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Executives

Aaron Hoffman – Vice President, Investor Relations

Brenda C. Barnes – Chairman, Chief Executive Officer

Marcel Smits – Chief Financial Officer

Analysts

Robert Moskow - Credit Suisse

Christopher Growe - Stifel, Nicolaus & Company, Inc.

Eric Katzman - Deutsche Bank Securities

Bryan Spillane - BofA Merrill Lynch

Judy Hong - Goldman Sachs

Vincent Andrews - Morgan Stanley

Alexia Howard - Sanford Bernstein

Timothy Ramey - D. A. Davidson & Co.

Terry Bivens - J.P. Morgan

[Andrew Simon] – Meridian Asset Management

Andrew Lazar - Barclays Capital

Sara Lee Corp. (SLE) F2Q10 Earnings Call February 4, 2010 10:30 AM ET

Operator

Good morning and welcome to Sara Lee’s second quarter earnings conference call for fiscal 2010. (Operator Instructions) I would now like to turn the call over to Aaron Hoffman, Vice President of Investor Relations for Sara Lee Corporation. Thank you. Aaron, you may begin.

Aaron Hoffman

Okay. Thanks a lot, Wendy. Good morning and welcome everyone to Sara Lee’s second quarter 2010 earnings conference call. Joining me for the call today are Brenda Barnes, our Chairman and CEO, and Marcel Smits, our Chief Financial Officer.

Our second quarter 2010 results were resulted at 6:30 Central Time this morning via press release that you can find on our website 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 concurrent with the press release.

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’ve provided additional information in our press release and Form 10-K for fiscal 2009 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 webcast portion of our website in the Investor Relations section. And as a reminder, all adjusted numbers we discuss on today’s call exclude the impact of significant items, contingent sales proceeds, acquisitions, divestitures and the effects of currency changes. The release contains a reconciliation of reported to adjusted numbers.

Now let me turn the time over to Brenda.

Brenda C. Barnes

Thank you, Aaron. Good morning everyone. I know you’ve had a busy morning today, so we appreciate your interest and your time.

We are extremely pleased with our results for the second quarter which builds on a very strong first quarter. And this improving performance is across all of our segments and underscores the dramatic progress we’ve made over the past three years in laying the groundwork for significant growth and value creation at Sara Lee. As we become a much more focused and nimble company, we are able to respond much more quickly and effectively to changing marketplace conditions. A good example of this was our recent pricing recalibration, which we’ve already begun to, has yield favorable volume trends and will drive sustainable growth.

In the current environment, our focus continues to be sustaining a disciplined approach to pricing, while offering consumers the best products and new innovations at the right value. We are pursuing a prudent pricing strategy which strikes the right balance and does not let the pendulum swing too far either way so as to hamper either margins or volume.

Our growing innovation pipeline and strong marketing and sales efforts continue to drive meaningful share gains and improve mix. Project Accelerate remains on track and is delivering bottom line benefits. Our competitive position continues to improve as we offer consumers real value while making the right investments to support our winning brands and strong portfolio.

That said, our goal remains the same, to make smart investments to drive future growth without sacrificing near term profitability. With our strong cash position we have the flexibility to both grow and reinvest for the future. The proverbial virtual cycle which we believe will deliver compelling returns over time.

As a result of our solid first half performance, we are again raising our annual EPS guidance and are now projecting a 20 to 30% increase in adjusted EPS, even as we make important investments that will set us up for another strong year in fiscal ’11.

Since our last quarterly update we’ve made further progress to divest our household and body care segment and it continues to deliver strong results. In spite of the significant disruption this type of process entails, our H&B team employees are doing a very good job of staying focused on delivering their plans and the results are outstanding.

As a reminder, we have announced two transactions. We have a binding offer to sell Body Care to Unilever for 1.275 billion euros or about $1.8 billion at today’s euro dollar rate. And during the second quarter we announced a binding offer with P&G to sell our Air Care business for 320 million euros or about $450 million. We’re actively negotiating to sell the remaining pieces, Shoe Care and Insecticides, and expect to have updates for you in the near future. All of these transactions are consistent with our over arching strategy to build a simpler, more focused company with compelling prospects to create shareholder value.

We know that the question on everyone’s mind is what will you do with proceeds? Today’s call will focus on our first half results and outlook for the year. At Cagny we will provide you with a comprehensive update on our capital structure, dividend and buyback plans.

Now turning to the quarter, this is the same chart that we showed you in the first quarter that you can reference as I take you through sales and income. Marcel will walk you through a discussion of some additional financial metrics including earnings per share, tax rate and cash flow.

Let’s start with reported sales and back out currency impacts and acquisitions and divestures to get to an adjusted sales of minus 2.7%. Next we’ll look at the components of the adjusted sales change. As you would expect, given the lower input costs we’ve seen of late and our pricing recalibration, the price mix was negative and worsened first quarter. While the volume is negative, it is an improvement over the first quarter and it’s worth digging a little further to put this decline in context.

Excluding our deliberate exit of the [commodity] meats and kosher meats businesses, volumes were actually up about 1% as our pricing actions began to be reflected. And importantly you can see that the second quarter was much stronger than the first quarter on the same basis.

Comparing volume trends in the second quarter to the first quarter in our segments, we’re very encouraged to see improved volume performance in every business except North American fresh bakery. I’ll talk more about this later. Of particular note, our two most profitable businesses, International Beverage and North American Retail, delivered positive volumes in the quarter. I’m pleased that we’ve improved the trends on volume as we continue to drive improved profit.

As you can see, the two highlighted figures on this chart add up to $140 million of bottom line improvement. Let’s walk through the components of this growth. You’ll see that we delivered an incremental $138 million of adjusted operating income in the quarter. Of that amount, $27 million was related to the favorable variance in commodity mark-to-market on a year-over-year basis. Excluding that, the increase was $111 million. $103 million of that came from our segments and about $8 million was from lower corporate costs, all excluding any significant items. The final piece of the improvement is Household and Body Care, which was up $29 million on an adjusted basis. So adding these figures together, you can see that we increased our bottom line performance by $140 million in the quarter.

