UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

 

 

Commission File No. 1-7275

 

 

CONAGRA FOODS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Registrant’s telephone number, including area code (402) 240-4000

 

 

Securities registered pursuant to section 12(b) of the Act:

 

 

Securities registered pursuant to section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ  No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o  No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ  No o

 

Indicate by check mark whether the registrant submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ  No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

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

 

     Large accelerated filer þ                                                 Accelerated filer o

 

     Non-accelerated filer o (Do not check if a smaller reporting company) Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o  No þ

 

The aggregate market value of the voting common stock of ConAgra Foods, Inc. held by non-affiliates on November 21, 2008 (the last business day of the Registrant’s most recently completed second fiscal quarter) was approximately $6,505,175,563 based upon the closing sale price on the New York Stock Exchange on such date.

 

At June 28, 2009, 442,092,759 common shares were outstanding.

 

Documents incorporated by reference are listed on page 1.

 

Documents Incorporated by Reference

 

Portions of the Registrant’s definitive Proxy Statement for the Registrant’s 2009 Annual Meeting of Stockholders (the “2009 Proxy Statement”) are incorporated into Part III.

 

 

TABLE OF CONTENTS

 

 

 

ConAgra Foods, Inc. (“ConAgra Foods”, “Company”, “we”, “us”, or “our”) is one of North America’s leading food companies, with brands in 97% of America’s households. ConAgra Foods also has a strong business-to-business presence, supplying potato, other vegetable, spice, and grain products to a variety of well-known restaurants, foodservice operators, and commercial customers.

 

ConAgra Foods is focused on expanding profit margins and improving returns on capital over time. To that end, we have significantly changed our portfolio of businesses over a number of years, focusing on branded, value-added opportunities, while divesting commodity-based and lower-margin businesses. Executing this strategy has involved the acquisition over time of a number of brands such as Banquet^®, Chef Boyardee^®, PAM^®, and Alexia^®, and more recently, has focused on product innovations such as Healthy Choice^® Café Steamers^tm, Healthy Choice^® Fresh Mixers^tm, Healthy Choice^® All Natural Entrées, Marie Callender’s^® Pasta Al Dente, Alexia^® Natural Crunchy Snacks, and others. More notable divestitures have included a trading and merchandising business, packaged meat operations, a poultry business, beef and pork businesses, and various other businesses. For more information about our more recent acquisitions and divestitures, see “Acquisitions” and “Divestitures” below.

 

As part of this strategy, we have also prioritized improving our overall operational effectiveness, focusing on better innovation and marketing programs, reducing manufacturing and selling, general and administrative costs, and enhancing our business processes, which are intended to drive profitable sales growth, expand profit margins, and improve returns on capital.

 

Currently we are focusing our efforts in the following areas, with our initiatives aligned with five strategic priorities: convenient meals, potatoes, snacks, meal enhancers, and specialty businesses:

 

 

We were initially incorporated as a Nebraska corporation in 1919 and were reincorporated as a Delaware corporation in December 1975.

 

 

We report our operations in two reporting segments:  Consumer Foods and Commercial Foods. The contributions of each reporting segment to net sales, profit contribution margin, operating profit, and the identifiable assets are set forth in Note 22 “Business Segments and Related Information” to the consolidated financial statements.

 

 

We compete throughout the food industry and focus on adding value for customers who operate in the retail food, foodservice, and ingredients channels.

 

Our operations, including our reporting segments, are described below. Our locations, including distribution facilities, within each reporting segment, are described in Item 2.

Consumer Foods

 

The Consumer Foods reporting segment includes branded and private label food products which are sold in various retail and foodservice channels, principally in North America. The products include a variety of categories (meals, entrées, condiments, sides, snacks, and desserts) across frozen, refrigerated, and shelf-stable temperature classes. The segment is comprised of and managed through five subsegments as described below:

 

Grocery Foods North America—includes branded and private label refrigerated or shelf-stable food products that are sold in various retail and foodservice channels primarily across the United States. Major brands include: Angela Mia^®, Chef Boyardee^®, Egg Beaters^®, Healthy Choice^® Fresh Mixers^tm, Hebrew National^®, Hunt’s^®, Manwich^®, PAM^®, Peter Pan^®, Snack Pack^®, Reddi-wip^®, Rosarita^®, Ro*Tel^®, Swiss Miss^®, and Van Camp’s ^®. The segment also includes the consumer foods businesses in Mexico and Canada, which distribute packaged foods that are both locally manufactured and imported from the United States.

 

Frozen Foods—includes branded and private label frozen food products that are sold in various retail and foodservice channels across the United States. Major brands include: Alexia^®, Banquet^®, Healthy Choice^®, Kid Cuisine^®, and Marie Callender’s^®.

 

Snacks and Store Brands—includes branded popcorn, meats, seeds, and specialty snacks, as well as private label food products that are sold in various retail and foodservice channels across the United States. Major brands include: ACT II^®, DAVID^®, Orville Redenbacher’s^®, and Slim Jim^®.

 

Enabler Brands—includes national and regional branded food products across shelf-stable, refrigerated, and frozen temperature classes. Products are sold in various retail and foodservice channels across the United States. Major brands include: Blue Bonnet^®, La Choy^®, Libby’s^®, The Max^®, Parkay^®, and Wesson^®.

 

Domestic Export—includes branded shelf-stable food products sold through distributors in various markets throughout the world.

 

The Consumer Foods’ supply chain and order-to-cash functions are centrally managed and largely integrated. Accordingly, we do not maintain balance sheets at the subsegment level. Selling, general and administrative expenses, other than advertising and promotion, are managed at the Consumer Foods reporting segment level, and as such, we do not separately allocate selling, general and administrative expenses other than advertising and promotion expenses to the Consumer Foods subsegments.

 

Commercial Foods

 

The Commercial Foods reporting segment includes commercially branded foods and ingredients, which are sold principally to foodservice, food manufacturing, and industrial customers. The segment’s primary products include: specialty potato products, milled grain ingredients, a variety of vegetable products, seasonings, blends, and flavors which are sold under brands such as ConAgra Mills^®, Lamb Weston^®, Gilroy Foods & Flavors^tm, and Spicetec^®.

