Sara Lee Corp. F3Q09 (Qtr End 03/28/09) Earnings Call Transcript

Sara Lee Corp. (SLE)

F3Q09 Earnings Call

May 7, 2009 10:00 a.m. ET

Executives

Aaron Hoffman - Vice President, Investor Relations

Brenda C. Barnes - Chief Executive Officer

Lambertus M. (Theo) de Kool - Chief Financial and Administrative Officer

Analysts

Chris Growe - Stifel Nicholas

Eric Serotta - Consumer Edge Research

Robert Moscow - Credit Suisse

Eric Katzman - Deutsche Bank

Andrew Lazar - Barclays Capital

Vincent Andrews - Morgan Stanley

Bryan Spillane – Banc of America

Bill Leach – [TIA Cress]

Terry Bivens - J.P. Morgan

Judy Hong - Goldman Sachs

Alexia Howard - Stanford Bernstein

Tim Ramey - D.A. Davidson

Ken Zaslow - BMO Capital Markets

Presentation

Operator

Good morning and welcome to Sara Lee's third quarter earnings conference call for fiscal 2009. (Operator Instructions)

I would now like to turn the call over to Mr. Aaron Hoffman, Vice President of Investor Relations for Sara Lee Corporation.

Aaron Hoffman

Good morning to everyone on the call and the Web cast this morning. We very much appreciate your time and your interest as always. Joining me for today's are Brenda Barnes, our Chairman and CEO, and Theo de Kool, our Chief Financial and Administrative Officer.

Our third quarter 2009 results were released at 6:30 a.m. Central Time this morning via press release that you will find on our Web site at saralee.com. If you have any problems accessing the release, please call Jeannie Williams at 630-598-8100. Our 10-Q was also filed this morning and is available on our Web site and of course on the Edgar Web site.

To begin, I will caution you that our remarks this morning contain forward-looking statements about Sara Lee's future operations, financial performance, and business conditions. These forward-looking statements are based on currently available competitive, financial and economic data, as well as management's views and assumptions regarding future events. Such forward-looking statements are inherently uncertain and investors must recognize that actual results may differ from those expressed or implied in these statements. Consequently, I need to caution you not to place undue reliance on forward-looking statements. We have provided additional information in our press release and Form 10-K for fiscal 2008 that I encourage you to review concerning factors that could cause actual results to differ materially from these forward-looking statements.

This morning we are providing slides to go along with our remarks. You can find the slides on the Web cast portion of our Web site in the Investor Relations section. Also, as stated in the press release, we have posted an updated guidance for each of our business segments in the Investor Relations section of our Web site.

Our press release and business segment posting also include the reconciliations of non-GAAP numbers to our reported results.

Now let me turn the time over to Brenda.

Brenda C. Barnes

Good morning everyone and thanks for joining us today. With three quarters behind us I am pleased to say that we remain right on plan to deliver another strong, solid year that builds on the strength of fiscal 2008. Our plan is working and the changes we have implemented to drive efficiencies and reduce cost, combined with our long-term commitment to innovation, marketing, and talent management are benefitting our bottom-line results despite ongoing macroeconomic challenges.

Given the performance improvement initiatives we continue to implement, we remain very confident that we are well positioned to benefit even further when the global economy begins to recover.

Our top line continues to improve. Reported net sales for the quarter were down 6.6% but on an adjusted basis increased 2.1%. For the first nine months reported net sales were essentially flat and on an adjusted basis increased 4.1%. And as a reminder, adjusted numbers exclude the impact of significant items, acquisitions, divestitures, and the effects of currency changes.

Behind the revenue growth, we are seeing generally strong market share trends in North America. In international markets our shares are fairly steady though in many cases the overall market is contracting. While on the whole our volume trends have been better than the majority of consumer products companies, we still have seen some volume softness.

One of the key top-line drivers is our ability to offset higher commodity costs with pricing. Year-to-date our commodity costs have increased by about $390.0 million and commodity and mark-to-market adjustments were $60.0 million unfavorable. These cost increases have been offset by about $465.0 million of pricing.

For the full year, we expect commodity costs to increase by approximately $410.0 million and commodity mark-to-market adjustments be about $50.0 million unfavorable to last year. We do anticipate that the full-year pricing actions will exceed the combined impact of commodity cost increases and commodity mark-to-market adjustments.

Our corporate performance saw a strong 30% increase in total adjusted operating income, driven by lower SG&A and MAP, as well as the strength of North American retail and international beverage.

We have been very judicious in allocating our MAP spend this year and this quarter saw a decline of 30%. Nearly half of the change is related to foreign exchange with a much weaker Euro relative to the dollar. This reduction also reflects a shift in our marketing strategies from mass market advertising to activities that are not included in MAP, such as coupons, pricing actions, in-store merchandising and other trade spending that are included in gross margin.

At the same time, we have improved the effectiveness of our spending and are benefitting from declining ad rates. And there are certain areas where we are comfortable that we are achieving our target for share hoist and can reduce spending.

Finally, the quarter also benefited from a $19.0 million commodity mark-to-market gain compared to a $10.0 million gain in the year-ago quarter, which led to a positive variance of $9.0 million. For the first nine months that number was a variance of negative $60.0 million and without this negative variance our year-to-date adjusted results would have been quite different.

Our adjusted earnings per share reflected this improvement as well. Diluted EPS, excluding significant items, rose by $0.03 to $0.25 per share in the quarter.

It's worth spending a minute on the rapid progress we are making with Project Accelerate. This is an aggressive cost reduction program that builds on our transformation, taking efficiencies to another level.

After establishing a solid foundation of capabilities over the past several years, we now have the standardized processes and integrated IT infrastructure to further reduce our costs while increasing productivity throughout the organization. As we have worked through many accelerated initiatives, we found additional cost savings and efficiency opportunities.

