Edgar Filing: Hillshire Brands Co

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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 December 29, 2012

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

Commission file number 1-3344

The Hillshire Brands Company

(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.)

400 South Jefferson Street, Chicago, Illinois		60607
(Address of principal executive offices)		(Zip Code)

(312) 614-6000

(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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “accelerated filer, large accelerated filer, smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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 December 29, 2012, the Registrant had 122,936,767 outstanding shares of common stock, par value $.01 per share.

The Hillshire Brands Company

INDEX


PART I -
ITEM 1 –	FINANCIAL STATEMENTS (Unaudited)

	Condensed Consolidated Balance Sheets—At December 29, 2012 and June 30, 2012	3

	Consolidated Statements of Income—For the Quarters and Six Months ended December 29, 2012 and December 31, 2011	4

	Condensed Consolidated Statements of Comprehensive Income—For the Quarters and Six Months ended December 29, 2012 and December 31, 2011	5

	Condensed Consolidated Statements of Equity—For the period July 2, 2011 to December 29, 2012	6

	Consolidated Statements of Cash Flows—For the Six Months ended December 29, 2012 and December 31, 2011	7

	Notes to Consolidated Financial Statements	8

ITEM 2 –	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	24

ITEM 4 –	CONTROLS AND PROCEDURES	44

PART II –

ITEM 1 –	LEGAL PROCEEDINGS	45

ITEM 1A –	RISK FACTORS	45

ITEM 2(c) –	REPURCHASES OF EQUITY SECURITES BY THE ISSUER	46

ITEM 5 –	OTHER INFORMATION	46

ITEM 6 –	EXHIBITS	47

Signature		48

THE HILLSHIRE BRANDS COMPANY

Condensed Consolidated Balance Sheets at December 29, 2012 and June 30, 2012

(Unaudited)


In millions	Dec 29, 2012		June 30, 2012
Assets
Cash and equivalents	$	299	$	235
Trade accounts receivable, less allowances		229		248
Inventories
Finished goods		191		196
Work in process		12		17
Materials and supplies		89		75

		292		288
Current deferred income taxes		104		114
Income tax receivable		21		52
Other current assets		46		65
Assets held for sale		39		—

Total current assets		1,030		1,002

Property, net of accumulated depreciation of $1,231 and $1,245, respectively		829		847
Trademarks and other identifiable intangibles, net		127		132
Goodwill		348		348
Deferred income taxes		26		36
Other noncurrent assets		79		80
Noncurrent assets held for sale		28		5

	$	2,467	$	2,450

Liabilities and Equity
Accounts payable	$	266	$	359
Accrued liabilities		403		469
Current maturities of long-term debt		10		5
Liabilities held for sale		27		—

Total current liabilities		706		833
Long-term debt		936		939
Pension obligation		157		166
Other liabilities		300		277
Non-current liabilities held for sale		1		—
Contingencies and commitments (Note 10)
Equity
Hillshire Brands common stockholders’ equity		367		235

	$	2,467	$	2,450

See accompanying Notes to Consolidated Financial Statements.

THE HILLSHIRE BRANDS COMPANY

Consolidated Statements of Income

For the Quarter and Six Months ended December 29, 2012 and December 31, 2011

(Unaudited)


	Quarter ended						Six Months ended
In millions, except per share data	Dec. 29, 2012			Dec. 31, 2011 (As Restated)			Dec. 29, 2012			Dec. 31, 2011 (As Restated)
Continuing Operations
Net sales	$	1,060		$	1,053		$	2,034		$	2,040

Cost of sales		728			755			1,408			1,469
Selling, general and administrative expenses		224			226			437			444
Net charges for exit activities, asset and business dispositions		9			45			6			66
Impairment charges		—			4			—			14

Operating income		99			23			183			47

Interest expense		11			22			22			45
Interest income		(1	)		(1	)		(3	)		(2	)

Income from continuing operations before income taxes		89			2			164			4
Income tax expense (benefit)		31			(8	)		57			(11	)

Income from continuing operations		58			10			107			15

Discontinued operations
Income (loss) from discontinued operations net of tax expense (benefit) of $(3), $(8), $(2) and $57		7			92			9			(223	)
Gain on sale of discontinued operations, net of tax expense of nil, $168, $1 and $338		—			368			2			460

Net income from discontinued operations		7			460			11			237

Net income		65			470			118			252
Less: Income from noncontrolling interests, net of tax
Discontinued operations		—			1			—			3

Net income attributable to Hillshire Brands	$	65		$	469		$	118		$	249

Amounts attributable to Hillshire Brands:
Net income from continuing operations		58			10			107			15
Net income from discontinued operations		7			459			11			234

Net income attributable to Hillshire Brands	$	65		$	469		$	118		$	249

Earnings per share of common stock
Basic
Income from continuing operations	$	0.47		$	0.09		$	0.88		$	0.13

Net income	$	0.53		$	3.96		$	0.97		$	2.11

Average shares outstanding		123			118			122			118

Diluted
Income from continuing operations	$	0.47		$	0.09		$	0.87		$	0.13

Net income	$	0.53		$	3.94		$	0.96		$	2.10

Average shares outstanding		123			119			123			119

Cash dividends declared per share of common stock	$	0.125		$	0.575		$	0.250		$	0.575

See accompanying Notes to Consolidated Financial Statements.

THE HILLSHIRE BRANDS COMPANY

Condensed Consolidated Statements of Comprehensive Income

For the Quarter and Six Months ended December 29, 2012 and December 31, 2011

(Unaudited)


	Quarter ended						Six Months Ended
In millions	Dec. 29, 2012			Dec. 31, 2011 (As Restated)			Dec. 29, 2012			Dec. 31, 2011 (As Restated)
Net Income	$	65		$	470		$	118		$	252
Translation adjustments, net of tax		—			16			1			(117	)
Net unrealized gain (loss) on qualifying cash flow hedges, net of tax		(11	)		(9	)		(4	)		(10	)
Pension/Postretirement activity, net of tax		—			(12	)		—			(2	)

Comprehensive income		54			465			115			123
Comprehensive income attributable to non-controlling interests		—			1			—			3

Comprehensive income attributable to Hillshire Brands	$	54		$	464		$	115		$	120

See accompanying Notes to Consolidated Financial Statements.

THE HILLSHIRE BRANDS COMPANY

Condensed Consolidated Statements of Equity

For the period July 2, 2011 to December 29, 2012

(Unaudited)


				Hillshire Brands Common Stockholders’ Equity
In millions	Total			Common Stock			Capital Surplus			Retained Earnings			Unearned Stock			Accumulated Other Comprehensive Income (Loss)			Noncontrolling Interest
Balances at July 2, 2011 (As restated)	$	1,893		$	6		$	39		$	2,161		$	(77	)	$	(265	)	$	29
Net income		848			—			—			845			—			—			3
Translation adjustments, net of tax		(23	)		—			—			—			—			(23	)		—
Net unrealized gain (loss) on qualifying cash flow hedges, net of tax		2			—			—			—			—			2			—
Pension/Postretirement activity, net of tax		(21	)		—			—			—			—			(21	)		—

Dividends on common stock		(138	)		—			—			(138	)		—			—			—
Dividends paid on noncontrolling interest/Other		(2	)		—			—			—			—			—			(2	)
Disposition of noncontrolling interest		(29	)		—			—			—			—			—			(29	)
Repurchase of noncontrolling interest		(10	)		—			(9	)		—			—			—			(1	)
Spin-off of international coffee and tea business		(2,408	)		—			(5	)		(2,566	)		—			163			—

Stock issuances -
Restricted stock		14			—			21			(7	)		—			—			—
Stock option and benefit plans		94			—			94			—			—			—			—
Reverse stock split		—			(5	)		5			—			—			—			—
ESOP activity and other		15			—			(1	)		—			16			—			—

Balances at June 30, 2012		235			1			144			295			(61	)		(144	)		—

Net income		118			—			—			118			—			—			—
Translation adjustments, net of tax		1			—			—			—			—			1			—
Net unrealized gain (loss) on qualifying cash flow hedges, net of tax		(4	)		—			—			—			—			(4	)		—

Dividends on common stock		(31	)		—			—			(31	)		—			—			—

Stock issuances -
Restricted stock		3			—			3			—			—			—			—
Stock option and benefit plans		41			—			41			—			—			—			—
ESOP activity and other		4			—			1			1			2			—			—

Balances at December 29, 2012	$	367		$	1		$	189		$	383		$	(59	)	$	(147	)	$	—

See accompanying Notes to Consolidated Financial Statements.

THE HILLSHIRE BRANDS COMPANY

Consolidated Statements of Cash Flows

For the Six Months ended December 29, 2012 and December 31, 2011

(Unaudited)


	Six Months Ended
In millions	Dec. 29, 2012			Dec. 31, 2011 (As Restated)
OPERATING ACTIVITIES -
Net income	$	118		$	252
Adjustments to reconcile net income to net cash from operating activities:
Depreciation		78			122
Amortization		8			20
Impairment charges		—			417
Net (gain) loss on business dispositions		(9	)		(802	)
Pension contributions, net of expense		(5	)		(127	)
Increase in deferred income taxes		18			113
Other		(1	)		37
Changes in current assets and liabilities, net of businesses acquired and sold
Trade accounts receivable		6			8
Inventories		(18	)		(113	)
Other current assets		16			(34	)
Accounts payable		(57	)		(10	)
Accrued liabilities		(57	)		(2	)
Accrued taxes		32			152

Net cash received from operating activities		129			33

INVESTING ACTIVITIES -
Purchases of property and equipment		(79	)		(128	)
Purchases of software and other intangibles		(3	)		(19	)
Acquisition of businesses		—			(29	)
Dispositions of businesses and investments		16			1,451
Cash received from derivative transactions		3			25
Sales of assets		1			1

Net cash received from (used in) investing activities		(62	)		1,301

FINANCING ACTIVITIES -
Issuances of common stock		39			36
Borrowings of other debt		—			142
Repayments of other debt and derivatives		(5	)		(242	)
Net change in financing with less than 90-day maturities		—			(197	)
Purchase of noncontrolling interest		—			(10	)
Payments of dividends		(31	)		(135	)

Net cash received from (used in) financing activities		3			(406	)

Effect of changes in foreign exchange rates on cash		—			(243	)

Increase in cash and equivalents		70			685
Add: Cash balances of discontinued operations at beginning of year		—			1,992
Less: Cash balances of discontinued operations at end of period		(6	)		(2,610	)
Cash and equivalents at beginning of year		235			74

Cash and equivalents at end of quarter	$	299		$	141

Supplemental Cash Flow Data:
Cash paid for restructuring actions	$	48		$	146
Cash contributions to pension plans		3			121
Cash paid for income taxes		6			120

See accompanying Notes to Consolidated Financial Statements.

