Sara Lee F3Q08 (Qtr End 3/29/08) Earnings Call Transcript

Sara Lee Corp. (SLE)

F3Q08 Earnings Call

May 6, 2008 10:00 am ET

Executives

Aaron Hoffman - Investor Relations

Brenda C. Barnes - Chairman of the Board, Chief Executive Officer

Theo de Kool - Chief Financial and Administrative Officer

Analysts

Vincent Andrews - Morgan Stanley

Alexia Howard - Sanford C. Bernstein

Bill Leach - Neuberger Berman

Jonathan Feeney - Wachovia

Chris Growe - Stifel Nicolaus

Robert Moskow - Credit Suisse

Eric Katzman - Deutsche Bank

Ken Zaslow - BMO Capital Markets

Tim Ramey - D.A. Davidson

Todd Divek - Banc of America

Pablo Zuanic - J.P. Morgan

Presentation

Operator

Good morning and welcome to Sara Lee Corporation’s third quarter earnings conference for fiscal 2008. (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

Thanks, Melissa and good morning to everyone. Welcome to Sara Lee's third quarter 2008 earnings conference call. As always, we very much appreciate your time and your interest. Joining me for today’s call this morning are Brenda Barnes, our Chairman and CEO; and Theo de Kool, our Chief Financial and Administrative Officer.

As you know, I suspect, our third quarter results were released this morning at 6:30 Central Time via press release that you can find on our website, and you can also find our 10-Q for the third quarter, which was filed this morning, both on our website and on the SEC website.

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 provide additional information in our press release and Form 10-K for fiscal 2007 that I encourage you to review concerning factors that could cause actual results to differ materially from these forward-looking statements.

Before we jump into the results, I want to spend just a moment on the earnings release and the 10-Q. First, for those of you keeping score at home, and I know there are a lot of you out there doing that, the release if 15 pages shorter than it was in the third quarter of last year and our 10-Q is over 20 pages shorter. I am confident that you will find that the documents are a little bit shorter but I think they are clear and more useful than they have been in the past.

We are now providing a more comprehensive reconciliation of significant items and earnings per share and various adjustments to our tax rate, which are delineated on page 11 of the release. And we’ve kept other key schedules, [like the sales bridge] on page 10 and our good guidance on page five.

I will point out that we did not include the income statement, balance sheet, or cash flow statement with the release since the 10-Q was filed at the same time and includes the exact same document.

And then one quick note on the guidance table -- as our Mexican meat joint venture is now a discontinued operation, we have restated the fiscal 2007 actual results and updated our fiscal 2008 guidance wherever appropriate to exclude that business.

So with that out of the way, let me now turn the time over to Brenda.

Brenda C. Barnes

Thanks, Aaron. Good morning, everyone. Good to have you joining us today. Although our adjusted operating profit is essentially flat, we feel good about the third quarter and the first nine months of the year. In spite of the historically high prices for wheat and fuel, along with a volatile green coffee market, we still did deliver solid results.

In the quarter, adjusted sales and volumes rose in size over our six segments, except for food service. Adjusted operating segment income increased in North America bakery, international bakery, and in household and body care. And on a reported basis, we realized very significant benefit from currency in both the quarter and the nine month results.

Beyond that, we increased our marketing investment in North America meats and international beverage to support new on-trend products. For the full year, better marketing and higher marketing spend have resulted in stable or increased market shares in virtually every significant category in which we compete.

There is no doubt that we are operating in a virtually unprecedented time for commodity increases and facing a challenging world global economy. The questions are first, how are we dealing with this level of input cost inflation and second, how has the consumer responded?

To start, our pricing actions in aggregate for our continuing businesses rose about $235 million for the first nine months and $90 million for the third quarter. This compares approximately to $240 million of incremental input costs in the nine months and $85 million for the quarter.

In total, our food and beverage businesses were able to price in excess of the climbing increases in the third quarter, as we expected, but this doesn’t necessarily hold true for every single segment.

We would have completely closed the gap on a year-to-date basis without the price declines in household and body care due in this case to competitive activity in several markets and categories.

On the question of how the consumer has responded to higher pricing, we are seeing very little adverse effect. In fresh bakery, retail meats, and international beverage, we’ve seen no real negative consumer reaction to these higher prices. We’ve only seen modest trade down effects in two segments; our North American food service business has seen a shift away from mid-scale and casual operators, as well as a movement from out-of-home to in-home dining. And we’ve seen some pressure in our Spanish fresh bread business. As I mentioned, our share positions are generally steady or increasing, another strong indicator that we are seeing good consumer demand for our products.

As wheat prices have been such an issue, it is worth reiterating that in North America, we’ve seen virtually no trade down in our fresh bakery business. In fact, our branded share of fresh baked goods continues to rise while private label continues a multi-year slide.

On our last call and at CAGNY, we let you know that we continued to identify exit areas of our business that are returning little or not profit. We exited certain meat commodity sales in both food service and retail. We’ve exited some of our DSD food service coffee routes and over an extended period, eliminated dozens of brands and thousands of SKUs in fresh bakery.

As an extension of this strategy, during the quarter we sold our interest in our Mexican meats joint venture, which lost money in fiscal 2007 and was barely profitable this year. As a result, we received $55 million of cash in the fourth quarter and we improved our operating margin structure by eliminating $300 million of annual sales that virtually had no profits associated with it.

And as you know, improving processes to drive efficiencies has been a key area of focus. We have consistently said that some centralization and the reorganization of businesses would lead to even more cost reduction opportunities. We’ve experienced many actions and significant savings to date and early in the fourth quarter, we took steps to right-size our North American organization, reducing headcount by about 300 employees. This will result in a $15 million to $20 million charge in the fourth quarter and an improved cost structure.

While we’ve reduced the top end of adjusted operating margin guidance by 10 basis points to a range of 7.5% to 7.8%, we still anticipate a final -- a strong final quarter for the year.