As a result, we now expect incremental benefits beyond the $200.0 million to $250.0 million we had forecasted and anticipate that we will exceed our original target of $150.0 million in one-time charges. We will update when we get more precision around these numbers.

Before I move on to my comments about our segments, I want to mention that on March 30 we announced that we are reviewing a range of strategic options for our international household and body care business. Our H&BC segment has very strong brands, great innovation, and a talented leadership team.

As we have said previously, our ultimate decision will be driven by whether or not we can generate incremental, long-term shareholder value. The process is well under way and when we have more to say about it we will communicate it. Beyond that I won't have any additional comments to share about this today.

Moving on to our segments, in North America our adjusted results reflect the current consumer trends. More than 40% of consumers say they are preparing meals at home more often and they are shifting to lower-cost outlets and using more coupons for value. Some 30% of consumers are serving less expensive cuts of meat, with hot dogs, lunch meat, and sausage reflecting volume increases as a result.

Importantly, Sara Lee shares in the majority of our categories are still growing and our brand health continues to improve.

Our retail and fresh bakery business segments reported sales increases of 3.1% and 6.4% respectively in the quarter, however, total volumes decreased by over 6%, which combines a 4% decline for retail meats with 14% lower units for non-retail commodity meats, which we have been aggressively exiting in our retail segments.

Ballpark hotdogs, Jimmy Dean entrees, and Breakfast Bowls, State Fair corndogs, and Hillshire Farms deli meats delivered strong volumes in the quarter.

In fresh bakery volumes were up 2.5% in the quarter, primarily driven by strong non-branded sales. We are seeing consumers trade down to private-label bakery items in the category. This trend is not unexpected and we are confident that our strong branded position, couple with category-leading innovation, will deliver strong incremental growth over the long term.

Building on our innovation strategy, new products are generating the sales growth I just mentioned. New products like Angus beef, bun-sized hotdogs, and Miller High Life beer broths, as well as strong marketing campaigns like the successful Sara Lee Fresh Bread tie-in with High School Musical 3.

And in our food service segment items like pre-sliced pies and mini desserts are on trend for value conscious consumers and customers.

One of the ways in which we will continue to fuel innovation is through our new North American innovation campus, the Kitchens of Sara Lee. We opened a few weeks ago at our headquarters in Downers Grove, [IL]. This 120,000 square foot R&D center houses more than 100 chefs, scientists, engineers and packaging designers. This facility brings our research and development teams closer to our brands, which should increase the speed in which we can bring new products to market.

In the quarter, adjusted operating segment income rose by almost 45% in our North American retail business and over 5% in food service, both primarily due to improved product mix, lower SG&A costs, and pricing actions.

I would point out that these two segments have now delivered four consecutive quarters of adjusted operating segment income growth. In fact, through nine months this year, North American retail has already generated the same amount of adjusted operating segment income than it did in all of fiscal 2008.

I am pleased that we continue to achieve these results in the face of a difficult economic picture and a turbulent commodity environment.

In fresh bakery, operating segment income decreased as branded volume slowed. Marketing spend increased and we lapped a $7.0 million gain on the termination of commodity contracts in the year-ago quarter.

As part of Project Accelerate we recently announced the closure of one bakery and the further reduction of our workforce in order to continue to right-size the organization and the supply chain.

One of the bright spots in our international business was international beverage, where adjusted sales grew by 7.7% on the strength of continued mix improvements behind some sales of single-serve coffee and Café Chez coffee concentrates as well as pricing actions.

However, part of our international business continues to face the same ongoing headwinds that we've discussed with you in the past. Spain is facing an unemployment rate in the mid-teens and a declining GDP. Both France and the U.K. are also suffering from deteriorating economic conditions. To give you a sense of the importance of these markets to Sara Lee, Spain, France, and the U.K. are the third, fourth, and sixth largest countries in which we do business.

The effects of these challenging economic conditions in three major markets has put our international bakery and household and body care segments under pressure. We are taking the appropriate actions to deal with these conditions. And we know that innovation continues to be the key to our success, especially in these tough economic times, which is why we continue to innovate and roll out new products to expand our sales base.

In Spain we introduced the Senseco machine and coffee pots, Bimbo mini bread snacks and cakes, and Tender Wheat bread. We launched Sanex Zero% and Radox tea infusion shower gel in France and the U.K. respectively.

The strong results in our international beverage business in the quarter are encouraging as adjusted operating segment income increased nearly 26%. We made important investments in the U.K. and Russian instant coffee categories in the first half of the year, which curtailed operating income improvement, as we expected.

The back half of the year, highlighted by a very strong third quarter, will be more in line with normalized performance.

Importantly, our single serve Senseo products, both pods and machines, continue to grow due to on-trend innovations. And our newest coffee innovation, [petit de rome] which allows for easy dosing and improves the taste profile, was successfully launched in France earlier this year.

Our international bakery segment is working to rationalize the business in response to the weak Spanish economy. To put this situation in context, Spain accounts for about two-thirds of all sales for this segment. As part of Project Accelerate, we are taking aggressive actions that should produce demonstrable benefits in fiscal 2010 and beyond.

And as you would expect in a tough economy, our private label refrigerated dough business in France has performed very well this year.

It is important to find out that household and body care has a significant amount of business in Spain, France, and the U.K. and is dealing with pricing pressures in these countries as competitors fight back for market share. In spite of the tough conditions, we have achieved successful deodorants and other body care roll outs.

The most significant weakness has come in the hair care category where volumes are down almost 12% in the first nine months.

Overall, our shares in Europe are holding fairly steady but we are experiencing volume declines as a number of categories are contracting under the current economic pressure.

Outside of Europe, we continue to see strong results, particularly from our Indian joint venture.

We recently announced additional cost reduction actions across our international business, as part of Project Accelerate, that should help offset some of the economic pressure we are facing and position the business to emerge even stronger when markets improve.