THE HILLSHIRE BRANDS COMPANY

Notes to Consolidated Financial Statements

1. Basis of Presentation

The Hillshire Brands Company is a manufacturer and marketer of high-quality, brand name food products and a leader in meat-centric food solutions for the retail and foodservice markets. References to “we,” “our,” “us,” “Hillshire Brands” and “the company” refer to The Hillshire Brands Company and its consolidated subsidiaries as a whole, unless the context otherwise requires. The company’s reportable segments are Retail and Foodservice/Other.

The consolidated financial statements for the quarter and six months ended December 29, 2012 and December 31, 2011 have not been audited by an independent registered public accounting firm, but in the opinion of management, these financial statements include all normal and recurring adjustments necessary for a fair presentation of our financial statements in accordance with U.S. generally accepted accounting principles (GAAP). The results of operations for the six months ended December 29, 2012 are not necessarily indicative of the operating results to be expected for the full fiscal year.

The interim consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Although management believes the disclosures are adequate to make the information presented not misleading, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. The preparation of the consolidated financial statements in conformity with GAAP requires management to make use of estimates and assumptions that affect the reported amounts and related disclosures. Actual results could differ from these estimates. These unaudited interim consolidated financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes thereto included in the company’s Form 10-K for the year ended June 30, 2012 and other financial information filed with the Securities and Exchange Commission.

The company’s fiscal year ends on the Saturday closest to June 30. Fiscal 2013 ends on June 29, 2013. The second quarter and first six months of fiscal 2013 ended on December 29, 2012, and the second quarter and first six months of fiscal 2012 ended on December 31, 2011. Each of the quarters was a thirteen-week period, and each of the six month periods was a twenty-six week period. Fiscal 2013 and fiscal 2012 are both 52-week years. Unless otherwise stated, references to years relate to fiscal years.

The condensed consolidated balance sheet as of June 30, 2012 has been derived from the company’s audited financial statements included in our Annual Report on Form 10-K for the year ended June 30, 2012. The balance sheet information for the Australian bakery business has met the criteria to be classified as held for sale beginning in the second quarter of 2013 and as a result, these balances are being reported in the asset and liabilities held for sale lines of the condensed consolidated balance sheet as of December 29, 2012. The fresh bakery, refrigerated dough and foodservice beverage businesses in North America as well as the international coffee and tea, household and body care, European bakery and Australian bakery businesses are presented as discontinued operations in the company’s condensed consolidated income statements. See Note 5 – “Discontinued Operations” for additional information regarding these discontinued operations. Unless stated otherwise, any reference to income statement items in these financial statements refers to results from continuing operations.

Financial Statement Corrections — As disclosed in Note 1, Nature of Operations and Basis of Presentation, in our Annual Report on Form 10-K for the fiscal year ended June 30, 2012, Hillshire Brands restated its previously issued financial statements for fiscal years 2010 and 2011, and the unaudited financial data for the first three quarters of fiscal 2011 and 2012 to recognize the correction of the following accounting errors.

On August 1, 2012, D.E Master Blenders 1753 N.V. (DEMB) announced that it had discovered accounting irregularities involving previously issued financial results for its Brazilian operations, which would require the restatement of their previously issued financial statements for the periods from fiscal 2009 to 2012. The financial results of the Brazilian operations are reported as part of discontinued operations in the Hillshire Brands financial statements as a result of the spin-off of the international coffee and tea operations. Hillshire Brands reflected the correction of the accounting irregularities by first restating the “as reported” historical financial results of the Brazilian operations and then recognizing the restated results as part of discontinued operations along with the other businesses that comprised the international coffee and tea business. As such, the adjustments to net sales noted in

the following tables represent corrections associated with the accounting irregularities in Brazil and do not relate to any businesses included in continuing operations. The accounting irregularities identified in the Brazil operations included the overstatement of accounts receivable due to the failure to write-off uncollectible customer discounts, improper recognition of sales revenues prior to shipments to customers, the understatement of accruals for various litigation issues, and the failure to write-off obsolete inventory and other inventory valuation issues. These accounting irregularities resulted from an ineffective control environment maintained by management in Brazil, including intentional overrides of internal controls, and extensive cross-functional collusion by company personnel and third parties in Brazil. These actions were designed to meet earnings targets in Brazil.

As a result of these error corrections, income from discontinued operations was increased by $20 million in the first six months of 2012. The cumulative impact of the error corrections prior to fiscal 2012 reduced stockholders’ equity at July 2, 2011 by $70 million.

In addition to the error corrections noted above, Hillshire Brands has also corrected several errors related to continuing and discontinued operations and has restated its previously issued financial statements for 2010 and 2011 and the unaudited financial data for the first three quarters of 2011 and 2012 for these items. These errors had been previously identified and corrected in fiscal years subsequent to their origination. The company originally recorded the error corrections in the periods in which they were discovered. Management continues to believe that these errors did not materially misstate the financial results of the periods in which the errors originated or the periods in which the errors were corrected but management has decided to record these adjustments in the periods in which they originated in conjunction with the financial statement corrections noted above. As a result of these error corrections, Income from continuing operations was reduced by $21 million and Income from discontinued operations was reduced by $1 million for the first six months of 2012. The cumulative impact of the error corrections prior to fiscal 2012 reduced stockholders’ equity at July 2, 2011 by $11 million.

Income Statement Impact

The impact of these error corrections on the income statement for the second quarter and first six months of 2012 is summarized in the following table:


(in millions)	Quarter ended December 31, 2011												Six Months ended December 31, 2011
(Unaudited)	As Reported ¹			Adjustment			Disc.Ops.			As Restated			As Reported ¹			Adjustment			Disc.Ops.			As Restated
Continuing Operations
Net sales	$	2,081		$	(5	)	$	(1,023	)	$	1,053		$	4,024		$	2		$	(1,986	)	$	2,040
Cost of sales		1,385			(5	)		(625	)		755			2,712			3			(1,246	)		1,469
Selling, general and administrative expenses		497			(4	)		(267	)		226			952			(3	)		(505	)		444
Net charges for exit activities, asset and business dispositions		84			(5	)		(34	)		45			116			(5	)		(45	)		66
Impairment charges		14			—			(10	)		4			32			—			(18	)		14

Operating income		101			9			(87	)		23			212			7			(172	)		47

Interest expense		29			—			(7	)		22			59			—			(14	)		45

Interest income		(11	)		—			10			(1	)		(20	)		—			18			(2	)

Income from continuing operations before tax		83			9			(90	)		2			173			7			(176	)		4
Income tax expense (benefit)		50			5			(63	)		(8	)		174			6			(191	)		(11	)

Income (loss) from Continuing Operations		33			4			(27	)		10			(1	)		1			15			15
Income (loss) from disc. operations, net of tax		65			—			27			92			(208	)		—			(15	)		(223	)
Gain on sale of disc. operations, net of tax		371			(3	)		—			368			463			(3	)		—			460

Net income from discontinued operations		436			(3	)		27			460			255			(3	)		(15	)		237
Net income		469			1			—			470			254			(2	)		—			252
Net income from non-controlling interest		1			—			—			1			3			—			—			3

Net income attributable to Hillshire Brands	$	468		$	1		$	—		$	469		$	251		$	(2	)	$	—		$	249

Earnings per share—Basic
Income (loss) from continuing operations	$	0.28		$	0.03		$	(0.22	)	$	0.09		$	(0.01	)	$	0.01		$	0.12		$	0.13
Net income		3.95			0.01			0.00			3.96			2.12			(0.01	)		0.00			2.11
Earnings per share—Diluted
Income (loss) from continuing operations	$	0.27		$	0.03		$	(0.22	)	$	0.09		$	(0.01	)	$	0.01		$	0.12		$	0.13
Net income		3.93			0.01			0.00			3.94			2.12			(0.01	)		0.00			2.10

¹	Amounts as reported in the company’s financial statements in its Quarterly Report on Form 10-Q for the period ended December 31, 2011

Comprehensive Income Impact

The following tables summarize the comprehensive income (loss) previously reported in the company’s filings and the restated amounts.


(in millions) (Unaudited)	Quarter ended December 31, 2011
(in millions) (Unaudited)	As Reported ¹			As Restated
Comprehensive Income
Net Income (loss)	$	469		$	470
Translation adjustments, net of tax		14			16
Net unrealized gain (loss) on qualifying cash flow hedges, net of tax		(9	)		(9	)
Pension/Postretirement activity, net of tax		(12	)		(12	)

Comprehensive income (loss)	$	462		$	465


(in millions) (Unaudited)	Six Months ended December 31, 2011
(in millions) (Unaudited)	As Reported ¹			As Restated
Comprehensive Income
Net Income (loss)	$	254		$	252
Translation adjustments, net of tax		(128	)		(117	)
Net unrealized gain (loss) on qualifying cash flow hedges, net of tax		(10	)		(10	)
Pension/Postretirement activity, net of tax		(2	)		(2	)

Comprehensive income (loss)	$	114		$	123

¹	Amounts as reported in the company’s financial statements in its Quarterly Report on Form 10-Q for the period ended December 31, 2011

Consolidated Statement of Cash Flow Impact

The restatement did not change the total cash flows from operating, investing or financing activities for any of the quarters or full years impacted by the restatements. However, certain amounts within Cash from Operating Activities were impacted by the non-cash adjustments to correct the errors. The following table shows the impact of the restatements on the previously reported cash flow items within Cash from Operating Activities for the first six months of 2012.