As you may recall, on the same basis the bottom line improvement in the first quarter was $77 million. That totals $217 million for the first half. We are pleased with our ability to generate sizable growth with real contributions coming from a variety of areas. One key source of bottom line improvement performance is Project Accelerate, a company wide initiative that touches corporate and every business segment. In the quarter and first half, every segment realized cost savings and productivity gains. Our supply chain operations continued to pare down the SKUs we produce, increasing efficiency and improving the mix of the products we sell. And our outsourcing efforts are right on track to deliver the projected benefits.

You can see our guidance for this initiative in the table on this Slide. We realized $50 million of savings in fiscal ’09 and expect an incremental $75 to $100 million of benefits this fiscal year, as we work to achieve cumulative benefits of $350 to $400 million by the end of fiscal ’12. We’ve already realized $48 million of incremental benefits in the first half. Please note that these figures include both continuing and discontinued operations and at a later date we’ll update the guidance to exclude Household and Body Care.

The other key driver of our performance of course has been our operating segments where innovation has helped drive our results. At the end of fiscal 2009, over 15% of our annual sales were generated by new products that were launched over the past three years, and that trend continued in the first half of 2010. Let’s start this segment review with North American Retail. This segment delivered another strong quarter with a 66% increase in adjusted operating segment income or OSI as I’ll refer to it throughout this review. Over the course of the second quarter, recalibrated pricing, combined with focused marketing and promotional efforts, have shifted volumes into positive territory. These volume increases have been driven by our strategic brands, Jimmy Dean, Hillshire Farm and Ball Park.

As I mentioned earlier, both volume and sales were negatively impacted by the exit of commodity and kosher meat businesses. We’ve also seen share increases in the majority of our core categories over the past 12 weeks. In the second half of the year, volumes are likely to continue to improve while OSI comparisons will be less robust, reflecting strong year-over-year comparisons, higher commodity costs and further reinvestments to fuel future growth.

I’d like to step back a minute and offer you a few thoughts about the operating margin progress of this segment. As you’ll recall, a few years ago the margin was less than 10% and has now steadily increased each year. You’ll see another step up this fiscal year and we expect further improvements in the years to come. However, there is some fluctuation between quarters and the 14.6% margin we’ve delivered in the first half frankly is above our trend line of steady increases. We expect the second half margin to moderate as we overlap price increases and invest in innovation. Over time, we will expand our margins while we invest in our future.

North American Food Service also delivered a good quarter with adjusted OSI up 12%. Lower commodity costs, the exit of low margin items and cost savings contributed to these results. While sales and volumes both were down modestly in the first half, this can be attributed primarily to the marketplace dynamics. The segment has delivered good results for the past five out of six quarters and this has been accomplished as operators have generally struggled with consumers changing their dining habits. We remain cautious about the back half of the fiscal year. We continue to focus on ways to deliver improved performance, but for now we believe we are prudent to expect this segment to show a decline in adjusted OSI for the year.

Similar to the first quarter, North American Fresh Bakery increased margin and OSI in a very challenging, competitive marketplace, with adjusted OSI up over 10%, driven by solid pricing discipline, lower commodity costs and productivity improvements. While volume trends are soft, we are beginning to see the impact of actions we took following the first quarter. We expect volumes to respond in the back half of the year as we do recalibrate pricing and launch our new products such as EarthGrains Eco-Grains and Sara Lee with Omega 3 DHA. Our productivity improvements ranging from automation and lean efficiencies in our bakeries, to advanced routing solutions to restructuring of the headquarters organization, are yielding meaningful results that have contributed to our OSI growth and should continue to do so.

International Beverage continues to invest in new markets and innovative new products around the world, with a clear goal of driving top line results at a strong margin. After recalibrating pricing to address marketplace challenges, the segment saw a strong rebound in volumes.

Other results in the quarter were strong as well, with adjusted OSI up 35%. This figure includes a positive variance of approximately $16 million, largely related to currency mark-to-market. As a reminder, we called out a negative variance that affected results in the first quarter. And remember that all coffees purchased in dollars and the products in the segment are largely sold in euros. We hedge the dollar euro relationship to reduce transactional volatility. This is a good business decision and helps to cover our economic exposure. However, since we use mark-to-market accounting it can introduce volatility to our P&L. Without this accounting issue, performance would have looked less favorable, but adjusted OSI would still have been up substantially.

That said, this segment continues to demonstrate marketplace strength. Our shares are generally being maintained or increasing. We have also seen our large foodservice coffee business, which is almost 30% of our sales with a compelling margin, continue to do well even as Europe has weathered a recession.

The second quarter marks the first growth in adjusted quarterly OSI the International Bakery segment has seen in several quarters. The improvement in the second quarter was driven by favorable commodities and Project Accelerate savings. It was also a result of meaningful restructuring initiatives that addressed challenges in the Spanish marketplace. As you recall, we sold several bakeries to a private label producer and contracted with them to leverage our combined volumes, resulting in a lower cost structure for both companies. Together, these savings, our pricing actions and innovations will enable us to show positive trends in the next several quarters and for the full year.

Let me wrap up with H&BC, which had another good quarter with a 45% increase in adjusted OSI. This was driven by strong body care, shoe care and insecticide performance. In body care, Sanex Naturprotect and Zero%, along with Radox Shower Gels all delivered improved results behind effective marketing campaigns. Insecticides margins expanded and overall results were driven by strong results in India and Malaysia.