Based on a number of factors, I am confident that we will deliver our forecast. First, we have lower marketing expense in the quarter compared to the year-ago period, in which we spent an incremental $31 million. We also have the benefit of having spent $43 million of incremental MAP in fiscal 2007 and an additional $61 million more thus far this year in fiscal 2008.

We should continue to see favorable pricing in excess of commodity increases in the quarter and finally, we have a lower cost structure in North America due to the cost reduction initiatives just implemented.

Now let’s take a look at the individual business segments -- our North American retail meats business is successfully moving its portfolio to consumer focus, on-trend value products, and grew adjusted sales by about 2% for the quarter. Retail sales rose 6.6%, excluding commodity sales, which were when we exited a facility that largely produced these products.

On the other hand, adjusted operating segment income fell by 2% behind a 14% increase in MAP spending to support new product launches and higher distribution costs largely caused by higher fuel prices.

This investment in our core and new products is driving further market share gains, highlighted by increases in Ball Park hot dogs, Hillshire Farms smoked and sliced meats, and Jimmy Dean sausages and protein breakfasts.

Behind continued new product success and share gains, our U.S. fresh bakery business had a strong quarter in the face of much higher commodity prices. For the total North American retail bakery segment, adjusted sales rose 11% and adjusted operating segment income rose from $2 million in last year’s third quarter to $14 million this quarter

As we discussed, we’ve been increasing pricing in fresh baked goods in order to keep pace with the historically high wheat costs and we anticipate taking more pricing as the market has continued to move up. Our ability to successfully partner with our customers during this challenging period demonstrates the real strength of our sales organization and the power of the Sara Lee brand. It remains the number one fresh bakery brand, growing sales by 17% in the U.S. this quarter.

In our food service segment, as I mentioned earlier, we’ve exited various low or no profit commodity meat products and some DSD coffee routes. While these actions are designed to improve profitability, there is an expected reduction in sales and volumes. However, quarterly results for the entire segment were pressured by challenging DSD coffee environment, slower pricing pass through than expected, and some trade down.

To help offset some of these issues, we are increasing our relevance to customers with solutions to reduce their labor cost and waste. We are also improving our overall value proposition with products like our one-touch coffee system and a number of more convenient items. At the same time, we are actively reducing the cost structure in the business.

I remain comfortable that we’ll show better results over time as pricing catches up to commodity price increases and as our strategic actions pay greater dividends.

Building on a strong first half, international beverage delivered good sales and unit volume growth. Adjusted sales rose over 7% and volumes were up 6%. Adjusted operating segment income decreased about 10% as we ramped up MAP spending by 19% at constant currency rates to support new product launches around the world.

For the first nine months, adjusted operating segment income rose by 2%, positioning us for a solid full year.

A key driver of the improvement continues to be the successful turnaround of our Brazilian business, where we accelerated profit growth significantly through strategic pricing and better sales and marketing efforts.

Another key performance driver continues to be our international Senseo business, where sales rose 21% in the first nine months on the strength of new offerings and currency benefits. The year-to-date results are very much in line with our strategy of driving revenue through innovation while maintaining or enhancing our attractive margin structure.

With a change in management in Spain and a more disciplined approach to sales and distribution, our international bakery business continues to see better fundamentals. Our French refrigerated dough business is doing well, while our Australian business is being repositioned to deliver improved results.

Adjusted sales rose over 4% while adjusted operating segment income was up 1%, despite pressure from higher commodity prices and a steadily weakening Spanish economy.

As our new management team continues to improve our marketplace capabilities, we are confident that we will see solid base business gains over the long-term.

Household and body care has kept a steady stream of successful product innovation flowing in the marketplace. These new offerings help offset some competitive and retail price pressure in various markets and categories around the world. While adjusted sales grew 2%, adjusted operating segment income increased by 6%.

After two challenging quarters, the segment has returned to the positive top and bottom line trends that it is capable of delivering over the long-term. Behind new Omnipure, Sanex, and Radox products, we continue to hold our share positions in an increasingly competitive environment.

Now turning to the financials, reported diluted earnings per share were $0.30 for the quarter. This number includes an $0.08 net gain from significant items, leading to adjusted earnings per share of $0.22. Cash from operations for the first nine months was $238 million, representing a $140 million improvement. This increase is all the more significant if you consider that in the first nine months of 2007, cash from operations included $76 million of cash flow from discontinued operations, while the first nine months of 2008 only included $10 million.

Looking forward, we are forecasting diluted EPS in the range of $1.13 to $1.17, which includes an $0.18 from the sale of our tobacco business in fiscal 1999, and $0.15 of net significant items for the first nine months. Our guidance does not include any additional significant items that may occur during the fourth quarter.

Our adjusted EPS guidance, which excludes significant items and the tobacco payment, is $0.80 to $0.84. We have increased our full year expectation for the Euro dollar from $1.43 to $1.47, lower our anticipated interest expense, and raised our adjusted tax rate by two points to 35%. The combination of these factors implies a reduction in our adjusted guidance of $0.02 to $0.04, which can largely be attributed to pressure on the profitability of the underlying business as we face volatile commodities and weaker economic conditions in some key countries.

We anticipate sales growth of 10% for the full year, which incorporates our increased Euro dollar assumptions. We now expect volumes to be up between 1% and 2%, which is better than our initial forecast. The bulk of our sales growth will come from price mix improvements and favorable currency.

Our guidance for full year adjusted operating margin is 7.5% to 7.8%, 10 basis points lower on the high end than previous guidance due to the weaker economy and commodity headwinds, though this still implies higher adjusted operating income. And while we’ve largely kept pace with input cost increases, we had planned incremental pricing in our initial assumptions. A lack of pricing and both commodity increases has a negative effect on results to date and on our guidance.

As I look at the results to date and what we need to achieve in the final quarter of the year, I recognize, as I am sure you do too, we need a strong conclusion to the year. I believe we will still achieve our plans. Simply put, we have significant pricing flowing through the business that should continue to outpace higher commodity prices.