(in millions) (Unaudited)	Six Months ended December 31, 2011
(in millions) (Unaudited)	As Reported¹			As Restated
Net Income	$	254		$	252
Adjustments to reconcile net income to net cash from operating activities:
Other		45			37
Changes in current assets and liabilities, net of businesses acquired and sold
Trade accounts receivable		12			8
Inventories		(115	)		(113	)
Other current assets		(37	)		(34	)
Accrued liabilities		(7	)		(2	)
Accrued taxes		148			152

Net cash from operating activities	$	33		$	33

¹	Amounts as reported in the company’s financial statements in its Quarterly Report on Form 10-Q for the period ended December 31, 2011

2. Net Income (Loss) Per Share

The computation of earnings (loss) per share (EPS) only includes results attributable to Hillshire Brands and does not include earnings related to non-controlling interests. Net income per share – basic is computed by dividing net income attributable to Hillshire Brands 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 fixed awards to be issued under stock-based compensation awards were converted into common stock. For the quarter and six months ended December 29, 2012, options to purchase 3.2 million shares of the company’s common stock had exercise prices that were greater than the average market price of those shares during the respective reporting periods. For the quarter and six months ended December 31, 2011, options to purchase 1.6 million of the company’s common stock had exercise prices that were greater than the average market price of those shares during the respective reporting periods.

The average shares outstanding increased in the second quarter and first six months of 2013 as compared to the second quarter and first six months of 2012 as a result of the impact of stock issuances related to the exercise of stock options and the accelerated vesting of restricted stock units (RSUs).

As of December 29, 2012, the company was authorized to repurchase approximately $1.2 billion of common stock under one of its existing share repurchase programs, plus 2.7 million shares of common stock that remain authorized for repurchase under the company’s other share repurchase program.

The following is a reconciliation of net income to net income per share – basic and diluted – for the second quarter and first six months of 2013 and 2012 (per share amounts are rounded and may not add to total):

Computation of Net Income per Common Share

(In millions, except per share data)


	Quarter Ended				Six Months Ended
	Dec. 29, 2012		Dec. 31, 2011		Dec. 29, 2012		Dec. 31, 2011
Amounts attributable to Hillshire Brands
Income from continuing operations	$	58	$	10	$	107	$	15
Income from discontinued operations, net of tax		7		459		11		234

Net income	$	65	$	469	$	118	$	249

Average shares outstanding – Basic		123		118		122		118
Dilutive effect of stock option and award plans		—		1		1		1

Diluted shares outstanding		123		119		123		119

Earnings per common share—Basic
Income from continuing operations	$	0.47	$	0.09	$	0.88	$	0.13
Income from discontinued operations		0.06		3.87		0.09		1.98

Net income	$	0.53	$	3.96	$	0.97	$	2.11

Earnings per common share – Diluted
Income from continuing operations	$	0.47	$	0.09	$	0.87	$	0.13
Income from discontinued operations		0.06		3.85		0.09		1.97

Net income	$	0.53	$	3.94	$	0.96	$	2.10

3. Segment Information

The following is a general description of the company’s two business segments:

•

Retail – sells a variety of packaged meat and frozen bakery products to retail customers in North America.

•

Foodservice/Other – sells a variety of meat and bakery products to foodservice customers in North America. It also includes results for the commodity pork and turkey businesses as well as the company’s Senseo coffee business in the United States which was exited in March 2012 and the results for the company’s live hog business that was exited in September 2011.

The following is a summary of net sales and operating income by business segment:


	Net Sales
(In millions)	Second Quarter 2013			Second Quarter 2012			Six Months 2013			Six Months 2012
Retail	$	777		$	761		$	1,496		$	1,459
Foodservice/Other		283			294			538			587

Total business segments		1,060			1,055			2,034			2,046
Intersegment sales		—			(2	)		—			(6	)

Net sales	$	1,060		$	1,053		$	2,034		$	2,040


	Income Before Income Taxes
(In millions)	Second Quarter 2013			Second Quarter 2012			Six Months 2013			Six Months 2012
Retail	$	112		$	85		$	198		$	129
Foodservice/Other		28			29			53			54

Total operating segment income		140			114			251			183
General corporate expenses		(36	)		(93	)		(67	)		(133	)
Mark-to-market derivative gains/(losses)		(4	)		3			1			(1	)
Amortization of intangibles		(1	)		(1	)		(2	)		(2	)

Operating income		99			23			183			47
Net interest expense		(10	)		(21	)		(19	)		(43	)

Income before income taxes	$	89		$	2		$	164		$	4

4. Impairment and Other Charges

The company recognized impairment charges of $4 million ($3 million after tax) in the second quarter of 2012 and $14 million ($9 million after tax) in the first six months of 2012, all of which related to the writedown of capitalized computer software that was determined to no longer have any future use by the company. These charges were recognized as part of general corporate expenses. The significant impairments are reported on the “Impairment Charges” line of the Consolidated Statement of Income. The related tax benefit is determined using the statutory tax rates for the tax jurisdiction in which the impairment occurred.

5. Discontinued Operations

The results of the fresh bakery, refrigerated dough and foodservice beverage operations in North America and the international coffee and tea, household and body care, European bakery and Australian bakery businesses are classified as discontinued operations and are presented as discontinued operations in the condensed consolidated statements of income for all periods presented. The assets and liabilities for these businesses met the accounting criteria to be classified as held for sale and have been aggregated and reported on a separate line of the Condensed Consolidated Balance Sheet prior to disposition. The assets and liabilities associated with the Australia Bakery business are being classified as held for sale beginning with the balance sheet at December 29, 2012.

On December 19, 2012, the company signed an agreement to sell its Australian bakery business to McCain Foods Limited. The results of this business were previously reported as the Australian Bakery business segment. Also included in the transaction are the license rights to certain intellectual property used by the Australia bakery business in the Asia-Pacific region. The total consideration expected to be received by the company in connection with the transaction is AUD $82 million (approximately $85 million U.S. dollars) subject to adjustment. The transaction is expected to close in the third quarter of 2013 and is subject to customary closing conditions and regulatory clearance.

The disposition of each of the businesses noted above, with the exception of the Australian bakery business, was completed prior to the end of fiscal 2012, and, as such, there are no operating results related to these discontinued operations in 2013. The income reported by the North American foodservice beverage operation in 2013 relates to the finalization of certain restructuring and other accruals. See Note 5, Discontinued Operations in the company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2012 for additional information regarding these discontinued operations.

The following is a summary of the operating results of the company’s discontinued operations for the second quarter and first six months of 2013 and 2012:


	Second Quarter 2013						First Six Months of 2013
(in millions)	Net Sales		Pretax Income (Loss)		Net Income (Loss)		Net Sales		Pretax Income (Loss)		Net Income (Loss)
Australian Bakery	$	34	$	2	$	6	$	71	$	5	$	8
North American Foodservice Beverage		—		2		1		—		2		1

Total	$	34	$	4	$	7	$	71	$	7	$	9


	Second Quarter 2012								First Six Months 2012
As Restated (in millions)	Net Sales		Pretax Income (Loss)			Net Income (Loss)			Net Sales		Pretax Income (Loss)			Net Income (Loss)
North American Fresh Bakery	$	195	$	8		$	74		$	724	$	29		$	144
North American Refrigerated Dough		—		—			—			74		13			9
North American Foodservice Beverage		165		(5	)		(6	)		302		(5	)		(3	)
International Coffee and Tea		994		86			90			1,922		169			42
European Bakery		115		(11	)		(4	)		263		(385	)		(360	)
Australian Bakery		35		3			(63	)		73		5			(57	)
International Household and Body Care		40		3			1			109		8			2

Total	$	1,544	$	84		$	92		$	3,467	$	(166	)	$	(223	)

In the first six months of 2012, the results of the European bakery operations include a $379 million pretax impairment charge. The results of the discontinued operations also include a $189 million tax benefit related to tax basis differences associated with the North American Fresh Bakery and European Bakery assets. It also includes $127 million of tax expense associated with the international coffee and tea business, which includes $84 million of discrete tax items. The discrete tax items relate to the following: $73 million of tax expense to establish a valuation allowance on net operating losses in France and $79 million of tax expense to establish a deferred tax liability related to earnings that are no longer permanently reinvested in Spain offset by a tax benefit of $68 million primarily related to a decrease in the amount of unrecognized tax positions in Spain. The tax rate was also impacted by the expected repatriation of a portion of fiscal 2012 earnings. For the second quarter and six months ended December 31, 2011, net income for the Australian bakery business includes tax expense of approximately $65 million and $60 million, respectively, related to the application of intraperiod tax allocation rules that require the Australian bakery business to absorb the impact of any change in the amount of taxes allocated to continuing operations before the discontinuance of the Australian bakery business and the taxes allocated to continuing operations after the discontinuance of the Australian bakery business.

The following is a summary of the gain on sale of the company’s discontinued operations for the second quarter and first six months of 2013 and 2012:


	Second Quarter 2013						First Six Months 2013
(In millions)	Pretax Gain on Sale		Tax (Expense) Benefit		After Tax Gain		Pretax Gain on Sale		Tax (Expense) Benefit			After Tax Gain
North American Fresh Bakery	$	—	$	—	$	—	$	1	$	—		$	1
North American Foodsrv. Beverage		—		—		—		2		(1	)		1

Total	$	—	$	—	$	—	$	3	$	(1	)	$	2

The gain on sale of discontinued operations reported in fiscal 2013 represents the impact of a final purchase price adjustment related to the North American fresh bakery disposition and gains related to the disposition of two manufacturing facilities related to the North American foodservice beverage operations.


	Second Quarter 2012								First Six Months 2012
(In millions) as restated	Pretax Gain on Sale		Tax (Expense) Benefit			After Tax Gain			Pretax Gain on Sale		Tax (Expense) Benefit			After Tax Gain
North American Fresh Bakery	$	105	$	(37	)	$	68		$	105	$	(37	)	$	68
North American Foodsrv. Beverage		222		(77	)		145			222		(77	)		145
North American Refrigerated Dough		—		—			—			198		(158	)		40
European Bakery		15		(5	)		10			15		(5	)		10
Non-European insecticides		192		(43	)		149			252		(55	)		197
Other Household and Body Care		2		(6	)		(4	)		6		(6	)		—

Total	$	536	$	(168	)	$	368		$	798	$	(338	)	$	460

In 2012, the $158 million tax expense recognized on the sale of the North American refrigerated dough business was impacted by $254 million of goodwill that had no tax basis.

