited


	Thirty-nine Weeks Ended
	April 1, 2006			April 2, 2005
OPERATING ACTIVITIES -
Net Income	$	547		$	867
Less: Cash received from contingent sale proceeds		(114	)		(117	)
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation		394			414
Amortization of intangibles		118			140
Impairment charges		394			—
Gain on business dispositions		(428	)		(57	)
Decrease in deferred income taxes		(107	)		(36	)
Other		(5	)		38
Changes in current assets and liabilities, net of businesses acquired and sold		27			(199	)

Net cash from operating activities		826			1,050

INVESTMENT ACTIVITIES -
Purchases of property and equipment		(367	)		(347	)
Acquisitions of businesses, net of cash acquired		(76	)		—
Dispositions of businesses and investments		672			72
Cash received from contingent sale proceeds		114			117
Sales of assets		78			67

Net cash from (used in) investment activities		421			(91	)

FINANCING ACTIVITIES -
Issuances of common stock		22			150
Purchases of common stock		(562	)		(345	)
Borrowings of long-term debt		35			338
Repayments of long-term debt		(243	)		(983	)
Short-term borrowings, net		1,344			158
Cash received from loans receivable		33			—
Payments of dividends		(459	)		(458	)

Net cash from (used in) financing activities		170			(1,140	)

Effect of changes in foreign exchange rates on cash		17			142

Increase in cash and equivalents during the period		1,434			(39	)
Cash and equivalents at beginning of year		533			634
Discontinued operations cash activity included above:
Add cash balance of discontinued operations at beginning of period		37			34
Less cash balance of discontinued operations at end of period		(32	)		(46	)

Cash and equivalents at end of quarter	$	1,972		$	583

COMPONENTS OF CHANGES IN CURRENT ASSETS AND LIABILITIES:
Decrease (increase) in trade accounts receivable	$	79		$	(24	)
Decrease in inventories		47			27
(Increase) decrease in other current assets		(72	)		1
Decrease in accounts payable		(131	)		(121	)
Increase (decrease) in accrued liabilities		104			(82	)

Changes in current assets and liabilities, net of businesses acquired and sold	$	27		$	(199	)

See accompanying Notes to Consolidated Financial Statements.

SARA LEE CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements

1. Net Income Per Share

Net income per share – basic is computed by dividing income available to common stockholders by the weighted average number of shares of common stock outstanding for the period. Net income per share – diluted reflects the potential dilution that could occur if options or other contracts to issue common stock were exercised or converted into common stock. For the thirteen and thirty-nine week periods ended April 1, 2006, options to purchase 48.1 million and 44.8 million shares of the corporation’s common stock had exercise prices that were greater than the average market price of those shares during the respective reporting periods. For the thirteen and thirty-nine week periods ended April 2, 2005, options to purchase 19.2 million and 19.5 million shares of the corporation’s common stock had exercise prices that were greater than the average market price of those shares during the respective reporting periods. As a result, these shares are excluded from the earnings per share calculation, as they are anti-dilutive.

The average shares outstanding declined in the first nine months of fiscal 2006 as a result of shares repurchased under the corporation’s ongoing share repurchase program. The corporation repurchases common stock at times management deems appropriate, given current market valuations. On August 1, 2005, the corporation’s Board of Directors authorized the repurchase of an additional 100 million shares of common stock. As a result of this action, the total number of shares authorized for repurchase increased to 116 million. At a $17 per share price, the authorization is equivalent to approximately $2 billion. During the first nine months of fiscal 2006, the corporation repurchased 30.1 million shares of common stock for a purchase price of $562 million. Of this total, 21.9 million shares were purchased for $400 million under an accelerated share repurchase program. The total purchase price was based upon the average daily share price over a period of approximately 5 months. The accelerated share repurchase program concluded during the third quarter of fiscal 2006 and the final purchase price settlement resulted in approximately 1.0 million shares of common stock delivered to the corporation at that time. No cash was paid or received by the corporation as part of the final settlement of the accelerated share repurchase program. At April 1, 2006, the corporation had approximately 86.2 million shares remaining on its existing share repurchase authorization.

The following is a reconciliation of net income to net income per share – basic and diluted for the thirteen and thirty-nine weeks ended April 1, 2006 and April 2, 2005:

Computation of Net Income per Common Share

(In millions, except per share data)


	Thirteen Weeks Ended					Thirty-nine Weeks Ended
	April 1, 2006			April 2, 2005		April 1, 2006		April 2, 2005
Income from continuing operations	$	137		$	151	$	521	$	766
Net (loss) income from discontinued operations		(95	)		38		26		101

Net income	$	42		$	189	$	547	$	867

Average shares outstanding – basic		761			791		768		790
Dilutive effect of stock option and award plans		4			6		2		6

Diluted shares outstanding		765			797		770		796

Income from continuing operations per share
Basic	$	0.18		$	0.19	$	0.68	$	0.97

Diluted	$	0.18		$	0.19	$	0.68	$	0.96

(Loss) income from discontinued operations per common share
Basic	$	(0.12	)	$	0.05	$	0.03	$	0.13

Diluted	$	(0.12	)	$	0.05	$	0.03	$	0.13

Net income per common share
Basic	$	0.06		$	0.24	$	0.71	$	1.10

Diluted	$	0.06		$	0.24	$	0.71	$	1.09

2. Segment Information

Effective in the first quarter of fiscal 2006, the corporation reorganized its business operations around distinct consumers, customers and geographic markets in order to build functional excellence, increase strategic focus and simplify the organization. These changes resulted in the corporation modifying its reportable business segments and historical results have been restated to present segment financial information on a comparable basis.

During the third quarter of fiscal 2006, the corporation began reporting its European Meats and U.S. Meat Snacks businesses as discontinued operations. In the second quarter of fiscal 2006, the European Meats business was reported as a separate segment and the U.S. Meat Snacks business was reported as part of the Foodservice segment. In fiscal 2005, both of these businesses were reported as part of a globally managed Meats business. See Note 4, titled “Discontinued Operations”, in these Consolidated Financial Statements, and Management’s Discussion and Analysis for further information on these operations.

The following is a general description of the corporation’s seven business segments:

•

North American Retail Meats – sells a variety of packaged meat products to retail customers in North America.

•

North American Retail Bakery – sells a variety of bakery products to retail customers in North America and includes the corporation’s U.S. Senseo retail coffee business.

•

Foodservice – sells meats, bakery and coffee products to four primary channels in North America – broad-line foodservice distributors, national restaurant chains, convenience stores and retail locations – providing on-the-go meal solutions.

•

International Beverage – sells coffee and tea products to retail and foodservice customers in major markets around the world, including Europe, Australia and Brazil.

•

International Bakery – sells a variety of bakery and dough products to retail and foodservice customers in Europe and Australia.

•

Household and Body Care – sells products in four primary categories – body care, air care, shoe care and insecticides.

•

Branded Apparel – sources, manufactures and markets basic branded apparel products under the categories of innerwear, outerwear and sheer hosiery in the Americas and Asia.

The following is a summary of sales and operating segment income by business segment for the thirteen and thirty-nine weeks ended April 1, 2006 and April 2, 2005.


	Thirteen Weeks Ended
	Net Sales						Income From Continuing Operations Before Income Taxes
(In millions)	April 1, 2006			April 2, 2005			April 1, 2006			April 2, 2005
North American Retail Meats	$	607		$	575		$	46		$	68
North American Retail Bakery		449			427			(3	)		(16	)
Foodservice		522			516			28			43
International Beverage		569			582			127			108
International Bakery		175			197			13			19
Household and Body Care		443			484			40			88
Branded Apparel		1,035			1,072			110			86

Total business segments		3,800			3,853			361			396
Intersegment sales		(11	)		(9	)		—			—

Total net sales and operating segment income, respectively		3,789			3,844			361			396
Amortization of intangibles		—			—			(18	)		(17	)
General corporate expenses		—			—			(89	)		(81	)

Total net sales and operating income, respectively		3,789			3,844			254			298
Net interest expense		—			—			(57	)		(50	)

Net sales and income from continuing operations before income taxes, respectively	$	3,789		$	3,844		$	197		$	248


	Thirty-nine Weeks Ended
	Net Sales						Income From Continuing Operations Before Income Taxes
(In millions)	April 1, 2006			April 2, 2005			April 1, 2006			April 2, 2005
North American Retail Meats	$	1,894		$	1,821		$	113		$	141
North American Retail Bakery		1,372			1,347			(23	)		(18	)
Foodservice		1,651			1,617			100			147
International Beverage		1,706			1,701			253			318
International Bakery		557			584			46			59
Household and Body Care		1,340			1,437			155			238
Branded Apparel		3,355			3,530			403			386

Total business segments		11,875			12,037			1,047			1,271
Intersegment sales		(31	)		(34	)		—			—

Total net sales and operating segment income, respectively		11,844			12,003			1,047			1,271
Amortization of intangibles		—			—			(51	)		(55	)
General corporate expenses		—			—			(239	)		(216	)
Contingent sale proceeds		—			—			114			117

Total net sales and operating income, respectively		11,844			12,003			871			1,117
Net interest expense		—			—			(168	)		(138	)

Net sales and income from continuing operations before income taxes, respectively	$	11,844		$	12,003		$	703		$	979

3. Impairment Charges

As part of its business transformation plan, the corporation indicated that it intended to dispose of certain businesses and assets. Actions were taken to execute this plan, and as a result, a number of impairment charges have been recognized. The following table sets out the charges recognized in fiscal 2006, all of which have been reported in the “Net (loss) income from discontinued operations, net of tax” line of the Consolidated Statement of Income.


	Third Quarter Fiscal 2006									Nine Months Fiscal 2006
(In millions)	Pretax Impairment Charge			Tax Benefit			After-tax Charge			Pretax Impairment Charge			Tax Benefit		After-tax Charge
European Meats	$	(125	)	$	—		$	(125	)	$	(125	)	$	—	$	(125	)
U.K. Apparel		(33	)		—			(33	)		(34	)		—		(34	)
U.S. Meat Snacks		(12	)		5			(7	)		(12	)		5		(7	)
European Branded Apparel		—			(2	)		(2	)		(179	)		47		(132	)
U.S. Retail Coffee		—			—			—			(44	)		5		(39	)

Total Impairment Charge Recognized in Discontinued Operations	$	(170	)	$	3		$	(167	)	$	(394	)	$	57	$	(337	)

A significant number of judgments and estimates are involved in determining whether an impairment has occurred and in measuring the amount of an impairment. A critical consideration in this process is determining whether a business is considered held for sale or held for use.

Held for sale status – In order to be considered held for sale, several criteria, including the probable disposition of the business within one year, must be achieved. Upon being classified as held for sale, the recoverability of the carrying value of a business must be assessed. Evaluating the recoverability of assets in a held for sale business follows a defined order in which property and intangible assets subject to amortization are considered only after the recoverability of goodwill, intangible assets not subject to amortization and other assets are assessed. After the evaluation of the goodwill, the intangible assets not subject to amortization, and the other assets is completed, the held for sale business is reported at the lower of its carrying value or fair value less cost to sell.

The carrying value of a held for sale business includes the portion of the cumulative translation adjustment related to the operation. In order to be reported as a discontinued operation, a business must be classified as held for sale.

Held for use status – Businesses that do not meet held for sale status are considered held for use. Evaluating the recoverability of assets in a held for use business follows a defined order. First, assets other than goodwill, property and intangibles are evaluated. This is followed by a review of property and intangibles subject to amortization and finally goodwill. In evaluating the recoverability of property and intangible assets subject to amortization in a held for use business, the carrying value of the business is first compared to the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the operation. If the carrying value exceeds the undiscounted expected cash flows, it is necessary to determine if an impairment exists. An impairment exists if the carrying value of the business exceeds its fair value.

There are inherent uncertainties associated with these judgments and estimates and it is possible that these can change in the future. The following is a description of the facts and circumstances leading to the impairment charges and how these amounts were measured:

European Meats – During fiscal 2006, the corporation initiated steps to sell this business, received a series of non-binding offers and entered into discussions with various third parties who had expressed an interest in acquiring the business. As the process progressed, the non-binding offers submitted by prospective buyers declined, and at the end of the second quarter of fiscal 2006, management concluded that it was not probable that the business would be sold and indicated that it was evaluating alternatives to maximize shareholder value. The business was considered to be held for use at the end of the second quarter of fiscal 2006 and the assets were evaluated for impairment. The undiscounted cash flows expected to result from the operation and disposition of the business, as well as the fair value of the business, exceeded the carrying value of the business and no impairment was recognized for any of the assets evaluated. The non-binding bids received from prospective buyers were used in the determination of the fair value of the business.

During the third quarter of fiscal 2006, discussions with prospective buyers started up again, revised non-binding offers were received, and at the end of the third quarter of fiscal 2006, the corporation concluded that it was probable that the business would be sold in the next year. The business was classified as held for sale and reported as a discontinued operation. The carrying value of the business was determined to exceed its fair value and goodwill was evaluated for impairment under the provisions of Statement of Financial Accounting Standards No. 142 (SFAS 142). The determination of the implied fair value of the goodwill utilized the third party offers received and involved a number of estimates including an assessment of the fair value of the property and the intangible assets of the business. As a result of the evaluation, the corporation recognized a $125 million goodwill impairment with no tax benefit. The impairment was recognized based upon preliminary estimates, and any adjustments resulting from the finalization of the review or the sale of the business will be recognized in subsequent reporting periods. After the recognition of the goodwill impairment, the fair value of the business exceeded its carrying value. In May 2006, the corporation entered into exclusive negotiations to sell this business to Smithfield Foods. As the parties continue their discussions, the corporation will consult with employee representatives from the appropriate works council regarding the potential sale.