 

Unconsolidated Equity Investments

 

We have a number of unconsolidated equity investments. Significant affiliates produce and market potato products for retail and foodservice customers.

 

Acquisitions

 

During the first quarter of fiscal 2009, we acquired Saroni Sugar & Rice, Inc., a distribution company included in the Commercial Foods segment.

 

During the second quarter of fiscal 2009, we acquired a 49.99% interest in Lamb Weston BSW, LLC (“Lamb Weston BSW” or the “venture”), a potato processing joint venture with Ochoa Ag Unlimited Foods, Inc. (“Ochoa”). This venture is considered a variable interest entity for which we are the primary beneficiary and is consolidated in our financial statements. This business is included in the Commercial Foods segment.

 

During the first quarter of fiscal 2008, we acquired Alexia Foods, Inc. (“Alexia Foods”) a privately held natural food company, headquartered in Long Island City, New York. Alexia Foods offers premium natural and organic food items including potato products, appetizers, and artisan breads.

During the second quarter of fiscal 2008, we acquired Lincoln Snacks Holding Company, Inc. (“Lincoln Snacks”), a privately held company located in Lincoln, Nebraska. Lincoln Snacks offers a variety of snack food brands and private label products.

 

Also during the second quarter of fiscal 2008, we acquired the manufacturing assets of Twin City Foods, Inc. (“Twin City Foods”), a potato processing business.

 

During the fourth quarter of fiscal 2008, we acquired Watts Brothers, a privately held group which owns and operates agricultural and farming businesses.

 

Divestitures

 

In June 2009, subsequent to our fiscal 2009 year end, we completed the divestiture of the Fernando’s^® foodservice brand for proceeds of $6 million. We reflected the results of these operations as discontinued operations for all periods presented. The assets and liabilities of the divested Fernando’s^® business have been reclassified as assets and liabilities held for sale within our consolidated balance sheets for all periods presented.

 

In July 2008, we completed the sale of our Pemmican^® beef jerky business for proceeds of approximately $29 million. Due to our continuing involvement with the business through providing sales and distribution support to the buyer for a period of up to five years, the results of operations of the Pemmican^® business have not been reclassified as discontinued operations.

 

In June 2008, we completed the sale of our trading and merchandising operations (previously principally reported as the Trading and Merchandising segment). We reflected the results of these operations as discontinued operations for all periods presented. The assets and liabilities of the divested trading and merchandising operations are classified as assets and liabilities held for sale within our consolidated balance sheets for all periods prior to divestiture.

 

During the fourth quarter of fiscal 2008, we completed our divestiture of the Knott’s Berry Farm^® (“Knott’s”) operations. We reflected the results of these operations as discontinued operations for all periods presented. The assets and liabilities of the divested Knott’s business are classified as assets and liabilities held for sale within our consolidated balance sheets for all periods prior to divestiture.

 

We finalized the dispositions of our packaged meats and cheese operations during the first half of fiscal 2007. We reflect the results of these businesses as discontinued operations for all periods presented.

 

We disposed of a refrigerated pizza business with annual revenues of less than $70 million during the second quarter of fiscal 2007. Due to our expected significant continuing cash flows associated with this business, we continue to include the results of operations of this business in continuing operations.

 

During the first quarter of fiscal 2007, we completed the divestiture of our nutritional supplement business. We reflected the gain within discontinued operations.

 

General

 

The following comments pertain to both of our reporting segments.

 

ConAgra Foods is a food company that operates in many sectors of the food industry, with a significant focus on the sale of branded, private label, and value-added consumer products. We use many different raw materials, the bulk of which are commodities. The prices paid for raw materials used in our products generally reflect factors such as weather, commodity market fluctuations, currency fluctuations, tariffs, and the effects of governmental agricultural programs. Although the prices of raw materials can be expected to fluctuate as a result of these factors, we believe such raw materials to be in adequate supply and generally available from numerous sources. We have faced increased costs for many of our significant raw materials, packaging, and energy inputs. We seek to mitigate the higher input costs through productivity and pricing initiatives, and through the use of derivative instruments used to economically hedge a portion of forecasted future consumption.

 

We experience intense competition for sales of our principal products in our major markets. Our products compete with widely advertised, well-known, branded products, as well as private label and customized products. Some of our competitors are larger and have greater resources than we have. We have major competitors in each of our reporting segments. We compete primarily on the basis of quality, value, customer service, brand recognition, and brand loyalty.

We employ processes at our principal manufacturing locations that emphasize applied research and technical services directed at product improvement and quality control. In addition, we conduct research activities related to the development of new products. Research and development expense was $81 million, $69 million, and $68 million in fiscal 2009, 2008, and 2007, respectively.

 

Demand for certain of our products may be influenced by holidays, changes in seasons, or other annual events.

 

We manufacture primarily for stock and fill customer orders from finished goods inventories. While at any given time there may be some backlog of orders, such backlog is not material in respect to annual net sales, and the changes from time to time are not significant.

 

Our trademarks are of material importance to our business and are protected by registration or other means in the United States and most other markets where the related products are sold. Some of our products are sold under brands that have been licensed from others. We also actively develop and maintain a portfolio of patents, although no single patent is considered material to the business as a whole. We have proprietary trade secrets, technology, know-how, processes, and other intellectual property rights that are not registered.

 

Many of our facilities and products are subject to various laws and regulations administered by the United States Department of Agriculture, the Federal Food and Drug Administration, the Occupational Safety and Health Administration, and other federal, state, local, and foreign governmental agencies relating to the quality and safety of products, sanitation, safety and health matters, and environmental control. We believe that we comply with such laws and regulations in all material respects, and that continued compliance with such regulations will not have a material effect upon capital expenditures, earnings, or our competitive position.

 

Our largest customer, Wal-Mart Stores, Inc. and its affiliates, accounted for approximately 16%, 15%, and 16% of consolidated net sales for fiscal 2009, 2008, and 2007, respectively. This reflects all Consumer Foods businesses, including those which are classified as discontinued operations.