Now I will turn to our current fiscal 2009 guidance. We anticipate to be between $12.8 billion and $13.0 billion for the full year, which is unchanged from our previous projection.

On a reported basis, we are forecasting diluted EPS in the range of $0.73 to $0.79, which includes a $0.21 gain from the sale of our tobacco business in fiscal 1999, and a $0.23 per share of net charges from significant items for the first nine months of the year.

Our guidance does not include any additional significant items that may occur during the remainder of the year.

Our adjusted EPS guidance, which excludes the tobacco payment and significant items, is $0.75 to $.081. This is an increase of $0.01 to $0.02 per share compared to our previous guidance, mainly due to lower corporate expense in the third quarter, continuing strength in our North American retail segment, and cost savings across the organization.

The final element of the outlook I'll discuss can be found on our Web site. We have provided an update on our segment guidance. For adjusted operating segment income we are increasing the projection for North American retail to reflect our outstanding performance this year.

Fresh bakery, food service, international beverage, and household and body care guidance is unchanged.

And we are reducing our outlook for the international bakery due to Spain's economic issues.

In sum, guidance in four of six segments is unchanged, one is up, and one is down.

Looking at the bigger picture, we remain confident that the success we have seen for the last four quarters in North America represents real strength in those businesses. At the same time, we continue to take aggressive actions worldwide to reduce costs and strengthen our market positions in key geographies and product segments and we are expanding our portfolio of consumer brands, serving large and growing markets.

We are taking the right steps to ensure that our international segments will weather the storms facing Europe. I remain confident that we are on track to achieve attainable profitable growth.

The investments we have made and the actions we have taken during our transformation are paying off in improved operating and financial performance. We expect to deliver another strong year, after making real progress in fiscal 2008.

And now Theo, Aaron, and I are happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Chris Growe - Stifel Nicholas.

Chris Growe - Stifel Nicholas

I have just a couple of questions for you. I feel compelled to ask about the marketing. I do have a recorder. So maybe a way to ask would be that it obviously was down in the quarter. Can you talk about how much is being put back into other forms of marketing, like trade promotion and coupons.

And then I also would ask along with that if the decline in volume this quarter, if you feel like it's at all related to the lower MAP spending or what could we do to get the volume growth moving up from that down rate this quarter?

Brenda C. Barnes

I guess I would start off my saying that the key metrics we're looking at is market share, on an ongoing basis. And that's how we're calibrating whether or not increases or decreases in MAP spending are having an effect.

So when we look at each of our segments, we feel very good that where we're putting our investments in our core brands, in our core categories, they are actually showing volume increases.

Right now we are suffering from volume declines in a couple of different ways. One is we have exited a number of businesses. You know, that show up in the numbers because they're not pulled out. We are de-emphasizing categories and products that are not long-term profitable for us. And there are certain markets where the economic conditions are just really hurting our volume trends. So I relate it more to those things than I do an immediate impact of the marketing decrease.

You know, our ups and downs on MAP are due to our product innovation of launches. You know, and some quarters were hurt by the investment and some quarters benefitted by reduction in the number, relative to a year ago.

But, having said all that, we are keeping a close eye on supporting our brands in the marketplace because that is our life blood and that is what we want to make sure that we keep supporting.

Chris Growe - Stifel Nicholas

You have kept a pretty range for EPS for the fourth quarter, on the low end, pretty good bit below the prior year and current levels of consensus. Is there a rationale for that? Are you just being conservative or is there something you see that could prompt a little softer fourth quarter?

Lambertus M. (Theo) de Kool

The only thing I can say is that we live in a world of uncertainty and that giving guidance is actually not our preferred activity in general. So we just are cautious to make sure that our results end up within the guidance that we gave. And the improvement on the guidance is coming from an improved third quarter and basically we stick to what we expected for the fourth quarter, although we have not given that explicitly through the market.

Operator

Your next question comes from Eric Serotta - Consumer Edge Research.

Eric Serotta - Consumer Edge Research

Brenda, if we could maybe return to the question of volume trend. You mentioned how you've been exiting some businesses and pruning SKUs in others. Could you give us an idea as to what the underlying volumes look like in the quarter and what the trend has been if you normalize or adjust for some of the volume that you effectively consciously walked away from.

Brenda C. Barnes

That's a hard question to answer in total because each segment has a different solution but we do have the mix shown by each product category. If that will help you I can go through that a little bit for you.

In third quarter total continuing businesses were down 3.7% on units, with price offsetting it by up 5.8%. So that's the 2.1% adjusted net sales change. And then if you look at acquisitions and divestures and foreign exchange, 0.5% is from acquisitions, divestures, negative, and foreign exchange accounts for 8.2%, the trend, equaling that total 6.6%.

Each segment has a different story behind it. And I refer to the chart on page 14 in our press release, because if you look at the specifics, you really get a different answer. Like in North American retail commodity meats alone was down 14% and that is something we are consciously exiting as we just are still in the business until some of our contracts expire.

Eric Serotta - Consumer Edge Research

I'm aware of the chart on page 14. I guess I was looking for some additional color of the volume that you walked away from that would show up in the volume decline lines rather than in the acquisitions and divesture line. So if you could give us a better idea as to what that 3.7% would like for continuing businesses, ex some of these conscious moves that you made in terms of volumes, or even if you could go through the segments and say North American retail meats was down 4.1% but there was still some portfolio pruning so it was down by a couple of points less than that. If you could give us some color for those segments that would be helpful.

Aaron Hoffman

What I would tell you first of all, is the question of the retail meats was actually answered on the chart that we were referring to because we do pull out the commodity meats, which we're in the process of exiting. You do see the effects of that delineated on that chart.

But beyond that, as Brenda pointed out, really it's a whole basket of initiatives, it's SKU's, it's product lines. I mean, it's a lot of stuff and there's not really an easy way to quantify it so we're really not able to do that.