The following is a summary of the assets and liabilities held for sale as of December 29, 2012 and June 30, 2012:


(in millions)	Dec. 29, 2012		June 30, 2012
Cash and equivalents	$	6	$	—
Trade accounts receivable		14		—
Inventories		15		—
Other current assets		4		—

Total current assets held for sale		39		—

Property		28		5

Assets held for sale	$	67	$	5

Accounts payable	$	13	$	—
Accrued expenses and other current liabilities		14		—

Total current liabilities held for sale		27		—

Other liabilities		1		—

Liabilities held for sale	$	28	$	—

The cash flows related to the discontinued operations are summarized in the table below:


	Six Months ended			Six Months ended
(In millions) – Increase / (Decrease)	Dec. 29, 2012			Dec. 31, 2011
Cash flow from (used in) operating activities	$	13		$	(97	)
Cash flow from (used in) investing activities		6			1,329
Cash flow from (used in) financing activities		(13	)		(371	)
Effect of changes in foreign exchange rates on cash		—			(243	)

Increase in net cash of discontinued operations		6			618
Cash and cash equivalents at beginning of year		—			1,992

Cash and cash equivalents at end of period	$	6		$	2,610

The cash used in financing activities primarily represents the net transfers of cash with the corporate office. The net assets of the discontinued operations assumed that the cash of those businesses has been retained as a corporate asset, with the exception of the international coffee and tea business, which retained its cash and equivalents after the spin-off of this business.

6. Exit, Disposal and Other Restructuring Activities

The company has incurred exit, disposition and restructuring charges for initiatives designed to improve its operational performance and reduce cost. In addition, in June 2012, the company completed the spin-off of its international coffee and tea operations into a new public company, which resulted in the company incurring certain costs in conjunction with the spin-off. These costs include restructuring actions such as employee termination costs and costs related to renegotiating contractual agreements; third party professional fees for consulting and other services that are directly related to the spin-off; and the costs of employees solely dedicated to activities directly related to the spin-off.

The nature of the costs incurred under these plans includes the following:

1) Exit Activities, Asset and Business Disposition Actions – These amounts primarily relate to:

•

Employee termination costs

•

Lease exit and other contract termination costs

•

Gains or losses on the disposition of assets or asset groupings that do not qualify as discontinued operations

2) Costs recognized in Cost of sales and Selling, general and administrative expenses primarily relate to:

•

Expenses associated with the installation of information systems

•

Consulting costs

•

Costs associated with the renegotiation of contracts for services with outside third-party vendors as part of the spin-off of the international coffee and tea operations

Certain of these costs are recognized in Cost of sales or Selling, general and administrative expenses in the Consolidated Statements of Income as they do not qualify for treatment as an exit activity or asset and business disposition under the accounting rules for exit and disposal activities. However, management believes the disclosure of these charges provides the reader greater transparency to the total cost of the initiatives.

The following is a summary of the (income) expense associated with ongoing actions, which also highlights where the costs are reflected in the Consolidated Statements of Income along with the impact on diluted EPS:


	Quarter ended						Six Months ended
(In millions)	Dec. 29, 2012			Dec. 31, 2011			Dec. 29, 2012			Dec. 31, 2011
Selling, general and administrative expenses	$	6		$	15		$	15		$	33
Exit activities, asset and business dispositions		9			45			6			66

Decrease in income from continuing operations before income taxes		15			60			21			99
Income tax benefit		(5	)		(20	)		(7	)		(31	)

Decrease in income from continuing operations	$	10		$	40		$	14		$	68

Impact on diluted EPS	$	0.08		$	0.34		$	0.11		$	0.57

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


	Quarter ended				Six Months ended
(In millions)	Dec. 29, 2012		Dec. 31, 2011		Dec. 29, 2012			Dec. 31, 2011
Retail	$	—	$	—	$	(3	)	$	8
Foodservice/Other		—		1		(2	)		2

Decrease in operating segment income		—		1		(5	)		10
Increase in general corporate expenses		15		59		26			89

Total	$	15	$	60	$	21		$	99

The following table summarizes the activity for the first six months of 2013 related to exit, disposal and restructuring related actions and the status of the related accruals as of December 29, 2012. The accrued amounts remaining represent the estimated cash expenditures necessary to satisfy remaining obligations. The majority of the cash payments to satisfy the accrued costs are expected to be paid in the next 12 months. Approximately $65 million to $75 million of charges, which includes accelerated depreciation, are expected to be recognized in 2013 related to these restructuring actions and other actions associated with cost reduction efforts related to the spin-off.


(In millions)	Employee termination and other benefits			IT and other costs			Non-cancellable leases/ Contractual obligations			Asset and business disposition actions			Total
Accrued costs as of June 30, 2012	$	42		$	16		$	21		$	—		$	79
Exit, disposal and other costs (income) recognized during 2013		1			14			13			(5	)		23
Cash payments		(15	)		(17	)		(15	)		—			(47	)
Noncash charges		—			(8	)		12			—			4
Charges (income) in discontinued operations		1			—			—			—			1
Change in estimate		(2	)		—			—			—			(2	)
Asset and business disposition action		—			—			—			5			5

Accrued costs as of December 29, 2012	$	27		$	5		$	31		$	—		$	63

The 2013 exit, disposal and restructuring related actions are summarized below:

•

Recognized costs associated with renegotiating global IT contracts and the installation of IT systems

•

Recognized third party costs associated with the spin-off of the international coffee and tea operations

•

Recognized lease exit costs

•

Disposed of certain manufacturing facilities related to the Retail and Foodservice/Other segments and recognized a pretax gain of $5 million

In 2012, the company recognized a charge to implement a plan to terminate approximately 520 employees, related to the retail, foodservice and corporate office operations and provide them with severance benefits in accordance with benefit plans previously communicated to the affected employee group or with local employment laws. Of the 520 targeted employees, approximately 420 have been terminated to date. The remaining employees are expected to be terminated within the next 12 months.

7. Financial Instruments

Background Information

The company uses derivative financial instruments, including futures, options and swap contracts to manage its exposures to commodity prices and interest rate risks. The use of these derivative financial instruments modifies the exposure of these risks with the intent to reduce the risk or cost to the company. The company does not use derivatives for trading or speculative purposes and is not a party to leveraged derivatives. More information concerning accounting for financial instruments can be found in Note 2, Summary of Significant Accounting Policies in the company’s 2012 Annual Report.

Types of Derivative Instruments—

Interest Rate and Cross Currency Swaps

The company has utilized interest rate swap derivatives to manage interest rate risk, in order to maintain a targeted amount of both fixed-rate and floating-rate long-term debt and notes payable. Interest rate swap agreements that are effective at hedging the fair value of fixed-rate debt agreements are designated and accounted for as fair value hedges. The company has a fixed interest rate on virtually all of its long-term debt, and as of December 29, 2012 the company is not a party to any interest rate swap agreements.

Prior to the spin-off of its international coffee and tea business in June 2012, the company issued certain foreign-denominated debt instruments and utilized cross currency swaps to reduce the variability of functional currency cash flows related to foreign currency debt. Cross currency swap agreements that are effective at hedging the variability of foreign-denominated cash flows are designated and accounted for as cash flow hedges. In the fourth quarter of 2012, the company entered into an offsetting cross currency swap to neutralize €229 million due under the company’s one remaining cross currency swap that matures in June 2013. The net cash due upon settlement of both derivative instruments is approximately $40 million.

Commodity Futures and Options Contracts

The company uses commodity futures and options to hedge a portion of its commodity price risk. The principal commodities hedged by the company include pork, beef, natural gas, diesel fuel, corn, wheat and other ingredients. The company does not use significant levels of commodity financial instruments to hedge commodity prices and primarily relies upon fixed rate supplier contracts to determine commodity pricing. In circumstances where commodity-derivative instruments are used, there is a high correlation between the commodity costs and the derivative instruments. For those instruments where the commodity instrument and underlying hedged item correlate between 80-125%, the company accounts for those contracts as cash flow hedges. However, the majority of commodity derivative instruments are accounted for as mark-to-market hedges. The company only enters into futures and options contracts that are traded on established, well-recognized exchanges that offer high liquidity, transparent pricing, daily cash settlement and collateralization through margin requirements.

Non-Derivative Instruments

Prior to the spin-off of its international coffee and tea business, the company used non-derivative instruments such as non-U.S. dollar financing transactions or non-U.S. dollar assets or liabilities, including intercompany loans, to hedge the exposure of changes in underlying foreign currency denominated subsidiary net assets, and they were declared as Net Investment Hedges.

The notional values of the various derivative instruments used by the company are summarized in the following table:


Notional Values (In millions)	Dec. 29, 2012		June 30, 2012		Hedge Coverage (Number of months)
Commodity Contracts:
Commodity Future Contracts:⁽¹⁾
Grains/Oilseed	$	55	$	56		0.1 – 4.0
Energy		26		27		0.1 – 11.0
Other commodities		22		25		0.1 – 5.0
Commodity Options Contracts:⁽²⁾
Grains/Oilseed		1		—		0.1

¹	Commodity futures contracts are determined by the initial cost of the contract

²	Option contract notional values are determined by the ratio of the change in option value to the change in underlying hedged item

Cash Flow Presentation

The cash receipts and payments from a derivative instrument are classified according to the nature of the instrument, when realized, generally in investing activities unless otherwise disclosed. However, cash flows from a derivative instrument that are accounted for as a fair value hedge or cash flow hedge are classified in the same category as the cash flows from the items being hedged provided the derivative does not include a financing element at inception. If a derivative instrument includes a financing element at inception, all cash inflows and outflows of the derivative instrument are considered cash flows from financing activities. If, for any reason, hedge accounting is discontinued, any remaining cash flows after that date shall be classified consistent with mark-to-market instruments.