 

At May 31, 2009, ConAgra Foods and its subsidiaries had approximately 25,600 employees, primarily in the United States. Approximately 53% of our employees are parties to collective bargaining agreements. Of the employees subject to collective bargaining agreements, approximately 37% are parties to collective bargaining agreements that are scheduled to expire during fiscal 2010. We believe that our relationships with employees and their representative organizations are good.

 

 

Foreign operations information is set forth in Note 22 “Business Segments and Related Information” to the consolidated financial statements.

 

 

We make available, free of charge through the “Company Information-Investor Information” link on our Internet web site at http://www.conagrafoods.com, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission. We use our Internet website, through the “Company Information-Investor Information” link, as a channel for routine distribution of important information, including news releases, analyst presentations, and financial information. We submitted the annual Chief Executive Officer certification to the NYSE for our 2008 fiscal year as required by Section 303A.12(a) of the NYSE Corporate Governance rules.

 

We have also posted on our website our (1) Corporate Governance Principles, (2) Code of Conduct, (3) Code of Ethics for Senior Corporate Officers, and (4) Charters for the Audit Committee, Nominating and Governance Committee, and Human Resources Committee. Shareholders may also obtain copies of these items at no charge by writing to: Corporate Secretary, ConAgra Foods, Inc., One ConAgra Drive, Omaha, NE, 68102-5001.

 

 

The following factors could affect our operating results and should be considered in evaluating us.

 

Deterioration of general economic conditions could harm our business and results of operations.

 

Our business and results of operations may be adversely affected by changes in national or global economic conditions, including inflation, interest rates, availability of capital markets, consumer spending rates, energy availability and costs (including fuel surcharges), and the effects of governmental initiatives to manage economic conditions.

 

The continued volatility in financial markets and the deterioration of national and global economic conditions could impact our business and operations in a variety of ways, including as follows:

 

 

Increases in commodity costs may have a negative impact on profits.

 

We use many different commodities such as wheat, corn, oats, soybeans, beef, pork, poultry, and energy. Commodities are subject to price volatility caused by commodity market fluctuations, supply and demand, currency fluctuations, and changes in governmental agricultural programs. Commodity price increases will result in increases in raw material costs and operating costs. We may not be able to increase our product prices and achieve cost savings that fully offset these increased costs; and increasing prices may result in reduced sales volume and profitability. We have experience in hedging against commodity price increases; however, these practices and experience reduce but do not eliminate the risk of negative profit impacts from commodity price increases.

 

Increased competition may result in reduced sales or profits.

 

The food industry is highly competitive, and increased competition can reduce our sales due to loss of market share or the need to reduce prices to respond to competitive and customer pressures. Competitive pressures also may restrict our ability to increase prices, including in response to commodity and other cost increases. Our profits could decrease if a reduction in prices or increased costs are not counterbalanced with increased sales volume.

 

The sophistication and buying power of our customers could have a negative impact on profits.

 

Many of our customers, such as supermarkets, warehouse clubs, and food distributors, have consolidated in recent years and consolidation is expected to continue. These consolidations and the growth of supercenters have produced large, sophisticated customers with increased buying power and negotiating strength who are more capable of resisting price increases and operating with reduced inventories. These customers may also in the future use more of their shelf space, currently used for our products, for their private label products. We continue to implement initiatives to counteract these pressures. However, if the larger size of these customers results in additional negotiating strength and/or increased private label competition, our profitability could decline.

We must identify changing consumer preferences and develop and offer food products to meet their preferences.

 

Consumer preferences evolve over time and the success of our food products depends on our ability to identify the tastes and dietary habits of consumers and to offer products that appeal to their preferences. Introduction of new products and product extensions requires significant development and marketing investment. If our products fail to meet consumer preference, then the return on that investment will be less than anticipated and our strategy to grow sales and profits with investments in marketing and innovation will be less successful.

 

If we do not achieve the appropriate cost structure in the highly competitive food industry, our profitability could decrease.

 

Our success depends in part on our ability to achieve the appropriate cost structure and operate efficiently in the highly competitive food industry, particularly in an environment of volatile input costs. We continue to implement profit-enhancing initiatives that impact our supply chain and general and administrative functions. These initiatives are focused on cost-saving opportunities in procurement, manufacturing, logistics, and customer service, as well as general and administrative overhead levels. If we do not continue to effectively manage costs and achieve additional efficiencies, our competitiveness and our profitability could decrease.

 

We may be subject to product liability claims and product recalls, which could negatively impact our profitability.

 

We sell food products for human consumption, which involves risks such as product contamination or spoilage, product tampering, and other adulteration of food products. We may be subject to liability if the consumption of any of our products causes injury, illness, or death. In addition, we will voluntarily recall products in the event of contamination or damage. In the past, we have issued recalls and have from time to time been and currently are involved in lawsuits relating to our food products. A significant product liability judgment or a widespread product recall may negatively impact our sales and profitability for a period of time depending on product availability, competitive reaction, and consumer attitudes. Even if a product liability claim is unsuccessful or is not fully pursued, the negative publicity surrounding any assertion that our products caused illness or injury could adversely affect our reputation with existing and potential customers and our corporate and brand image.

 

If we fail to comply with the many laws applicable to our business, we may face lawsuits or incur significant fines and penalties.

 

Our facilities and products are subject to many laws and regulations administered by the United States Department of Agriculture, the Federal Food and Drug Administration, the Occupational Safety and Health Administration, and other federal, state, local, and foreign governmental agencies relating to the processing, packaging, storage, distribution, advertising, labeling, quality, and safety of food products and health and safety of our employees. Our failure to comply with applicable laws and regulations could subject us to lawsuits, administrative penalties and injunctive relief, civil remedies, including fines, injunctions, and recalls of our products. Our operations are also subject to extensive and increasingly stringent regulations administered by the Environmental Protection Agency, which pertain to the discharge of materials into the environment and the handling and disposition of wastes. Failure to comply with these regulations can have serious consequences, including civil and administrative penalties and negative publicity.

 

Our information technology resources must provide efficient connections between our business functions, or our results of operations will be negatively impacted.