Trends in air care are improving behind Ambi-Pur National Geographic Air Fresheners, a line of co-branded products inspired by unique fragrances from around the world. In three of its initial markets, the UK, the Netherlands and Spain, National Geographic has already garnered a 9.3% share increase of the plug-in air freshener market and is helping drive our share of the total air care market. At the same time, we’re realizing savings from Project Accelerate on the manufacturing side and are benefiting from SKU rationalization as well.

That wraps up my look at the key results and now Marcel will take you through some additional financials.

Marcel Smits

Thank you, Brenda. Good morning to everybody on the call. Brenda left it with a summary results Slide which she also started and I’m going to take it from there.

Let’s just first look at how that translates into EPS figures. Now let me start by pointing out that this is the first time that we have provided you with adjusted EPS on a quarterly basis. As many of you note, the contingent tobacco payment we have received for the past seven years is tax free and in fiscal ’10 is going to be the last year that we have this income.

To help you see the tax benefits of the tobacco proceeds on a quarterly basis, we filed an 8-K last week restating each quarter for fiscal 2009. Now previously I believe that most of the street was simply assuming that the entire EPS benefit of the tobacco proceeds, and that’s this year $0.19 per share, fell in the first quarter of each year. Now that’s largely correct. However, there is a small residual benefit in each of the subsequent quarters due to tax benefits. In order for us to provide you with a quarterly EPS excluding this amount, it requires some estimates of how much income will fall in each quarter.

Now with that said, you can see on this sheet that we delivered a very strong adjusted EPS growth in the quarter, up $0.17 in the quarter and in the first half, $0.26. You’ll note that the primary difference between reported and adjusted EPS in the quarter was significant items. In the second quarter we were up $0.17 on an adjusted basis and we were up $0.55 on a reported basis. Now let me know circle these significant items on the sheet. Last year we had charges of $0.22 in the quarter and this year we actually have a benefit of $0.15.

Let’s go to the next page which shows the significant items this quarter in more detail. In short, the story comes down to a large impairment charge in the second quarter of ’09, included in the $0.22 up and above on this sheet and this year we had a very large, discrete tax benefit which creates a sizable variance. These are the main items.

Now you will want to know more about the $0.17 of discrete tax benefit no doubt. $0.17 gain in continuing operations relates to a number of items. First, we reached favorable conclusions of several tax audits around the world, we’re utilizing current year UK net operating losses and you’ll recognize these NOLs from our first quarter release and that they relate to the sale of H&BC. We were also to release a Brazilian valuation allowance as the business is now firmly profitable.

Discontinued, meanwhile, we realized a $0.04 per share gain. Part of the benefits from the tax audits that we concluded show up in discontinued operations. As a result of concluding these audits, certain net operating losses were validated and became available to offset gains from the H&BC transaction. Lastly, we also had the benefit of some capital loss carry forwards.

Now the conclusion of all of this is that we had good news on tax in the quarter. However, that of course raises the question about what our normalized tax rate is. And to look into that, I’ll focus in on the tax rate for continuing operations that are meaningful to your analysis. First you can see on a reported basis that the significant items result in a negative rate of 21.5% in the second quarter and a single digit rate of 9.4% for the first half. However, if we back out the impact of significant items and the contingent sales proceeds, we arrive at a tax rate of 31.5% for the second quarter and a 33.3% for the first half. The first half is much more in line with our ongoing expectations for 2010.

Now let’s go back to the sheet that you’ve already seen. The conclusion is that we’ve done very well. It was a very good quarter and a very good first half of the year. In fact, let me just recall that we told you in August that we had to cover an incremental $65 million or about $0.07 a share of annual pension expense taking about $0.03 in the first half. We’re understandably pleased with our EPS growth.

Now to round it out, then, EPS guidance. As we’ve discussed, we believe we’re in good shape. We’ve had a strong first half and we’re right on plan to accelerate investments in the second half of the year in order to continue the healthy trends we’ve shown recently. The previous adjusted 2010 EPS guidance as you all no doubt remember was $0.90 to $0.96 per share. We’re increasing that by $0.09 to $0.10 and that has updated the guidance to a range of $1 to $1.05. This is a reflection of $0.03 to $0.04 per share of operational improvement, $0.02 from a lower tax rate. That’s been combined with a change in accounting treatment for the depreciation and amortization for H&BC, which is worth another $0.04 per share. For that $0.04 we don’t take any credit as it is a change specified by GAAP accounting which says that in a discontinued operation, one should stop expensing the D&A.

Again the net result is about $0.09 to $0.10 per share increase in guidance. And as a reminder, this comes on the heels of the first quarter where we raised guidance by $0.06 of which $0.05 at that time related to improved operational performance.

In a moment we’ll look into what the updated guidance implies for the second half of the year. But before we do that, let me remind you of a couple of key figures from fiscal 2009. As you can see here, in ‘9 in the first half we took a big hit in the commodity mark-to-market of $58 million and that reversed in the second half and provided $40 million of tailwind in the second half. For 2010, meanwhile mark-to-market was basically flat in the first half, so in the comparison with fiscal 2009 we had a big uplift in the first half of this year. If for the sake of the argument we assume that in the second half of fiscal ’10 mark-to-market is going to be flat, we will have headwind of some $40 million. Now that’s mark-to-market and the conclusion is simple. We’ve got tailwinds in the first half and we’ll have probably headwinds in the second half.

Now then corporate expenses, and that’s a similar story. For the second half of 2009, corporate expenses were below our trend line. You may remember that we reported a number of one off items in the fourth quarter. For this year, our best guess is that we will have a normal pattern with the first half and the second half being roughly equal. However, keep in mind that all other things being equal, having a 53rd week actually causes slightly higher corporate costs in the second half of this year. And that may lead us to the same conclusion as the one we’ve just seen from mark-to-market, [actual] variables on the corporate expenses provide a headwind in the second half.