U.K. Apparel – The corporation’s apparel operations in the United Kingdom were classified as held for sale and reported as a discontinued operation in the second quarter of fiscal 2006. It is expected that this business will be sold in two transactions with one buyer purchasing the Courtaulds’ operations and a second buyer purchasing the corporation’s ownership interest in several consolidated Sri Lankan ventures which supply a portion of Courtaulds inventory needs. Based upon an offer from a prospective buyer at the end of the second quarter of fiscal 2006, the corporation recognized an impairment charge of $1 million to write down the carrying value of the Courtaulds business to zero. As a result of continuing negotiations with the same buyer, in the third quarter of fiscal 2006, the corporation concluded that it would be necessary to leave cash

and a higher amount of working capital in the business in order to complete the sale. This resulted in the recognition of a $33 million impairment charge in the third quarter with no tax benefit. The corporation will not receive a material amount of consideration as a result of the sale and will retain certain obligations of the Courtaulds business, the most significant of these being the defined benefit pension plans which were under funded by $483 million at the end of fiscal 2005. See Note 7 titled, “Pensions” for further information on the retained obligations of this business and the arrangements that have been made to fund this obligation. In May 2006, the corporation announced that it had entered into a definitive agreement to sell the U.K. based Courtaulds business.

U.S. Meat Snacks - The U.S. Meat Snacks operation was classified as held for sale and reported as a discontinued operation in the third quarter of fiscal 2006. During the third quarter of fiscal 2006, the corporation entered into an agreement to sell this operation for $9 million, which was less than the carrying value of the business. As a result of these developments, the goodwill of the business was evaluated for impairment under SFAS 142. The determination of the implied fair value of the goodwill utilized the selling price and involved a number of estimates, including the assessment of the fair value of the property and the intangible assets of the business. As a result of this evaluation, the corporation recognized a goodwill impairment charge of $12 million pretax and $7 million after-tax. After the recognition of the goodwill impairment, the fair value of the business exceeded its carrying value. In May 2006, the corporation closed on the sale of this business.

European Branded Apparel - During fiscal 2005, steps were taken to market and identify potential buyers for this business. As part of this process, the corporation received a series of non-binding bids for the business. During 2005, the operating results of the business deteriorated and failed to meet planned expectations. Prospective buyers reacted to this downturn by progressively lowering their offers. The non-binding offers received in the fourth quarter of fiscal 2005 were less than the carrying value of the reporting unit and resulted in a pretax charge of $305 million to recognize the impairment of $182 million of goodwill and $123 million of indefinite lived trademarks in this reporting unit. The assets of this reporting unit were classified as held for use at the close of fiscal 2005 and the corporation indicated that it was evaluating alternative courses of action.

In September 2005, the corporation’s Board of Directors authorized management to negotiate and enter into a definitive agreement to sell this business and the corporation entered into an exclusive negotiating period with a prospective buyer. The business was classified as held for sale and reported as a discontinued operation in the first quarter of fiscal 2006. Utilizing the agreed upon sales price, the corporation conducted an impairment review of the business and recognized an impairment charge of $179 million in the first quarter of fiscal 2006. The sale of this business closed in the third quarter of fiscal 2006.

U.S. Retail Coffee - In fiscal 2005, the corporation initiated steps to dispose of certain assets used to manufacture and market roast and ground coffee products in the U.S. retail coffee channel. These assets were part of a larger U.S. coffee reporting unit that also provides coffee products to the foodservice channel. The specific retail coffee trademarks and assets identified for disposal were classified as held for use as of the end of fiscal 2005, and the corporation obtained a third-party estimate of the selling price of these assets. The carrying value of the retail coffee asset group exceeded the estimated future cash flows, and a pretax charge of $45 million was recorded to recognize the impairment of $13 million of manufacturing assets and $32 million of trademarks in the asset group.

During the first quarter of fiscal 2006, the corporation began to actively market the assets of the U.S. Retail Coffee business, classified the asset group as held for sale, and allocated a portion of the goodwill associated with the U.S. coffee reporting unit to the retail coffee asset group to be sold. In October 2005, the corporation announced that it had entered into an agreement to sell the U.S. Retail Coffee business for $82.5 million. As a result of allocating the goodwill to the U.S. Retail Coffee business to be sold, and utilizing the agreed upon selling price of the business, the corporation recognized an impairment charge of $44 million in the first quarter of fiscal 2006 to record the impairment of $29 million of goodwill and $15 million of other long-lived assets. No tax benefit was recognized on the goodwill impairment.

4. Discontinued Operations

Net (loss) income from discontinued operations

As part of the corporation’s transformation plan, steps were taken to dispose of several businesses. At the end of the third quarter of fiscal 2006, seven businesses were reported as discontinued operations in the current and prior periods. The amounts in the tables below include the operating results of the businesses reported as discontinued operations. These operating results include the impact of the impairments discussed in Note 3 to these Consolidated Financial Statements. Gains and losses related to the disposal of discontinued operations are excluded from the following tables; however, they are discussed below.


	Third Quarter Fiscal 2006								Third Quarter Fiscal 2005
(In millions)	Net Sales		Pretax Income (Loss)			Income (Loss)			Net Sales		Pretax Income (Loss)			Income (Loss)
Direct Selling	$	—	$	—		$	—		$	115	$	13		$	10
U.S. Retail Coffee		—		—			—			51		2			1
European Branded Apparel		94		1			(1	)		326		20			11
U.K. Apparel		112		(46	)		(45	)		127		(4	)		(5	)
European Nuts & Snacks		14		2			—			15		3			2
European Meats		262		(111	)		(108	)		300		24			19
U.S. Meat Snacks		6		(13	)		(8	)		7		(1	)		—

Total	$	488	$	(167	)	$	(162	)	$	941	$	57		$	38


	Nine Months of Fiscal 2006								Nine Months of Fiscal 2005
(In millions)	Net Sales		Pretax Income (Loss)			Income (Loss)			Net Sales		Pretax Income (Loss)			Income (Loss)
Direct Selling	$	202	$	13		$	54		$	345	$	39		$	28
U.S. Retail Coffee		122		(45	)		(39	)		156		2			1
European Branded Apparel		641		(186	)		(153	)		941		19			5
U.K. Apparel		361		(51	)		(51	)		441		7			6
European Nuts & Snacks		42		5			2			48		8			5
European Meats		831		(74	)		(60	)		888		74			57
U.S. Meat Snacks		22		(14	)		(9	)		23		(1	)		(1	)

Total	$	2,221	$	(352	)	$	(256	)	$	2,842	$	148		$	101

Results of Discontinued Operations in the Third Quarter of Fiscal 2006 – The corporation recognized a $162 million loss from the operation of businesses reported as discontinued operations versus income of $38 million in the comparable period of the prior year. This decline was due to the $167 million impairment charge recognized in fiscal 2006, the sale of the Direct Selling and U.S. Retail Coffee businesses in the second quarter of fiscal 2006, the sale of the European Branded Apparel business in February 2006, and lower operating results in the remaining discontinued operations.

Results of Discontinued Operations in the First Nine Months of Fiscal 2006 – The corporation recognized a $256 million loss in the first nine months of fiscal 2006 from the operation of businesses reported as discontinued operations versus income of $101 million in the comparable period of the prior year. This decline was due to $337 million of impairment charges recognized in the first nine months of fiscal 2006, the sale of the Direct Selling and U.S. Retail Coffee businesses in the second quarter of fiscal 2006, the sale of the European Branded Apparel business in February 2006, and lower operating results in the remaining discontinued operations.

Gain on the Sale of Discontinued Operations

During fiscal 2006, the corporation has sold three of the seven businesses reported as discontinued operations. The gain recognized in the third quarter and first nine months of fiscal 2006 are summarized in the following table. A further discussion of each disposition follows:


	Third Quarter of Fiscal 2006								First Nine Months of Fiscal 2006
(In millions)	Pretax Gain / (Loss) on Sale			Tax (Charge) / Benefit		After-tax Gain / (Loss)			Pretax Gain on Sale		Tax (Charge) / Benefit			After-tax Gain
European Branded Apparel	$	34		$	40	$	74		$	34	$	40		$	74
U.S. Retail Coffee		—			—		—			5		(2	)		3
Direct Selling		(10	)		3		(7	)		303		(98	)		205

Total	$	24		$	43	$	67		$	342	$	(60	)	$	282

Businesses Sold in the Third Quarter of Fiscal 2006

European Branded Apparel – During the third quarter of fiscal 2006, the corporation sold substantially all of the Branded Apparel Europe business. Using foreign exchange rates on the date of the transaction, the corporation received cash proceeds of $117 million and recognized pretax and after-tax gains of $34 million and $74 million, respectively. The tax benefit recognized on the transaction resulted from a capital loss which the corporation was able to carryback against a capital gain recognized in a prior transaction. The definitive sales agreement provides for the sale of certain operations in the Philippines; however, transfer of legal title to these assets is awaiting the receipt of local government approval. Once such approval is received, and title to the assets transferred, the corporation expects to receive additional cash proceeds of $3.5 million and recognize the sale of these assets.

Under the terms of the transaction, the corporation can receive additional cash proceeds if the buyer receives cash distributions as a result of certain events such as the sale of the business, the payment of dividends, or redemption of capital or loans. Distributions of available cash from the sold business will be made in the following order:

•

The buyer will first receive any amounts owed as a result of working capital and other purchase price adjustments.

•

After the purchase price adjustments are satisfied, the corporation will receive 49% of the next 200 million euros of cash distributions.

•

If additional cash is distributed, the corporation may receive between 15% and 25% of these amounts.

If any amounts are received, they will be recognized in income when the cash is received. The corporation has no continuing involvement in the business after the date of sale and does not expect any material direct cash inflows or outflows with the sold entity.

Under the terms of the sale agreement, the corporation retained certain under-funded pension obligations related to this business. As a result of the transaction, the corporation is required to contribute 49.5 million British pounds in fiscal 2006 to fully fund the obligations. It is anticipated that the trustees of these plans will purchase annuities for the plan participants and it is expected that this action will result in a settlement loss. The exact timing of the settlement of these obligations has not been determined. See Note 7, titled “Pensions”, for further information on cash contributions to the corporation’s defined benefit pension plans.

The European Branded Apparel business was previously included in the corporation’s Branded Apparel segment.

Businesses Sold Prior to the Third Quarter of Fiscal 2006

Direct Selling – On August 10, 2005, the corporation announced that it had entered into a definitive agreement to sell this business, and in December 2005, the corporation completed the sale of substantially all of the operations to Tupperware Corporation. The net pretax and after-tax gain recognized on the sale of the Direct Selling business was $303 million and $205 million, respectively, and the corporation received the following consideration:

•

$370 million which consists of $413 million of cash received less $43 million of cash which was included in the net assets transferred to the buyer.

•

The liabilities transferred to the buyer included a $34 million obligation to a retained foreign subsidiary of the corporation. Subsequent to the closing, the buyer remitted cash to the corporation to settle this obligation. The payment of this obligation is reflected in the financing activities section of the Consolidated Statement of Cash Flows.

•

Subsequent to the closing, the buyer paid $93 million to settle certain tax obligations of Sara Lee that were directly related to the sale transaction.

The definitive sales agreement provides for the sale of the Direct Selling business in the Philippines; however, transfer of legal title to these assets is awaiting the receipt of local government approval. The selling price of this component of the business has been placed in escrow pending the receipt of these approvals. Upon receipt of the $38 million of escrowed funds and transfer of title to the assets, the corporation expects to recognize a pretax and after-tax gain of $28 million and $19 million, respectively.

The sales agreement provides for working capital and other customary post-closing adjustments relating to the assets transferred. The final resolution of these items will impact the gain recognized. During the third quarter of fiscal 2006, the corporation completed certain customary post-closing adjustments and recorded a reduction in the net gain of $7 million. The corporation expects to complete the remaining post-closing adjustments in the fourth quarter of fiscal 2006 or early fiscal 2007. Under the terms of the sales agreement, the corporation has no significant continuing involvement in the business after the disposal date and does not expect any material direct cash inflows or outflows with the sold entity.

The Direct Selling business had previously been reported within the Household and Body Care segment.

U.S. Retail Coffee – In the first quarter of fiscal 2006, the corporation announced that it had entered into an agreement to sell its U.S. Retail Coffee business and in the second quarter of fiscal 2006, the transaction closed. In the second quarter of fiscal 2006, the corporation received $82.5 million of cash at closing and recognized a pretax and after-tax gain of $5 million and $3 million, respectively.

The sales agreement provides for working capital and other customary post-closing adjustments relating to the assets transferred. The final resolution of these items may impact the gain recognized. In addition, the agreement provides for a future payment of up to $2.5 million if the business generates a defined level of profits in the first year after the disposal. Any amounts received will be recognized in income when they are received.

Under the terms of the sales agreement, the corporation has no significant continuing involvement in the business after the disposal date and does not expect any material direct cash inflows or outflows with the sold entity.

Prior to the change in the corporation’s reportable segments, the U.S. Retail Coffee business had been reported as part of the Beverage segment.

Carrying Value of Assets Sold – The carrying value of the major classes of assets sold were as follows:


	Carrying Value of Assets and Liabilities Sold
	Direct Selling		U.S. Retail Coffee		European Branded Apparel		Total
Current Assets	$	157	$	46	$	411	$	614
Property		36		17		—		53
Intangibles		96		35		—		131
Other Noncurrent Assets		15		—		10		25

Total Assets	$	304		98		421		823

Current Liabilities		95		24		261		380
Noncurrent Liabilities		37		—		86		123

Total Liabilities		132		24		347		503

Net Assets Sold	$	172	$	74	$	74	$	320

Other Businesses Held for Sale

Four of the businesses reported as discontinued operations have not been sold as of April 1, 2006. The status of these operations is as follows:

European Meats – The carrying value of the net assets held for sale at the end of the third quarter of fiscal 2006 is $540 million. In May 2006, the corporation entered into exclusive negotiations to sell this business to Smithfield Foods. As the parties continue their discussions, the corporation will consult with employee representatives from the appropriate works council regarding the potential sale. Based upon current negotiations with the prospective buyer, the corporation does not expect to have any continuing involvement in the business after it is sold and does not expect to have any material direct cash inflows or outflows with the business after its disposition. In fiscal 2005, this business was reported as part of the Sara Lee Meats segment.