I think what I would take away from it is if you look at the nine-month trend, you know, the retail meats business excluding commodities is basically flat, North American bakery is up. Then you get into some other ones where the markets are simply contracting. The food service market is getting smaller in North America. The international markets are under a lot of pressure and you see that reflected in the volumes. But as Brenda pointed out, the market share is critical and that's where we really feel like we are holding our ground.

Eric Serotta - Consumer Edge Research

And just a question on another area. Fresh bakery profit was down substantially on sequential basis. I know you mentioned one of the factors, the gain in the year-ago period is what drove the year-on-year decline.

Is there a seasonal reason why that should be down so much or was there a pick up in competitive activity or was this really largely the deterioration and mix as consumers traded down that led to the sequential decline from the calendar fourth quarter to the calendar first quarter?

Brenda C. Barnes

There is huge seasonality in bakery. You know, when you enter the summer months you certainly get into grilling season. Buns take a big spike. So there's definitely seasonality going on. So the key is to look at versus year ago because that takes the same seasonality.

The two things you mentioned were a factor. The $7.0 million overlap from the year-ago period. We had a $7.0 million benefit last year. Marketing spending was up significantly for the bakery segment, 26% in the quarter, as we launched the second phase of High School Musical 3.

And the price/mix shift, consumers trading down so much, certainly you have to cover that whole infrastructure so that did in fact hurt our profitability.

Operator

Your next question comes from Robert Moscow - Credit Suisse.

Robert Moscow - Credit Suisse

Following up on Chris Growe's question, we added up all the segments guidance and tried to figure out what fourth quarter looks like and it looks like corporate expense is the plug here and it would be a big step up on corporate expense in fourth quarter in order for EPS guidance to flow through.

Am I looking that the right way and if so, is there something happening in fourth quarter on the corporate line that's different from third quarter?

Lambertus M. (Theo) de Kool

No, I think the way to look it is that the third quarter was an unusual low number for corporate expenses. Certainly we cannot sustain it at that level. We expect a normal fourth quarter from a corporate expense point of view and that is what it is. But the total adds up to the guidance we gave in the press release.

Robert Moscow - Credit Suisse

And I guess the follow-up is why was third quarter unusually low?

Lambertus M. (Theo) de Kool

There are a few elements. One is that for previous divestitures we had contingent lease accruals and with time going on we could re-lease a couple of them. We have some lower pension costs in the corporate expense line as well this quarter. And there was another element, there is a one-time non-income-tax-related refund on one of our countries overseas which I believe was $8.0 million, gave a one-time benefit there as well.

Robert Moscow - Credit Suisse

As we look towards fiscal 2010, back in November you gave what I had thought was some pretty aggressive long-term guidance of 8% to 10% operating income growth. And you kind of said that would imply that the world is kind of back to normal, I suppose, from an economic standpoint. The world is not back to normal yet so how should we think about next year in terms of comparing that your long-term guidance?

Brenda C. Barnes

We will be giving you guidance for fiscal 2010 in August so we'll give you specific numbers then.

I just want to clarify on the long-term guidance that we have given in the past, it's over the 3- to 5-year time frame, it didn't ever intend to mean any one particular year. So we will fill in the specifics for 2010 in a couple of months.

Operator

Your next question comes from Eric Katzman - Deutsche Bank.

Eric Katzman - Deutsche Bank

The MAP spending, I understand the deflation in advertising and the changes that I guess the consumer in some ways are demanding. Is there any link to the decision to potentially sell the household and body care division and the mass spend adjustment? Because I think you said it's very new-product sensitive and it seems to me that of all your categories, the household and body care is probably the most new product intense.

Brenda C. Barnes

You are right there. And household absolutely spends on new products. It has a higher percentage each year being introduced. And shorter life cycles in that category than others. But that had absolutely nothing to do with the decision of what we're doing.

Lambertus M. (Theo) de Kool

From an exploring strategic options.

Eric Katzman - Deutsche Bank

From our standpoint, we're trying to model, international businesses are tough enough but then you get the beverage business like you have which is a little bit more commodity-oriented so you have the swings in the underlying coffee costs. I think international beverage, if my numbers are correct, excluding the various items and adding back corporate expense and stuff, like international beverages accounted for 45% or so of EBIT and that was despite what I assume was a pretty big currency headwind in dollar terms.

So, can you just tell us a little bit more about what is going so right in that business at the moment? Is there some commodity swings that's really helping out? I mean, I don't remember a quarter where we had close to 20% operating margins in that segment.

Aaron Hoffman

I remember 20%+.

Brenda C. Barnes

We really, really like our coffee business and three years ago I would say it was not much attention paid to it because it was this reliable machine that generated EBIT, brew did very well. We had a hiccup last quarter and all of a sudden it got a lot of attention. And we came back this quarter, which we knew we would, because of what we were overlapping in our plans in place.

But in general, we have a very good position in the coffee segment. We have leading market shares in many, many countries. I would argue that we are the lead innovator in the segment at the retail side and we continue to get far more sophisticated in terms of our pricing discipline, our trade tools in what we're doing, and our executional capability.

So if you look at Senseo, you know, here's a product that's many, many years in the market. It's still growing and we're still expanding it. So we have put it into Spain. It had not yet been introduced in Spain and we still have a lot of other countries it can go into.

This is product in France that I mentioned is really a very great innovation and Ralston Brown, which has been around for centuries, just makes it easier for the consumer.

So I would say overall we are just going into instants. We didn't have instants many years ago and that's certainly a different margin structure than Ralston Brown. The consumer is shifting away from Ralston Brown to these new segments and we are innovating quite a bit in there.

And we also have this business which is wonderful which is called Out Of Home, in international. Café Chez is a very innovative liquid product that has an extraordinary taste profile and huge benefits for operators. So that is something that is also contributing to our results.