 

Each year we engage in billions of dollars of transactions with our customers and vendors. Because the amount of dollars involved is so significant, our information technology resources must provide connections among our marketing, sales, manufacturing, logistics, customer service, and accounting functions. If we do not allocate and effectively manage the resources necessary to build and sustain the proper technology infrastructure and to maintain the related automated and manual control processes, we could be subject to billing and collection errors, business disruptions, or damage resulting from security breaches. We are currently implementing new financial and operational information technology systems. Some systems were placed into production during fiscal 2008 and

2009. Additional changes and enhancements will be placed into production at various times in fiscal 2010. If future implementation problems are encountered, our results of operations could be negatively impacted.

 

 

None.

 

 

Our headquarters are located in Omaha, Nebraska. In addition, certain shared service centers are located in Omaha, Nebraska, including a product development facility, supply chain center, business services center, and an information technology center. The general offices and location of principal operations are set forth in the following summary of our locations.

 

We maintain a number of stand-alone distribution facilities. In addition, there is warehouse space available at substantially all of our manufacturing facilities.

 

Utilization of manufacturing capacity varies by manufacturing plant based upon the type of products assigned and the level of demand for those products. Management believes that our manufacturing and processing plants are well maintained and are generally adequate to support the current operations of the business.

 

We own most of the manufacturing facilities. However, a limited number of plants and parcels of land with the related manufacturing equipment are leased. Substantially all of our transportation equipment and forward-positioned distribution centers and most of the storage facilities containing finished goods are leased or operated by third parties. Information about the properties supporting our two business segments follows.

 

CONSUMER FOODS REPORTING SEGMENT

 

General offices in Omaha, Nebraska, Edina, Minnesota, Naperville, Illinois, Miami, Florida, Toronto, Canada, Mexico City, Mexico, San Juan, Puerto Rico, Shanghai, China, Panama City, Panama, and Bogota, Columbia.

 

Thirty-eight domestic manufacturing facilities in Arkansas, California, Georgia, Illinois, Indiana, Iowa, Massachusetts, Michigan, Minnesota, Missouri, Nebraska, North Carolina, Ohio, Oregon, Pennsylvania, Tennessee, Texas, and Wisconsin. Four international manufacturing facilities in Canada and Mexico (one 50% owned) and one in Arroyo Dulce, Argentina.

 

COMMERCIAL FOODS REPORTING SEGMENT

 

Domestic general, marketing, and administrative offices in Omaha, Nebraska, Eagle, Idaho, and Tri-Cities, Washington. International general and merchandising offices in Beijing, China, Shanghai, China, Tokyo, Japan, and Singapore.

 

Fifty-two domestic production facilities in Alabama, California, Colorado, Florida, Georgia, Idaho, Illinois, Minnesota, Nebraska, New Jersey, New Mexico, Nevada, Ohio, Oregon, Pennsylvania, Texas, Utah, and Washington; one international production facility in Guaynabo, Puerto Rico and Qingdao, China; one manufacturing facility in Taber, Canada; one 50% owned manufacturing facility in Colorado, Minnesota, Washington, and the United Kingdom; and three 50% owned manufacturing facilities in the Netherlands.

 

 

In fiscal 1991, we acquired Beatrice Company (“Beatrice”). As a result of the acquisition and the significant pre-acquisition contingencies of the Beatrice businesses and its former subsidiaries, our consolidated post-acquisition financial statements reflect liabilities associated with the estimated resolution of these contingencies. These include various litigation and environmental proceedings related to businesses divested by Beatrice prior to its acquisition by the Company. The litigation includes several public nuisance and personal injury suits against a number of lead paint and pigment manufacturers, including ConAgra Grocery Products and the Company as alleged successors to W. P. Fuller Co., a lead paint and pigment manufacturer owned and operated by Beatrice until 1967. Although decisions favorable to us have been rendered in Rhode Island, New Jersey, Wisconsin, and Ohio, we

remain a defendant in active suits in Illinois and California. The Illinois suit seeks class-wide relief in the form of medical monitoring for elevated levels of lead in blood. In California, a number of cities and counties have joined in a consolidated action seeking abatement of the alleged public nuisance.

 

The environmental proceedings include litigation and administrative proceedings involving Beatrice’s status as a potentially responsible party at 35 Superfund, proposed Superfund, or state-equivalent sites; these sites involve locations previously owned or operated by predecessors of Beatrice that used or produced petroleum, pesticides, fertilizers, dyes, inks, solvents, PCBs, acids, lead, sulfur, tannery wastes, and/or other contaminants. Beatrice has paid or is in the process of paying its liability share at 33 of these sites. Reserves for these matters have been established based on our best estimate of the undiscounted remediation liabilities, which estimates include evaluation of investigatory studies, extent of required cleanup, the known volumetric contribution of Beatrice and other potentially responsible parties, and its experience in remediating sites. The reserves for Beatrice environmental matters totaled $88.8 million as of May 31, 2009, a majority of which relates to the Superfund and state-equivalent sites referenced above. Expenditures for Beatrice environmental matters are expected to continue for a period of up to 20 years.

 

We are a party to a number of lawsuits and claims arising out of the operation of our business, including lawsuits and claims related to the February 2007 recall of our peanut butter products and litigation we initiated against an insurance carrier to recover our settlement expenditures and defense costs. We recognized a charge of $25.3 million during the second half of fiscal 2009 in connection with the disputed coverage with this insurance carrier.

 

An investigation by the Division of Enforcement of the U.S. Commodity Futures Trading Commission (“CFTC”) of certain commodity futures transactions of a former Company subsidiary, has led to an investigation by the CFTC of the Company itself. The investigation may result in litigation by the CFTC against the Company. The former subsidiary was sold on June 23, 2008, as part of the divestiture of our trading and merchandising operations. The CFTC’s Division of Enforcement has advised the Company that it questions whether certain trading activities of the former subsidiary violated the Commodity Exchange Act (the “CEA”) and that the CFTC has been evaluating whether we should be implicated in the matter based on the existence of the parent-subsidiary relationship between the two entities at the time of the trades. Based on information we have learned to date, the Company believes that both it and the former subsidiary have meritorious defenses. We have submitted a statement to the Division of Enforcement contesting any purported liability. We also believe the sale contract with the buyer of the business provides us indemnification rights. Accordingly, we do not believe any decision by the CFTC to pursue this matter will have a material adverse effect on the Company. If litigation ensues, the Company intends to defend itself vigorously.