Contingent Features/Concentration of Credit Risk

All of the company’s derivative instruments are governed by International Swaps and Derivatives Association (i.e., ISDA) master agreements, requiring the company to maintain an investment grade credit rating from both Moody’s and Standard & Poor’s credit rating agencies. If the company’s credit rating were to fall below investment grade, it would be in violation of these provisions, and the counterparties to the derivative instruments could request immediate payment or demand immediate collateralization on the derivative instruments in net liability positions. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that are in a liability position was $40 million on December 29, 2012 and $40 million on June 30, 2012, for which the company has posted no collateral. If the credit-risk-related contingent features underlying these agreements were triggered on December 29, 2012 and June 30, 2012, the company would be required to post collateral of, at most, $40 million with its counterparties.

A large number of major international financial institutions are counterparties to the company’s financial instruments. The company enters into financial instrument agreements only with counterparties meeting very stringent credit standards (a credit rating of A-/A3 or better), limiting the amount of agreements or contracts it enters into with any one party and, where legally available, executing master netting agreements. The company regularly monitors these positions. While the company may be exposed to credit losses in the event of nonperformance by individual counterparties of the entire group of counterparties, the company has not recognized any losses with these counterparties in the past and does not anticipate material losses in the future.

Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., exit price) in an orderly transaction between market participants at the measurement date. Assets and liabilities measured at fair value must be categorized into one of three different levels depending on the assumptions (i.e., inputs) used in the valuation. Level 1 provides the most reliable measure of fair value while level 3 generally requires significant management judgment. Assets and liabilities are classified in their entirety based on the lowest level of input significant to the fair value measurement.

The carrying amounts of cash and equivalents, trade accounts receivables, accounts payable, derivative instruments and notes payable approximate fair values due to their short-term nature. The carrying value of derivative instruments approximate fair value but may be considered Level 1 or Level 2 based on the valuation inputs used (see balance sheet classification and fair value determination in the table presented later in this disclosure.) The fair value of the company’s long-term debt (considered Level 2), including the current portion, is estimated using discounted cash flows based on the company’s current incremental borrowing rates for similar types of borrowing arrangements.


	Dec. 29, 2012				June 30, 2012
(In Millions)	Fair Value		Carrying Amount		Fair Value		Carrying Amount
Long-term debt, including current portion	$	992	$	946	$	1,004	$	944

Information on the location and amounts of derivative fair values in the Condensed Consolidated Balance Sheet at December 29, 2012 and June 30, 2012 is as follows:


	Assets				Liabilities
	Other Current Assets				Accrued Liabilities-Other
(In millions)	Dec. 29, 2012		June 30, 2012		Dec. 29, 2012		June 30, 2012
Derivatives designated as hedging instruments:
Foreign exchange contracts (a)	$	—	$	—	$	40	$	40
Derivatives not designated as hedging instruments:
Foreign exchange contracts (a)		—		1		—		—

Total derivatives	$	—	$	1	$	40	$	40

^(a)	Categorized as level 2: Fair value of level 2 assets and liabilities as of Dec. 29, 2012 are nil and $40 million and at June 30, 2012 are $1 million and $40 million, respectively.

Information related to our cash flow hedges, net investment hedges, fair value hedges and other derivatives not designated as hedging instruments for the quarters and six months ended December 29, 2012 and December 31, 2011 follows:


	Interest Rate Contracts Quarter ended				Foreign Exchange Contracts Quarter ended					Commodity Contracts Quarter ended					Total Quarter ended
(In millions)	Dec. 29, 2012		Dec. 31, 2011		Dec. 29, 2012		Dec. 31, 2011			Dec. 29, 2012			Dec. 31, 2011		Dec. 29, 2012			Dec. 31, 2011
Cash Flow Derivatives:
Amount of gain (loss) recognized in other comprehensive income (OCI) (a)	$	—	$	—	$	—	$	1		$	(4	)	$	3	$	(4	)	$	4
Amount of gain (loss) reclassified from AOCI into earnings (a) (b)		—		—		—		11			6			1		6			12
Amount of ineffectiveness recognized in earnings (c) (d)		—		—		—		—			—			1		—			1
Amount of gain (loss) expected to be reclassified into earnings during the next twelve months		—		—		—		(2	)		5			1		5			(1	)

Net Investment Derivatives:
Amount of gain (loss) recognized in OCI (a)		—		—		—		252			—			—		—			252
Amount of gain (loss) recognized from OCI into earnings (f)		—		—		—		(198	)		—			—		—			(198	)


Fair Value Derivatives:
Amount of derivative gain (loss) recognized in earnings (e)		—		—		—		—			—			—		—			—
Amount of hedged item gain (loss) recognized in earnings (e)		—		3		—		—			—			—		—			3
Derivatives Not Designated as Hedging Instruments:
Amount of gain (loss) recognized in Cost of Sales		—		—		—		—			(1	)		—		(1	)		—
Amount of gain (loss) recognized in SG&A		—		—		—		(6	)		(1	)		2		(1	)		(4	)

^(a)	Effective portion

^(b)	Gain (loss) reclassified from AOCI into earnings is reported in interest, for interest rate swaps, in selling, general, and administrative (SG&A) expenses for foreign exchange contracts and in cost of sales for commodity contracts.

^(c)	Gain (loss) recognized in earnings is related to the ineffective portion and amounts excluded from the assessment of hedge effectiveness.

^(d)	Gain (loss) recognized in earnings is reported in interest expense for foreign exchange contracts and SG&A expenses for commodity contracts.

^(e)	The amount of gain (loss) recognized in earnings on the derivative contracts and the related hedged item is reported in interest for the interest rate contracts and SG&A for the foreign exchange contracts.

^(f)	The gain (loss) recognized from OCI into earnings is reported in gain on sale of discontinued operations.


	Interest Rate Contracts				Foreign Exchange Contracts						Commodity Contracts						Total
	Six Months ended				Six Months ended						Six Months ended						Six Months ended
(In millions)	Dec. 29, 2012		Dec. 31, 2011		Dec. 29, 2012			Dec. 31, 2011			Dec. 29, 2012			Dec. 31, 2011			Dec. 29, 2012			Dec. 31, 2011
Cash Flow Derivatives:
Amount of gain (loss) recognized in other comprehensive income (OCI) (a)	$	—	$	—	$	—		$	197		$	8		$	2		$	8		$	199
Amount of gain (loss) reclassified from AOCI into earnings (a) (b)		—		—		—			204			11			4			11			208
Amount of ineffectiveness recognized in earnings (c) (d)		—		—		—			(2	)		—			2			—			—
Amount of gain (loss) expected to be reclassified into earnings during the next twelve months		—		—		—			(3	)		(6	)		(3	)		(6	)		(6	)

Net Investment Derivatives:
Amount of gain (loss) recognized in OCI (a)		—		—		—			427			—			—			—			427
Amount of gain (loss) recognized from OCI into earnings (f)		—		—		—			(207	)		—			—			—			(207	)

Fair Value Derivatives:
Amount of derivative gain (loss) recognized in earnings (e)		—		1		—			—			—			—			—			1
Amount of hedged item gain (loss) recognized in earnings (e)		—		3		—			—			—			—			—			3
Derivatives Not Designated as Hedging Instruments:
Amount of gain (loss) recognized in Cost of Sales		—		—		—			—			3			(1	)		3			(1	)
Amount of gain (loss) recognized in SG&A		—		—		(1	)		(18	)		—			1			(1	)		(17	)

^(a)	Effective portion

^(b)	Gain (loss) reclassified from AOCI into earnings is reported in interest, for interest rate swaps, in selling, general, and administrative (SG&A) expenses for foreign exchange contracts and in cost of sales for commodity contracts.

^(c)	Gain (loss) recognized in earnings is related to the ineffective portion and amounts excluded from the assessment of hedge effectiveness.

^(d)	Gain (loss) recognized in earnings is reported in interest expense for foreign exchange contracts and SG&A expenses for commodity contracts.

^(e)	The amount of gain (loss) recognized in earnings on the derivative contracts and the related hedged item is reported in interest for the interest rate contracts and SG&A for the foreign exchange contracts.

^(f)	The gain (loss) recognized from OCI into earnings is reported in gain on sale of discontinued operations.

8. Pension and Other Postretirement Benefit Plans

The components of the net periodic benefit cost (benefit) for the pension and postretirement benefit plans for the second quarter and first six months of 2013 and 2012 are as follows:


	Pension Plans
(In millions)	Second Quarter 2013			Second Quarter 2012			First Six Months 2013			First Six Months 2012
Service cost	$	3		$	2		$	6		$	4
Interest cost		18			18			35			37
Expected return on plan assets		(23	)		(21	)		(46	)		(41	)
Amortization of:
Net actuarial loss		1			1			2			2
Settlement loss		1			—			1			—

Net periodic benefit cost (benefit)	$	—		$	—		$	(2	)	$	2


	Postretirement Benefit Plans
(In millions)	Second Quarter 2013			Second Quarter 2012			First Six Months 2013			First Six Months 2012
Service cost	$	1		$	—		$	1		$	1
Interest cost		1			1			2			2
Amortization of:
Prior service cost (benefit)		(2	)		(2	)		(4	)		(4	)

Net periodic benefit cost (benefit)	$	—		$	(1	)	$	(1	)	$	(1	)

The net periodic benefit costs of the defined benefit pension plans were lower in the first six months of 2013 than in 2012 due to the increase in the expected return on plan assets, which results from the higher level of plan assets as of the beginning of this fiscal year due to improved asset returns during 2012.

During the quarter ended December 29, 2012, the company recognized a $1 million loss associated with the settlement of a defined benefit plan in Canada that was related to an entity that had previously been sold. The loss resulted from the recognition of the unamortized actuarial loss associated with this plan. The company also recognized a $2 million loss related to the payout of a portion of the surplus assets of this plan, which was in an overfunded position.

The company contributed $3 million to its defined benefit pension plans related to continuing operations during the first six months of 2013 and 2012. At the present time, the company expects to contribute approximately $4—$5 million of cash to its defined benefit pension plans in 2013. 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. As a result, the actual funding in 2013 may differ from the current estimate.