We have the benefit of lower marketing spend this quarter and the momentum gained from a strong commitment to marketing and new products for over a year now. Our continuous improvement efforts are paying dividends across the business and our new IT systems have facilitated better trade spending and strategic pricing.

And the actions we’ve taken recently including a reduction in North American costs and the sale of our Mexican meat joint venture should further improve our results.

Fundamentally, I believe that we are well-positioned to deliver our plan with a very strong fourth quarter. And now with that, Theo, Aaron and I are happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Vincent Andrews with Morgan Stanley. Please go ahead.

Vincent Andrews - Morgan Stanley

Good morning, everyone. Am I correct that your volume in the quarter was better than you had anticipated when we last spoke on the second quarter call?

Theo de Kool

It is better than previous. I think it is in line with our expectations of 2.4% and it’s better than year-to-date so far, so we are quite satisfied with that.

Vincent Andrews - Morgan Stanley

Okay, and another question I had was you indicated that there was a benefit from I think the closing of commodity contracts in the meats business. Could you quantify that?

Theo de Kool

Qualification of the commodities --

Aaron Hoffman

I think that’s in the bakery.

Vincent Andrews - Morgan Stanley

I’m sorry, yes, in the bakery business -- was that a gain on hedging or something like that?

Theo de Kool

No, we have [inaudible] and we have hedges far out and there was a moment in time that we of course advantageous to close that hedge. We renewed it so we are still covered for the period ahead of time but it is a benefit that came into the quarter.

Vincent Andrews - Morgan Stanley

And you are not going to quantify what that benefit was?

Theo de Kool

Correct.

Vincent Andrews - Morgan Stanley

I’m sorry?

Theo de Kool

On a relatively low profit, that has a significant impact. That’s why we carved it out in the earnings release.

Vincent Andrews - Morgan Stanley

Okay but I didn’t see a number associated with that.

Theo de Kool

No, we didn’t give any numbers. For competitive reasons, we don’t disclose the exact numbers there but if -- we felt for disclosure reasons, we needed to mention that.

Vincent Andrews - Morgan Stanley

Okay, but if I look at the underlying operating profit going from $2 million to $14 million, can you give me any sort of indication of how much of a contributing factor that gain was?

Theo de Kool

No, I can’t give you an indication but there are gains from hedge accounting, actually, because of the lack of hedge accounting [here] to apply mark-to-market and that impacts the segment and [inaudible] that can reverse in next quarters.

Vincent Andrews - Morgan Stanley

Okay, understood. And then finally, you noted in the North American beverage business that you had some difficulty in certain coffee segments. Could you just detail that a little further?

Brenda C. Barnes

Yeah, the food services segment is made up of different pieces of business, one of which is the direct store door coffee route system. So we have that coffee business and we also have a national account business that tends to go through a different distribution network and includes both liquid coffee as well as roast and ground. The one that I was referring to is on the route system, which is typically smaller independent operators that probably feel the pressure of this economy more so than the big chains might, and that’s the segment that is soft.

Vincent Andrews - Morgan Stanley

Okay, and one last one -- there were some labor cost increases in meats. Can you help me understand that?

Brenda C. Barnes

We have normal inflation on the labor costs. I don’t know exactly which number you are referring --

Vincent Andrews - Morgan Stanley

I guess you called it out in the detail as a headwind to operating income due to increased labor costs.

Theo de Kool

No, I think it is in SG&A and a big part of our SG&A is labor costs, so it was driven by that. And actually, one of the reasons why we mentioned also that we did a right-sizing in North America is to bring that more in line with the business performance at the moment.

Vincent Andrews - Morgan Stanley

Okay, and as we look forward to fiscal 2009, you are obviously -- you’ve been able to offset the commodity cost increases in the quarter through pricing and on the last call, you said that you were 100% hedged on certain things but not on others. Costs have gone up and hedges will obviously run off, so how do we think about where you are going to be going into next year from an input cost perspective?

Theo de Kool

Although I have to caution you, we don’t give exact guidance, our expectation on commodity cost is that they will continue to go up. This year we estimate our total cost to be up in the range of $350 million and I expect next year a similar number, maybe a little lower but still very significant. That is why we continue to increase our prices where we can to pass it through to the customer. We have been relatively successful so far and in the fourth quarter, we expect to further catch up with pricing versus commodity costs.

Brenda C. Barnes

And if I could just add, something that allows us to do that is we have a procurement department that allows us to have visibility to the outlook, you know, as skilled and capable as anyone else can. We also have a pricing discipline that is built into the marketplace along the timeframe for which we have a visibility on pricing and we have an IT system that helps support it with the SAP implementation, so it’s these three coming together that’s allowed us to price ahead of or equal to or ahead of the commodity increases.

Vincent Andrews - Morgan Stanley

Okay. I’ll pass it along. Thank you very much.

Operator

Thank you. Our next question comes from Alexia Howard with Sanford Bernstein. Please go ahead.

Alexia Howard - Sanford C. Bernstein

I guess the margin guidance has come down a little bit this quarter again. Can you just clarify what the gross margin number was on a recurring basis? I believe it came down by 60 basis points but I just wanted to check into that.

Aaron Hoffman

It would have been -- yeah, down 60 for the quarter is exactly right, Alexia.

Alexia Howard - Sanford C. Bernstein

Okay, great. So going forward, it seems as though the price mix growth was a little bit light this quarter. Are you expecting this ongoing pricing and competitive pressures in the -- particularly in the household and body, is that going to continue to be a challenge? And do you expect that the -- how do you expect the price mix to develop as we go into the fourth quarter and beyond?

Brenda C. Barnes

As we said, we think our outlook is that we will have an offset to our input inflation in the fourth quarter. I do think we need to expect ongoing competitive activity as everybody is fighting for market share and trying to win through innovation and discounting. So our approach has been that we’ll be competitive and that’s a little bit why you see in the third quarter that household wasn’t able to offset the -- the pricing was less driven by input costs than it was the competitive environment, so I think that that is going to be continue, maybe not as intensely but time will tell.