In all, we have about $70 million of headwind in the comparables in the second half of fiscal 2010 and that’s equivalent to about $0.07 per share. Now, keep that $0.07 in mind and let’s look at what the updated guidance implies for the second half. On this sheet you see the very strong first half performance that we’ve discussed already today. I’d like to focus on the implications for the second half of the year. The guidance implies $0.40 to $0.45 of earnings in the back half compared to $0.48 in the year ago period. Now recall the $0.07 per share that we just computed and the conclusion is that we will either be a little bit ahead or a little behind on a truly comparable basis. Bear in mind that we said that we will also accelerate marketing investments in the second half.

In sum, we’re confident that we will deliver a very strong full year with adjusted EPS up between 20 and 30% while also laying the foundation for more growth in fiscal ’11.

Now let me then conclude with cash flow. We’re currently forecasting $750 to $850 million for the full year. That’s slightly down from fiscal ’09, mainly as a result of the prior cash taxes and cash restructuring. Now let me point out that in both years on a cash basis we earned over $1 a share, which I think reflects the good improvements in net income that Sara Lee has delivered over the past several years, and this was aided by some working capital management. This improvement has also helped us build up $1.3 billion of cash on the balance sheet. Thinking about the first and the second half of this fiscal year, you see a similar situation to what we’ve just discussed concerning EPS. In this case the variability is driven by the timing effects of restructuring payments and the flow of working capital throughout the year.

For today, let me just end the discussion on cash flow with that and assure you that we will peel back the onion further at the Cagny conference.

Now let me turn it back to Brenda to provide you with some closing remarks. Brenda?

Brenda C. Barnes

Thanks, Marcel. In sum, we had a great quarter and we’re even more optimistic about the future. We’re seeing improved operating and financial results and we’re building great brands. We’ve seen our volume trends improve and our share grow as a result of pricing recalibration and an innovation pipeline that is poised to deliver more breakthrough products. And on the customer front, we are building a track record as a winning and valued business partner. The bottom line is that our organization is more effective than it’s ever been. Our 41,000 employees around the world continue to meaningfully contribute to our strong momentum and to sustaining the significant progress we’ve achieved in recent years. We look forward to their continued contributions as we accelerate our momentum for the future.

And with that, today we think Sara Lee is a strong company. And as we continue to focus on top line growth driven by great brands in big categories, substantial cost saving initiatives around the world and a strong balance sheet, we’ll only get better and more competitive over the next few years. And our accelerating momentum will translate into compelling value creation for our shareholders.

And with that, Marcel, Aaron and I are happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Robert Moskow - Credit Suisse.

Robert Moskow - Credit Suisse

I guess I’m curious, though, regarding your internal expectations, this is such an over delivery versus what we were expecting, how much higher did you over deliver from what you were expecting and to what do you attribute it? Is it marketplace, market share gains or is it favorable costs or just something else?

Brenda C. Barnes

Well, if you remember after first quarter we found that our profit number was great but that we needed some balance between the volume and the pricing side of things. So we went into the marketplace and made that adjustment and the good news is we, in many places, started seeing the improvement pretty quickly. And we took the pricing very carefully so we were able to maintain what we think was good value to the consumer, holding onto some of the price over commodity increases, and you know continuing to start really building an investment for the second half and going forward. So we don’t guide by quarter so I don’t have an exact number to overstate but it all worked out as we had planned, as we had hoped. And the profit came in and we’re feeling really good about continuing to invest in the growth ideas we have for the second half.

Robert Moskow - Credit Suisse

Since the operating margin and I’ve got here like 11.2 and you had a visionary margin of 12 many years ago, how close are we to getting there? I don’t expect an 11 margin in the back half of the year but what do you think?

Brenda C. Barnes

Well, what we’ve said all along is we gave guidance five years ago actually this month that we would steadily improve our margins over time. At that time we were more specific than I wish we had been, but the good news is we’re delivering the consistent margin improvement and see no reason why we can’t keep doing that. Without pegging an exact number, the outlook looks quite good for more improvement.

Marcel Smits

Let me add just one more thing to that. As you may have seen in the press release we’re saying that we’re confident about further improvements in 2011.

Operator

Your next question comes from Christopher Growe - Stifel, Nicolaus & Company, Inc.

Christopher Growe - Stifel, Nicolaus & Company, Inc.

Regarding the transactions you’ve already put in place to sell the House Supply division. Are the euros you’re receiving for that hedged so are you kind of marking down the proceeds as the euro rates moves around?

Marcel Smits

The answer to that question is the euros are not hedged and we have been scratching our heads as to whether or not we should or we shouldn’t. There’s big questions around that. But the answer to your question is, for the moment no hedge.

Christopher Growe - Stifel, Nicolaus & Company, Inc.

I wondered, Marcel, if you could help me with that second half bridge again on EPS and I wasn’t quite clear on the $0.07 and what that referred to. I’m just trying to make sure I’m kind of looking at my modeling correctly for the second half in relation to your expectations.

Marcel Smits

Yes, let me just do that again. Real simple and unscripted. It’s actually real simple. In 2009 we had mark-to-market costs in the first half and a benefit in the second half. And the benefit was around $40 million. That is probably going to be headwind because I haven’t got a better estimate for mark-to-market than a zero. So that would mean that we’ve got $40 million of comparable headwind on mark-to-market. That’s one.

Christopher Growe - Stifel, Nicolaus & Company, Inc.

And that’s worth about $0.04 a share?

Marcel Smits

That’s around $0.04 a share. Yes, $10 million is $0.01 per share. Then last year we had corporate expenses coming in very skewed so they were bunched toward the first half of the year and the second half was relatively low. And that had to do with a number of one off items and that’s good for another $30 million. If you assume this year that our corporate expenses are just going to be evenly spread over the year, so it’s just around the same figure the second half as we’ve had in the first half. That’s another $30 million or $0.03. So that’s $0.07. That $0.07 you should take out in order to judge the performance of the segments and if you take it out, you can see that the second is either going to be somewhat up or somewhat down, depending on how the year plays out.