U.K. Apparel – It is expected that this business will be sold in two transactions with one buyer purchasing certain manufacturing operations in Sri Lanka and a separate buyer purchasing the Courtaulds operations centered in the U.K. The carrying value of the net assets of the U.K. Apparel business are approximately zero. Based on current negotiations with prospective buyers, the corporation does not expect to have any continuing involvement in the business after it is sold and does not expect to have any material direct cash inflows or outflows with the sold entity. In May 2006, the corporation announced that it had entered into a definitive agreement to sell the U.K. based Courtaulds business. In fiscal 2005, this business was reported as part of the Branded Apparel segment.

The planned sale of the U.K. Apparel operations will result in the corporation retaining certain pension obligations associated with the business to be sold. The fiscal 2006 net periodic benefit cost of these plans was $52 million and these costs are recognized in Selling, General and Administrative expenses of the corporation’s continuing operations. The projected benefit obligations of these plans, using a 5.3% discount rate, exceeded the plan assets by $483 million at the close of fiscal 2005. In the third quarter of fiscal 2006, the corporation entered into an agreement to fund the deficit in these plans over a 10-year period. This arrangement is described in Note 7 to these Consolidated Financial Statements.

European Nuts and Snacks – During the second quarter of fiscal 2006, the corporation entered into a definitive agreement to sell its European Nuts and Snacks business for 130 million euro which is equivalent to $158 million at the end of the third quarter of fiscal 2006. The sale transaction is subject to regulatory and other government approvals before the transaction can be completed. The closing date is expected to take place near the end of the current fiscal year. The carrying value of the net assets held for sale is approximately $26 million and the corporation does not expect to have any significant continuing involvement in this business after it is sold and does not expect to have any material direct cash inflows or outflows with the sold entity. In fiscal 2005, the operations of this business were previously included in the Beverage segment.

U.S. Meat Snacks – In March 2006, the corporation entered into a definitive agreement to sell its U.S. Meat Snacks business for $9 million. The carrying value of the net assets held for sale at the end of the third quarter of fiscal 2006 is $8 million. The corporation does not expect to have any significant continuing involvement in this business after it is sold and does not expect to have any material direct cash inflows or outflows with the sold entity. In fiscal 2005, this business was reported as part of the Sara Lee Meats segment. Subsequent to the end of the third quarter of fiscal 2006, in May 2006, the corporation completed the sale of the U.S. Meat Snacks business in accordance with the terms outlined above.

The following is a summary of the net assets held for sale as of April 1, 2006. These amounts include the net assets of the European Meats, U.K. Apparel, European Nuts and Snacks and U.S. Meat Snacks businesses, as well as the net assets of the Direct Selling and European Branded Apparel businesses in the Philippines. The summary below also includes certain assets that are held for sale and do not qualify as discontinued operations. The change in the net assets held for sale between July 2, 2005 and April 1, 2006 is primarily the result of the assets disposed of in completed sale transactions and impairments recognized since the beginning of the fiscal year.


	April 1, 2006			July 2, 2005
Cash and short-term investments	$	32		$	37
Trade accounts receivable		172			421
Inventories		185			606
Other current assets		72			108

Total current assets held for sale		461			1,172

Property		213			343
Trademarks and other intangibles		156			325
Goodwill		19			244
Other assets		2			26

Assets of discontinued operations held for sale	$	851		$	2,110

Notes payable	$	17		$	26
Accounts payable		157			379
Accrued expenses and other current liabilities		239			511

Total current liabilities held for sale		413			916

Other liabilities		56			163
Cumulative translation adjustment of businesses held for sale		(203	)		(198	)

Liabilities and cumulative translation adjustment of discontinued operations held for sale	$	266		$	881

5. Exit Activities and Business Dispositions

The reported results for the third quarter and first nine months of fiscal years 2006 and 2005 reflect amounts recognized for exit and disposal actions. Reported amounts also include the impact of certain activities that were completed for amounts more favorable than previously estimated and other restructuring plan adjustments. The following is a summary of the expense (income) associated with these actions. These amounts are recognized in the “Charges for (income from) exit activities and business dispositions” line of the Consolidated Statements of Income.


	Thirteen Weeks Ended						Thirty-nine Weeks Ended
(In millions)	April 1, 2006			April 2, 2005			April 1, 2006			April 2, 2005
Exit and disposal programs:
Fiscal 2006 restructuring actions	$	38		$	—		$	109		$	—
Other restructuring actions		—			11			—			7

Total exit costs (income)		38			11			109			7
Business dispositions		(49	)		(27	)		(66	)		(39	)

Impact on income from continuing operations before income taxes	$	(11	)	$	(16	)	$	43		$	(32	)

The impact of these actions on the corporation’s business segments and general corporate expenses is summarized as follows:


	Thirteen Weeks Ended						Thirty-nine Weeks Ended
(In millions)	April 1, 2006			April 2, 2005			April 1, 2006			April 2, 2005
North American Retail Meats	$	1		$	(30	)	$	11		$	(35	)
North American Retail Bakery		2			—			4			(1	)
Foodservice		4			—			4			—
International Beverage		(35	)		—			10			—
International Bakery		(2	)		—			3			—
Household and Body Care		9			—			(11	)		(14	)
Branded Apparel		2			—			2			(8	)

Decrease (increase) in operating segment income		(19	)		(30	)		23			(58	)
Increase in general corporate expenses		8			14			20			26

Total	$	(11	)	$	(16	)	$	43		$	(32	)

The following provides a detailed description of the exit activities and business disposition actions impacting the reported results for the third quarter and first nine months of fiscal years 2006 and 2005.

Fiscal 2006

The reported results for fiscal 2006 reflect amounts recognized for exit activities and disposal actions that increased income from continuing operations before income taxes by $11 million for the third quarter and decreased income from continuing operations before income taxes by $43 million for the first nine months. During the third quarter and first nine months of fiscal 2006, the corporation approved a series of actions to exit certain business activities and lower its cost structure. Each of these actions is to be completed within a 12-month period after being approved. Offsetting these charges, in part, were gains realized on the disposal of certain assets. In addition, certain adjustments have been made to reflect the actual cost of planned headcount reductions and other plan changes. These adjustments are also reflected in the net charge. The components of the net charges recognized in the third quarter and first nine months of fiscal 2006 were as follows:

•

The corporation’s management approved a series of actions to terminate employees and provide them with severance benefits in accordance with benefit plans previously communicated to the affected employee groups. Actions to terminate 759 employees at a net cost of $36 million were approved in the third quarter. For the first nine months of fiscal 2006, actions to terminate 1,584 employees from continuing operations at a net cost of $102 million were approved. Certain changes have been made to the originally targeted headcount due to voluntary departures and other plan changes. The specific location of these employees and the status of the terminations are summarized in a table contained in this note.

•

During the third quarter and first nine months of fiscal 2006, the corporation recognized charges of $2 million and $7 million, respectively, for the exit of three leased facilities and various bakery stores in connection with the transformation efforts of the corporation. These costs consist of noncancelable lease and other contractual obligations.

•

During fiscal 2006, the corporation completed the disposal of certain assets and incurred costs associated with the preparation of certain businesses for disposal. The net

effect of these actions resulted in the recognition of a net gain of $49 million for the third quarter of fiscal 2006. The $49 million of income from business dispositions consists of a $55 million gain on the sale of working capital related to a European rice product line, which was partially offset by a $6 million charge for professional fees to prepare businesses for disposition. The net gain recognized in the first nine months of the fiscal 2006 was $66 million, which consists of a $55 million gain on the sale of working capital related to a European rice product line, a $28 million gain realized on the sale of certain trademarks and inventory related to a line of skin care and sunscreen products, a $4 million gain realized on the disposal of an investment in a foreign branded apparel business and a $3 million gain related to the sale of a corporate aircraft for an amount more favorable than originally estimated. Offsetting these gains is $24 million of professional fees incurred in connection with preparing certain businesses for disposition. The total cash proceeds from the investment and asset dispositions were $124 million.

The following table summarizes the charges recognized for exit activities approved during fiscal 2006, excluding business dispositions, and the related status as of April 1, 2006. Any accrued liabilities remaining in the Condensed Consolidated Balance Sheet represent those cash expenditures necessary to satisfy remaining obligations.


(In millions)	Exit Costs Recognized		Cash Payments			Accrued Exit Costs as of April 1, 2006
Employee termination and other benefits	$	102	$	(22	)	$	80
Noncancelable lease and other contractual obligations		7		(4	)		3

	$	109	$	(26	)	$	83

The following table summarizes the employee terminations by location and business segment:


Number of Employees	North American Retail Meats	North American Retail Bakery	Food- service	International Beverage	Inter- national Bakery	Household and Body Care	Branded Apparel	Corporate	Total
United States	134	181	40	—	—	1	131	58	545
Europe	—	—	—	609	45	115	1	—	770
Australia	—	—	—	16	11	77	—	—	104
Mexico	—	—	—	—	—	—	165	—	165

	134	181	40	625	56	193	297	58	1,584

As of April 1, 2006:
Actions completed	121	138	19	346	29	71	—	10	734
Actions remaining	13	43	21	279	27	122	297	48	850

	134	181	40	625	56	193	297	58	1,584

Fiscal 2005

The reported results for the third quarter and first nine months of fiscal 2005 reflected amounts recognized for exit activities and disposal actions that increased income from continuing operations before income taxes by $16 million and $32 million, respectively. During the third quarter and first nine months, the corporation approved actions to exit certain business activities and lower its cost structure. In addition, certain exit activities were completed for amounts that were less than previously anticipated. The components of the net credits recognized in the third quarter and first nine months of fiscal 2005 were as follows:

•

During the third quarter of fiscal 2005, the corporation recognized a charge of $11 million related to the severance costs for certain officers of the corporation in accordance with existing benefit plans and local employment laws. Exit costs for the first nine months of fiscal 2005 consisted of these severance charges, offset in part by $4 million of income related to the completion of certain previously approved exit activities for amounts that were less than originally anticipated.

•

During the third quarter of fiscal 2005, the corporation recognized $27 million of income related to various business dispositions. Of this amount, $31 million relates to the gain recognized on the

disposition of certain trademarks and other assets of the corporation’s canned meats business. Offsetting this gain is $4 million of professional fees incurred in connection with several planned future business dispositions. For the first nine months of fiscal 2005, the corporation recognized $39 million of income related to various business dispositions. Included in this amount are $55 million of gains related to various completed transactions in the North American Retail Meats, Household and Body Care and Branded Apparel businesses. The most significant of these gains is the $31 million gain related to the canned meat business, a $14 million gain related to the disposal of an ethnic skin care products line primarily sold in the U.S, and $6 million received from prior business dispositions. Offsetting these gains is $16 million of professional fees incurred in connection with several planned future business dispositions.

Status of Restructuring Reserves

Fiscal 2005 Exit Activities

During fiscal 2005, the corporation approved a series of actions to exit certain defined business activities and lower its cost structure. Each of these actions was to be completed within a 12-month period after being approved. The net impact was to reduce income from continuing operations before income taxes by $131 million. The components of this charge are as follows:

•

$123 million of the charge was for the cost associated with terminating 1,870 employees and providing them with severance benefits in accordance with benefit plans previously communicated to the affected employee groups. Certain changes have been made to the originally targeted headcount due to voluntary departures and other plan changes. Adjustments have been made to reflect the actual cost of these terminations and are reflected in the net charge. The specific location of the employees and the status of the terminations are summarized in a table contained in this note.

•

$8 million of the net charge was for the cost of certain noncancelable lease and other contractual obligations. The lease costs related to the exit of 11 retail stores for the Branded Apparel segment. The other contractual obligations related to the exit of a German distribution agreement for the International Beverage business. The retail spaces had been exited by the end of fiscal 2005 and there are no remaining obligations owed to third parties.

The following table summarizes the charges taken for the exit activities approved during fiscal 2005 and the related status as of April 1, 2006. Any accrued liabilities remaining in the Condensed Consolidated Balance Sheet represent those cash expenditures necessary to satisfy remaining obligations.


(In millions)	Exit Costs Recognized		Cash Payments			Accrued Exit Costs as of April 1, 2006
Employee termination and other benefits	$	123	$	(52	)	$	71
Noncancelable lease and other contractual obligations		8		(3	)		5

	$	131	$	(55	)	$	76

The majority of the cash payments to satisfy the accrued costs noted in the table above will be paid in the next year.

The following table summarizes the employee terminations by location and business segment:


Number of Employees	North American Retail Meats	North American Retail Bakery	Foodservice	Inter- national Beverage	Inter-national Bakery	Household and Body Care	Branded Apparel	Corporate	Total
United States	24	152	241	—	—	—	716	10	1,143
Canada	—	—	—	—	—	—	209	—	209
Mexico	—	—	—	—	—	—	139	—	139
Europe	—	—	—	121	60	137	—	1	319
Australia	—	—	—	—	—	60	—	—	60

	24	152	241	121	60	197	1,064	11	1,870

As of April 1, 2006:
Actions Completed	23	148	125	82	48	153	951	11	1,541
Actions Remaining	1	4	116	39	12	44	113	—	329

	24	152	241	121	60	197	1,064	11	1,870

Other Restructuring Actions

In prior periods, the corporation had approved various actions to exit certain defined business activities and lower its cost structure. As of the end of the third quarter of fiscal 2006, these actions had been completed. The accrued liabilities remaining in the Condensed Consolidated Balance Sheet related to these actions total $13 million and represent various severance and noncancelable lease obligations. These accrued amounts are expected to be satisfied in cash and will be funded from operations.