Alexia Howard - Sanford C. Bernstein

And then one final one, on productivity, it seems as though you’ve got pricing to cover most of the input cost inflation, obviously marketing spending was up a little bit ahead of sales this time around. Does that mean the productivity improvements have kind of slowed down just for this quarter and now maybe you are getting a little bit tougher on some of the central costs, as we’ve seen in the headcount reductions recently? Can you just speak a little bit about how you expect the productivity improvements to shape up going forward and then into next year as well?

Brenda C. Barnes

As the input costs are so visible and you can look at them and see the higher number, what certainly is happening for us and everybody else is there are days inflation costs that go into our entire cost structure, whether it’s labor rates, warehouse management, all those things that are in the cost line of running a business. So the good news of what we put in place is that our process improvements have been able to offset that inflation, which was part of our model, if you remember, that we showed at CAGNY, use product improvement to offset inflation and use pricing to drive margin improvement, mix and margin improvement.

I think that formula is the right one and has been working, with the exception of we can’t price to offset [costs] and price to drive the margin increase. So on an ongoing basis, we’ll continue to have that continuous process improvement but we also are evolving as an organization and each step we take, we are able to do the next wave, the next step of things, like this 300 person reduction in North America and that came as a result because we combined the supply chains between the meat business and the food service business, and we have centralized things and taken people out with the SAP implementation. So we are going to have continued waves of step function kinds of improvements like that.

Alexia Howard - Sanford C. Bernstein

Okay, so we can expect those to continue? All right. Thank you very much. I’ll pass it on.

Operator

Thank you. Our next question comes from Bill Leach with Neuberger Berman. Please go ahead.

Bill Leach - Neuberger Berman

Good morning. Theo, what is your tax rate expectations for the June quarter and what should we use for a normalized tax rate next fiscal year?

Theo de Kool

For next year I can’t give you but I have given a long-term guidance of 33% for our core earnings. This quarter, we reported that for the full year we expect a 35% for our core earnings, two percentage points up. I don’t think that will be structural but it will be -- if the region is actually -- if there is a change in law that made some of our interest cost not anymore deductible in some foreign operations, and secondly in general, foreign earnings are taxed only in the U.S. once you repatriate. There is one exception and that is income like interest and dividends and royalties. And because of the higher currency, that number has gone higher as well and we have to pay some taxes for that in the U.S.

I don’t think that’s structural but it hits us in this quarter. So if I give you the 35% on core earnings for the full year, you know where we are, you can do the calculation because that’s not a number I can give at the moment.

Bill Leach - Neuberger Berman

Actually, I don’t know where you are. You’ve got so many significant items and those things.

Theo de Kool

Well, no, if you include that -- but I was referring to -- actually, I don’t have top of mind for the total year if you include the significant items. Sorry, I have to come back to that. I don’t know that top of mind.

Bill Leach - Neuberger Berman

But anyway, the core ongoing tax rate should still be about 33%?

Theo de Kool

It is but it will be 35% for this year.

Bill Leach - Neuberger Berman

Right. Okay, thank you.

Operator

Thank you. Our next question comes from Jonathan Feeney with Wachovia. Please go ahead.

Jonathan Feeney - Wachovia

Good morning. Thank you. I wanted to ask about -- speaking about the international beverage business a little bit more specifically, Brenda, I know you made some pretty impressive increases in MAP spending. I guess I’m just a little surprised that the strong volume growth you are seeing there isn’t giving operating leverage to offset that. And I guess if you could maybe give us a little more color as to when you look at that margin decline, how much was MAP spending, how much was pricing not keeping up with commodity costs? Can you give us how much leverage you [kind of intend] when you grow a business like that at 6%?

Brenda C. Barnes

Our whole approach -- I’m going to take a step back and just talk about broadly on the coffee business, it’s a fantastic business. It’s got a great margin, we’ve got great trademarks and we have lots of areas for growth opportunity. So what we have been doing this year and as part of our long-term approach on coffee is to continue to push investment so that we keep fueling this growth over multiple countries in multiple segments, whether the segment is instant coffee, single serve, new flavors of types and roast and ground. So we’ve been -- we knew that the first half, the results on coffee were significantly higher than what we were going to see for the full year because we had a series of investments that we wanted to make.

So a large portion of what happened in the third quarter is the MAP spending and a somewhat smaller portion of it is in the quarter not offsetting the pricing as offsetting the commodity increase.

As you know, coffee is very volatile and we are moving up and down with the market as best we can and there will be some tight periods, short periods where we may not be able to offset it exactly on that same time. So it’s really MAP and a little bit of the pricing impact.

Jonathan Feeney - Wachovia

And I guess when you think about -- let’s say you are setting an appropriate level of brand reinvestment to keep this top line going, when we look forward to say ’09, 2010, I mean, is this 16%-ish type operating margin maybe a more normal operating margin for this business do you think, or --

Brenda C. Barnes

I’ll only go back to what I’ve said in past meetings, which is our strategy and approach on coffee and tea is to hold margin while we drive the top line. Basically that’s the statement we’ve made, so we think this is a long-term healthy business with lots of growth opportunity and what we look at, which I think is a very critical variable is if you go back a few years, we were losing share and milking this segment, and we do not want to milk this segment. We want to grow share and develop the business and that’s what our long-term approach is going to be.

Jonathan Feeney - Wachovia

Okay. Thank you very much.

Operator

Thank you. Our next question comes from Chris Growe with Stifel Nicolaus. Please go ahead.

Chris Growe - Stifel Nicolaus

Good morning. I have a couple of questions for you, two real quick follow-ups and the first one is relative to the cost savings and is cited for a lot of businesses and I believe Alexia asked about it but can you quantify for the year what you would expect in the way of cost savings coming through from the business?