 

After taking into account liabilities recognized for all of the foregoing matters, management believes the ultimate resolution of such matters should not have a material adverse effect on our financial condition, results of operations, or liquidity.

 

 

None.

EXECUTIVE OFFICERS OF THE REGISTRANT AS OF JULY 24, 2009

 

 

The foregoing executive officers have held the specified positions with ConAgra Foods for the past five years, except as follows:

 

Gary M. Rodkin joined ConAgra Foods as Chief Executive Officer in October 2005. Prior to joining ConAgra Foods, he was Chairman and Chief Executive Officer of PepsiCo Beverages and Foods North America (a division of PepsiCo, Inc., a global snacks and beverages company) from February 2003 to June 2005. He was named President and Chief Executive Officer of PepsiCo Beverages and Foods North America in 2002. Prior to that, he was President and Chief Executive Officer of Pepsi-Cola North America from 1999 to 2002, and President of Tropicana North America from 1995 to 1998.

 

John F. Gehring has served ConAgra Foods as Executive Vice President, Chief Financial Officer since January 2009. Mr. Gehring joined ConAgra Foods as Vice President of Internal Audit in 2002, became Senior Vice President in 2003, and most recently served as Senior Vice President and Corporate Controller since July 2004. He served as ConAgra Foods’ interim Chief Financial Officer from October 2006 to November 2006. Prior to joining ConAgra Foods, Mr. Gehring was a partner at Ernst & Young LLP (an accounting firm) from 1997 to 2001.

 

Colleen R. Batcheler joined ConAgra Foods in June 2006 as Vice President, Chief Securities Counsel and Assistant Corporate Secretary. In September 2006, she was appointed Corporate Secretary and in February 2008, she was named to her current position, Senior Vice President, General Counsel and Corporate Secretary. From 2003 until joining ConAgra Foods, Ms. Batcheler was Vice President and Corporate Secretary of Albertson’s, Inc. (a retail food and drug chain).

 

André J. Hawaux joined ConAgra Foods in November 2006 as Executive Vice President, Chief Financial Officer. Prior to joining ConAgra Foods, Mr. Hawaux served as Senior Vice President, Worldwide Strategy & Corporate Development, PepsiAmericas, Inc. (a manufacturer and distributor of a broad portfolio of beverage products) from May 2005. Previously, from 2000 until May 2005, Mr. Hawaux served as Vice President and Chief Financial Officer for Pepsi-Cola North America (a division of PepsiCo, Inc.).

 

Patrick D. Linehan has served ConAgra Foods as Senior Vice President, Corporate Controller since January 2009. Mr. Linehan joined ConAgra Foods in August 1999 and held various positions of increasing responsibility, including Director, Financial Reporting, Vice President, Assistant Corporate Controller, and most recently as Vice President, Finance from September 2006 until January 2009. Mr. Linehan briefly left ConAgra Foods to serve as Controller of a financial institution in April 2006 and returned to ConAgra Foods in September 2006. Prior to joining ConAgra Foods, Mr. Linehan was with Deloitte LLP (an accounting firm).

 

Scott E. Messel joined ConAgra Foods in August 2001 as Vice President and Treasurer, and in July 2004 was named to his current position.

 

Peter M. Perez has served ConAgra Foods as Executive Vice President, Human Resources since June 2007. He joined ConAgra Foods as Senior Vice President, Human Resources in December 2003. Prior to joining ConAgra

Foods, he was Senior Vice President, Human Resources of Pepsi Cola General Bottlers from 1995 to 2000, Chief Human Resources Officer for Alliant Foodservice (a wholesale food distributor) in 2001, and Senior Vice President, Human Resources of W.W. Grainger (a supplier of facilities maintenance and other products) from 2001 to 2003.

 

Robert F. Sharpe, Jr. has served ConAgra Foods as Executive Vice President, External Affairs and President, Commercial Foods since June 2008. Previously, he served ConAgra Foods as Executive Vice President, Legal and Regulatory Affairs from November 2005 to December 2005 and Executive Vice President, Legal and External Affairs from December 2005 to May 2008. He also served as Corporate Secretary from May 2006 until September 2006. From 2002 until joining ConAgra Foods, he was a partner at the Brunswick Group LLC (an international financial public relations firm).

 

OTHER SENIOR OFFICERS OF THE REGISTRANT AS OF JULY 24, 2009

 

 

Albert D. Bolles joined ConAgra Foods in March 2006 as Executive Vice President, Research & Development, and Quality. He was named to his current position in June 2007. Prior to joining the Company, he was Senior Vice President, Worldwide Research and Development for PepsiCo Beverages and Foods from 2002 to 2006. From 1993 to 2002, he was Senior Vice President, Global Technology and Quality for Tropicana Products Incorporated.

 

Douglas A. Knudsen joined ConAgra Foods in 1977.  He was named to his current position in May 2006. He previously served the Company as President, Retail Sales Development from 2003 to 2006, President, Retail Sales from 2001 to 2003, and President, Grocery Product Sales from 1995 to 2001.

 

Gregory L. Smith joined ConAgra Foods in August 2001 as Vice President, Manufacturing. He previously served the Company as President, Grocery Foods Group, Executive Vice President, Operations, Grocery Foods Group, and Senior Vice President, Supply Chain. He was named to his current position in December 2007. Prior to joining ConAgra Foods, he served as Vice President, Supply Chain for United Signature Foods from 1999 to 2001 and Vice President for VDK Frozen Foods from 1996 to 1999. Before that, he was with The Quaker Oats Company for eleven years in various operations, supply chain, and marketing positions.

 

Joan K. Chow joined ConAgra Foods in February 2007 as Executive Vice President, Chief Marketing Officer. Prior to joining ConAgra Foods, she served Sears Holding Corporation (retailing) as Senior Vice President and Chief Marketing Officer, Sears Retail from July 2005 until January 2007 and as Vice President, Marketing Services from April 2005 until July 2005. From 2002 until April 2005, Ms. Chow served Sears, Roebuck and Co. as Vice President, Home Services Marketing.