A key item that we’re also highlighting today is we’re going to be accelerating investments behind innovation that’s coming out of the pipeline now, so the second half we’re anticipating that we’ll have an increase in that. And that’s the way you should look at our figures.

Christopher Growe - Stifel, Nicolaus & Company, Inc.

Can you quantify the input costs benefit in second quarter and perhaps give us a feel for in rough terms what you’re looking at for the year? We’ve had a lot of volatility like in the meats for example of late. Are those numbers you can provide some help on?

Marcel Smits

Yes. Let me just give you those figures. In the first quarter the modeling pricing was $112 million down and we had pricing $14 million in back. And in the second quarter the commodity pricing gave us a benefit of $102 million and pricing was $48 million down so the gap between commodity pricing and our own pricing has narrowed quite significantly. In that respect it’s interesting to see that our second quarter in terms of profit bump was much better than the first quarter. We felt great about the first quarter and as you can imagine, you know, we feel great about the second quarter.

Brenda C. Barnes

And Chris, I think it’s fair to assume that the second half will show some increases in commodity costs.

Operator

Your next question comes from Eric Katzman - Deutsche Bank Securities.

Eric Katzman - Deutsche Bank Securities

So just to follow up on Chris’s question, the $0.04 mark-to-market, I mean I don’t think most people are including the mark-to-market swings in their model anyway. Right? So I understand you have to do the GAAP stuff but most people weren’t including mark-to-market changes anyway unless you’re not talking about what goes into the coffee commodity stuff, right? You’re talking about what’s in the corporate line.

Marcel Smits

That’s correct. That’s actually correct. Yes.

Eric Katzman - Deutsche Bank Securities

And so we can ignore that $0.04 because most people weren’t including it anyway.

Aaron Hoffman

You can do that, we can’t, as you know, right? Because we have to report it. But yes, I think everyone is pretty much in line with you and not worrying about the mark-to-market. We just want to call it out to make sure everybody has a full picture of that.

Eric Katzman - Deutsche Bank Securities

This is getting technical and I’m not sure I’m ever going to understand the tax stuff, but did you say that part of the benefit was tied to UK NOLs associated with the Household and Body Care division?

Aaron Hoffman

That’s correct.

Eric Katzman - Deutsche Bank Securities

And that was flowing through to the continuing operations? Like how do you use NOLs from discontinued operations and put them in continuing operations?

Marcel Smits

Well, it’s my challenge to make sure you understand what’s going on on that and I’ve been studying it for the past couple of months. I don’t think it’s all that complicated so we’ll try and help you.

Well basically what’s happening is in the UK, on a taxable basis, we have some losses which in this year we will actually be able to offset against the gain of H&BC as and when it comes on a go forward basis. So that’s why we can now, given the fact that we anticipate that, we will have a part of the H&BC gains turning up in the UK. We can have another look at the ongoing taxable losses in the UK and say hey, we now have a profit against which we will probably be able to offset that once the closing of the H&BC deal comes, and therefore we have to value it. And that actually turns up in your [DTA] calculation. It turns up in your P&L. Does that help?

Eric Katzman - Deutsche Bank Securities

Well, I guess it just seems strange like why a discontinued operation of linked benefit is being included in continuing operations.

Marcel Smits

Because the losses that we have in the UK are of a continuing nature. Remember that we have [kortoff’s] pension payments in the UK, and kortoff pension payments are in our continuing operations. And we need to peel that off a bit in order to make it easier for you all to understand it because equally you could say well, why is kortoff in continuing operations? You know you sold it many years ago and this is just a GAAP invention and that’s why now that we have visibility on closing the H&BC deal, we have to look again at our operating losses in certain jurisdictions. And it just happens to be that in continuing operations we say as a result of the anticipated H&BC gain, we can actually value some of these losses.

Eric Katzman - Deutsche Bank Securities

Two more questions, more operations related. Brenda, I think you had over 4% volume in coffee and I’m just kind of surprised at how strong that was and maybe you could just go a little bit more because most data coming out of Europe is for pretty significant weakness. And so maybe you could just kind of go through that and I have a follow up on the bakery.

Brenda C. Barnes

A fair amount of the increase comes from Brazil, where we have a trend of good solid growth and improvement and that quarter just happened to be very strong. So that’s a high tonnage marketplace that contributed to it, less so than what the price and margin would be to our base coffee business. So that helped a lot.

In addition in our core markets, European markets, the increase wouldn’t be that strong but we are seeing continued strength in some sale trends, our signature business. Some of the companies have moderated up from first quarter so if you add all that up, that’s where you get the volume growth.

Eric Katzman - Deutsche Bank Securities

On the bakery, I guess there’s been a lot of commentary as to like who shot first and I just wondered if do you think that you’re, like some people say that you’ve been the most promotional in the category. Some say that it was initially Interstate Hostess. You know Flower says that they’re kind of reacting to everybody. How do you lay out the picture of what’s happened in the category? Because obviously that was an area that I think historically you had hoped would be the biggest contributor to profit growth on a consolidated basis.

Brenda C. Barnes

Yes. Okay. I will start out by saying we feel pretty good about our profit increase in bakery in the first half, so we are continuing to improve profits and improve margins. So that’s a good thing for us. The hard thing for us is this volume trend that you brought up. It’s hard to ever say who did what in what order but the really most important thing is this is a very local business. It’s not a price point for the country and every single city and every single market differs in terms of what the competitive set is, what the dynamics are with the product mix in those areas and if you tear it all apart, you probably will find most people are guilty. And add to that that you had an enormous uptick in commodities and an enormous downswing. So there was just disruption in the whole industry and I think the right thing to do is keep offering reasonable value and not give the product away anywhere because it doesn’t make sense for the retailer.