Aaron Hoffman

Not a number that we guide on, Chris, so not really able to give -- one of the decisions we made on that number, because it became kind of lumpy and moved around a lot is to just kind of update you guys on our analyst day every fall and just give you a full year number, tell you where we were for the previous year and where we think we are going to go for the coming year. And we’ll just probably do that again for you in late September, early October when we do that meeting.

Chris Growe - Stifel Nicolaus

Okay and then as I look at the second quarter on a separate topic, the input cost inflation that you cited wasn’t that different from last quarter, yet the pricing was well below where it was last quarter. So when you say you offset the cost inflation, you are incorporating perhaps a greater level of cost savings when you make that statement -- is that correct?

Brenda C. Barnes

We have both pricing versus commodities, which I think is what the numbers that you are looking for, and the commodities, including energy, was 242 and pricing was up 235, so that fell short by seven for the quarter.

Theo de Kool

No, that’s --

Brenda C. Barnes

I’m sorry.

Theo de Kool

85 versus 89.

Aaron Hoffman

Correct, and then we actually had about close to $95 million of commodity increase in the second quarter and $85 million roughly this quarter, so we exceeded it this quarter by $4 million with pricing and we were behind by about $10 million in the second quarter.

Chris Growe - Stifel Nicolaus

Okay, and then the other question I had for you just was on your share repurchase activity. It looks like you’ve kind of completed that now for the year. Should we expect any incremental share repurchase? You have of course authorization but what should we expect for the cash flow here for the fourth quarter?

Theo de Kool

We have completed what we have guided for during this quarter. We have no concrete plans to do anything else this year and for next year, we still have to make a decision how we do that. We know we have a commitment of about $1 billion to go versus our original commitment for the next two years but we have not made any decision there.

So cash flow guidance is unchanged of cash flow from operations of 350 to 450 and I still feel comfortable that we make that number.

Chris Growe - Stifel Nicolaus

Okay. I’m sorry, one more quick follow-up, if I could, and that was your reduction in your sales guidance, is that in part related to the Mexican joint venture being out of the business or was there something --

Aaron Hoffman

What it is is the -- we back out about $300 million of sales from the Mexico piece and then we add in roughly $100 million for currency, so net negative $200 million.

Chris Growe - Stifel Nicolaus

Okay. Thanks for that.

Operator

Thank you. Our next question comes from Robert Moskow with Credit Suisse. Please go ahead.

Robert Moskow - Credit Suisse

Thank you. There’s a couple of food commodities that are arguably coming down over the next six months. Wheat costs, you can see it on the futures curve, are starting to normalize. Pork costs, there might be a break in the action but I suppose as we head into 2009, those will go up again. Let me focus on wheat. And actually the third thing would be coffee, because at least in the U.S. many coffee companies are lowering price.

On the wheat side, do you perceive any price cuts on the bread business as a result of this, or is that offset by other commodity costs? And then on the coffee side, what’s happening in Europe on the pricing side? I mean, are the coffee bean input costs coming down at all in Europe, or are they still rising? Thank you.

Brenda C. Barnes

In terms of pricing, we don’t have a pricing formula that says we price to commodity costs, period, over and out. So we price to what the consumer is willing to pay for our products, driven by both innovation and brand support. And so to the extend that we can hang on to price increase, that’s certainly what we would do to drive margins.

Theo de Kool

And on top of that, for your question on wheat, we are still playing catch-up to have all our pricing in the market and not in all segments we have been able to fully do that, so even if the futures come down a little bit, which we were happy to see, that has not a big impact on the overall position at the moment. And as you have seen, the markets are very volatile. The fluctuations we have seen we have never seen before going up as much and down again a couple of days later. So we don’t base our price policy on the flavor today but more of a long-term view, and the long-term view is that wheat cost is not going to be materially cheaper than it is today.

Robert Moskow - Credit Suisse

Okay, and then Brenda, just as we head into fiscal ’09, what parts of your portfolio do you feel strongest about currently and which do you think are going to have the best growth profile and which ones do you think need some more work?

Brenda C. Barnes

Well, I think in terms of how we’ve talked about the various aspects of our business, each play a unique role for our company and I can reiterate a little bit of what we said before but clearly coffee, as I said earlier, is a hold the margin and drive the growth, mostly in developing countries and maintaining our core very strong. Household is very similar. It’s a high margin story with a lot of growth opportunity through new products and geographic expansion.

Clearly the U.S. role in our portfolio is to significantly improve the margin structure and that’s what we will focus on through a combination of ongoing cost adjustments and managing up the product mix in our new product portfolio, and driving significant operational improvements, particularly in the bakery business.

I’d say the one thing that is to be seen is how long will the food service -- what’s going to happen in food service with the consumer, because the consumer has certain discretionary money to spend and one place one can cut is going out to dinner, so that’s where we did see the trade down. Now, I don’t know how long that will last into ’09 but that’s one we’ll probably keep an eye on very closely.

Robert Moskow - Credit Suisse

Okay. Thank you.

Operator

Thank you. Our next question comes from Eric Katzman with Deutsche Bank. Please go ahead.

Eric Katzman - Deutsche Bank

Good morning, everybody. Could we just follow-up for a second with I think it was Bill Leach’s question on the tax rate? This is more kind of a -- I guess a longer term issue but as part of the multi-year restructuring, I thought the effort was to significantly reduce the number of legal entities and I would think that that would allow you to be a little bit more capable of giving us an -- let’s say a less volatile kind of tax rate. So can you just kind of comment on that and why it seems that your tax rate in particular relative to other big global companies -- you know, it just seems like yours is just so far beyond the volatility spectrum. I don’t really get it.

Theo de Kool

First of all, on the legal entities, we have a project called Project 350, which means we started we 350 legal entities. We plan to put that in-house and we have currently in place or reduced or will reduce in the near future about 100 of them. That has in itself little to do with the expectations of the tax rate. It’s a simplification of our accounting and reporting structure that is in line with other simplifications that are trying to do in other parts of the company, like SKU rationalization, et cetera.