 

Allen J. Cooper joined ConAgra Foods in March 2003 and has held various finance and internal audit leadership positions with the Company, including Director, Internal Audit from 2003 until 2005; Vice President, Finance from 2005 until 2006; Vice President, Supply Chain Finance from 2006 until 2007; Senior Director, Finance; and most recently as Senior Director, Internal Audit. He was named to his current position in February 2009. Prior to joining the Company, he was with Ernst & Young LLP from October 1997.

 

 

Our common stock is listed on the New York Stock Exchange where it trades under the ticker symbol: CAG. At June 28, 2009, there were approximately 25,800 shareholders of record.

 

Quarterly sales price and dividend information is set forth in Note 23 “Quarterly Financial Data (Unaudited)” to the consolidated financial statements and incorporated herein by reference.

 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

The following table presents the total number of shares of common stock purchased during the fourth quarter of fiscal 2009, the average price paid per share, the number of shares that were purchased as part of a publicly announced repurchase program, and the approximate dollar value of the maximum number of shares that may yet be purchased under the share repurchase program:

 

 

 

 

We initiated an accelerated share repurchase program during the first quarter of fiscal 2009. We paid $900 million and received 38.4 million shares under this program during the first quarter. We received an additional 5.6 million shares during the fourth quarter at no additional cost to us.

ITEM 6.    SELECTED FINANCIAL DATA

 

 

 

 

The following discussion and analysis is intended to provide a summary of significant factors relevant to our financial performance and condition. The discussion should be read together with our consolidated financial statements and related notes in Item 8, Financial Statements and Supplementary Data. Results for the fiscal year ended May 31, 2009 are not necessarily indicative of results that may be attained in the future.

 

Executive Overview

 

ConAgra Foods, Inc. (NYSE: CAG) is one of North America’s leading food companies, with brands in 97 percent of America’s households. Consumers find Banquet^®, Chef Boyardee^®, Egg Beaters^®, Healthy Choice^®, Hebrew National^®, Hunt’s^®, Marie Callender’s^®, Orville Redenbacher’s^®, PAM^®, Peter Pan^®, Reddi-wip^®, and many other ConAgra Foods brands in grocery, convenience, mass merchandise, and club stores. ConAgra Foods also has a strong business-to-business presence, supplying potato, other vegetable, spice, and grain products to a variety of well-known restaurants, foodservice operators, and commercial customers.

 

Fiscal 2009 diluted earnings per share were $2.15, including $1.42 per diluted share of income from continuing operations and income of $0.73 per diluted share from discontinued operations. Fiscal 2008 diluted earnings per share were $1.90, including income from continuing operations of $1.06 per diluted share and income from discontinued operations of $0.84 per diluted share. Several items affect the comparability of results of continuing operations, as discussed below.

 

Items Impacting Comparability

 

Items of note impacting comparability for fiscal 2009 included the following:

 

Reported within Continuing Operations

 

 

In addition, fiscal 2009 income per share benefited by approximately $.03 as a result of the fiscal year including 53 weeks.

 

Items of note impacting comparability for fiscal 2008 included the following:

 

Reported within Continuing Operations

 

 

Operating Initiatives

 

We continue to execute against our operational improvement initiatives that are intended to generate profitable sales growth, improve profit margins, and expand returns on capital over time.

Recent developments in our strategies and action plans include:

 

 

 

References to the restructuring plans refer to both the 2006-2008 restructuring plan and the 2008-2009 restructuring plan, unless otherwise noted.

 

 

 

We also made strategic investments in fiscal 2008 and 2009 in order to enhance our portfolio. In fiscal 2009, we entered into a potato processing venture, Lamb Weston BSW, with an initial investment of $46 million. We consolidate this venture. In fiscal 2008, we acquired Alexia Foods, Lincoln Snacks, Watts Brothers, and Twin City Foods for a total of approximately $255 million in cash plus assumed liabilities.

 

Dispositions of Businesses

 

Before-tax proceeds from the trading and merchandising operations divestiture were comprised of (1) approximately $2.26 billion of cash, net of transaction costs (including incentive compensation amounts due to divested business employees), (2) payment-in-kind debt securities issued by the purchaser with aggregate principal amount of $550 million, recognized at fair market value of $479 million, and (3) a four-year warrant to purchase approximately 5% of the issued common equity of the purchaser, recognized at estimated fair market value of approximately $2 million. We recognized an after-tax gain on the divestiture of approximately $301 million.

 

Proceeds from the disposition of the trading and merchandising business were primarily used as follows: 1) to fund a $900 million accelerated share repurchase, 2) to pay down commercial paper borrowings outstanding as of the beginning of fiscal 2009 as well as commercial paper borrowings drawn for the purpose of funding working capital needs of the trading and merchandising business just prior to the disposition, and 3) to pay income taxes on the gain resulting from the transaction.

 

Before-tax proceeds from the Knott’s Berry Farm^® divestiture were $55 million, with the transaction resulting in no significant gain or loss, while before-tax proceeds from the Pemmican^® divestiture were approximately $29 million and we recognized an after-tax gain of approximately $11 million.

 

Capital Allocation

 

In fiscal 2009, we took advantage of a favorable interest rate environment and refinanced a portion of our debt. Specifically, we issued $1 billion aggregate principal amount of senior notes ($500 million maturing in 2014 and $500 million maturing in 2019), with an average blended interest rate of approximately 6.4%. With the proceeds from this debt issuance, we repaid approximately $900 million aggregate principal amount of senior notes and, in the process, paid approximately $50 million ($31 million after-tax) of premiums and related transaction fees. In addition, we contributed $100 million to our company-sponsored defined benefit pension plans.

 

In fiscal 2009, we funded an accelerated share repurchase program totaling $900 million (approximately 44.0 million shares of common stock), utilizing a portion of the proceeds from the trading and merchandising business divestiture.

 

In addition, during fiscal 2009, we executed the following:

 

 

Opportunities and Challenges

 

We believe our operating initiatives will favorably impact future sales, profits, and returns on capital. Because of the scope of change underway, there is risk that these broad change initiatives will not be successfully implemented. Input costs, competitive pressures, the ability to execute operational changes and implement pricing actions, among other factors, will affect the timing and impact of these initiatives.