It’s one of the top, top profit makers for a retailer. And to the extent that any of us drive the price to low, the retailer hurts, too. So I just expect there’ll be a little bit more rationality on everybody’s part.

Eric Katzman - Deutsche Bank Securities

Are you seeing any of that?

Brenda C. Barnes

In some places. Yes, in some places. You know we’ve been holding as steady as we can to react to a combination of things, the marketplace, what the consumer value price points are and to what new innovations are worth by market. And I think we’re seeing a little bit of steadiness but we’re not going to be at the price points from a year ago. I think that’s a really important thing to remember, just because of the commodity change that’s going on.

Marcel Smits

Eric, I don’t want to be argumentative or something, but you just said that we were pinning our hopes on the largest profit increase coming from the bakery business. I think that’s not doing a service to the other businesses which have actually had great profit increases over the last few years and which have very good prospects of profit increases in the years to come. Our future doesn’t hinge on profit increases in the bakery business.

Operator

Your next question comes from Bryan Spillane - BofA Merrill Lynch.

Bryan Spillane - BofA Merrill Lynch

Just first a modeling question. The restatement, the 8-K restating the prior years, were there any other adjustments that you’re making or restating other than just the tobacco proceeds? It looked like there might have been some other change in the way you’re recognizing currency adjustments.

Aaron Hoffman

There were some previous restatements which are referenced in the front of that document and that is only to let the reader know that over the past several years there have been a number of restatements which are reflected in that document. The new information that you would find in the 8-K filed one week ago is number one, a separation between continuing and discontinuing operations for all of full year 2008 and then the quarters for 2009. And then you will also find adjusted earnings per share on a quarterly basis for every quarter in fiscal ’09.

So that’s the only new information. If you played along with us and gotten all the restatements since your model previously, that would be the only new information you would find in the 8-K.

Bryan Spillane - BofA Merrill Lynch

I’ll follow up with you later on. I’m still having a hard time following that.

Aaron Hoffman

We’ll be glad to help you out.

Marcel Smits

We were hoping that this was a [popular] restatement in the sense that it provided more information rather than confuse everybody, so that definitely was the purpose of that restatement.

Bryan Spillane - BofA Merrill Lynch

Brenda, on the North American retail business it looks like your especially Jimmy Dean and Hillshire Farms are responding really well to the actions you’ve taken, whether it’s promotional spending, advertising spending. Can you just talk to one, what your spending levels are or your level of activity is relative to the competition? Is it partly that you’ve just got more effective messaging? And is there something about that category or those products that are causing it to respond as well as it has? Because it looks like you’re getting almost an immediate impact from what you’re doing.

Brenda C. Barnes

There’s probably a far more detailed answer than the one you’re probably looking for. But that segment is really, really doing well in total and has for many, many, many quarters. So the trend is a combination of really great products that have been marketed significantly well over the last couple of years. Good brand positioning, expanding the product line from Jimmy Dean rolled sausage to bold to Delights which have lower calories, or taking Ball Park and premiumizing it to Angus Ball Park hot dogs. Or, you know, I could go on and on so it’s a combination of the brands and the marketing behind it, the supply chain which has been integrated for all of North America over the last couple of years that is driving significant improvement in costs in terms of the whole supply chain.

So we still get a premium on our products on those brands, so that illustrates the brand strength. And great presence on the shelf. So all of those things really are an engine that’s cranking along. The little tweaking that we did first quarter and second quarter was we were probably a little tick higher on the price point relative to the competition. Again, still at a premium and just by adjusting that we saw a response to it. A lot of things have gone into the success for North America.

Bryan Spillane - BofA Merrill Lynch

And then the profitability in that business has been helped by the lower input costs, lower protein costs. So when we look at the margins there, I know you talked about there being potentially some contraction in the second half, but do you think that this is sort of as good as it gets margin wise over time, given how low your input costs have been? Or do you think that it can get better than this over time?

Brenda C. Barnes

The first quarter as I was trying to say is a bit higher than the steady trend will be and should be. And that’s because of what you mentioned, which is the commodity costs have dropped significantly and we were able to hold onto some of that pricing longer than probably we should have, which drove the margins quite a bit higher. So as we started to plow back some of that commodity savings into price competitiveness, you know we’re giving some of it back, if that’s one way to look at it. So the margin from that point will moderate. Over time, though, we should see comparable margins to our peer group in those segments which is probably low double digits to mid double digits.

Operator

Your next question comes from Judy Hong - Goldman Sachs.

Judy Hong - Goldman Sachs

Brenda, I just wanted to go back and follow up on Bryan’s question about margin outlook and this is maybe more of a longer term question. Clearly you’ve talked about the progress that you’ve made over the last few years in improving margins and retail meats now at double digits, you’re seeing improvement in foodservice, etc. I’m just wondering maybe conceptually if you think about the next drivers of margin improvements, where do you see the biggest opportunity either by segment or whether you think cost savings or mixed improvement in sort of buckets of next drivers of margin improvement?

Brenda C. Barnes

Are you talking about across all of our segments, Judy?

Judy Hong - Goldman Sachs

Yes. I guess its more meats and North America because I think on international it seems like you’re focused on growing volume on the coffee side.

Brenda C. Barnes

Let me just touch on those two segments since they’re the biggest ones in that. Coffee, you’re right. We will continue our strategy as we talked at [management] to premiumize the mix over time. And so we will continue to come out with new innovations that have a margin premium price point that ups the mix over time on the margin side as we stay competitive on roast and ground. So the idea there is to hold our margin in total over time with coffee and tea and drive the top line. So that’s a quick summary on that.

On North America, it will be a combination of things. Certainly one will be changing the product mix. So whenever we have an innovation pipeline and anything we come out with has a higher margin than our base, because it’s more value added, hitting consumer segments with the things they need at a reasonable margin. So you will see a shift in mix as well as ongoing cost savings. Those would be the two drivers.