First of all, on Bill’s question, we have in the guidance reported tax rate for the full year of 17% and year-to-date we are at 10.6. We have not calculated the number for the fourth quarter.

Secondly, yes there is volatility and it is mainly because of -- well, we have a lot of positions around the world and as you know, we have in itself quite a network of structures that support that. And it is sometimes just unsure of a point in time whether those structures will survive and if they survive, it’s kind of a yes or a no and a cushion will have to be used to pay, or we can release it. And in certain cases, we take provisions and then we don’t get the termination and it just expires and therefore we release it into earnings.

I cannot answer why we are more volatile than other companies. I can just say yeah, it’s complicated. It’s around the world. It’s not just one jurisdiction and that is how it comes together.

Aaron Hoffman

And I would just add that the amount of discrete tax items that flow through our financials are not materially different, I would suggest to you, than a lot of other multinational companies that you cover. And I think we all know that that is the case at this point, that this is not a fair lease thing -- this is an accounting environment thing and I recognize that there is complexity to our tax rate but at the same time, the world has changed in how things are disclosed from a discrete tax item perspective that’s very different than even four or five years ago, and I don’t think we are a whole lot different than some other big multinationals that we all are aware of.

Eric Katzman - Deutsche Bank

Okay. Let me move on to the operating -- I guess on the household and body care, Brenda, I mean, that business over the years has had -- when it’s had good new product effort and success in the market, it seems like you’ve been able to do pretty well versus competition. Can you just go a little bit more into the nature of the competitive threat? I mean, it seems like historically that business has competed more on new products and not so much price discounting, and if that’s a change across the key four segments, that could be pretty problematic, I would think.

Brenda C. Barnes

Clearly the segment competes on new products. I mean, it’s all about new products and if you don’t have the latest thing out there first that the consumer wants, someone will be there knocking at your door. So let’s take [Three Vilutia] -- we were out with that product, no one else was. We got it out there, a great win, good market share, we rolled it across the world. Well, it’s not long before competitors come out with an alternative and when they come out with an alternative, they are going to be trying to take your market share. So we are defending in some cases the second or third entry into that.

So it’s not so much it’s become a -- there’s a lifecycle on these products and so our challenge is to stay ahead of the curb, always coming up with the next new thing. We have a new Sanex deodorant that has [alum]. I think -- as far as I know, we are the only one that has it in. We are getting great success with that, driving great sales. We don’t have to discount it a lot. Now if someone else comes out with their version of it, it will be a competitive battle at the store shelf.

So I think that’s the normal cycle of things. So I just think we have to be even more diligent about being out there first with the best ideas, and I feel very good about the pipeline that the household group has lined up for the next several quarters, because you have to have them in place now if we are going to be able to supply them in the market.

Eric Katzman - Deutsche Bank

Okay, and then last question and I’ll pass it on, the international beverage was I’d say the biggest disappointment versus what we were internally looking for. It sounds like your -- when given the opportunity, you are going to spend on A&P to drive the top line and the top line has been pretty strong. So I guess the question is the business on a run-rate basis has been kind of somewhere between let’s say $120 million and $130 million of EBIT per quarter. I mean, do you see with the sales growth that you are generating that that $120 million, $130 million per quarter can lift significantly over time and kind of track the -- you know, by keeping margins stable? Is that what you are suggesting and that maybe this quarter was a little bit more of an anomaly on pricing versus the commodity and A&P spend?

Brenda C. Barnes

I’ll answer it on a long-term basis -- this is a very strong segment for Sara Lee. We have many, many, many years of capability, knowledge, expertise in the coffee business. We kind of -- not kind of, we did -- we put far more emphasis on being aggressive and being innovative and taking some chances. There will be times perhaps that some of the chances -- you know, we try something and it doesn’t work but that’s okay. We are going to keep trying it.

So I wouldn’t take this quarter and have a long-term worry about the coffee segment.

Eric Katzman - Deutsche Bank

Okay, I’ll pass it on. Thank you.

Brenda C. Barnes

-- business and feel very, very strong about it.

Operator

Thank you. Our next question comes from Ken Zaslow with BMO Capital Markets. Please go ahead.

Ken Zaslow - BMO Capital Markets

Good morning, everyone. How comfortable are you with your new product innovation in household products? Do you feel like it is still competitive and you are still on the forefront of it, or do you feel like there’s been increased competition and you really haven’t stayed ahead of it?

Brenda C. Barnes

I think we’ve been ahead in each of our core categories. I don’t think that has been -- that has not been the issue. Like I said, we are defending people now coming after us in some of those innovations but I think our pipeline is quite good. And if you look at our market shares within various countries, I think you’d see strong performance there as well.

Ken Zaslow - BMO Capital Markets

And you are comfortable going forward with the -- your product pipeline, not just the past, the future?

Brenda C. Barnes

Yes.

Ken Zaslow - BMO Capital Markets

And I don’t think last time you mentioned on the call but this time you did is sort of more weak economic conditions around the world, rather than just in the U.S. Are you starting to feel a greater impact from the consumer outside the U.S.?

Brenda C. Barnes

I think probably the country that we feel it quite a bit is in Spain and Spain for us is a very large country, if you add up all of our businesses -- we have a good business in Spain. The economy there has taken quite a turn. You know, for a year or two years ago, it was growing very rapidly, huge immigration flow, jobs, all that. And if you read the trends in Spain, it’s made quite a shift. So that’s probably the biggest worry right now.

Ken Zaslow - BMO Capital Markets

Great. I appreciate it. Thank you.

Operator

Thank you. Our next question comes from Tim Ramey with D.A. Davidson. Please go ahead.

Tim Ramey - D.A. Davidson

Good morning. Theo, I wonder if you would comment on some of your hedging positions for currency, coffee, meat, in particular maybe wheat.