 

We have faced increased costs for many of our significant raw materials, packaging, and energy inputs. We seek to mitigate the higher input costs through pricing and productivity initiatives, and through the use of derivative instruments used to economically hedge a portion of forecasted future consumption. We are also focusing on selling, general and administrative cost initiatives, as evidenced by the implementation of our restructuring plans as

well as our zero overhead growth initiative. If the benefits from pricing actions, supply chain productivity improvements, economic hedges, and selling, general and administrative cost reduction initiatives are insufficient to cover these expected higher input costs, results of operations, particularly Consumer Foods operating profit, may continue to be negatively impacted.

 

Changing consumer preferences may impact sales of certain of our products. We offer a variety of food products that appeal to a range of consumer preferences and utilize innovation and marketing programs to develop products that fit with changing consumer trends. As part of these programs, we introduce new products and product extensions.

 

Consolidation of many of our customers continues to result in increased buying power, negotiating strength, and complex service requirements for those customers. This trend, which is expected to continue, may negatively impact gross margins, particularly in the Consumer Foods segment. In order to effectively respond to this customer consolidation, we continually evaluate our consumer marketing, sales, and customer service strategies. We are implementing trade promotion programs designed to improve return on investment and pursuing shelf placement and customer service improvement initiatives.

 

The continuing volatility in financial markets and the deterioration of national and global economic conditions could impact our business and operations in a variety of ways. Consumers may shift purchases to lower-priced private label or other value offerings or may forego certain purchases altogether during economic downturns, which may adversely affect our results of operations. The financial stability of our customers and suppliers may be compromised, which could result in additional bad debts for us or non-performance by suppliers. Volatility in the equity markets or interest rates could substantially increase our pension costs and required pension contributions. Decreased demand in the restaurant business, particularly casual and fine dining, may adversely affect our Commercial Foods operations.

 

Other

 

On June 9, 2009, an accidental explosion occurred at our manufacturing facility in Garner, North Carolina. This facility was the primary production facility for our Slim Jim^® branded meat snacks. The packaging area of the plant is expected to be out of service for the foreseeable future. On June 13, 2009, the U.S. Bureau of Alcohol, Tobacco, Firearms and Explosives announced its determination that the explosion was the result of an accidental natural gas release, and not a deliberate act.

 

We maintain comprehensive property (including business interruption), workers’ compensation, and general liability insurance policies with very significant loss limits that we believe will provide substantial and broad coverage for the currently foreseeable losses arising from this accident. We anticipate that we will incur modest costs related to deductibles and co-payment obligations under available insurance policies, as well as other one-time costs that are not currently expected to be material.

 

SEGMENT REVIEW

 

We report our operations in two reporting segments:  Consumer Foods and Commercial Foods.

 

In June 2009, subsequent to our fiscal 2009 year end, we completed the divestiture of the Fernando’s^® foodservice brand for proceeds of approximately $6.4 million. We reflected the results of these operations as discontinued operations for all periods presented. The assets and liabilities of the divested Fernando’s^® business have been reclassified as assets and liabilities held for sale within our consolidated balance sheets for all periods presented.

 

Presentation of Commodity and Foreign Currency Derivative Gains and Losses in Segment Results

 

Prior to fiscal 2008, we designated certain commodity derivative instruments as cash flow hedges qualifying for hedge accounting treatment. We discontinued designating derivatives as cash flow hedges during the first quarter of fiscal 2008. In fiscal 2008, subsequent to the cessation of designating derivatives for hedge accounting

treatment, derivative gains and losses were recorded immediately in our segment results as a component of cost of goods sold regardless of when the item being hedged impacted earnings.

 

Following the sale of our trading and merchandising operations and related organizational changes in fiscal 2009, we transferred the management of commodity hedging activities (except for those related to our milling operations) to a centralized procurement group. Beginning in the first quarter of fiscal 2009, we began to reflect realized and unrealized gains and losses from derivatives (except for those related to our milling operations) used to hedge anticipated commodity consumption in earnings immediately within general corporate expenses. The gains and losses are reclassified to segment operating results in the period in which the underlying item being hedged is recognized in cost of goods sold. We believe this change results in better segment management focus on key operational initiatives and improved transparency to derivative gains and losses.

 

In fiscal 2008, we began to centrally manage foreign currency risk for all of our reporting segments. Foreign currency derivatives used to manage foreign currency risk are not designated for hedge accounting treatment. As such, these derivatives are recognized at fair market value with realized and unrealized gains and losses recognized in general corporate expenses. The gains and losses are subsequently recognized in the operating results of the reporting segments in the period in which the underlying transaction being economically hedged is included in earnings. We believe that these derivatives provide economic hedges of the foreign currency risk of certain forecasted transactions.

 

The following table presents the net derivative losses from economic hedges of forecasted commodity consumption and foreign currency risk for fiscal 2009, under this new methodology (in millions):

 

 

Based on our forecasts of the timing of recognition of the underlying hedged items, we expect to reclassify losses of $7.8 million and gains of $2.5 million to segment operating results in fiscal 2010 and 2011, respectively.

 

In fiscal 2008, net derivative gains from economic hedges of forecasted commodity consumption and currency risk of our foreign operations were $62.6 million in the Consumer Foods segment and $26.4 million in the Commercial Foods segment. In fiscal 2007, net derivative gains from economic hedges of forecasted commodity consumption and currency risk of our foreign operations were $14.0 million in the Consumer Foods segment and $7.6 million in the Commercial Foods segment.

 

Consumer Foods

 

The Consumer Foods reporting segment includes branded and private label food products that are sold in various retail and foodservice channels, principally in North America. The products include a variety of categories (meals, entrees, condiments, sides, snacks, and desserts) across frozen, refrigerated, and shelf-stable temperature classes. The segment is comprised of and managed through five subsegments as described below:

 

Grocery Foods North America—includes branded and private label refrigerated or shelf-stable food products that are sold in various retail and foodservice channels primarily across the United States. Major brands include: Angela Mia^®, Chef Boyardee^®, Egg Beaters^®, Healthy Choice^® Fresh Mixers^tm, Hebrew National^®, Hunt’s^®, Manwich^®, PAM^®, Peter Pan^®, Snack Pack^®, Reddi-wip^®, Rosarita^®, Ro*Tel^®, Swiss Miss^®, and Van Camp’s ^®. The segment also includes the consumer foods businesses in Mexico and Canada, which distribute packaged foods that are both locally manufactured and imported from the United States.