Marcel Smits

Yes, the other element that I would add to that is the Kansas City plant which will get us to a lower cost platform for our [inaudible] meat. So that should have a meaningful impact as well.

Brenda C. Barnes

That’s a structural change. We show that on meat management, the cost per pound is tested in the industry.

Marcel Smits

So it accelerates savings at the Kansas City plants and it makes improvements as we go forward.

Judy Hong - Goldman Sachs

On the North American bakery side, I mean just given the competitive dynamics there are you seeing any movement in some of the regions where you’re seeing more consolidation opportunities or are there any changes on that front?

Brenda C. Barnes

No changes. There have been big ones obviously in the last year, so obviously the Bimbo Weston consolidation has happened. That’s a major change for the industry, but nothing really major since then that I’m aware of.

Operator

Your next question comes from Vincent Andrews - Morgan Stanley.

Vincent Andrews - Morgan Stanley

Maybe if I could just follow up on the U.S. bakery business a little bit, I guess one of the things I’m wondering is why is there sort of a secular issue here from a branded perspective relative I guess to private label? And the competition that you’re seeing, how much of it is explicitly brand to brand versus brand to brand trying to fend off private label as well?

Brenda C. Barnes

Just look at the ten year trends in this segment and you’ve had private label in the 20s for a really, really long time. So private label has established a major piece of that business. So you have the desire and the need for branded practices to stay within a range of that, that the consumer accepts because of the quality and innovation that the branded products offer. And on top of that, you have a very strong competitive interaction among the branded players. So I think that’s what we’re all fighting for. And in an industry that is big and important and profitable to the retailer, we’re all obviously trying to come at it to get innovation in the marketplace, like we did with thin buns, this Omega 3 DHA that we’re coming out with and I don’t know if you saw the announcement on our EarthGrains Eco bread but you can innovate in the bread segment. And we’re continuing to do that to keep the premium on the branded products there with value added products.

Vincent Andrews - Morgan Stanley

And it sounds like your sense is the competition in bread and bakery is starting to bottom out.

Brenda C. Barnes

Competition will always be there, there is no bottoming out on the competition whatsoever. It’s all about market scale. You know the more margin you drop per store, the more the economics improve radically.

Marcel Smits

Vincent, if I can just make one more remark, just as a reminder. The North American Fresh Bakery business does $38 million of adjusted profit, just in segment income for the first six months. That is to be compared with $660 million of the special segment income that we have cost driven. So it’s just over 5% or something like that.

Operator

Your next question comes from Alexia Howard - Sanford Bernstein.

Alexia Howard - Sanford Bernstein

Just a couple of real quick ones. Did you elaborate on the drivers that the increase in corporate spending year on year in the second half?

Marcel Smits

Yes we did. We did. We explained that actually this year corporate expenses are expected to be evenly balanced for the first half and the second half. That is unlike what happened in 2009 where the second half corporate expenses were very low as a result of a number of one offs which we had in [inaudible] at the time, particularly in the fourth quarter. So 2010 is the normal year, 2009 was the abnormal year.

Alexia Howard - Sanford Bernstein

Secondly, on pricing trends going forward I guess you’ve seen a bit of a dip in price trends between the first quarter and the second quarter. Might we expect given the comparables from last year that that might dip down again next quarter? Or are we kind of at the low level here in terms of your own pricing strategy year on year?

Marcel Smits

Well, we had favorable variance between commodity and pricing for the second quarter and of course you know the outlook incorporates our assumption that that’s going to be smaller going forward.

Brenda C. Barnes

And we’ll be overlapping, you know, it’s a whole different scenario on pricing overlapping second half versus last year. You won’t see the kind of increase relative to commodities in the second half.

Alexia Howard - Sanford Bernstein

So it’s like you said, the trend’s downward year on year from here on out. Is that the right way to interpret that?

Marcel Smits

I think it’s too early to say whether or not we’re going to have a positive or a negative variance of the total of pricing and commodity. The most important thing that we’ve called out is that we see accelerated map spend in the second half as the pipeline of innovation comes through.

Alexia Howard - Sanford Bernstein

Thank you very much.

Marcel Smits

That’s a very key component that you need to understand in order to understand our outlook for the year.

Brenda C. Barnes

There will be movement on commodities in second half, more on the upward pressure. We will be experiencing versus second quarter some of the implementation of actions we’ve put in place to get a little bit more price competitive. And we’re overlapping a very different second half, so take all those things, it’ll be a different picture.

Operator

Your next question comes from Timothy Ramey - D. A. Davidson & Co.

Timothy Ramey - D. A. Davidson & Co.

Marcel, you know your discussion of [kortalbs] continuing pension obligations brings to mind a conversation we had earlier this year and you know I mean it just seems like there’s so much opportunity to help people understand kind of the legacy items that Sara Lee has that really are unrelated to the current operations. Is that going to be part of your discussion of capital and buybacks and dividends and so on at Cagny? I sure hope it will be.

Marcel Smits

As much as we can, Tim. You know I’m bound by regulatory constraints but to the extent we can, we will provide as much visibility as logical because as we’ve discussed earlier, I tend to look at things on some sort of multiple on cash flow. And in our cash flow we have meaningful items which relate to the past and you should look at them on an also basis, on an [MVD] basis. That’s all I’m going to say for today. We’ll peel it off further in the Cagny presentation and we’ll do our damnedest to try and help.

Timothy Ramey - D. A. Davidson & Co.

Was there any structural reason why you didn’t buyback stock in the first half?

Marcel Smits

We’ll address that at Cagny as well, Tim.

Operator

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

Terry Bivens - J.P. Morgan

Brenda, just a question on the North American retail margins which were quite a bit higher than I was looking for and I think most folks. Just looking at I guess one way to get at it may be if you look at pork prices, I guess they started the quarter down pretty significantly just on a spot basis and ended up pretty high, year on year. Did you lock in a lot of supply early? Is that one of the factors there?