Theo de Kool

Well, on currency, we don’t hedge our earnings but when we enter into a contract in foreign currency, so we make a fixed commitment. We hedge the currency as well. And we don’t comment exactly on what our position is but it is safe to say I think that on wheat, we are perhaps more further ahead than on meat, definitely. And on energy, we are entering specifically in North America into hedges. A lot of them don’t qualify for hedge accounting and they therefore cause some fluctuations, like we just discussed in the beverage business in this quarter, we were hit by negative mark-to-market accounting losses. So that it will give some more fluctuations but we feel that we have to cover at least for the time period between the purchase and the moment that we can pass it on to the customer and that is by and large three to six months, depending upon the segment and which place you are.

Tim Ramey - D.A. Davidson

So there were mark-to-market losses in coffee in international beverage?

Theo de Kool

Yes, there were. We have not given the details by the segments. In other segments, there were some gains -- net net, there was a positive but in coffee, it was definitely a negative this quarter.

Tim Ramey - D.A. Davidson

Got it. And was there a conscious pricing strategy there? It appeared that you were not keeping up with the change in the input cost and now the input costs have come back down. Can you kind of talk through that a little? Yes, international coffee, yeah.

Theo de Kool

The quarter had a small disadvantage of about $5 million I think that costs increased further than we were able to price it in and that’s pure timing. We expect in the next quarter to catch up with things, all things being equal.

Tim Ramey - D.A. Davidson

Got it. Okay, and do you have any views on the shape -- I know you are not going to give earnings guidance for ’09 today but the shape of cash flow for next year -- without the big repatriation benefits, we should expect some pretty substantial increases. Do you have any comment there, Theo?

Theo de Kool

I can confirm what you said and not much more.

Tim Ramey - D.A. Davidson

Okay. Thanks so much.

Aaron Hoffman

I would just -- you know, quickly, the point you are making is that there is $400 million of cash taxes on a one-time repatriation opportunity and there is about $130 million, $150 million of cash taxes on restructuring which should continue to work its way -- it should be much smaller [inaudible] less restructuring in the current year, so I think the point you are making is that one would sort of intuit that there is going to be a -- above on cash flow in the next year, although we haven’t given specific guidance on that.

Tim Ramey - D.A. Davidson

Thanks so much.

Operator

(Operator Instructions) Our next question comes from Todd Divek with Banc of America Securities. Please go ahead.

Todd Divek - Banc of America

Good morning. I wanted to ask if, Theo, if you could comment on what you are thinking about your $300 million note that is maturing next month. You’ve got plenty of liquidity under your credit facility and I think you had indicated previously you plan to refinance that. Are you thinking about tapping the debt capital markets or probably taking that out with your credit facility in the near-term?

Theo de Kool

We will plan to replace that with commercial paper short-term and we will consider terming it out in ’09 depending upon the market circumstances. We will not draw on our unused facility because we keep that kind of more for a contingency reason in case we need it.

Todd Divek - Banc of America

Okay, and just to clarify, when you say you will consider terming it out in ’09, are you talking your fiscal ’09?

Theo de Kool

I am talking fiscal ’09, yes.

Todd Divek - Banc of America

Okay, and also on the -- in the retail bakery segment, posted your best quarter in quite some time. Was any of that a result of -- or can you quantify how much of that was because of commodity contracts?

Theo de Kool

No, I cannot quantify it but as I said before, there was a gain from the termination of a commodity contract and some positive mark-to-market on wheat, so from that perspective, it is somewhat inflated and could reverse in the later quarter.

Todd Divek - Banc of America

Okay, and I guess in retail bakery, I mean, it’s been a long haul turning that business around, and I would expect that you would be closer to status quo or a stabilization in that business today than you were a year ago and two years ago. Can you kind of frame it for us in terms of when do you think you will be what you would consider normalized operating margins in that business?

Brenda C. Barnes

There is no way we are at status quo at all. If you look over the past three years into the next three years, there’s a -- each year is a fairly substantial increase in the profitability and margin structure of that business. So we still have a lot to do. We’ve made a lot of progress but we are not at where we want to be.

Todd Divek - Banc of America

Okay, and then just finally within retail bakery again, can you comment on your acquisition appetite, if you are open to acquisitions opportunistically in that segment or other segments?

Brenda C. Barnes

We haven’t made specific statements about what we would want to acquire but we did say that we are open to looking at some acquisition activity that sits within our core businesses in total.

Todd Divek - Banc of America

Okay, very good. Thank you.

Operator

Thank you. Our next question comes from Pablo Zuanic with J.P. Morgan. Please go ahead.

Pablo Zuanic - J.P. Morgan

Good morning, everyone. Just on MAP spending, I mean, you’ve given us a lot of color in terms of what’s been the change year-on-year, but can you comment in terms of where MAP is in total as a percentage of sales, on whether when you look into ’09, that ratio has to increase or it is already now at the level that you think it can be stabilized?

Brenda C. Barnes

I think the ratio will be dependent on what the commodity inflation effect has on the top line, so it’s -- if pricing keeps going up, the ratio may in fact drop from a percentage basis.

We have committed over time to continually increasing the MAP investment each year to each year as part of our whole transformation plan and we do plan to do that.

Pablo Zuanic - J.P. Morgan

Again, in terms of margin expansion, obviously -- I know you are not going to give guidance for ’09 but I’m just trying to think of what’s a reasonable run-rate here as we look forward. You know, it was up 10 basis points last year. This year you are giving guidance for 30 to 60, although it is down 40 basis points for the first nine months. How should we think about that? I mean, to some extent there was a comp issue with MAP spending in ’08 I understand, but as you look into ’09, 2010, what is reasonable -- 30, 40 basis points for the year? How should we think about that, Brenda?

Brenda C. Barnes

Well, what we’ve said is expect a steady improvement in the margin structure of our company over the next three years. We haven’t pinned it down to an exact number and we look forward to giving you guidance when we get together in September I think for ’09.

Aaron Hoffman

-- when we give you the full year results for this current fiscal year, we will give you guidance for ’09 at that point.