6. Contingent Sale

The corporation sold its European cut tobacco business in fiscal 1999. Under the terms of that agreement, the corporation will receive an annual cash payment of 95 million euros if tobacco continues to be a legal product in the Netherlands, Germany and Belgium through 2010. The legal status of tobacco in each country accounts for a portion of the total contingency with the Netherlands accounting for 67%, Germany 22% and Belgium 11%. If tobacco ceases to be a legal product within any of these countries, the corporation forfeits the receipt of all future amounts related to that country. The contingencies associated with the fiscal 2006 and fiscal 2005 payments each passed in the first quarter, respectively, of each fiscal year and the corporation received the annual payments. The fiscal 2006 annual payment was equivalent to $114 million, and the fiscal 2005 annual payment was equivalent to $117 million based upon the respective exchange rates on the dates of receipt. Each of these amounts was recognized in the corporation’s earnings when received and each of the payments increased diluted earnings per share by $0.15 when they were recognized.

7. Pensions

The components of the net periodic pension cost and the postretirement medical cost related to continuing operations for the third quarter and first nine months of fiscal 2006 and 2005 are as follows:


	Thirteen Weeks Ended April 1, 2006						Thirteen Weeks Ended April 2, 2005
(In millions)	Pension			Postretirement Medical and Life Insurance			Pension			Postretirement Medical and Life Insurance
Service cost	$	31		$	3		$	36		$	3
Interest cost		68			4			67			6
Expected return on plan assets		(65	)		—			(61	)		—
Amortization of
Transition (asset) obligation		—			—			—			—
Prior service cost		—			(5	)		1			(4	)
Net actuarial loss		19			1			21			1

Net periodic benefit cost	$	53		$	3		$	64		$	6

Curtailment gain	$	—		$	—		$	—		$	2


	Thirty-nine Weeks Ended April 1, 2006						Thirty-nine Weeks Ended April 2, 2005
(In millions)	Pension			Postretirement Medical and Life Insurance			Pension			Postretirement Medical and Life Insurance
Service cost	$	99		$	9		$	105		$	11
Interest cost		205			14			200			18
Expected return on plan assets		(194	)		—			(181	)		—
Amortization of
Transition (asset) obligation		—			(1	)		—			(1	)
Prior service cost		1			(14	)		3			(12	)
Net actuarial loss		61			2			63			2

Net periodic benefit cost	$	172		$	10		$	190		$	18

Curtailment gain	$	—		$	—		$	—		$	28

As indicated in the above table, the net periodic benefit cost of the corporation’s defined benefit pension plans was lower in the third quarter and first nine months of fiscal 2006 than in the comparable periods of fiscal 2005, primarily as a result of lower service cost and the expected return on plan assets increasing by a greater amount than the interest on plan obligations increased.

•

Effective on January 1, 2006, certain domestic employee groups ceased earning future pension benefits and this reduced the service cost component of the plan expense. The reduction in pension benefits was offset in part by increased costs related to defined contribution benefit plans.

•

The expected return on plan assets is based upon the fair value of plan assets and the assumed rate of return on those assets at the start of the year. The higher level of expected returns in fiscal 2006 is primarily due to an increase in the fair value of plan assets during fiscal 2005.

•

The interest on plan obligations is based on the projected benefit obligation of the plans and the discount rate assumption at the start of the fiscal year. The higher level of interest on plan obligations in fiscal 2006 is primarily due to an increase in plan obligations in fiscal 2005.

The net periodic benefit cost of the corporation’s postretirement medical and life insurance plans declined primarily as a result of plan amendments instituted in fiscal 2005 which eliminated post-65 coverage and increased cost sharing by covered employees in the North American bakery operations. These benefit changes reduced plan obligations and the interest on those obligations. In addition, the amendments increased the level of negative prior service cost being amortized in the determination of net periodic benefit expense.

The curtailment gain recognized in fiscal 2005 was as a result of the termination of certain bakery employees. The postretirement medical benefit plan in which these individuals participated had negative prior service cost from a previous plan amendment that was recognized upon termination of the employees.

In the first nine months of fiscal 2006, the corporation contributed $277 million in cash to its defined benefit pension plans, with $225 million of cash contributed in the third quarter of the year. At the present time, the corporation expects to contribute $323 million of cash to its pension plans in fiscal 2006. Approximately $5.2 million of the full-year funding is related to pension plans being assumed by the buyers of businesses classified as discontinued operations.

Included in the current year estimate is the anticipated payment of $85 million to fully fund certain pension obligations of the European Branded Apparel business. These obligations were retained when the business was sold on February 3, 2006. It is anticipated that the trustees of these plans will use substantially all of the proceeds to purchase annuities for plan participants at a future date, and this action will likely result in the recognition of a settlement loss. The exact timing of the settlement of these obligations has not been determined.

The corporation’s planned sale of its U.K. Apparel operations will result in the corporation retaining the pension obligations associated with the business to be sold. The projected benefit obligation of these plans, using a 5.3% discount rate, exceeded plan assets by $483 million at the close of fiscal 2005. The fiscal 2006 net periodic benefit cost of these plans was $52 million and these costs are recognized in the selling, general and administrative expenses of the corporation’s continuing operations. On April 4, 2006, the corporation signed a Funding and Guarantee Agreement with the Sara Lee U.K. Pension Plan Trustees. Significant provisions of this agreement are as follows:

•

The corporation will increase annual pension funding of these plans to 32 million British pounds through 2015. If at any time prior to January 1, 2016, Sara Lee Corporation ceases to have a credit rating equal to or greater than the following ratings, the annual pension funding will increase by 20%: Standard and Poor’s minimum credit rating of “BBB-”; Moody’s Investor Services minimum credit rating of “Baa3” and Fitch Ratings minimum credit rating of “BBB-”.

•

In fiscal 2016, the corporation will make a lump sum payment, if necessary, to ensure that the plans have achieved the funding required by U.K. pension protection fund (PPF) legislation. In all periods after 2016, the corporation will be required to make contributions sufficient to ensure that the plans continue to be funded to the PPF funding level. At the present time the PPF funding deficit is approximately 335 million British Pounds.

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. In addition, the corporation has announced its intent to dispose of certain businesses and the terms of those transactions may impact the timing and amount of future contributions to these plans. As a result, the actual funding in fiscal 2006 may differ from the current estimate.

8. Acquisitions

At the end of the third quarter of fiscal 2006, the corporation acquired Butter-Krust Baking, a domestic fresh bakery business for $52 million of cash and the assumption of $20 million of debt and other liabilities. The acquisition of Butter-Krust will allow the corporation to expand its distribution of fresh baked products in the mid-Atlantic region. The excess of the purchase price over the net assets acquired was $44 million and has been preliminarily allocated to goodwill. The corporation expects to finalize the purchase price after third-party appraisers have completed their valuation work.

During the third quarter of fiscal 2006, the corporation acquired certain trademarks and working capital related to a Mexican processed meat business for $18 million of cash. The acquisition will allow the corporation to expand distribution of its meat products under these acquired trademarks in the Mexican marketplace. The purchase price has been preliminarily allocated to the assets and trademarks acquired and no goodwill has been recognized as a result of the transaction.

During the first quarter of fiscal 2006, the corporation acquired National Textiles, LLC, a domestic yarn and textile production company for $3 million in cash and the assumption of $84 million of debt. The fair value of the assets acquired, net of liabilities assumed, approximated the $3 million purchase price based upon preliminary valuations and no goodwill has been recognized as a result of the transaction. The corporation expects to finalize the purchase price allocation after third-party appraisers have completed their valuation work. Substantially all of the yarn and textiles produced by the acquired business will be used in products produced by the domestic Branded Apparel business.

9. Stock Based Compensation

The corporation has various stock option, employee stock purchase and stock award plans. At April 1, 2006, 71.8 million shares were available for future grant in the form of options, restricted shares or stock appreciation rights.

On July 3, 2005, the corporation adopted the provisions of Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment” (FAS No. 123(R)) using the modified prospective method. FAS No. 123(R) requires companies to recognize the cost of employee services received in exchange for awards of equity instruments based upon the grant date fair value of those awards. Under the modified prospective method of adopting FAS No. 123(R), the corporation will recognize compensation cost for all share-based payments granted after July 3, 2005, plus any awards granted to employees prior to July 3, 2005 that remain unvested at that time. Under this method of adoption, no restatement of prior periods is made. The impact of adopting FAS No. 123(R) did not have a significant impact on income from continuing operations, income before income taxes, net income, cash flow from operations or earnings per share during the period.

Prior to July 3, 2005, the corporation recognized the cost of employee services received in exchange for equity instruments in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB No. 25). APB No. 25 required the use of the intrinsic value method, which measures compensation cost as the excess, if any, of the quoted market price of the stock over the amount the employee must pay for the stock. Compensation expense for substantially all of the corporation’s equity-based awards was measured under APB No. 25 on the date the shares were granted. Under APB No. 25, no compensation expense has been recognized for stock options, replacement stock options and shares sold under the Employee Stock Purchase Plan. Compensation expense was recognized under APB No. 25 for the cost of restricted share unit awards granted to employees.

During the thirteen and thirty-nine weeks ended April 2, 2005, had the cost of employee services received in exchange for equity instruments been recognized based on the grant date fair value of those instruments in accordance with the provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-based Compensation,” the corporation’s net income and earnings per share would have been impacted as shown in the following table.


(In millions)	Thirteen Weeks Ended April 2, 2005			Thirty-nine Weeks Ended April 2, 2005
Reported net income	$	189		$	867
Plus – Stock-based employee compensation included in reported net income, net of related tax effects		9			25
Less – Total stock-based employee compensation expense determined under the fair-value method for all awards, net of related tax effects		(14	)		(39	)

Pro forma net income	$	184		$	853

Earnings per share:
Basic – as reported	$	0.24		$	1.10

Basic – pro forma	$	0.23		$	1.08

Diluted – as reported	$	0.24		$	1.09

Diluted – pro forma	$	0.23		$	1.07

Stock Options

The exercise price of each stock option equals or exceeds the market price of the corporation’s stock on the date of grant. Options can generally be exercised over a maximum term of 10 years. Options generally vest ratably over three years. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model using the weighted average assumptions as outlined in the following table.


	Thirty-nine Weeks Ended April 1, 2006		Thirty-nine Weeks Ended April 2, 2005
Weighted average expected lives	6.1 years		3.4 years
Weighted average risk-free interest rate	4.3	%	3.2	%
Range of risk-free interest rates	4.2 – 4.3	%	2.8 – 3.7	%
Weighted average expected volatility	26.2	%	23.2	%
Range of expected volatility	25.2 – 26.4	%	22.8 – 24.5	%
Expected dividend yield	4.2	%	3.6	%

The corporation uses historical volatility for a period of time that is comparable to the expected life of the option to determine volatility assumptions. The corporation has discontinued the granting of replacement options after the start of fiscal 2006. As a result of this change, the corporation utilizes the simplified method outlined in SEC Staff Accounting Bulletin No. 107 to estimate expected lives for options granted during the period.

A summary of the changes in stock options outstanding under the corporation’s option plans during the thirty-nine weeks ended April 1, 2006 is presented below:


Shares in Thousands and Intrinsic Value in Millions	Shares	Weighted Average Exercise Price		Weighted Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value
Options Outstanding at July 2, 2005	53,543	$	22.14	3.8	$	25
Granted	2,002		19.54
Exercised	420		14.93
Canceled/expired	3,731		24.36

Options Outstanding at April 1, 2006	51,394	$	21.93	3.3	$	9

Options Exercisable at April 1, 2006	48,970	$	22.03	3.0	$	9

The weighted average grant date fair value of options granted during the first nine months of fiscal 2006 and the first nine months of fiscal 2005 was $4.01 and $2.85, respectively. The total intrinsic value of

options exercised during the first nine months of fiscal 2006 and the first nine months of fiscal 2005 was $2 million and $44 million, respectively. The fair value of options that vested during the first nine months of fiscal 2006 was $6 million. The corporation received cash from the exercise of stock options during the first nine months of fiscal 2006 of $6 million. As of April 1, 2006, the corporation had $5 million of total unrecognized compensation expense related to stock option plans that will be recognized over the weighted average period of 1 year.

Employee Stock Purchase Plan

The ESPP permits eligible full-time employees to purchase a limited number of shares of the corporation’s common stock at 85% of market value. Under the plan, the corporation sold 828 and 1,216 shares to employees in the first nine months of fiscal 2006 and in the first nine months of fiscal 2005, respectively. Compensation expense is calculated for the fair value of the employees’ purchase rights using the Black-Scholes model. Assumptions include an expected life of 1/4 of a year and weighted average risk-free interest rates of 4.2% in the first nine months of fiscal 2006, and 2.1% in the first nine months of fiscal 2005. Other underlying assumptions are consistent with those used for the corporation’s stock option plans described above. The weighted average fair value of individual options granted during the first nine months of fiscal 2006 and the first nine months of fiscal 2005 was $3.42 and $4.12, respectively. In November 2005, the corporation eliminated the 15% discount on shares acquired through the ESPP. Future purchases under the ESPP plan will be at the fair value of the shares.