We just believe this segment will continue to be a very high margin—our guidance always has been, we're not looking to increase coffee margins, we want to hold them and expand the top line in volume expansion, and that's still our strategy.

Eric Katzman - Deutsche Bank

And then if I could have one more detailed follow-up for Theo, good luck in retirement, by the way.

This is probably the last detailed question you want, but this corporate expense line, I talked with Aaron earlier and I guess he gave some explanation but like if I look at the numbers on the 10-Q for other and mark-to-market versus what was in the press release, I mean in absolute terms they're different. And so like in the Q you've a $14.0 million mark-to-market gain and on the press release you've got $19.0 million and then other is $38.0 million and in the Q it's $32.0 million.

Aaron Hoffman

This is exactly what I was telling you when we were on the phone earlier. You need that—on page 31 of the 10-Q is only the aggregated segment results on that table. You need to go to page 38, which is the segment plus corporate and you will get the exact same numbers as the press release.

The explanation for those numbers just happens to be on page 31. And that's why I was pointing out page 38 when we talked earlier. So that's the trick. You've got to look at page 38 to see the whole run of the numbers and then they will match up perfectly with the press release.

Don't worry. The numbers are right on the press release. The numbers are right in the Q. It's just a matter of the iterative process as you work through the Q and where you get from segment and then you layer in corporate. That's the only difference. For everybody on the call, page 31 and page 38, and the explanation of what we're talking about is on page 31. That's the reason I took you to that page.

Eric Katzman - Deutsche Bank

And so the corporate expense kind of run rate ex the one-time stuff and not including the mark-to-market, I mean, you're still like in a $60.0 billion kind of run rate. I mean, I know you talked about that that number is a focus area and that should be coming down but not this quickly, I assume is the message.

Lambertus M. (Theo) de Kool

That's exactly what we said before and that's still the case. And indeed we talked in the script about a $60.0 million swing, which is actually the $39.0 million loss to date versus a $20.0 million gain year-to-date last year on mark-to-market s the numbers are very consistent.

Operator

Your next question comes from Andrew Lazar - Barclays Capital.

Andrew Lazar - Barclays Capital

Brenda, if I take a step back for a minute and just think about how things may play out for Sara Lee and the industry over maybe like the next full year or so. It seems like we'll continue to see more emphasis and a shift toward trade spend and promotions to drive sort of the value message and volumes. So I get that.

What I would like your perspective on is do you think that one of the overhangs on the group, and Sara Lee perhaps, you know, about food companies needing to spend back all of the potential favorability from an input cost standpoint on promotions and therefore not see any margin recovery is over blown. Again, I'm thinking now over the next year or so. Maybe you can use Sara Lee's situation and your expectation kind of as an example.

I mean, how reasonable is that really?

Brenda C. Barnes

We are in such a very unusual time so I would hate to take one of the world's worst recessions for the last several months and say this is the ongoing forever trend. So for us, I will speak for us, and like maybe the same for everybody else, the consumer still wants innovative, high-quality, value-added products and to the extent that we provide that to them at the right value, with the right price on it, it will continue to grow.

We have to be nimble a little bit at times like this and change our mix, and shift it one way or the other, to deal with the very extraordinary circumstances. So our long-term goal is still we will drive for improved margins, driven by the same things we've been saying all along, although we have been slow a little bit from quarter to quarter, month to month, and it will come from a mix shift to higher value-added products.

Especially if the consumer is eating at home more, if that stays, you really want some good convenience. And you don't want to have to do all the work that goes with cooking. I don't think the consumer has changed that much.

We will have to make sure that we are the category leaders with our trade and drive category profitability. We will have to adjust pricing to make sure we are maintaining our market share and spend at the level direct to the consumer that we need to be able to maintain our share.

So I don't think there is a fixed formula. Our intent is to build brands that bring value-added to the consumer and keep driving that. And at various times it's going to come into different tactics. I don't know if that answers your question.

Andrew Lazar - Barclays Capital

I'm just trying to get at how reasonable is it really that this industry, even in this tough time, which will clearly spend more on promotions to get volume back, realistically is the industry sort of have to spend back all of the potential favorability on the costs. I just wondered how reasonable that really is.

Brenda C. Barnes

The costs this year are still higher than they were last year. So the rate of increase certainly has decelerated but we are not in an environment of shrinking costs, for the long-term future. I just don't think that's a realistic assumption.

Andrew Lazar - Barclays Capital

As we go forward from a top-line perspective, when you think about how volume and then price mix sort of shake out going forward, you start to lap as of the industry, right, much more significant pricing actions going forward. So I assume the price/mix piece starts to come in a bit sequentially as we go forward.

What would be your expectation, therefore, on how much or how quickly volumes start to come back to make up some of that ground. So how much does the mix between volume and price/mix really change dramatically over the course of the next couple of quarters?

Brenda C. Barnes

I think we're certainly in the situation where our philosophy all along has been we want pricing to offset commodity increases. To the extent that is closed, we will not keep seeing the increasing price point to the consumer. So I think that should moderate a little bit of the volume trend issue, you know, to the extent of consumers trading down.

So I think it's going to recalibrate because pricing on commodities will not be accelerating like they are.

Andrew Lazar - Barclays Capital

And just in the quarter, with respect to the price/mix being up 5.8 or what have you. Obviously just a little of a deceleration from last quarter. how much of that was just lapping pricing from last year versus promotions starting to kick in on the top line as you switch a little bit to trade?

Brenda C. Barnes

I think a large part would be the overlap. Because if you go back to when things really started sky-rocketing, it was towards this time period a year ago.

Aaron Hoffman

And the fact that you could get a deceleration in terms of the price as a percentage of the sales, it was priced at 3.7% of the sales increase for the quarter but 5% for the year-to-date so you can see that that is decelerating exactly to Brenda's point.