Brenda C. Barnes

One of the factors for sure is that prices were really low and then went up. So in that time where buy costs went up, we held our pricing so therefore we reached over normal profit. I’ll call it that. We also knew that the cycle was going to be changing and that pork prices would be going up and that’s exactly what we’re seeing happening now. So I don’t just right in front of me have our hedging numbers on.

Terry Bivens - J.P. Morgan

Yes, I was just going to try to get you to parse that margin gain just a little bit, if I might. I mean one of the things you mentioned was advertising was up on those three brands you singled out, but was it up overall in that unit? Or was it just up on the?

Aaron Hoffman

It was up $12 million for the first half.

Terry Bivens - J.P. Morgan

But in the quarter?

Aaron Hoffman

It was up in the quarter. I’ll give you the exact amount.

Terry Bivens - J.P. Morgan

Yes, what I’m trying to get there is yes, you know, half of it was input costs, another half. If it can kind of be broken down even in some relatively rough way.

Aaron Hoffman

It was up $5 million in the quarter.

Marcel Smits

These details are available in the queue as well. So you could look at it there.

Terry Bivens - J.P. Morgan

And that will give me some idea of the dimensions of where this came from?

Marcel Smits

Yes. It should. Combined with the figures that we’ve given you earlier in the call, pricing and commodities, that should give you very clear visibility.

Brenda C. Barnes

And brand innovation. There are many things that are contributing as I said earlier, with brands as well as our supply chain costs.

Terry Bivens - J.P. Morgan

One last thing just on the bread side. I know they’re on some questions today, but you know if you take the view that it’s probably only going to get worse in terms of the competition and if you look at the fact that over time it’s never been a particularly good return business, as a matter of fact it’s been pretty poor, my question would be, and looking at the overall contribution of U.S. baking to your operating line, why not just get rid of it? You know it would be a prettier portfolio without it.

Brenda C. Barnes

I’ll tell you what. We don’t comment on what we’re going in or staying out of, but what we are committed to is even though it’s never going to be a margin of mid-teens to high teens like coffee, it will certainly be higher than our zero margin before and our 1 and 2 in the last year and our 3 this year. So that’s what you can count on for us is to keep improving it.

Operator

Your next question comes from [Andrew Simon] – Meridian Asset Management.

[Andrew Simon] – Meridian Asset Management

You said in the release that capital spending this year would be $425 to $450 million but you have only spent in the first half of the year $142 million. So what, well not including software, so does that mean you’re going to be spending a lot more in the second half than you did in the first? And why?

Marcel Smits

Yes, that’s true. Our capital spend tends to be bunched towards the second half of the year. We’ve seen that big gap. Part of that is investments in the Kansas City facility which is coming through. So it’s a big gap. We tend to be somewhat conservative but we’ve looked at it and we are comfortable that the figures we’ve given you are in the ballpark of the range where we’ll end up. So it’s not some sort of oversight saying oh, you know, hey we haven’t seen that. Yes, we’ve seen that. It’s a function of how some of our capital purchases are playing out.

[Andrew Simon] – Meridian Asset Management

Your free cash flow in this quarter, you know not including the foreign exchange effect on cash in other jurisdictions, was about $239 million. And your net debt is down during the quarter from $1.605 billion at the end of first quarter to $1.482 billion, net debt. So I guess I’m trying to figure out whether there’s some seasonality to it and whether you know net debt is going to go up in the second half of the year or whether it may be down some more.

Marcel Smits

Well, that depends first on what we announce on the capital structure in terms of seasonality. What I’ve so far seen is that our CapEx tends to sit more towards the second half than the first half and we’ll try and provide you some visibility as to why that is. I know for this year it possibly relates to the Kansas City plans, but it’s better than we’ve seen over the past few years. In terms of working capital, our pattern tends to be that we have an affluence in the first half and then we have a bit of an inflow in the second half. Last year in 2009 that was much bigger than what we normally have, but there is a bit of seasonality in the working capital as well.

Operator

Your last question comes from Andrew Lazar - Barclays Capital.

Andrew Lazar - Barclays Capital

In the guidance table that you provide in the release, under the total operating income outlook for fiscal 2010, it looks reasonably similar to what that outlook was in that table last quarter and then you noted that you have a $0.03 to $0.04 operational improvement in terms of the guidance and EPS upticking for the year. I just want to try and make sure what I’m missing and what I’m trying to reconcile those two.

Aaron Hoffman

The issue is that the adjusted EPS guidance excludes a significant item. The operating income figures you’re referring to actually include the significant items. I think that’s an area where on this table going forward we’ll be more clear. And I apologize for any confusion that would have caused.

And those are as reported numbers and include the significant items.

Andrew Lazar - Barclays Capital

I think you had said that your operating profit year-over-year in the second quarter obviously was up in a bigger way than it was year-over-year relative to the first quarter. Yet the gap between pricing and inflation narrowed in the second quarter versus the first quarter. I think that’s what I heard, which I guess would mean there’s some other factors that are obviously helping operating income look better year-over-year. I guess part of that is the productivity coming through, I guess volume being.

Marcel Smits

Volume is an important one.

Andrew Lazar - Barclays Capital

Right. Less negative than what we saw in the first quarter. Do I have that right and anything else I’m missing there that would help that?

Marcel Smits

I think that’s just about right.

Brenda C. Barnes

Yes, volume on the cost side, too.

Aaron Hoffman

Thanks everyone for your time today. We recognize it’s been a very busy morning for a lot of folks and we appreciate you taking the time to join us today. I’ll be around to take any additional questions over the course of today and tomorrow and beyond that. And if not, we’ll look forward to seeing you in 12 days at Cagny. Thanks.

Operator

Thank you. This concludes today’s conference. Thank you for participating. You may disconnect at this time.

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