Stock Unit Awards

Restricted stock units (RSUs) are granted to certain employees to incent performance and retention over periods ranging from one to five years. Upon the achievement of defined goals, the RSUs are converted into shares of the corporation’s common stock on a one-for-one basis and issued to the employees. A substantial portion of all RSUs vest solely upon continued future service to the corporation. A small portion of RSUs vest based upon continued future employment and the achievement of certain defined performance measures. The cost of these awards is determined using the fair value of the shares on the date of grant, and compensation is recognized over the period during which the employees provide the requisite service to the corporation. A summary of the changes in the stock unit awards outstanding under the corporation’s benefit plans during the first nine months of fiscal 2006 is presented below:


Shares in Thousands and Intrinsic Value in Millions	Shares		Weighted Average Grant-Date Fair Value		Weighted Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value
Nonvested share units at July 3, 2005	8,088		$	20.59	1.0	$	159
Granted	2,471			19.23
Vested	(3,301	)		19.71
Forfeited	(188	)		20.62

Nonvested share units at April 1, 2006	7,070		$	20.53	1.0	$	126

Exercisable share units at April 1, 2006	216		$	19.12	2.6	$	4

The total fair value of share-based units that vested during the first nine months of fiscal 2006 was $65 million. As of April 1, 2006, the corporation had $48 million of total unrecognized compensation expense related to stock unit plans which will be recognized over the weighted average period of 1.3 years.

For all share-based payments, during the third quarter of fiscal 2006, the corporation recognized total compensation expense of $18 million, and recognized a tax benefit of $5 million. During the first nine months of fiscal 2006, the corporation recognized total compensation expense of $72 million, and recognized a tax benefit of $23 million. The corporation will satisfy the requirement for common shares for share-based payments by issuing newly authorized shares.

10. Accumulated Other Comprehensive Income (Loss)

The components of accumulated other comprehensive income (loss) are as follows:


	Cumulative Translation Adjustment			Net Unrealized Gain (Loss) on Qualifying Cash Flow Hedges			Minimum Pension Liability Adjustment			Accumulated Other Comprehensive Income (Loss)
Balance at July 3, 2004	$	(793	)	$	(14	)	$	(587	)	$	(1,394	)
Other comprehensive income (loss) activity		279			(38	)		—			241

Balance at April 2, 2005		(514	)		(52	)		(587	)		(1,153	)

Other comprehensive income (loss) activity		(217	)		38			(70	)		(249	)

Balance at July 2, 2005		(731	)		(14	)		(657	)		(1,402	)

Other comprehensive income (loss) activity		(15	)		(31	)		—			(46	)

Balance at April 1, 2006	$	(746	)	$	(45	)	$	(657	)	$	(1,448	)

Comprehensive income in the third quarters of fiscal 2006 and 2005 was $72 million and $24 million, respectively. Comprehensive income in the first nine months of fiscal 2006 and 2005 was $501 million and $1,108 million, respectively.

11. Derivative Reporting

The corporation is exposed to changes in interest rates, foreign exchange rates and commodity prices. To manage the risk from these changes, the corporation uses derivative instruments and enters into various hedging transactions. A description of the corporation’s hedging programs and instruments is included in the corporation’s 2005 annual report on Form 10-K which is filed with the Securities and Exchange Commission. As of July 2, 2005, the net accumulated derivative loss recorded in Accumulated Other Comprehensive Income was $14 million. During the nine months ended April 1, 2006, $15 million of accumulated net derivative losses were deferred into Accumulated Other Comprehensive Income and $16 million of accumulated net derivative gains were released from Accumulated Other Comprehensive Income into earnings since the related hedged item was realized during the period, resulting in a balance in Accumulated Other Comprehensive Income at April 1, 2006 of an accumulated loss of $45 million. At April 1, 2006, the maximum maturity date of any cash flow hedge was approximately 1¹/4 years, excluding derivative hedges related to the payment of variable interest on existing financial instruments. The corporation expects to reclassify into earnings during the next twelve months, net losses from Accumulated Other Comprehensive Income of approximately $18 million, at the time the underlying hedged transaction is realized.

Other disclosures related to hedge ineffectiveness, amounts excluded from the assessment of effectiveness and amounts reclassified into earnings as a result of the discontinuation of hedge accounting because it was probable that the original forecasted transaction would not occur, have been omitted due to the insignificance of these amounts. During the nine months ended April 1, 2006, a net loss of $11 million arising from effective hedges of net investments has been reflected in the cumulative translation adjustments account within consolidated stockholders’ equity.

12. Litigation

Since 1995, three complaints have been filed on behalf of former employees of Aris Philippines, Inc. (“Aris”) alleging unfair labor practices associated with Aris’ termination of manufacturing operations in the Philippines. Each of these three complaints includes allegations with the same issues and facts. With regard to two of these complaints, Aris prevailed in the administrative hearings held in the Philippines. Although implicated in these complaints, Sara Lee was not a party. The third complaint is a consolidation of cases filed from 1998 through July 1999 by individual complainants in the Republic of the Philippines, Department of Labor and Employment, National Labor Relations Commission. On December 11, 1998, the complaint was amended to name Sara Lee as a party. The case is styled: Emelinda Mactlang, et al. v.

Aris Philippines, Inc., et al. In the underlying proceedings the arbitrator ruled against Sara Lee and awarded the plaintiffs $60 million in damages and fees. Sara Lee is appealing this administrative ruling. Sara Lee believes that the plaintiffs’ claims are without merit and is vigorously defending the remaining complaint. However, no assurance can be given that an adverse outcome in the matter will not occur.

13. Issued But Not Yet Effective Accounting Standards

Accounting Changes and Error Corrections

The FASB issued Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections” (Statement No. 154), which requires retroactive application of a voluntary change in accounting principle to prior period financial statements unless it is impractical. Statement No. 154 also requires that a change in method of depreciation, amortization, or depletion for long-lived, non-financial assets be accounted for as a change in accounting estimate that is affected by a change in accounting principle. Statement No. 154 replaces APB Opinion 20, “Accounting Changes,” and SFAS 3, “Reporting Accounting Changes in Interim Financial Statements.” The corporation will adopt the provisions of Statement No. 154, effective in fiscal 2007. Management currently believes that adoption of the provisions of Statement No. 154 will not have a significant impact on the corporation’s consolidated financial statements.

14. Goodwill and Intangible Assets

Goodwill increased from $3,018 million at July 2, 2005 to $3,067 million at April 1, 2006. This was primarily due to the $44 million of goodwill recognized in the preliminary purchase price allocation of the Butter-Krust acquisition that is described in Note 8 to the financial statements and changes in foreign currency exchange rates. In addition, the corporation recognized a $1 million impairment charge related to an International Beverage business as part of its annual goodwill review. This charge is recognized in continuing operations in the selling, general and administrative expense caption of the income statement.

Trademarks and other identifiable intangible assets declined from $1,395 million at July 2, 2005 to $1,336 million at April 1, 2006. This reduction was primarily due to amortization and changes in foreign exchange rates. At the end of the second quarter of 2006, the corporation concluded that an apparel trademark with a carrying value of $79 million no longer had an indefinite life and it would be amortized in future periods. As of April 1, 2006, approximately 87% of the corporation’s identifiable intangible assets are being amortized.

Item II

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 third quarter and first nine months of fiscal 2006 compared with the third quarter and first nine months of fiscal 2005 and a discussion of the changes in financial condition and liquidity during the first nine months of fiscal 2006. The following is an outline of the analyses included herein:

•

Overview

•

Third Quarter of Fiscal 2006

•

First Nine Months of Fiscal 2006

•

Cash Flow

•

Description of the Business Segments

•

Transformation Plan

•

Consolidated Results – Third Quarter of Fiscal 2006 Compared with Third Quarter of Fiscal 2005

•

Operating Results by Business Segment – Third Quarter of Fiscal 2006 Compared with Third Quarter of Fiscal 2005

•

Consolidated Results – First Nine Months of Fiscal 2006 Compared with First Nine Months of Fiscal 2005

•

Operating Results by Business Segment – First Nine Months of Fiscal 2006 Compared with First Nine Months of Fiscal 2005

•

Financial Condition

•

Liquidity

•

Significant Accounting Policies and Critical Estimates

•

Forward-looking Information

Overview

Third Quarter of Fiscal 2006

Continuing Operations – During the third quarter of fiscal 2006, net sales decreased by $55 million, or 1.4%, over the third quarter of fiscal 2005, to $3,789 million. Changes in foreign currencies, particularly in the European euro and the British pound, decreased reported net sales by $71 million, or 1.9%. Net sales were impacted by acquisitions and dispositions in both fiscal 2006 and 2005 and these reduced net sales by $18 million, or 0.4%. The remaining net sales increase was $34 million, or 0.9%, as sales increases in the North American Retail Meats, North American Retail Bakery, Foodservice and the International Beverage segments were partially offset by declines in the International Bakery, Household and Body Care and Branded Apparel segments.

Operating income for the corporation in the third quarter of fiscal 2006 declined by $44 million, or 14.4%, and was composed of the following:

•

The corporation’s gross profit declined by $22 million, primarily as a result of lower unit volumes in certain segments, and higher commodity and energy costs that led to a slightly lower gross profit margin percentage.

•

SG&A expenses in the third quarter of fiscal 2006 increased by $17 million over the comparable period of the prior year. As a percent of sales, SG&A expenses increased from 29.8% in the third quarter of fiscal 2005 to 30.7% in the third quarter of fiscal 2006. The impact of the ongoing transformation expenses and other cost increases more than offset savings from the transformation plan and lower advertising and promotion costs.

•

In the third quarter of fiscal 2006, the corporation recognized income of $11 million from exit activities and business dispositions, while in the third quarter of fiscal 2005, the corporation recognized $16 million of income.

Pretax income from continuing operations declined $51 million, or 20.1%, as a result of the $44 million decline in operating income and a $7 million increase in net interest expense. The effective tax rate on continuing operations declined from 39.1% in the third quarter of fiscal 2005 to 30.6% in the third quarter of fiscal 2006. This reduction was primarily attributable to the favorable outcome of a foreign tax contingency and the recognition of a tax benefit associated with the disposition of certain assets.

As a result of these factors, income from continuing operations declined by $14 million or 9.0%.

Discontinued Operations – The corporation has reported its Direct Selling, U.S. Retail Coffee, European Branded Apparel, U.K. Apparel, European Nuts and Snacks, European Meats and U.S. Meat Snacks businesses as discontinued operations. The European Branded Apparel operation was sold in the third quarter.

•

The operating results of the discontinued businesses are presented in Note 4 to the Consolidated Financial Statements. In the third quarter of fiscal 2006, the corporation recognized a $162 million loss from the operation of businesses reported as discontinued operations versus income of $38 million in the comparable period of the prior year. This decline was due to the $167 million impairment charge recognized in fiscal 2006, the earnings impact of the disposition of the Direct Selling and U.S. Retail Coffee businesses that were sold in the second quarter of fiscal 2006, the sale of the European Branded Apparel business in February 2006 and lower operating results in the remaining discontinued operations.

•

During the third quarter of fiscal 2006, the corporation sold its European Branded Apparel operation and completed certain post-closing adjustments related to its Direct Selling business. As a result, the corporation recognized a pretax and after-tax gain of $24 million and $67 million, respectively.

Net income in the third quarter of fiscal 2006 decreased by $147 million, or 77.4%, and diluted EPS decreased $0.18, or 75.0%, primarily from the decline related to discontinued operations of $133 million.

First Nine Months of Fiscal 2006

Continuing Operations – During the first nine months of fiscal 2006, net sales decreased by $159 million, or 1.3%, over the first nine months of fiscal 2005, to $11,844 million. Changes in foreign currencies, particularly in the European euro and the British pound, decreased reported net sales by $112 million, or 0.9%. Net sales were impacted by acquisitions and dispositions in the first nine months of both fiscal 2006 and 2005 and the impact of these transactions reduced net sales by $73 million, or 0.6%. The remaining net sales increase was $26 million as sales increased in each of the corporation’s business segments except the Household and Body Care and Branded Apparel segments.

Operating income for the corporation in the first nine months of fiscal 2006 declined by $246 million, or 22.0%, and was composed of the following:

•

The corporation’s gross profit declined by $107 million primarily as a result of higher costs for certain raw materials, commodities and energy costs, which contributed to the 0.4% decline in the gross profit margin.

•

SG&A expenses in the first nine months of fiscal 2006 increased by $61 million over the comparable period of the prior year. As a percent of sales, SG&A expenses increased from 29.3% in the first nine months of fiscal 2005 to 30.2% in the first nine months of fiscal 2006. The impact of the ongoing transformation expenses and other cost increases more than offset savings from the transformation plan and lower advertising and promotion costs.

•

In the first nine months of fiscal 2006, the corporation recognized a charge of $43 million for exit activities and business dispositions, while in the first nine months of fiscal 2005, the corporation recognized $32 million of income from exit and business disposition activities.

•

The corporation received and recognized contingent sales proceeds of $114 million in the first nine months of fiscal 2006 and $117 million of contingent sales proceeds in the first nine months of fiscal 2005 from the sale of the corporation’s cut tobacco business. These payments represent the annual payments for fiscal 2006 and 2005.

Income from continuing operations before income taxes declined by $276 million, or 28.2%, as a result of the $246 million decline in operating income and higher short-term interest rates which increased net interest expense by $30 million. The effective tax rate for the first nine months of fiscal 2006 and fiscal 2005 were 25.9% and 21.7%, respectively. The increase in the effective tax rate was primarily due to an increased level of taxes provided to repatriate to the U.S. the earnings on non-U.S. operations. In fiscal 2005, the corporation was able to repatriate a significant amount of accumulated earnings under the American Jobs Creation Act, while in fiscal 2006, the repatriation of current year earnings has a higher effective tax rate.

Discontinued Operations – The corporation reported its Direct Selling, U.S. Retail Coffee, European Branded Apparel, U.K. Apparel, European Nuts and Snacks, European Meats and U.S. Meat Snacks businesses as discontinued operations and several operations were sold prior to the close of the nine month period.