Pablo Zuanic - J.P. Morgan

Okay, and just -- thanks, Aaron and just a couple of follow-ups; corporate expenses, I calculate [ex items], I believe they were down about 20%. I’m just trying to think again there as a percentage of sales, what should be the run-rate there -- it’s 1.9%, 2% of sales? How should we think about that?

Theo de Kool

I think the current quarter is somewhat positive but that’s in itself a good run-rate by quarter, and again I did not calculate it as a percentage of sales because sales is fluctuating. It’s not so much a function of sales as more of we managed the corporate costs to a constant level of down, so the trend is in the right direction. We have several measures there but it there is also some normal [inaudible] income there that fluctuates as amortization of intangibles. But if anything, the trend is down or at best, stable.

So as a percentage of sales, it will decline.

Pablo Zuanic - J.P. Morgan

Thanks, and just a couple of follow-ups at the divisional level; Brenda, can you comment a bit more on the bread business? I know it’s a small percentage of earnings but it’s I guess strategically relevant. What are you seeing -- at the local level, based on the Nielsen data, I see mixed results, share loss in Chicago, share gains in the West Coast -- you know, as companies try to increase prices, I find that some are succeeding more than others, with more or less [inaudible] volumes. And then I suppose in some markets where [ABC] is exiting, various companies may be gaining share but just give us a bit of a sense of where you are in terms of share gains and regional momentum and pricing power relative to your competitors.

Brenda C. Barnes

You are raising a good point, Pablo, because this category clearly is a regional business. You can’t -- you have to look at it region by region for a number of reasons. You’ve got very different competitive dynamics. You have very different share positions and density of drops, so we’ve talked in the past how part of our challenge is to make sure we can move what I’ll call the tail end of the markets in terms of share, profitability, more to what some of our really great markets are. So our pricing strategy, our disciplines, what we do in each market varies.

Some markets we have great pricing power, some we have to be competitive with the local player. So across the board, you’ll see differences by market and that’s the appropriate thing to do as we are going to market.

And you are right, Southern California is a great example of somewhere where we’ve had terrific market share gains.

Pablo Zuanic - J.P. Morgan

Thank you and just one last one, going back to coffee in Europe, I know you touched on it before but in terms of the growth there, I’m trying to understand, is it a market share gain in Western Europe or is it more about keeping -- I mean, what are the regions where you have opportunities for share gains and where maybe you already have topped out, or is it more about focusing on emerging markets? And at the product level, is there more room to grow in terms of packaging sizes or in Senseo or in new brands, new flavors -- just more color in terms of what is going to [drive the results in] coffee would help internationally.

Brenda C. Barnes

I’ll start with Senseo -- we have an over 20% growth rate year-to-date on Senseo after seven, eight years of being in market. How does that happen? It’s happened by one, coming out with new varieties of it, flavors, you know, new ingredients, new dark, deep, rich roast coffee as one of our kind of most recent entries. That’s one source of it. The other is expanding into markets where we weren’t in over the last couple of years, so that brings a -- and three, setting the price at the appropriate level relative to what the marketplace is doing.

So early on, we had the market to ourselves totally and as it became under competitive attack, we adjusted our pricing and as a result, increased our market share. So that to me is a great example of an innovation being priced right with product innovations to keep the momentum going on that brand, so that is one piece.

The other sources of growth are in places like Brazil and Russia. Brazil is one approach on roasting grounds. Clearly a roasting ground market but it is going to more premium preferences. And we’ve gotten the pricing at the right levels that we can in fact improve our profitability there.

In Russia, it’s an instant market. We have a premium product that we’ve been testing in St. Petersburg. We have the opportunity to roll that out in the rest of Russia and get a significant increase in a market that’s growing and growing quite well.

Europe also we tend to overlook the food service segment quite often. It’s a very good large piece of business where we have a proprietary system. If you look at our liquid coffee with the equipment that goes with it and a service network that does quite well with it.

So that’s -- you know, we continue to see both category and market growth opportunities.

Pablo Zuanic - J.P. Morgan

That’s very useful [inaudible] on the subject of coffee, one just last follow-up; in the case of Folgers, if another large company, global coffee company were to buy Folgers in the U.S., would that put you at a disadvantage on a global basis because their scale would be much larger, relative to where you are right now, or we shouldn’t think about it in those terms?

Brenda C. Barnes

Yeah, probably you’d have to look at -- I would encourage you if you are looking at it to look at sources of scale. Where does the scale come from? You know, we have a point of view for Sara Lee that our scale comes from density within markets and that’s where we think the big opportunity is -- it’s scale in going to market, it’s scale in local manufacturing, it’s scale on the sales force, it’s scale in local marketing activity. And I would distinctly ask the question do you get scale in adding things in markets where you don’t currently exist -- I’m not sure.

Pablo Zuanic - J.P. Morgan

Thank you.

Operator

Thank you. Our next question comes from Tim Ramey with D.A. Davidson. Please go ahead.

Tim Ramey - D.A. Davidson

Just to follow-up on Aaron’s comment, thanks again for the lack of -- or the reduction in complexity but one request, or suggestion; maybe with this increase complexity of mark-to-market hedging, it would be good to at least get a bottom line number on that adding all your hedge positions together, because that is becoming a source of volatility in the numbers that isn’t easily transparent. So any thoughts on that would be appreciated.

Aaron Hoffman

That’s actually a conversation we’ve already been having internally and we are looking at what the right way to handle that would be if there is a way that works so that we aren’t giving away some competitive dynamic and can do something that is more constructive for the street, so I appreciate the thought and just know we are already working on it, to find a way if possible.

Tim Ramey - D.A. Davidson

Thanks.

Operator

Thank you. I show no further questions at this time.

Aaron Hoffman

Terrific. As always, we appreciate everyone’s time, interest, and for our shareholders, your ongoing commitment to the company. If we can be of any help, as always, feel free to give us a call. Thank you very much.

Operator

Thank you. That does conclude today’s conference. You may disconnect at this time.

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