Operator

Your next question comes from Vincent Andrews - Morgan Stanley.

Vincent Andrews - Morgan Stanley

Aaron, did I just hear you correctly, that price was 3.7% in the quarter and so mix would be the difference between the 5.8% and the 3.7%?

Aaron Hoffman

You got it.

Vincent Andrews - Morgan Stanley

Brenda, if I could ask you on the MAP spend, at some point MAP spending will need to go back up whether it's because of new product innovation or just because there's a need to be spending dollars that way. How do you feel about being able to take away what you're doing in the store, whether it's from a coupon perspective or what have you, as you need to reallocate dollars back to traditional mass spending? Are you worried about the stickiness of what you're doing for the consumer?

Brenda C. Barnes

I think the idea of a traditional mass spending is probably gone because the way the consumer behaves today is very different than years ago and the traditional approach of media on air reaching the consumer is getting a small—it's a smaller percentage of the mix.

So we absolutely, whatever we do, have to touch the consumer in many different ways, where they live, shop, entertain, all that, and it has to hit them at the point of sale. So all of our spending will be geared to building awareness, especially on new products. Building awareness and giving them a reason to bump into the product in the store, just through display activity, special coupon promotions, whatever.

So we won't walk away from the tactics that interact with the consumer the way that they live and shop.

The problem is, it's just not showing up in that line as a spending to the consumer. That's really the next evolution we have to get to, assuming I can, from an accounting standpoint, do that. What dollars are touching the consumer?

Vincent Andrews - Morgan Stanley

So when we think about mass spend on a go-forward basis, should we think about is if for fiscal 2010 is the level going to be the same as fiscal 2009 or will it be a little lower because you probably haven’t reached the run—maybe this quarter was the go-forward run rate? How should we think about that.

Brenda C. Barnes

I can't give specific guidance yet on fiscal 2010. I will go back to our long-term strategy, which is to continue to invest in spending against our earnings product and reaching the consumer. So that all along has been our approach. And the fact that we finished this research facility, and is spending to the consumer, too, by the way, which is a major investment and is enabling us to come out with the new products that we have been coming out with. And that doesn't show up in that, either.

Vincent Andrews - Morgan Stanley

If your volumes are down but your share is up, that means the category is not growing or generally the categories are not growing. How do you characterize that and what is your level of concern over that?

Brenda C. Barnes

That conclusion isn't true in each of our segments so it would be true in household, let's say. You know, that the markets are in fact contracting. If you look at retail, we have a mix of products that are very much growing and growing faster than category and we have some exits that bring that whole number down and we have the commodities piece that brings the whole number down. So the devil is in the details on this.

You know, from a broad category standpoint I think it's probably more true in fresh bakery, what you just said. Category is not shrinking as much as the big mix shift that's going on.

Aaron Hoffman

The dollar side of the category is shrinking a bit because of the shift in unbranded. Probably from a volume standpoint it may be actually expanding a bit. It depends on how you slice that piece of the data.

Operator

Your next question comes from Bryan Spillane – Banc of America.

Bryan Spillane – Banc of America

Just a couple of questions on free cash flow. If you look at the year, free cash flow has increased pretty nicely. Cash from operations is about $90.0 million above last year year-to-date and free cash flow is about $150.0 million better. Can you talk a bit about, one, which divisions that's coming from, is the free cash generation somewhat better from one division versus the next, or improving more in one division versus the next?

And then, as we sort of model out free cash flow, going forward, should we continue to expect it to grow at a rate that's faster than earnings or we sort of closer to the range of the free cash flow generation in this business?

Lambertus M. (Theo) de Kool

The first part of the answer is that in general the segment's operating increments we reported is pretty close relation with the operating cash flow because we want systems in place to monitor working capital which is the biggest deviation short term. We are on the ball across the board there. Actually in the North American segments we have one accounts receivable department which has services, and the same for payables. We are driving our inventory down where we can.

So we have the same processes in place across the board, which actually leads to what I said before, that operating cash flow is pretty close to operating income.

I can't give you guidance going forward about the cash flow. What I can say is that in spite of challenging times, where customers start to lengthen the payment terms and predictability of sales is more difficult than before, I expect that we can still improve over time with our working capital and therefore there should be some potential upside in our free cash flow.

Bryan Spillane – Banc of America

And as a follow-up to that, in a scenario where the international household and body care business would be divested, and setting aside proceeds and how much they would be and what you would do with them, if I'm calculating this right it seems like the free cash flow from the rest of the businesses would still be able to support the dividend. Am I looking at that correctly?

Brenda C. Barnes

When we have more to say on this we will give you a full picture on how all those variable intertwine and what our guidance is.

Operator

Your next question comes from Bill Leach – [TIA Cress].

Bill Leach – [TIA Cress]

What should we use for the tax rate for the fourth quarter and as we model out next fiscal year what should we use for the tax rate.

And could you also elaborate on the North American bakery business, why you can't seem to make any money in that segment. The margin was less than 1% in the quarter.

Lambertus M. (Theo) de Kool

The tax rate, you can make your calculations. We gave you a range for the tax rate on the reported basis of 32% to 34% so I think the fourth quarter will be not too far off unless significant items would change that. But I don't expect deviations in the fourth quarter. And I can't give you the guidance for next year.

Aaron Hoffman

But we have said over a long term tax rate expectation of 29% to 31%. So that's the long-term view and you can obviously apply to that your model however you would like for fiscal 2009.

Brenda C. Barnes

And the bakery question you had, we have not hidden at any point that this is a low margin business, that we have a long-term plan and it should significantly improve. Over the last four to eight years we have made significant improvement in the profitability of that segment. This one quarter is below expectations for sure, we talked about the one-time lap of $7.0 million credit last year. We talked about the mix shift to non-branded items which brings that profitability down somewhat, and we talked about more investment in marketing. So that explains the particular quarter.