9. Income Taxes

The following table sets out the tax expense and the effective tax rate for the company from continuing operations:


	Second Quarter						Six Months
(In millions)	2013			2012			2013			2012
Continuing operations
Income before income taxes	$	89		$	2		$	164		$	4
Income tax expense (benefit)		31			(8	)		57			(11	)
Effective tax rate		34.4	%		(420.1	)%		34.8	%		(277.4	)%

Second quarter and first six months of 2013

In the second quarter of 2013, the company recognized tax expense of $31 million on pretax income from continuing operations of $89 million, or an effective tax rate of 34.4%.

In the first six months of 2013, the company recognized tax expense of $57 million on pretax income from continuing operations of $164 million, or an effective tax rate of 34.8%. The tax expense and related effective tax rate on continuing operations was determined by applying a 34.9% estimated annual effective tax rate to pretax earnings and recognizing various discrete tax items, none of which were material individually or in the aggregate.

Second quarter and first six months of 2012

In the second quarter of 2012, the company recognized a tax benefit of $8 million on pretax income from continuing operations of $2 million, or a negative effective tax rate of (420.1)%.

In the first six months of 2012, the company recognized a tax benefit of $11 million on pretax income from continuing operations of $4 million, or a negative effective tax rate of (277.4)%. The tax benefit and related effective tax rate on continuing operations was determined by applying a negative 264.6% estimated annual effective tax rate to pretax earnings and recognizing various discrete tax items, none of which were material individually or in the aggregate. The negative 264.6% estimated annual effective tax rate was derived by considering the full year impact of estimated pretax charges for restructuring and other actions, a portion of which are non-deductible for tax purposes.

Unrecognized Tax Benefits

Each quarter, the company makes a determination of the tax liability needed for unrecognized tax benefits that should be recorded in the financial statements. For tax benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by the taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement.

The year-to-date net liability for unrecognized tax benefits declined from $74 million at June 30, 2012 to $73 million at December 29, 2012 as a result of the expiration of statutes of limitations in various state jurisdictions. At this time, the company estimates that it is reasonably possible that the liability for unrecognized tax benefits will decrease by $5—$30 million in the next twelve months from a variety of uncertain tax positions as a result of the completion of tax audits currently in process and the expiration of statutes of limitations.

The company’s tax returns are routinely audited by federal, state, and foreign tax authorities and these audits are at various stages of completion at any given time. The Internal Revenue Service (IRS) has completed examinations of the company’s U.S. income tax returns through 2008. With few exceptions, the company is no longer subject to state and local income tax examinations by tax authorities for years prior to 2005.

10. Contingencies and Commitments

Aris – This is a consolidation of cases filed by individual complainants with the Republic of the Philippines, Department of Labor and Employment and the National Labor Relations Commission (NLRC) from 1998 through July 1999. The complaint alleges unfair labor practices due to the termination of manufacturing operations in the Philippines by Aris Philippines, Inc. (Aris), a former subsidiary of the company. The complaint names the company as a party defendant. In 2006, the arbitrator ruled against the company and awarded the plaintiffs approximately $80 million in damages and fees. This ruling was appealed by the company and subsequently set aside by the NLRC in December 2006. Both the complainants and the company have filed motions for reconsideration. The company continues to believe that the plaintiffs’ claims are without merit; however, it is reasonably possible that this case will be ruled against the company and have a material adverse impact on the company’s results of operations and cash flows. The company has initiated settlement discussions for this case and has established an accrual for the estimated settlement amount.

Multi-Employer Pension Plans – The company participates in a multi-employer pension plan that provides retirement benefits to certain employees covered by collective bargaining agreements (MEPP). Participating employers in a MEPP are jointly responsible for any plan underfunding. MEPP contributions are established by the applicable collective bargaining agreements, however, the MEPPs may impose increased contribution rates and surcharges based on the funded status of the plan and the provisions of the Pension Protection Act, which requires substantially underfunded MEPPs to implement rehabilitation plans to improve funded status. Factors that could impact funded status of a MEPP include investment performance, changes in the participant demographics, financial stability of contributing employers and changes in actuarial assumptions.

In addition to regular contributions, the company could be obligated to pay additional contributions (known as a complete or partial withdrawal liability) if a MEPP has unfunded vested benefits. These withdrawal liabilities, which would be triggered if the company ceases to make contributions to a MEPP with respect to one or more collective bargaining units, would equal the company’s proportionate share of the unfunded vested benefits based on the year in which the liability is triggered. Management believes that the MEPP in which it currently participates has significant unfunded vested benefit. Withdrawal liability triggers could include the company’s decision to close a plant or the dissolution of a collective bargaining unit. Due to uncertainty regarding future withdrawal liability triggers, management is unable to determine the amount and timing of the company’s future withdrawal liability, if any, or whether the company’s participation in this MEPP could have any material adverse impact on its financial condition, results of operations or liquidity. Disagreements over potential withdrawal liability may lead to legal disputes.

The company’s regularly scheduled contributions to MEPPs related to continuing operations totaled approximately $2 million in 2012 and $3 million in 2011. For continuing operations, the company incurred withdrawal liabilities of an immaterial amount in 2012 and 2011.

ITEM 2

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 second quarter and first six months of 2013 compared with the second quarter and first six months of 2012 and a discussion of the changes in financial condition and liquidity during the first six months of 2013. Below is an outline of the analyses included herein:

•

Business Overview

•

Summary of Results

•

Consolidated Results – Second Quarter and First Six Months of 2013

•

Operating Results by Business Segment

•

Financial Condition

•

Liquidity

•

Non-GAAP Financial Measures Definitions

•

Significant Accounting Policies and Critical Estimates

•

Issued but not yet Effective Accounting Standards

•

Forward-Looking Information

Business Overview

Our Business

Hillshire Brands is a manufacturer and marketer of high-quality, brand name food products. Virtually all of its sales are in the United States, where it is one of the leaders in meat-centric food solutions for the retail and foodservice markets. In the retail channel, the company sells a variety of packaged meat products that include hot dogs, corn dogs, breakfast sausages, dinner sausages and lunchmeats as well as a variety of frozen baked products and specialty items including cakes and cheesecakes. These products are sold primarily to supermarkets, warehouse clubs and national chains. The company also sells a variety of meat and bakery products to foodservice customers.

The company’s portfolio of brands includes Jimmy Dean, Ball Park, Hillshire Farm, State Fair, Sara Lee and Chef Pierre, as well as artisanal brands Aidells and Gallo.

Strategy

The company is focused on building sustainable, profitable growth through margin-accretive innovation; improved management agility; achieving and maintaining share leadership in key categories; delivering superior quality and value to our customers; driving operating efficiencies; as well as, evaluating acquisition opportunities to leverage our assets and advance our strategy for value creation.

Unless stated otherwise, any reference to income statement items in these financial statements refers to results from continuing operations. The results of the fresh bakery, refrigerated dough and foodservice beverage businesses in North America, and the international coffee and tea, household and body care businesses and the European and Australian bakery businesses are being reported as discontinued operations. See Note 5 – “Discontinued Operations” for additional information.

Financial Statement Restatements

On August 1, 2012, D.E Master Blenders 1753 N.V. (DEMB) announced that it had discovered accounting irregularities involving previously issued financial results for its Brazilian operations, which would require the restatement of their previously issued financial statements for the periods from fiscal 2009 to 2012. The financial results of the Brazilian operations are reported as part of discontinued operations in the Hillshire Brands financial statements as a result of the spin-off of the international coffee and tea operations. As such, Hillshire Brands has restated the historical financial results of its discontinued operations to reflect the correction of the accounting irregularities in the Brazilian operations.

In addition, the company corrected several errors related to its continuing and discontinued operations and restated its financial statements for 2010 and 2011 and the unaudited financial data for the first three quarters of 2012 for these items. These errors had been previously identified and corrected in fiscal years subsequent to their origination. The company originally recorded the error corrections in the periods in which they were discovered. Management continues to believe that these errors did not materially misstate the financial results of the periods in which the errors originated or the periods in which the errors were corrected but management has decided to record these adjustments in the periods in which they originated. See Note 1 – Basis of Presentation for additional information regarding these restatements.

Summary of Results

The business highlights include the following:

•

Reported operating income for the second quarter of 2013 was $99 million, which was $76 million higher than the prior year due to: improved operating results for the Retail segment due to the impact of higher volumes and lower commodity costs; a $50 million net decrease in charges for restructuring actions and other significant items; and lower general corporate expenses partially offset by a $7 million year-over-year decrease related to the mark-to-market adjustment associated with unrealized commodity derivatives. Adjusted operating income increased $26 million, or 25.8%

•

Net sales for the second quarter of 2013 were $1.060 billion, $7 million, or 0.7%, higher than the prior year due in part to the growth in the Retail segment partially offset by declines in the Foodservice/Other segment due to the impact of businesses that have been exited. Adjusted net sales, which exclude the impact of businesses that have been disposed of or exited, rose $25 million, or 2.5%. The increase in adjusted net sales was driven by higher volumes which offset an unfavorable shift in sales mix.

•

Diluted earnings per share from continuing operations for the second quarter increased from $0.09 in 2012 to $0.47 in 2013 due to the increase in operating income partially offset by an increase in income taxes. Average shares outstanding increased from 119 million to 123 million on a year-over-year basis due to the impact of the exercise of stock options and the accelerated vesting of restricted stock units. Adjusted EPS, which excludes the impact of significant items, increased from $0.48 in 2012 to $0.62 in 2013.

•

Total cash flow from operating activities improved from $33 million in the first six months of 2012 to $129 million for the first six months of 2013. The most significant driver of the change was related to discontinued operations, which reported a use of cash of $97 million in 2012 and a source of cash of $13 million in 2013. The year-over-year change was due to the completion of business dispositions during 2012. The decline in cash from operating activities related to continuing operations was due to an increase in cash used to fund working capital needs which was partially offset by improved operating results and a decrease in cash interest payments.