•

The operating results of the discontinued businesses are presented in Note 4 to the financial statements. In the first nine months of fiscal 2006, the corporation recognized a $256 million loss from the operation of the businesses reported as discontinued operations versus income of $101 million in the comparable period of the prior year. This decline was due to $337 million of impairment charges recognized in the first nine months of fiscal 2006, the earnings impact of the disposition of the Direct Selling and U.S. Retail Coffee businesses in the second quarter of fiscal 2006, the sale of the European Branded Apparel business in February 2006 and lower operating results in the remaining discontinued operations.

•

As noted earlier, the corporation also recognized an after-tax gain of $282 million as a result of disposing of several businesses in the first nine months of fiscal 2006.

Net income in the first nine months of fiscal 2006 decreased by $320 million, or 36.9%, and diluted EPS decreased by $0.38, or 34.9%, primarily due to the decline of $245 million in income from continuing operations and the $75 million decrease related to discontinued operations.

A table which summarizes the significant items that impacted the third quarters and first nine months of fiscal 2006 and 2005 is presented below.

Impact of Significant Items on Income From Continuing Operations and Net Income


	13 Weeks Ended April 1, 2006												13 Weeks Ended April 2, 2005
In millions, except per share data	Pretax Impact			Tax			Net Income			Diluted EPS Impact (1)			Pretax Impact			Tax			Net Income			Diluted EPS Impact (1)
Income from continuing operations	$	197		$	(60	)	$	137		$	0.18		$	248		$	(97	)	$	151		$	0.19

Net income							$	42		$	0.06								$	189		$	0.24

Significant items affecting comparability of income from continuing operations and net income:
(Charges for) income from exit activities and business dispositions:
(Charges for) income from exit activities	$	(38	)	$	11		$	(27	)	$	(0.03	)	$	(11	)	$	4		$	(7	)	$	(0.01	)
(Charges for) income from business disposition activities		49			(17	)		32			0.04			27			(9	)		18			0.02

Subtotal		11			(6	)		5			0.01			16			(5	)		11			0.01

(Charges) to cost of sales and SG&A expenses
Transformation charges in cost of sales and SG&A		(44	)		17			(27	)		(0.04	)		—			—			—			—
Accelerated depreciation and amortization		(8	)		2			(6	)		(0.01	)		(4	)		1			(3	)		—
Bakery curtailment gain		—			—			—			—			2			(1	)		1			—

Impact of significant items on income from continuing operations before income taxes:		(41	)		13			(28	)		(0.04	)		14			(5	)		9			0.01

Significant tax matters affecting comparability:
Dutch tax rate change		—			—			—			—			—			—			—			—

Impact of significant items on income from continuing operations:		(41	)		13			(28	)		(0.04	)		14			(5	)		9			0.01

Significant items impacting discontinued operations:
European Branded Apparel impairment		—			(2	)		(2	)		—			—			—			—			—
U.K. Apparel impairment		(33	)		—			(33	)		(0.04	)		—			—			—			—
European Meats impairment		(125	)		—			(125	)		(0.16	)		—			—			—			—
U.S. Meat Snacks impairment		(12	)		5			(7	)		(0.01	)		—			—			—			—
Charges for exit activities and transformation expenses		—			—			—			—			—			—			—			—
Tax benefit from European Meats		—			6			6			0.01			—			—			—			—
Net gain on the sale of Direct Selling, and European Branded Apparel operations		24			43			67			0.09			—			—			—			—

Impact of significant items on net income	$	(187	)	$	65		$	(122	)	$	(0.16	)	$	14		$	(5	)	$	9		$	0.01

Notes:

(1)	EPS amounts are rounded to the nearest $0.01 and may not add to the total.

Impact of Significant Items on Income From Continuing Operations and Net Income


	39 Weeks Ended April 1, 2006												39 Weeks Ended April 2, 2005
In millions, except per share data	Pretax Impact			Tax			Net Income			Diluted EPS Impact (1)			Pretax Impact			Tax			Net Income			Diluted EPS Impact (1)
Income from continuing operations	$	703		$	(182	)	$	521		$	0.68		$	979		$	(213	)	$	766		$	0.96

Net income							$	547		$	0.71								$	867		$	1.09

Significant items affecting comparability of income from continuing operations and net income:
(Charges for) income from exit activities and business dispositions:

(Charges for) income from exit activities	$	(109	)	$	35		$	(74	)	$	(0.10	)	$	(7	)	$	2		$	(5	)	$	(0.01	)
(Charges for) income from business disposition activities		66			(23	)		43			0.06			39			(12	)		27			0.04

Subtotal		(43	)		12			(31	)		(0.04	)		32			(10	)		22			0.03

(Charges) income to cost of sales and SG&A expenses
Transformation charges in cost of sales and SG&A		(111	)		39			(72	)		(0.09	)		—			—			—			—
Hurricane losses		(5	)		2			(3	)		—			—			—			—			—
Accelerated depreciation and amortization		(29	)		10			(19	)		(0.02	)		(29	)		7			(22	)		(0.03	)
Change in vacation policy		14			(5	)		9			0.01			—			—			—			—
Bakery curtailment gain		—			—			—			—			28			(10	)		18			0.02

Impact of significant items on income from continuing operations before income taxes:		(174	)		58			(116	)		(0.15	)		31			(13	)		18			0.02

Significant tax matters affecting comparability
Dutch tax rate change		—			—			—			—			—			24			24			0.03

Impact of significant items on income from continuing operations:		(174	)		58			(116	)		(0.15	)		31			11			42			0.05

Significant items impacting discontinued operations:
European Branded Apparel impairment		(179	)		47			(132	)		(0.17	)		—			—			—			—
U.S. Retail Coffee impairment		(44	)		5			(39	)		(0.05	)		—			—			—			—
U.K. Apparel impairment		(34	)		—			(34	)		(0.04	)		—			—			—			—
European Meats impairment		(125	)		—			(125	)		(0.16	)		—			—			—			—
U.S. Meat Snacks impairment		(12	)		5			(7	)		(0.01	)		—			—			—			—
Charges for exit activities and transformation expenses		(8	)		3			(5	)		(0.01	)		—			—			—			—
Tax benefit from Direct Selling and European Meats		—			49			49			0.06			—			—			—			—
Gain on the sale of Direct Selling, U.S. Retail Coffee and European Branded Apparel operations		342			(60	)		282			0.37			—			—			—			—

Impact of significant items on net income	$	(234	)	$	107		$	(127	)	$	(0.16	)	$	31		$	11		$	42		$	0.05

Notes:

(1)	EPS amounts are rounded to the nearest $0.01 and may not add to the total.

Cash Flow

Operating Activities - The corporation’s cash flow from operations in the first nine months of fiscal 2006 was $826 million as compared to $1,050 million in the comparable period of fiscal 2005. The $224 million decline was primarily due to a $245 million decline in income from continuing operations. While the operating results of discontinued operations declined, this was primarily attributable to non-cash impairment charges.

Investment Activities - Investment activities generated $421 million of cash in the first nine months of fiscal 2006 as compared to a $91 million use of cash in the comparable period of the prior year. This $512 million increase was primarily due to the fact that the corporation generated $600 million of additional cash flow from business dispositions, offset in part by $76 million of cash used to acquire businesses. During fiscal 2006, the corporation completed the sales of its Direct Selling, European Branded Apparel, and U.S. Retail Coffee businesses, and also disposed of the assets of the rice and sun care products companies. The funds expended on business dispositions primarily relates to the acquisition of the Butter-Krust Bakery business and a meat business in Mexico.

Financing Activities - Significant items impacting the cash generated and used in financing activities are as follows:

•

Cash generated from the issuance of common shares declined from $150 million to $22 million in the fiscal 2006 period. The elimination of the 15% discount on the purchase of shares through the employee stock purchase plan essentially eliminated employee purchases of the corporation’s stock and the lower stock price substantially reduced the exercise of employee stock options.

•

The corporation used $562 million of cash to purchase 30.1 million shares of common stock in fiscal 2006, as compared to a $345 million use of cash to purchase 15.9 million shares in the fiscal 2005 period. The corporation intends to repurchase additional shares with a value of up to $450 million in early fiscal 2007. The repurchase will likely occur after the spin-off of Branded Apparel Americas/Asia; however, the timing and amount of future share repurchases may also be influenced by market conditions and other factors.

•

During the first nine months of fiscal 2006 and fiscal 2005, the corporation had net repayments of long-term debt of $208 million and $645 million, respectively, by utilizing a combination of cash on hand and the issuance of short-term debt.

•

At the end of the third quarter of fiscal 2006, the corporation did not utilize cash on the balance sheet to repay outstanding notes payable borrowings as it had done at the end of the third quarter of 2005 and the end of fiscal 2005. At the end of the third quarter of fiscal 2005 and the end of fiscal 2005, the corporation scheduled certain notes payable obligations, primarily in the form of short-term commercial paper, to mature prior to the end of the fiscal period. Cash on hand in various operating units in different geographic locations was utilized to repay these commitments when they matured. At the beginning of the subsequent quarter, issuances of commercial paper were made and cash was returned to the corporation’s operating locations. Shortly before the end of fiscal 2005, using cash on hand, the corporation repaid $2,080 million of outstanding notes payable. That is, notes payable and cash would have been higher at the end of fiscal 2005 by $2,080 had the cash repayments not been made. As a result of the decision not to utilize cash on hand to repay outstanding notes payable, the corporation had $1,972 of cash on the balance sheet at the end of the third quarter of fiscal 2006 versus $533 million at the end of fiscal 2005, and had outstanding notes payable of $1,595 million at the end of the third quarter of fiscal 2006, versus $239 at the end of fiscal 2005.

Further information and details regarding the performance of the corporation and its business segments follows.

Description of the Business Segments

During fiscal 2006, the corporation reorganized its business operations around distinct customers, consumers and geographic markets in order to build functional excellence, increase strategic focus and simplify the organization. As a result of these changes, the corporation reorganized its business operations and reports its results in seven business segments. Historical results have been restated to present the business segments on a comparable basis. The following is a general description of the corporation’s seven business segments.

•

North American Retail Meats – sells a variety of meat products including hot dogs, corn dogs, breakfast sausages and sandwiches, bacon, smoked and dinner sausages, as well as premium deli and luncheon meats.

•

North American Retail Bakery – sells a wide variety of fresh and frozen baked products including bread, buns and bagels as well as specialty items including frozen pies, cakes and cheesecakes.

•

International Beverage – sells coffee and tea products to retail and foodservice customers primarily in Europe, Brazil and Australia.

•

International Bakery – sells frozen bakery, dough products and a variety of fresh bread products to retail and foodservice customers in Europe and Australia.

•

Household and Body Care – sells products in four primary categories – body care, air care, shoe care and insecticides.

•

Branded Apparel – sources, manufactures and markets basic branded apparel products including men’s and women’s underwear, intimate apparel, casualwear, socks and sheer hosiery in the Americas and Asia.

Transformation Plan

In February 2005, the corporation announced a transformation plan designed to improve the corporation’s performance and better position Sara Lee for long-term growth. The plan is expected to be completed by fiscal 2010 and a number of significant gains and losses are anticipated to be recognized over this period. The following is an update on the actions taken in the transformation plan and the impact on the third quarter and first nine months of fiscal 2006.

Organization Structure

The corporation reorganized its operations around distinct consumers, customers and geographic markets in order to build functional excellence, increase strategic focus and simplify the organization. The corporation’s new structure is organized around seven business segments, which were described above.

The corporation announced plans to locate the management of its North American businesses along with a majority of its corporate staff at a single site in suburban Chicago (Downers Grove, Illinois). As a result of this change:

•

Costs are being incurred to relocate those individuals who were requested to remain with the organization and elected to do so.

•

A number of individuals elected not to relocate to Chicago and it was necessary to pay certain of these personnel stay bonuses to preserve business continuity while replacements were hired.

•

Certain positions and employees are being eliminated from the organization structure and severance benefits are being paid to these individuals.

•

Costs were incurred to recruit new employees to work in the Chicago area as well as to staff positions in newly created functions.

•

Bonuses are being accrued for certain employees deemed critical to the success of the transformation effort. These amounts are to incent individuals to remain with the organization and compensate them for an increased workload.

The corporation expects to finalize the employee centralization in the fall of 2006. In the third quarter of fiscal 2006, management approved a formal plan to centralize the research and development activities for North America into a temporary single site by the summer of 2006, while management starts construction on a permanent North American research center.

In Europe, the corporation has started executing plans to centralize management into a single location per country or region. Each centralized location would be supported by a shared services organization which will provide back-office functions. As a result of the plans to centralize management and eliminate operating locations, certain planned workforce reductions are in process.

As a result of these actions, pretax charges of $90 million were recognized in the third quarter of fiscal 2006 related to exit activities, transformation costs and accelerated depreciation and amortization in order to simplify the organizational structure. In the first nine months of fiscal 2006, the corporation has recognized pretax charges from transformation and exit activities of $249 million, including $109 million of severance costs, $29 million of accelerated depreciation and amortization, $21 million of employee retention costs, $17 million of relocation costs, $11 million of recruiting costs, and $62 million related to consulting, information technology and other transformation and exit efforts. Additional restructuring actions are expected over the life of the transformation plan and further details regarding these actions is contained in this Management Discussion and Analysis section and in Note 5, titled “Exit Activities and Business Dispositions” to the Consolidated Financial Statements.

Portfolio Changes

The corporation announced plans to dispose of a number of businesses in order to concentrate financial and management resources on a smaller number of entities that are better positioned for growth. At the close of the third quarter of fiscal 2006, seven of these businesses had been reported as discontinued operations. The status of the portfolio changes is as follows:

•

Direct Selling – Substantially all of this business was sold in December 2005 and an after-tax gain of $205 million was recognized as a result of this transaction. The disposition of the Direct Selling operations in the Philippines is expected to close in late fiscal 2006 after receiving government approval.