Over the long term, what we are doing is major operational changes in that business to take a fixed cost, make the business more variable, changing our flexibility in terms of route delivery, things like that that have a ongoing steady improvement plan in the long-term forecast.

Aaron Hoffman

I would point out just real quickly is that obviously the quarter is a little anomalous. If you look at the nine months the margin is 2.4% which is up 30 basis points over the previous nine months. So granted, as Brenda said, we're not thrilled with that margin, but third quarter is a little bit of an anomaly. So I don’t want to leave people with that impression.

Bill Leach – [TIA Cress]

Do you think that Senseo lost in that quarter?

Aaron Hoffman

Senseo is not part of the retail segment, since the beginning of this fiscal year. We moved the frozen bakery, the traditional heritage Sara Lee retail products, as well as the U.S. Senseo business, out of the bakery business and into the retail business. The bakery segment that is reported now is only the DFD delivered fresh bakery products.

Operator

Your next question comes from Terry Bivens - J.P. Morgan.

Terry Bivens - J.P. Morgan

Theo, I'm not trying to rush you out the door, but I thought maybe we could get an update on how the CFO search is going, Brenda.

And more broadly, I understand the foreign exchange deduction from MAP spending, but the last time we saw a company that kind of systematically cut back on advertising and marketing like this in packaged consumer foods, it ended pretty badly. I'm just wondering, why would this one be different.

Brenda C. Barnes

I'll take the CFO question and then the second one.

The great legacy that Theo leaves behind is a fantastic organization, so we've got teams of people heading up each function that are many years in experience and know our category and know our industry and are great leaders of those segments. So rest assured we have got a great team in place across the board in finance.

The search is going well. I mentioned that we have an ongoing process. We are deep into it and have seen and will continue to see a number of great candidates and will announce a permanent replacement as soon as we can.

On the MAP thing, one of these days I'm going to find a way to answer this question because it's every quarter. And in the end we're very much judging our business and our progress based on market share, building of brands, and our profitability improvement. And I think that in 2008 and so far this year we are demonstrating very good progress on all those fronts and have plans in place to keep doing it.

We will invest in our brands to keep those brands healthy, keep them strong. We are going to innovate them, and we will spend the money when we have product news and I have said before, too, that we're not going to be so worried about quarter-to-quarter overlap versus a year ago. We're going to spend it when and where it makes the most sense.

So I hope you don't worry that we're walking away from supporting our brands. That is what our company is all about, and in the exits we've been taking it's getting us more and more concentrated on being a very strong branded company.

Operator

Your next question comes from Judy Hong - Goldman Sachs.

Judy Hong - Goldman Sachs

Brenda, I wanted to ask about the margin progression. If you look at the consolidated margin, I think it was up, but a large part of that was because of the corporate expenses being down and then you've got the hedging gains that helped you in the quarter. And then if I look at the segment operating income, it looks like some of the segments you are seeing margin progression but then the mass spending was down. I'm just trying to sort through a lot of the factors and understand what's happening from an underlying margin perspective.

And then if you can also talk about maybe some of the incremental initiatives that you are looking at as part of the parts to accelerate and how significant that would be to drive further margin progression.

Brenda C. Barnes

We said in our long-term plan that each segment has a different role in terms of the corporate margin improvement. So from an absolute margin percentage basis the international businesses of coffee and tea and household, the idea there was to hold margin while expanding volume improvement.

So far coffee and tea had demonstrated the capability of doing both, in terms of margin improvement and top line. Household has declined somewhat due to the economic conditions and the category compression that we're facing, as I mentioned earlier.

Fresh bakery and international is the same situation. We are not having the margin progression we would like because of the short-term challenge that we have in Spain.

The U.S. retail segment is in fact steadily improving their margin delivery and bakery over the course of the year is as well and will continue to do so over time.

So that's just a headline. Certainly this quarter corporate did contribute quite a bit to our overall corporate margin improvement. But it's really a balance between the segments plus corporate that gave us the quarterly results.

Judy Hong - Goldman Sachs

And did the parts that accelerate, the additional initiatives you said you're looking at.

Brenda C. Barnes

This has gotten pretty exciting for us because it's building blocks. We have put in place lots of things over the last few years and now we are capable of doing things we could not possibly have done three years ago because we didn't have a common SAP platform, we didn't have processes in place that we could track metrics and see where the improvement is. And we have got a capable organization to do more.

So the initiatives range from what you would consider traditional cost cutting, like cutting some benefits, doing a pay freeze, cutting some people. You know, that's on the cut side. Most of the benefits will come from really doing improved ways of operating the business. For example, taking a look at how many distribution centers we have on a particular product line, consolidating that, having less inventory as a result, giving better service to the customers, and then being able to close a distribution depot. That's one example.

Another example would be reducing SKUs to really make the entire supply chain more profitable and have better fill rates and better serve up customers. That's a whole entire long list of benefits that you get from something like that and we clearly have debated by SKU of what we should keep and what we should exit and we are doing that across our businesses.

As I mentioned, each business is finding more than the original set of ideas and that's why we're going to go higher than $200.0 million to $250.0 million benefit over the next three years.

Judy Hong - Goldman Sachs

And can you remind us how much of that $200.0 million to $250.0 million has been realized so far?

Brenda C. Barnes

We haven't split it out specifically but a lot of these are longer-term projects and the bulk of benefits will flow over the next couple of three years.

Operator

Your next question comes from Alexia Howard - Stanford Bernstein.

Alexia Howard - Stanford Bernstein

On the retail segment, I wanted to ask about the impact of the exit of commodity meats is having. We have obviously seen that segment post some incredibly strong operating profit growth on an adjusted basis over the last couple of quarters.