Consolidated Results – Second Quarter of 2013 Compared with Second Quarter of 2012

The following table summarizes net sales and operating income for the second quarter of 2013 and 2012 and certain items that affected the comparability of these amounts:


	Quarter ended
Total Company Performance (In millions)	Dec. 29, 2012			Dec. 31, 2011 (As restated)			Change			Percent Change
Net sales	$	1,060		$	1,053		$	7			0.7	%

Less: Increase / (decrease) in net sales from:
Dispositions		—			18			(18	)

Adjusted net sales	$	1,060		$	1,035		$	25			2.5	%

Operating income	$	99		$	23		$	76			NM

Less: Increase / (decrease) in operating income from:
Restructuring actions	$	(15	)	$	(60	)	$	45
Accelerated depreciation		(10	)		(6	)		(4	)
Impairment charges		—			(4	)		4
Other significant items		(3	)		(11	)		8
Dispositions		—			3			(3	)

Adjusted operating income	$	127		$	101		$	26			25.8	%

Net Sales

Net sales increased by $7 million or 0.7%. Adjusted net sales increased by $25 million or 2.5% due to the favorable impact of a 2.9% increase in volumes partially offset by an unfavorable shift in sales mix and the impact of pricing actions.

The components of the percentage change in net sales as compared to the prior year are as follows:


Second Quarter 2013	Volumes			+	Mix			+	Price			+	Other			+	Divestitures			=	Net Sales Change
Net Sales Changes
Total Continuing Business		2.9	%			(0.4	)%			(0.3	)%			0.3	%			(1.8	)%			0.7	%

Operating Income

Operating income increased by $76 million. The year-over-year net impact of the changes in restructuring charges, accelerated depreciation and the other factors identified in the table of operating results increased operating income by $50 million. Adjusted operating income increased $26 million, or 25.8% due in part to lower commodity costs, higher volumes and a $11 million decrease in general corporate expenses, excluding significant items, partially offset by an increase in MAP investment and the unfavorable impact of a $7 million decrease in unrealized commodity mark-to-market derivative gains/losses versus the prior year. General corporate expenses declined primarily due to the impact of headcount reductions and other cost savings initiatives.

Gross Margin

Gross margin dollars in the second quarter of 2013 increased $34 million over the prior year due to lower commodity costs, higher volumes and savings from continuous improvement programs which were only partially offset by an unfavorable sales mix and a year-over-year decrease in mark-to-market gains related to unrealized commodity derivatives. The gross margin percent increased from 28.2% in the second quarter of 2012 to 31.3% in the second quarter of 2013 primarily due to the impact of lower commodity costs.

Selling, General and Administrative Expenses


	Quarter ended
(In millions)	Dec. 29, 2012		Dec. 31, 2011			Change			Percent Change
SG&A expenses in the business segment results:
Media advertising and promotion	$	42	$	30		$	12			39.4	%
Other		154		153			1			1.1	%

Total business segments		196		183			13			7.4	%
General corporate expenses		26		44			(18	)		(42.2	)%
Mark-to-market derivative (gains) / losses		1		(2	)		3			NM
Amortization of identifiable intangibles		1		1			—			0.0	%

Total SG&A Expenses	$	224	$	226		$	(2	)		(0.7	)%

Selling, general and administrative (SG&A) expenses decreased by $2 million, or 0.7%. Measured as a percent of sales, SG&A expenses were 21.1% in 2013, which was virtually unchanged from the 21.4% in 2012. SG&A expenses in the business segments increased by $13 million, or 7.4%, due to an increase in MAP investment. General corporate expenses were $18 million lower due primarily to a reduction in charges for restructuring actions and the favorable year-over-year impact of an $11 million litigation accrual that was recognized in the prior year and the favorable impact of headcount reductions and other cost savings initiatives. The year-over-year change in the mark-to-market gains/losses related to unrealized commodity derivatives increased SG&A expenses by $3 million.

Exit Activities and Other Significant Items

The reported results for the second quarter of 2013 and 2012 reflect amounts recognized for actions associated with the company’s ongoing business improvement and cost reduction program and other exit and disposal actions. The amounts reported for exit activities, asset and business dispositions were $9 million in the second quarter of 2013 versus $45 million in the second quarter of 2012. As discussed in Note 6 to the financial statements, “Exit, Disposal and Other Restructuring Activities,” the charges in 2013 relate to lease exit costs while the charges in 2012 are primarily for contract termination costs.

Net Interest Expense

Net interest expense of $10 million in the second quarter of 2013 was $11 million lower than the second quarter of the prior year. The decline was due to the impact of the repayment of approximately $2 billion of debt during 2012 primarily using proceeds received from the completed business dispositions as well as the transfer of $650 million of debt to D.E MASTER BLENDERS 1753 N.V. as part of the spin-off of the international coffee and tea business.

Income Tax Expense

Note 9 to the Consolidated Financial Statements provides a detailed explanation of the determination of the interim tax provision. The following table sets out the tax expense and the effective tax rate for the company from continuing operations:


	Second Quarter
(In millions)	2013			2012
Continuing operations
Income before income taxes	$	89		$	2
Income tax expense (benefit)		31			(8	)
Effective tax rate		34.4	%		(420.1	)%

In the second quarter of 2013, the company recognized tax expense of $31 million on pretax income from continuing operations of $89 million, or an effective tax rate of 34.4%.

In the second quarter of 2012, the company recognized a tax benefit of $8 million on pretax income from continuing operations of $2 million, or an effective tax rate of negative 420.1%. The tax benefit and related effective tax rate on continuing operations was determined by applying a negative 264.6% estimated annual effective tax rate to the year to date pretax earnings and recognizing various discrete tax items, none of which were material individually or in the aggregate. The negative 264.6% estimated annual effective tax rate was derived by considering the full year impact of estimated pretax charges for restructuring and other actions, a portion of which are non-deductible for tax purposes.

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

Income from continuing operations in the second quarter of 2013 was $58 million, an increase of $48 million over the comparable period of the prior year due to the improvement in operating segment results, and a decrease in restructuring and impairment charges and net interest expense partially offset by higher income taxes.

Diluted EPS from continuing operations increased from $0.09 in the second quarter of 2012 to $0.47 in the second quarter of 2013 due to the increase in operating income noted above. Adjusted EPS increased from $0.48 in 2012 to $0.62 in 2013. The diluted EPS in 2013 were negatively impacted by the higher average shares outstanding. The average shares outstanding increased from 119 million in 2012 to 123 million in 2013 due to the exercise of stock options and the accelerated vesting of RSUs as a result of the spin off of the international coffee and tea business.

Discontinued Operations

Income (loss) from discontinued operations – The income from discontinued operations for the second quarter was $85 million lower than the comparable period of the prior year. The year over year decline is due to the completion of the disposition of all of the discontinued operations, with the exception of the Australian bakery business, prior to the end of 2012. The income reported in 2013 primarily relates to the results of the Australian bakery operations, whereas the results in 2012 include several businesses that have been sold. See Note 5 – “Discontinued Operations.”

Gain on sale of discontinued operations – There were no business dispositions in the second quarter of 2013. In the second quarter of 2012, the company completed the disposition of its North American fresh bakery and foodservice beverage businesses as well as its non-European insecticides businesses, the Spanish bakery business and portion of the shoe care business. It recognized a pretax gain of $536 million and an after tax gain of $368 million. Further details regarding these transactions are included in Note 5, “Discontinued Operations.”

Net Income and Diluted Earnings per Share (EPS)

In the second quarter of 2013, the company reported net income of $65 million in 2013 versus $470 million in the comparable period of the prior year. The change in net income was primarily driven by the results for discontinued operations, which declined by $453 million. As noted above, prior year included a $368 million gain on the sale of businesses. The decline in results for discontinued operations was partially offset by the $48 million increase income from continuing operations. The net income attributable to Hillshire Brands was $65 million in the second quarter of 2013 compared to $469 million in the second quarter of 2012.

Diluted EPS was $0.53 in the second quarter of 2013 as compared to $3.94 per share in the second quarter of 2012. Diluted EPS were impacted by higher average shares outstanding during the second quarter of 2013, which resulted from the exercise of stock options and the accelerated vesting of RSUs.

Consolidated Results – First Six Months of 2013 Compared with First Six Months of 2012

The following table summarizes net sales and operating income for the first six months of 2013 and 2012 and certain items that affected the comparability of these amounts:


	Six Months ended
Total Company Performance (In millions)	Dec. 29, 2012			Dec. 31, 2011			Change			Percent Change
Net sales	$	2,034		$	2,040		$	(6	)		(0.3	)%

Less: Increase / (decrease) in net sales from:
Dispositions		—			52			(52	)

Adjusted net sales	$	2,034		$	1,988		$	46			2.3	%

Operating income	$	183		$	47		$	136			NM

Less: Increase / (decrease) in operating income from:
Restructuring actions	$	(26	)	$	(99	)	$	73
Income from asset dispositions		5			—			5
Accelerated depreciation		(21	)		(12	)		(9	)
Impairment charges		—			(14	)		14
Other significant items		(3	)		7			(10	)
Dispositions		—			7			(7	)

Adjusted operating income	$	228		$	158		$	70			44.2	%

Net Sales

Net sales decreased by $6 million or 0.3%. Adjusted net sales increased by $46 million or 2.3% due to the favorable impact of a 3.1% increase in volumes partially offset by pricing actions and an unfavorable shift in sales mix.

The components of the percentage change in net sales as compared to the prior year are as follows:


First Six Months 2013	Volumes			+	Mix			+	Price			+	Other			+	Divestitures			=	Net Sales Change
Net Sales Changes
Total Continuing Business		3.1	%			(0.4	)%			(0.6	)%			0.2	%			(2.6	)%			(0.3	)%

Operating Income

Operating income increased by $136 million. The year-over-year net impact of the changes in restructuring charges, accelerated depreciation and the other factors identified in the table of operating results increased operating income by $66 million. Adjusted operating income increased $70 million, or 44.2%. The increase in adjusted operating income was due in part to an increase in operating segment income driven by lower commodity costs and higher volumes and a decrease in general corporate expenses. General corporate expenses declined primarily due to the impact of headcount reductions and other cost savings initiatives.

Gross Margin

Gross margin dollars in the first six months of 2012 increased $55 million over the prior year due to lower commodity costs, higher volumes and savings from continuous improvement programs which were only partially offset by an unfavorable sales mix. The gross margin percent increased from 28.0% in the first six months of 2012 to 30.8% in the first six months of 2013 primarily due to the impact of lower commodity costs.