•

U.S. Retail Coffee – This business was sold in December 2005. An after-tax gain of $3 million was recognized as a result of this transaction.

•

European Branded Apparel – Substantially all of this business was sold in February 2006 and an after-tax gain of $74 million was recognized. The sale of the Branded Apparel operations in the Philippines is awaiting certain regulatory licenses and is expected to close in the fourth quarter of fiscal 2006.

•

European Nuts and Snacks – The corporation has entered into an agreement to sell this business and expects to close on this transaction in late fiscal 2006 or early fiscal 2007. The timing of the closing date is dependent upon the receipt of regulatory and government approvals.

•

United Kingdom (U.K.) Apparel – The corporation anticipates that this business will be sold prior to the end of the current fiscal year.

•

U.S. Meat Snacks – The corporation has entered into a definitive agreement to sell its U.S. Meat Snacks operations and expects to close this transaction in the fourth quarter of fiscal 2006.

•

European Meats – The corporation has entered into exclusive negotiations to sell this business and it was reported as a discontinued operation in the third quarter of fiscal 2006.

•

Branded Apparel Americas / Asia – The corporation is in the process of preparing to spin off this business in the first quarter of fiscal 2007.

Note 4 to the Consolidated Financial Statements contains a detailed discussion of the businesses reported as discontinued operations, the significant terms of the transactions completed to date and the impact these discontinued operations had on the reported results of the corporation.

Improving Operational Efficiency

The third element of the transformation plan involves several initiatives to improve the operational efficiency of the corporation. These initiatives include the following:

•

The simplification of the organization structure will result in the termination of a number of employees and the elimination of certain manufacturing facilities. The exit activities initiated by the corporation in fiscal 2006 are fully explained in other sections of this Management Discussion and Analysis and in Note 5, titled “Exit Activities and Business Dispositions,” in the Consolidated Financial Statements. In the remaining portion of fiscal 2006, the corporation expects to recognize additional exit costs to reduce employment levels in the organization and eliminate manufacturing capacity.

•

The company expects to reduce the number of brands utilized in its North American Retail Bakery business as well as to increase the research and development and marketing spending behind a smaller group of large brands. The carrying value of the trademarks in the North American Bakery operations at the end of the third quarter of fiscal 2006 was $317 million. The North American bakery customer relationship intangible asset may also be impacted by any decision to exit regional bakery brands. The carrying value of this asset was $137 million at April 1, 2006. When a plan is developed and approved by management to exit certain of these trademarks, the ongoing amortization will increase and a charge to recognize the impairment of these assets may result.

•

The corporation expects to make a substantial investment to improve information technology systems and processes. This is primarily related to the costs to implement a standardized information technology platform in the North American operations and the continued consolidation of information processing. There are a number of variables that impact the cost of installing and transitioning to new information systems. At the present time, the corporation expects that from fiscal 2006 through 2010, the cost of these information technology initiatives will be $235 million, with a substantial portion of the cost being incurred after fiscal 2006.

Consolidated Results – Third Quarter of Fiscal 2006 Compared with Third Quarter of Fiscal 2005

Continuing Operations – Operating results by business segment in the third quarter of fiscal 2006 compared with the third quarter of fiscal 2005 are as follows:


	Thirteen Weeks Ended
	Net Sales						Income From Continuing Operations Before Income Taxes
(In millions)	April 1, 2006			April 2, 2005			April 1, 2006			April 2, 2005
North American Retail Meats	$	607		$	575		$	46		$	68
North American Retail Bakery		449			427			(3	)		(16	)
Foodservice		522			516			28			43
International Beverage		569			582			127			108
International Bakery		175			197			13			19
Household and Body Care		443			484			40			88
Branded Apparel		1,035			1,072			110			86

Total business segments		3,800			3,853			361			396
Intersegment sales		(11	)		(9	)		—			—

Total net sales and operating segment income, respectively		3,789			3,844			361			396

Amortization of intangibles		—			—			(18	)		(17	)
General corporate expenses		—			—			(89	)		(81	)

Total net sales and operating income, respectively		3,789			3,844			254			298
Net interest expense		—			—			(57	)		(50	)

Net sales and income from continuing operations before income taxes, respectively	$	3,789		$	3,844		$	197		$	248

The following table summarizes net sales and operating income performance for the third quarter of fiscal 2006 and 2005 and certain significant items that affected the comparability of these amounts.


	Thirteen Weeks Ended
Corporate Performance - (In millions)	April 1, 2006			April 2, 2005			Change			Percent Change
Net sales	$	3,789		$	3,844		$	(55	)	(1.4	)%

Increase / (decrease) in net sales from changes in foreign currency exchange rates	$	—		$	71		$	(71	)
Acquisitions / dispositions		25			43			(18	)

Total	$	25		$	114		$	(89	)

Operating income	$	254		$	298		$	(44	)	(14.4	)%

Increase / (decrease) in operating income from receipt of contingent sale proceeds	$	—		$	—		$	—
Changes in foreign currency exchange rates		—			15			(15	)
Exit activities and business dispositions		11			16			(5	)
Curtailment gain		—			2			(2	)
Accelerated depreciation on facilities sold		(8	)		(3	)		(5	)
Accelerated amortization of intangibles		—			(1	)		1
Transformation charges		(44	)		—			(44	)
Acquisitions/dispositions		1			5			(4	)

Total	$	(40	)	$	34		$	(74	)

Net Sales

Consolidated net sales decreased $55 million, or 1.4%, in the third quarter of fiscal 2006 over the third quarter of fiscal 2005, to $3,789 million. Changes in foreign currency, particularly in the European euro and British pound, decreased reported net sales by 1.9%, or $71 million. The net impact of acquisitions and dispositions between the third quarter of fiscal 2006 versus the third quarter of fiscal 2005 reduced net sales by $18 million, or 0.4%. The remaining net sales increase of $34 million, or 0.9%, resulted from increases in net sales in the North American Retail Meats, North American Retail Bakery, Foodservice, and the International Beverage segments. The North American Retail Meats experienced higher sales primarily as a result of strategic pricing actions that increased unit volumes, while the higher sales in the North American Retail Bakery segment was primarily due to higher product pricing. Both the Foodservice and International Beverage segments had higher sales as a result of an improved product mix and higher unit selling prices, which were partially offset by lower unit volumes. In the International Bakery segment, lower unit volumes for fresh bread were the primary reason for the sales decline during the quarter. In the Household and Body Care segment, continued competitive pricing pressures in the marketplace were only partially offset by higher unit volumes, resulting in a decline in net sales. In the Branded Apparel segment, net sales declined primarily from lower unit volumes as certain large customers reduced inventories as compared to the prior year period and lower average pricing.

Unit Volumes

Unit volumes in the North American Retail Meats segment increased 6% with increases coming in both the U.S. and Mexico. Increased sales of branded fresh bread products and the corporation’s single serve retail coffee products were offset by declines for unbranded frozen bakery products resulting in unit volumes being unchanged in the third quarter in the North American Retail Bakery segment. Unit volumes decreased 3% in the Foodservice segment as declines in coffee products and bakery products were only partially offset by higher unit sales of meat products. In the International Beverage segment, unit volumes were unchanged as increases in the foodservice channel were offset by declines in the retail channel. In the International Bakery segment, unit volumes declined 4% as declines for fresh and frozen products in Europe and Australia, respectively, were only partially offset by increases for dough products in Europe. The unit volumes for the four core categories of the Household and Body Care segment increased 1% in the third quarter primarily due to strength in the body care and insecticide categories. In the third quarter, unit volumes declined 1% in the Branded Apparel segment based upon declines in the three categories of innerwear, sheer hosiery and in international markets as certain large customers reduced inventories during the period, the exit of certain low margin product lines within the innerwear, outerwear and international categories, and the decline in sheer hosiery shipments.

Gross Margin Percent

The gross margin percentage for the corporation declined by 0.1% in the third quarter of fiscal 2006, from 37.2% in the third quarter of fiscal 2005 to 37.1% in the third quarter of fiscal 2006, as three of the segments experienced higher gross margins and four of the segments experienced lower gross margins. The gross margin percentage in the North American Retail Meats segment increased 3.4% during the quarter as the segment experienced increased unit volumes, a favorable product mix and lower raw material commodity costs. The gross margin percentage in the Branded Apparel segment increased 2.7% as lower commodity costs were partially offset by lower unit volumes and higher energy costs, and the impact of higher slow moving inventory costs in the prior year period. In the North American Retail Bakery segment, higher product pricing was the primary contributor to a 1.1% increase in the gross margin percentage.

The Foodservice, International Beverage, International Bakery and Household and Body Care segments each experienced lower gross margin percentages. In the International Beverage segment, the full impact of higher commodity costs could not be fully passed along to the customer,

which was the primary reason for a 4.2% decline in the gross margin percentage during the quarter. The Household and Body Care segment’s gross margin percentage declined by 3.4%, primarily from an unfavorable product mix, competitive pricing in the marketplace and unfavorable energy costs. In the International Bakery segment, the gross margin percentage declined by 1.6%, primarily due to a decline in unit volumes in Europe. In the Foodservice segment, the gross margin percentage declined by 1.3%, primarily from declines in unit volume for beverage and bakery products and higher energy costs.

Selling, General and Administrative Expenses


	Thirteen Weeks Ended
(In millions)	April 1, 2006		April 2, 2005		Change		Percent Change
Selling, general and administrative expenses:
SG&A expenses in the business segment results	$	1,056	$	1,048	$	8	0.6	%
Amortization of identifiable intangibles		18		17		1	6.3
General corporate expenses		89		81		8	9.4

Total SG&A expenses	$	1,163	$	1,146	$	17	1.3	%

Total selling, general and administrative (SG&A) expenses increased $17 million, or 1.3%, in the third quarter of fiscal 2006 over the comparable prior year quarter. Changes in foreign currency exchange rates, primarily in the euro, decreased SG&A expenses by $25 million, or 2.3%. Therefore, the remaining increase in SG&A expenses was $42 million, or 3.6%. Measured as a percent of sales, SG&A expenses increased from 29.8% in the third quarter of fiscal 2005 to 30.7% in the third quarter of fiscal 2006. SG&A expenses as a percentage of sales increased in four business segments and declined in three business segments. SG&A as a percent of sales increased in the North American Retail Meats, Foodservice, International Bakery, and Household and Body Care segments, and declined in the North American Retail Bakery, International Beverage and Branded Apparel segments.

Each of the corporation’s business segments experienced costs related to the corporation’s transformation activities. Transformation expenses are recognized in SG&A expenses in the business segments and in general corporate expenses and generally include accelerated depreciation on facilities that will be exited, relocation and recruiting expenses related to the centralization of the corporation’s management team, and costs associated with the disposition of various businesses.

Total SG&A expenses reported in the business segments increased by $8 million, or 0.6%, between the third quarter of fiscal 2005 and the third quarter of fiscal 2006, primarily due to costs associated with the corporation’s transformation program, partially offset by lower media advertising and promotion costs. Amortization of intangibles increased by $1 million in the third quarter of fiscal 2006 versus the third quarter of fiscal 2005. General corporate expenses, which are not allocated to the individual business segments, increased by $8 million, or 9.4%, as higher transformation expenses were partially offset by favorable foreign currency impacts.

As more fully described in Note 4 to the Consolidated Financial Statements, titled “Discontinued Operations,” the corporation has reported its U.K. Apparel business as a discontinued operation. The corporation’s sale of the U.K. Apparel business will result in the corporation retaining the pension plan for its U.K. employees and its related liabilities, and certain other liabilities for workers’ compensation claims. As a result, the corporation has recognized the net periodic costs associated with benefit plans being retained in general corporate expenses in all periods presented and will report future expenses related to these liabilities also as general corporate expenses. The reclassification of these expenses did not have a significant impact on the change in SG&A expenses between the periods.

Transformation Actions and Other Significant Items

The reported results for the third quarters of fiscal 2006 and fiscal 2005 reflect amounts recognized for actions associated with the corporation’s ongoing business transformation program and other significant amounts. These amounts include:

•

Business Transformation Costs – This includes costs to retain and relocate existing employees, recruit new employees, third-party consulting costs associated with transformation efforts and incremental depreciation costs associated with decisions to close facilities at dates sooner than originally anticipated. In addition, the business transformation effort has resulted in the corporation eliminating certain employee benefits which has reduced costs and positively impacted reported results.

•

Exit and Business Disposition Activities – These costs are reported on a separate line in the Consolidated Statement 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. Business disposition activities include costs associated with separating businesses targeted for sale and preparing financial statements for these businesses, as well as gains and losses associated with the disposition of asset groups that do not qualify for discontinued operations reporting.

The following is a summary of the transformation and other significant items that have impacted the third quarter of fiscal 2006 and the comparable period of fiscal 2005.