Is that mainly because you are ratcheting down that commodity meats business extremely rapidly? Are you pretty much done with that process at this point? Are we out of the commodity meats business? And how much longer can these kinds of margin improvements continue?

Lambertus M. (Theo) de Kool

The decrease in the sales of the commodity business has a very modest impact on the bottom line because there are small losses attached to it but it's certainly not the driver for the success in retail.

Pretty much the success is based on successful new product launches, very consistent execution of the plan, cost savings programs in place, having a much better connection between the supply chain and the marketing units, and all of that works together and gives this great results at the moment.

But how much it can go on? If we manage this well this can be at this high level. Whether it can increase at the same rate I would say I would be a little more cautious there.

Alexia Howard - Stanford Bernstein

Coming back to the fresh bakery segment, can you give us some numbers on exactly how the mix from branded products into private label is flowing right now? I know it had been very stable I think for the last few quarters but it has obviously started to deteriorate. Maybe if you could tell us what proportion is private label at this point and maybe what the year-over-year mix shift was this quarter.

Aaron Hoffman

From a total fresh bakery standpoint, looking at the past 12 weeks, the category is up on a dollar basis 2.5%, up 6.7% for 52 weeks. And I'm sure a lot of that is the past through pricing on wheat and flour over that time period. Private label we are seeing up over a point in 12 weeks and about the same amount over 52 weeks. Our share is down just slightly in both periods and the Sara Lee brand is basically flat in the 12 weeks and up just slightly [inaudible].

Alexia Howard - Stanford Bernstein

And roughly what proportion of your own sales are private label right now within the fresh bakery business?

Aaron Hoffman

In dollar terms it's in the mid-twenties and volume terms it's higher than that.

Operator

Your next question comes from Tim Ramey - D.A. Davidson.

Tim Ramey - D.A. Davidson

A little follow-on on Alexia's question. Is there a way for you to break out what happened in your mix versus price in the quarter? Because I assume mix was a significant negative, price was a significant positive from your verbal comments.

Aaron Hoffman

We can do that. The price represented 4.7 points of the increase in sales. Mix would be then a negative 80 basis points for the quarter. And it's basically the same, very mild mix degradation for the nine months.

Tim Ramey - D.A. Davidson

Brenda, on the unit decline on meats, which was really the only unit decline that concerned me in the quarter, you didn't have a tough comp there. You had really strong new product performance. We've seen this general trend to hot dogs and cheaper meal solutions. Are you concerned by that? What's your take on that number?

Brenda C. Barnes

Well, we never want to see a unit decline so I don't want to gloss over that and say we don't look at that; of course we do. We certainly are growing in the main brands and categories that we really want to have growing market share. So that's a real positive. We certainly are looking at all the other pieces of that business segment to make sure we are giving the full support to all the brands that may be contributing to the total decline.

It's turning that little dial on calibrating in terms of market share and pricing and trade promotion activity. We keep dialing it in as tightly as we can. We hope not to have volume declines other than the commodity side.

Tim Ramey - D.A. Davidson

Senseo launch in Spain with 17% unemployment. That's got to be difficult. But an attractive coffee market for you. Do you have plans to limit your losses there or what type of losses should we think about for say a 12-month run rate in Spain?

Brenda C. Barnes

I don't have a specific number I can give you but we had a lot of debate about whether or not to proceed with that and Spain is a very strong coffee market of ours and this product is so consumer on target that there is a segment of the population in Spain that is employed, that does have good income, that would in fact be a solid customer for this. So we expect that to build probably very much like it did in the other launch markets.

First year is a lot of investment in it. Second year it starts picking up on profitability, third year is a great year on profitability, in general terms.

Operator

Your next question comes from Ken Zaslow - BMO Capital Markets.

Ken Zaslow - BMO Capital Markets

Have you seen any changes in food service trends at all? You hear from a lot of the restaurants that things have started to bottom out. How do you use that in the U.S. versus Europe?

Brenda C. Barnes

We definitely have seen ongoing challenges in that segment. The good news is I think there are a lot of food service outlets that are responding to the economic conditions and offering value to the consumer. So how has that affected us? Desserts is an example. We have a product line that is a smaller portion of dessert and the retail unit is trying to the shopper, the restaurant, a dessert at a lower price point. So that's helping us. We're starting to see that.

And then we're starting to see some come back on the other businesses. But it's still a ways to go.

Ken Zaslow - BMO Capital Markets

So you haven't yet seen the bottom in the food service side yet?

Brenda C. Barnes

We don't think the bottom has hit yet, on what we sell.

Ken Zaslow - BMO Capital Markets

With the H1N1 virus out there and you do sell some pork-related products, have you seen any change in consumption patterns or anything that's changed on way or the other way on that? Either in the U.S. or outside.

Brenda C. Barnes

No, not really and I think the industry has done a great job making sure that everybody knows you cannot contract this by eating pork. And there has been a great PR effort, all the whole industry joining in on that. So we have not seen anything meaningful in the marketplace.

Ken Zaslow - BMO Capital Markets

So in the U.S. in all your pork-related products you haven't seen any change in U.S. consumption.

Brenda C. Barnes

No.

Ken Zaslow - BMO Capital Markets

There is a lot of talk about the new administration with taxing foreign earnings and stuff like that. Is that going to affect you?

Lambertus M. (Theo) de Kool

I think it's too early to comment on that because it's not at all clear how these rules will play so I really can't be specific. The only thing I can say that of course on an ongoing basis should a percentage of our foreign income and we are paying additional cash to export that if they are going to tax it anyway wherever we make a profit, then obviously that repatriation policy will be impacted. But as I said it's way too early to be specific because the rules are not specific and it has to go a long way before it's called a law.

Operator

There are no further questions in the queue.

Aaron Hoffman

Thank you all very much for you time today. And we are glad to take any follow-up questions that you have today.

Operator

This concludes today’s conference call.

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