Selling, General and Administrative Expenses


	Six Months ended
(In millions)	Dec. 29, 2012		Dec. 31, 2011		Change			Percent Change
SG&A expenses in the business segment results:
Media advertising and promotion	$	88	$	77	$	11			13.4	%
Other		292		303		(11	)		(3.3	)%

Total business segments		380		380		—			0.1	%
General corporate expenses		54		62		(8	)		(14.2	)%
Mark-to-market derivative (gains) / losses		1		—		1			NM
Amortization of identifiable intangibles		2		2		—			(16.4	)%

Total SG&A Expenses	$	437	$	444	$	(7	)		(1.8	)%

Selling, general and administrative (SG&A) expenses decreased by $7 million, or 1.8%. Measured as a percent of sales, SG&A expenses decreased from 21.8% in 2012 to 21.5% in 2013. SG&A expenses in the business segments were unchanged as higher MAP investment was offset by a decrease in other selling and administrative costs. General corporate expenses were $8 million lower in 2013 due in part to a decline in net charges for restructuring actions and charges related to a litigation accrual which were only partially offset by the unfavorable year-over-year impact of a $15 million gain recognized in the prior year associated with the settlement of a tax dispute with Hanesbrands Inc. Excluding significant items, general corporate expenses declined $17 million primarily due to the favorable impact of headcount reductions and other cost savings initiatives. The mark-to-market derivative gains/losses related to unrealized commodity derivatives and the year-over-year change were not significant in the six month period of either year.

Exit Activities and Other Significant Items

The reported results for the first six months of 2013 and 2012 reflect amounts recognized for actions associated with the company’s ongoing business improvement and cost reduction program and other exit and disposal actions. The amounts reported for exit activities, asset and business dispositions were charges of $6 million in the first six months of 2013 versus charges of $66 million in the first six months of 2012. As discussed in Note 6 to the financial statements, “Exit, Disposal and Other Restructuring Activities,” the charges in 2013 relate to lease termination costs net of gains related to the disposition of manufacturing facilities that had been held for sale while the charges in 2012 are primarily for employee severance costs associated with headcount reductions and contract termination costs.

Net Interest Expense

Net interest expense of $19 million in the first six months of 2013 was $24 million lower than the first six months of the prior year due to the repayment of approximately $2 billion of debt during 2012 primarily using proceeds received from the completed business dispositions as well as the transfer of $650 million of debt to D.E MASTER BLENDERS 1753 N.V. as part of the spin-off of the international coffee and tea business.

Income Tax Expense


	Six Months
(In millions)	2013			2012
Continuing operations
Income before income taxes	$	164		$	4
Income tax expense (benefit)		57			(11	)
Effective tax rate		34.8	%		(277.4	)%

In the first six months of 2013, the company recognized tax expense of $57 million on pretax income from continuing operations of $164 million, or an effective tax rate of 34.8%. The tax expense and related effective tax rate on continuing operations were determined by applying a 34.9% estimated annual effective tax rate to pretax earnings and recognizing various discrete tax items, none of which were material individually or in the aggregate.

In the first six months of 2012, the company recognized a tax benefit of $11 million on pretax income from continuing operations of $4 million, or an effective tax rate of negative 277.4%. The tax benefit and related effective tax rate on continuing operations was determined by applying a negative 264.6% estimated annual effective tax rate to pretax earnings and recognizing various discrete tax items, none of which were material individually or in the aggregate. The negative 264.6% estimated annual effective tax rate was derived by considering the full year impact of estimated pretax charges for restructuring and other actions, a portion of which are non-deductible for tax purposes.

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

Income from continuing operations in the first six months of 2013 was $107 million as compared to $15 million in the prior year. The $92 million increase in earnings was due to the improvement in operating segment results, and a decrease in restructuring and impairment charges and net interest expense partially offset by higher income taxes.

Diluted EPS from continuing operations increased from $0.13 in the first six months of 2012 to $0.87 in the first six months of 2013 due to the increase in operating income noted above. Adjusted EPS increased from $0.74 in 2012 to $1.10 in 2013. The diluted EPS in 2013 were negatively impacted by the higher average shares outstanding. The average shares outstanding increased from 119 million in 2012 to 123 million in 2013 due to the exercise of stock options and the accelerated vesting of RSUs.

Discontinued Operations

Income (loss) from discontinued operations – Discontinued operations reported income of $9 million in 2013 versus a loss of $223 million in 2012. The year-over-year change was due to the completion of the disposition of most of the businesses that were part of discontinued operations prior to the end of 2012. The results in 2013 relate primarily to the Australian bakery operations. In the first six months of 2012, the loss was primarily related to the results of the European bakery operations which includes a $379 million pretax impairment charge. The results of the discontinued operations in 2012 also include a $189 million tax benefit related to tax basis differences associated with the North American Fresh Bakery and European Bakery assets. It also includes $127 million of tax expense associated with the international coffee and tea business, which includes $84 million of discrete tax items.

Gain on sale of discontinued operations – In the first six months of 2013, the company recognized a $2 million gain, which related to a final purchase price adjustment associated with the North American fresh bakery operation and a gain on the sale of manufacturing facilities related to the North American foodservice beverage operations. In the first six months of 2012, the company completed the disposition of its North American fresh bakery, foodservice beverage and refrigerated dough businesses in North America as well as its European Spanish bakery business, its non-European insecticides businesses and a portion of the shoe care business. It recognized a total pretax gain of $798 million and an after tax gain of $460 million. The tax provision on the refrigerated dough disposition was negatively impacted by a book/tax basis difference related to $254 million of goodwill that is not deductible. Further details regarding these transactions are included in Note 5, “Discontinued Operations.”

Net Income and Diluted Earnings per Share (EPS)

For the first six months of 2013, the company reported net income of $118 million versus net income of $252 million for the comparable period of the prior year. The decrease in net income was driven by the results for discontinued operations, which included a loss from discontinued operations of $223 million and a $460 million gain on sale of business in 2012. As noted above, the loss in 2012 was primarily due to an impairment charge related to the European bakery operations. Partially offsetting the decline related to discontinued operations was a $92 million increase in income related to continuing operations. The results for continuing operations improved due to an increase in operating segment income as well as a reduction in charges for exit activities and impairment charges and interest expense. The net income attributable to Hillshire Brands was $118 million in the first six months of 2013 compared to $249 million in the first six months of 2012.

Diluted EPS was $0.96 in the first six months of 2013 as compared to $2.10 per share in the first six months of 2012. Diluted EPS were impacted by higher average shares outstanding during the first six months of 2013, which resulted from the exercise of stock options and the accelerated vesting of RSUs.

Operating Results by Business Segment

Net sales and income before income taxes by business segment for 2013 and 2012 are as follows:


	Net Sales
	Quarter ended					Six Months ended
(In millions)	Dec. 29, 2012		Dec. 31, 2011			Dec. 29, 2012		Dec. 31, 2011
Retail	$	777	$	761		$	1,496	$	1,459
Foodservice/Other		283		294			538		587

Total business segments		1,060		1,055			2,034		2,046
Intersegment sales		—		(2	)		—		(6	)

Total net sales	$	1,060	$	1,053		$	2,034	$	2,040


	Income from Continuing Operations before Income Taxes
	Quarter ended						Six Months ended
(In millions)	Dec. 29, 2012			Dec. 31, 2011			Dec. 29, 2012			Dec. 31, 2011
Retail	$	112		$	85		$	198		$	129
Foodservice/Other		28			29			53			54

Total operating segment income		140			114			251			183

General corporate expense		(36	)		(93	)		(67	)		(133	)
Mark-to-market derivative gains/(losses)		(4	)		3			1			(1	)
Amortization of intangibles		(1	)		(1	)		(2	)		(2	)

Total operating income		99			23			183			47
Net interest expense		(10	)		(21	)		(19	)		(43	)

Income from continuing operations before income taxes	$	89		$	2		$	164		$	4

The following tables illustrate the components of the change in net sales versus the prior year for each business segment and the total company:


Second Quarter 2013	Volumes			+	Mix			+	Price			+	Other			+	Divestitures			=	Net Sales Change
Net Sales Changes
Retail		1.1	%			0.7	%			0.0	%			0.4	%			0.0	%			2.2	%
Foodservice/Other		6.6	%			(2.9	)%			(1.0	)%			0.1	%			(6.5	)%			(3.7	)%

Total Continuing Business		2.9	%			(0.4	)%			(0.3	)%			0.3	%			(1.8	)%			0.7	%


First Six Months 2013	Volumes			+	Mix			+	Price			+	Other			+	Divestitures			=	Net Sales Change
Net Sales Changes
Retail		1.7	%			1.0	%			(0.4	)%			0.3	%			0.0	%			2.6	%
Foodservice/Other		6.0	%			(4.0	)%			(1.1	)%			(0.2	)%			(9.0	)%			(8.3	)%

Total Continuing Business		3.1	%			(0.4	)%			(0.6	)%			0.2	%			(2.6	)%			(0.3	)%

The following tables summarize the net sales and operating segment income for each of the business segments for 2013 and 2012 and certain items that affected the comparability of these amounts:

Retail


	Quarter ended										Six Months ended
(In millions)	Dec. 29, 2012		Dec. 31, 2011			Change		Percent Change			Dec. 29, 2012			Dec. 31, 2011			Change		Percent Change
Net Sales	$	777	$	761		$	16		2.2	%	$	1,496		$	1,459		$	37		2.6	%

Adjusted Net Sales	$	777	$	761		$	16		2.2	%	$	1,496		$	1,459		$	37		2.6	%

Operating segment income	$	112	$	85		$	27		31.5	%	$	198		$	129		$	69		53.6	%

Less: Increase/(decrease) in operating segment income from
Restructuring actions	$	—		—		$	—				$	—		$	(8	)	$	8
Income from asset dispositions		—		—			—					3			—			3
Accelerated depreciation		—		(6	)		6					(1	)		(12	)		11

Adjusted operating segment income	$	112	$	91		$	21		23.2	%	$	196		$	149		$	47		31.8	%

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company