	Thirteen Weeks Ended
(In millions)	April 1, 2006			April 2, 2005
Cost of sales
Accelerated depreciation related to facility closures	$	17		$	3
Curtailment gain from bakery workforce reduction		—			(2	)

Selling, general and administrative expenses
Transformation charges		44			—
Accelerated amortization of intangibles		—			1
Accelerated depreciation		(9	)		—

Charges for (income from)
Exit activities		38			11
Business dispositions		(49	)		(27	)

Impact on income from continuing operations before income taxes		41			(14	)

Income tax (benefit) expense		(13	)		5

Impact on income from continuing operations	$	28		$	(9	)

The impact of the costs (income) of the above actions on the corporation’s business segments and amortization expense are summarized as follows:


	Thirteen Weeks Ended
(In millions)	April 1, 2006			April 2, 2005
North American Retail Meats	$	12		$	(29	)
North American Retail Bakery		4			(1	)
Foodservice		6			(2	)
International Beverage		(24	)		—
International Bakery		(2	)		—
Household and Body Care		13			2
Branded Apparel		3			—

Impact on the business segments		12			(30	)
General corporate expenses		29			15
Accelerated amortization of intangibles		—			1

Impact on income from continuing operations before income taxes	$	41		$	(14	)

Third Quarter of Fiscal 2006 – The amount recognized in “Cost of sales,” as noted in the table above, consists of $17 million of accelerated depreciation on facilities targeted for sale in the North American Retail Meats, International Beverage and Household and Body Care segments. The amounts recognized in “Selling, general and administrative expenses” include a charge of $44 million for actions related to the corporation’s transformation plan, which was partially offset by a $9 million credit related to accelerated depreciation. The corporation recognized $11 million of income related to exit activities and business dispositions during the third quarter of fiscal 2006. The $11 million of income consists of a $38 million charge for exit activities and a net $49 million of income related to business dispositions. The $38 million charge for exit activities consists of a $36 million charge for management’s approved actions related to the termination of 759 employees and a $2 million charge for the exit of certain leased facilities. The $49 million of income from business dispositions consists of a $55 million gain on the sale of working capital related to a European rice product line, which was partially offset by a $6 million charge to prepare businesses for disposition. The net impact of these actions was to decrease income from continuing operations before income taxes and income from continuing operations by $41 million and $28 million, respectively, and reduce diluted EPS by $0.04.

Third Quarter of Fiscal 2005 – The amount recognized on the line titled “Cost of sales,” as noted in the table above, consists of a $2 million curtailment gain from the closure of certain Bakery plants, which was partially offset by a $3 million charge for accelerated depreciation on certain facilities to be sold in the Household and Body Care segment. SG&A expenses include a $1 million charge for accelerated amortization for the cost to abandon certain Bakery intangible assets. The line titled “Charges for (income from) exit activities and business dispositions” includes income of $16 million which consists of the following components: an $11 million charge for exit activities and a $27 million net gain from business dispositions. The $11 million charge primarily relates to certain approved severance actions. The $27 million net gain consists of a $31 million gain related to the disposition of trademarks, working capital and certain fixed assets related to a canned meats business, partially offset by a $4 million charge related to the cost to evaluate the disposition of certain other businesses. The net impact of these actions was to increase income from continuing operations before taxes and income from continuing operations by $14 million and $9 million, respectively, and increase diluted earnings per share by $0.01.

These actions are more fully described in the Exit Activities and Business Dispositions note to the Consolidated Financial Statements. As a result of exit activities taken since the beginning of fiscal

2004, and transformation actions taken since the beginning of the transformation plan in fiscal 2005, the corporation’s cost structure was reduced and efficiency was improved. The following table summarizes the actual and projected savings from these actions.


(In millions)	Actual Savings Recognized in Fiscal 2005		Anticipated Savings in Fiscal 2006		Actual Savings in the 3^rd Quarter of Fiscal 2005		Actual Savings in the 3^rd Quarter of Fiscal 2006
Restructuring Actions Approved in:
Fiscal 2004	$	58	$	87	$	16	$	21
Fiscal 2005		6		61		2		15
1^st nine months of fiscal 2006		—		14		—		5

	$	64	$	162	$	18	$	41

In the remaining portion of fiscal 2006, the corporation expects to recognize additional transformation, exit and accelerated depreciation costs as the corporation reduces employment levels and eliminates manufacturing capacity.

Under the corporation’s transformation plan, which is described earlier in this document, a number of businesses have been targeted for sale, or have been sold. The Direct Selling, European Branded Apparel, U.K. Apparel, U.S. Retail Coffee, European Nuts and Snacks, European Meats and U.S. Meat Snacks businesses have been targeted for disposal and reported as discontinued operations. The Branded Apparel Americas / Asia business has also been targeted for disposal. However, this business was classified as held for use at the end of the third quarter of fiscal 2006. The following table summarizes the actual and projected savings related to only those businesses that are expected to be a part of continuing operations after the targeted businesses are disposed of.


(In millions)	Actual Savings Recognized in Fiscal 2005		Anticipated Savings in Fiscal 2006		Actual Savings in the 3^rd Quarter of Fiscal 2005		Actual Savings in the 3^rd Quarter of Fiscal 2006
Restructuring Actions Approved in:
Fiscal 2004	$	26	$	27	$	6	$	7
Fiscal 2005		6		28		2		8
1^st nine months of fiscal 2006		—		14		—		5

	$	32	$	69	$	8	$	20

Net Interest Expense

Net interest expense increased by $7 million in the third quarter of fiscal 2006, to $57 million, as a result of higher average interest rates on outstanding debt and lower interest income, partially offset by lower average debt balances due to the receipt of cash proceeds from business dispositions.

Income Tax Expense

The effective tax rate on continuing operations in the third quarter of fiscal 2006 and the comparable period of the prior year were impacted by a number of significant items.

•

The effective tax rate on continuing operations in the third quarter of fiscal 2006 was 30.6%. During the quarter, the corporation recognized a $57 million charge to repatriate to the U.S. approximately $220 million of cash related to the current year’s earnings outside the U.S. This charge was partially

offset by a $33 million credit related to the favorable outcome of a foreign tax contingency and the recognition of a $14 million tax benefit associated with the disposition of certain assets outside the U.S. In total, these items increased the effective tax rate by 4.8%.

•

The effective tax rate on continuing operations in the third quarter of fiscal 2005 was 39.1%. During the quarter, the corporation recognized a tax charge of $51 million as a result of management’s approval of a plan to repatriate $928 million of accumulated income from controlled foreign corporations to the U.S. under the American Jobs Creation Act of 2004. This charge was partially offset by a $19 million benefit to adjust prior estimates on the cost of the repatriation of foreign earnings. In total, these items increased the effective tax rate by 13.0%

Income from Continuing Operations and Diluted Earnings Per Share (EPS)

Income from continuing operations in the third quarter of fiscal 2006 was $137 million, which was $14 million, or 9.0%, less than the prior year comparable period. The decline in income from continuing operations was primarily due to the following factors.

•

The corporation’s gross profit declined by $22 million, primarily as a result of lower unit volumes in certain business segments and higher commodity and energy costs which contributed to a slightly lower gross profit margin percentage.

•

SG&A expenses in the third quarter of fiscal 2006 increased by $17 million over the comparable period of the prior year primarily due to costs associated with the corporation’s transformation, higher distribution costs primarily related to higher energy and employee costs. SG&A expenses as a percentage of sales increased from 29.8% in the third quarter of fiscal 2005 to 30.7% in the third quarter of fiscal 2006.

•

In the third quarter of fiscal 2006, the corporation recognized income of $11 million for exit activities and business dispositions, while in the third quarter of fiscal 2005, the corporation recognized income of $16 million.

•

Due to the increase in average borrowing rates, net interest expense increased by $7 million in the third quarter of fiscal 2006.

•

Income tax expense decreased by $37 million in the third quarter of fiscal 2006 versus the third quarter of fiscal 2005.

Diluted EPS from continuing operations decreased from $0.19 in the third quarter of fiscal 2005 to $0.18 in the third quarter of fiscal 2006, a decrease of 5.3%. Diluted EPS declined at a lower rate than income from continuing operations as a result of lower average shares outstanding during the third quarter of fiscal 2006 than the third quarter of fiscal 2005. The corporation repurchased 1 million shares in the third quarter of fiscal 2006 due to the completion of the corporation’s previously announced accelerated share repurchase program that was initiated earlier in the fiscal year. In fiscal year 2006, the corporation has repurchased 30.1 million shares of common stock under the share repurchase program.

Discontinued Operations

Discontinued operations include the results of the corporation’s Direct Selling, U.S. Retail Coffee, European Branded Apparel, U.K. Apparel, European Nuts and Snacks, European Meats and U.S. Meat Snacks businesses. The following summarizes the results of the discontinued operations for the third quarters of fiscal 2006 and 2005.


In millions	Third Quarter of Fiscal 2006			Third Quarter of Fiscal 2005			Change			Percent Change
Net Sales	$	488		$	941		$	(453	)	(48.1	)%

(Loss) income before taxes	$	(167	)	$	57		$	(224	)
Income tax benefit (expense)		5			(19	)		24
Gain of sale of discontinued operations		24			—			24
Income tax benefit (expense) on gain		43			—			43

Net income from discontinued operations	$	(95	)	$	38		$	(133	)

Results of Discontinued Operations

Net sales of the discontinued operations decreased by $453 million, or 48.1%, in the third quarter of fiscal 2006 as compared to the third quarter of fiscal 2005. The corporation completed the sale of the European Branded Apparel business during the third quarter and completed the sale of the Direct Selling and the U.S. Retail Coffee businesses prior to the start of the third quarter. Therefore, a full quarter of comparable sales was not included in the fiscal 2006 period. Additionally, the remaining businesses reported in discontinued operations reported lower sales in the third quarter of fiscal 2006 as compared to the third quarter of fiscal 2005. Income before taxes declined by $224 million in the third quarter of fiscal 2006, as the corporation recognized $170 million of impairment charges in the current year third quarter. Additionally, certain businesses have been sold and a full quarter of results are not included in the current year period, and the remaining businesses reported lower profitability during the period. During the third quarter of fiscal 2006, the corporation recognized the following pretax impairment charges: a $33 million charge related to the U.K. Apparel business; a $125 million charge related to the European Meats business; and a $12 million charge related to the U.S. Meat Snacks business. Further details regarding these charges can be found in the note to the Consolidated Financial Statements titled, “Discontinued Operations.”

The corporation recognized a tax benefit in discontinued operations of $5 million in the third quarter of fiscal 2006, as compared to a tax provision of $19 million in the third quarter of fiscal 2005. The tax benefit reflected in the third quarter of fiscal 2006 was primarily impacted by the $125 million impairment loss for European Meats and the $33 million impairment loss for the U.K. Apparel business where no tax benefit was provided.

Gain on Sale of Discontinued Operations

The corporation completed the sale of its European Branded Apparel operations and completed certain post-closing adjustments related to its Direct Selling business during the third quarter of fiscal 2006 and recognized a pretax and after-tax gain of $24 million and $67 million, respectively. The $43 million tax benefit recognized on the sale of discontinued operations is primarily related to the sale of the European Branded Apparel operations which was completed during the period.

Consolidated Net Income and Diluted Earnings Per Share

Net income of $42 million in the third quarter of fiscal 2006 was $147 million, or 77.4% lower than reported in the prior year comparable period. The decrease in net income was primarily due to the impairment charges that contributed to the $162 million loss reported by the discontinued operations, the $14 million reduction in income from continuing operations, partially offset by the $67 million gain reported on the sale of discontinued operations. Diluted EPS decreased from $0.24 in the third quarter of fiscal 2005 to $0.06 in the third quarter of fiscal 2006, a decrease of 75.0%.

Operating Results by Business Segment – Third Quarter of Fiscal 2006 Compared with Third Quarter of Fiscal 2005

North American Retail Meats


	Thirteen Weeks Ended
(In millions)	April 1, 2006			April 2, 2005			Change			Percent Change
Change in unit volume										6	%

Net sales	$	607		$	575		$	32		5.6	%

Increase / (decrease) in net sales from
Changes in foreign currency exchange rates	$	—		$	(3	)	$	3
Dispositions		—			2			(2	)

Total	$	—		$	(1	)	$	1

Operating segment income	$	46		$	68		$	(22	)	(31.9	)%

Increase / (decrease) in operating segment income from
Changes in foreign currency exchange rates	$	—		$	—		$	—
Exit activities and business dispositions		(1	)		29			(30	)
Transformation charges		(7	)		—			(7	)
Accelerated depreciation on facilities sold		(4	)		—			(4	)

Total	$	(12	)	$	29		$	(41	)

Unit volumes in the North American Retail Meats segment for processed meats increased 6%, as compared to the prior year, consisting of increases of 6% in the U.S. and 9% in Mexico. Unit volumes increased as the segment strategically reduced average selling prices for certain processed meat products, as compared to the prior year, and the recent introduction of several new products.

Net sales in the North American Retail Meats segment increased by $32 million, or 5.6%, to $607 million in the third quarter of fiscal 2006 from $575 million in the third quarter of the prior year. During the quarter, the strengthening of the Mexican peso increased reported net sales by $3 million, or 0.6%. Net sales of businesses disposed of since the beginning of the third quarter of fiscal 2005 reduced net sales by $2 million, or 0.4%. The remaining net sales increase of $31 million, or 5.4%, was primarily due to increases in unit volumes.

The North American Retail Meats gross margin percentage increased 3.4%, from 27.4% in the third quarter of fiscal 2005, to 30.8% in the third quarter of fiscal 2006 as the impact of lower commodity costs, higher unit volumes, and a favorable product mix were partially offset by price reductions and higher energy and packaging costs.

Operating segment income in North American Retail Meats decreased by $22 million, or 31.9%, from $68 million in the third quarter of fiscal 2005 to $46 million in the third quarter of fiscal 2006. Changes in foreign currency exchange rates did not have a significant impact on reported operating segment income. During the third quarter of fiscal 2006, the North American Retail Meats segment recognized charges for exit activities, transformation charges and accelerated depreciation. During the third quarter of fiscal 2005, the segment recognized income from exit activities. The net impact of exit activities, accelerated depreciation, and transformation expenses between the third quarters of fiscal 2006 and 2005 decreased operating segment income by $41 million, or 81.9%. The remaining operating segment income increase of $19 million, or 50.0%, as compared to the same quarter of the prior year is primarily the result of higher gross margins, partially offset by the impact of higher selling, general and administrative expenses.

North American Retail Bakery


	Thirteen Weeks Ended
(In millions)	April 1, 2006		April 2, 2005		Change		Percent Change
Change in unit volume⁽¹⁾							—	%

Net sales	$	449	$	427	$	22