Frozen Foods—includes branded and private label frozen food products that are sold in various retail and foodservice channels across the United States. Major brands include: Alexia^®, Banquet^®, Healthy Choice^®, Kid Cuisine^®, and Marie Callender’s^®.

 

Snacks and Store Brands—includes branded popcorn, meats, seeds, and specialty snacks, as well as private label food products that are sold in various retail and foodservice channels across the United States. Major brands include: ACT II^®, DAVID^®, Orville Redenbacher’s^®, and Slim Jim^®.

 

Enabler Brands—includes national and regional branded food products across shelf-stable, refrigerated, and frozen temperature classes. Products are sold in various retail and foodservice channels across the United States. Major brands include: Blue Bonnet^®, La Choy^®, Libby’s^®, The Max^®, Parkay^®, and Wesson^®.

 

Domestic Export—includes branded shelf-stable food products sold through distributors in various markets throughout the world.

 

The Consumer Foods’ supply chain and order-to-cash functions are centrally managed and largely integrated. Accordingly, we do not maintain balance sheets at the subsegment level. Selling, general and administrative expenses, other than advertising and promotion, are managed at the primary segment level, and as such, we do not separately allocate selling, general and administrative expenses other than advertising and promotion expenses to the Consumer Foods subsegments.

 

Commercial Foods

 

The Commercial Foods reporting segment includes commercially branded foods and ingredients, which are sold principally to foodservice, food manufacturing, and industrial customers. The segment’s primary products include: specialty potato products, milled grain ingredients, a variety of vegetable products, seasonings, blends, and flavors, which are sold under brands such as ConAgra Mills^®, Lamb Weston^®, Gilroy Foods & Flavors^tm, and Spicetec^®.

 

2009 vs. 2008

 

Net Sales

($ in millions)

 

 

Overall, our net sales increased $1.17 billion to $12.73 billion in fiscal 2009, reflecting improved pricing and mix in the Consumer Foods segment and increased pricing in the milling and specialty potato operations of the Commercial Foods segment.

 

Consumer Foods net sales for fiscal 2009 were $8.03 billion, an increase of 8% compared to fiscal 2008. Results reflected an increase of 7% from improved net pricing and product mix, and flat volume. Volume reflected a benefit of approximately 2% in fiscal 2009 due to the inclusion of an additional week of results. The strengthening

of the U.S. dollar relative to foreign currencies resulted in a reduction of net sales of approximately 1% as compared to fiscal 2008. Highlights by subsegment are as follows:

 

Grocery Foods North America

 

Grocery Foods North America net sales were $2.90 billion, an increase of 8% compared to fiscal 2008. Results reflected net pricing and mix improvement of 7% and increased volume of approximately 3%. The increase in volume reflected a benefit of approximately 2% in fiscal 2009 due to the inclusion of an additional week of results. The strengthening of the U.S. dollar relative to foreign currencies resulted in a reduction of net sales (principally related to our operations in Canada and Mexico) of approximately 2% in fiscal 2009. Sales of some of the subsegment’s most significant brands, including Chef Boyardee^®, Hebrew National^®, Hunt’s^®, Reddi-wip^®, Manwich^®, Peter Pan^®, Ro*Tel^®, Rosarita^®, Snack Pack ^®, and Swiss Miss^®, grew in fiscal 2009. Sales of Egg Beaters^® declined in fiscal 2009.

 

Frozen Foods

 

Frozen Foods net sales were $1.88 billion, an increase of 8% compared to fiscal 2008. Results reflected net pricing and mix improvement of 3% and increased unit volume of approximately 5%. Volume reflected a benefit of approximately 2% in fiscal 2009 due to the inclusion of an additional week of results. Sales of Banquet^®, Healthy Choice^®, Kid Cuisine^®, and Marie Callender’s^® branded products increased in fiscal 2009.

 

Snacks and Store Brands

 

Snacks and Store Brands net sales were $1.51 billion, an increase of 8% compared to fiscal 2008. Results reflected net pricing and mix improvement of 15%, partially offset by a decline in volume of 7%. Volume reflected a benefit of approximately 2% in fiscal 2009 due to the inclusion of an additional week of results. We achieved sales growth in fiscal 2009 for Crunch ‘N Munch^®, DAVID^®, Orville Redenbacher’s^®, and Slim Jim^®. Sales of ACT II^® declined in fiscal 2009. The decrease in ACT II^® volume reflected the elimination of certain low-margin sales in favor of more focus behind higher margin Orville Redenbacher’s^® popcorn.

 

Enabler Brands

 

Enabler Brands net sales were $1.57 billion, an increase of 10% compared to fiscal 2008. Results reflected net pricing and mix improvement of approximately 11%, partially offset by a 1% decline in volume. Volume reflected a benefit of approximately 2% in fiscal 2009 due to the inclusion of an additional week of results. We achieved sales growth in fiscal 2009 for the following brands: Blue Bonnet^®, La Choy^®, Libby’s^®, The Max^®, Van Camp’s^®, and Wesson^®. These increases were offset by sales declines in Pemmican^®.

 

Domestic Export

 

Domestic Export net sales were $182 million, a decrease of 5% compared to fiscal 2008. Results reflected net pricing and mix improvement of 7%, which was more than offset by a 12% decline in volume, reflecting our exit from a number of international markets in fiscal 2009. Volume reflected a benefit of approximately 2% in fiscal 2009 due to the inclusion of an additional week of results.

 

Commercial Foods net sales were $4.70 billion in fiscal 2009, an increase of $572 million, or 14% compared to fiscal 2008. Increased net sales reflected the pass through of higher wheat prices by the segment’s flour milling operations and higher selling prices in our Lamb Weston^® specialty potato products business, partially offset by lower foodservice volumes for our potato products. Results reflected a benefit of approximately 2% due to the inclusion of an additional week in fiscal 2009. Net sales from Watts Brothers and Lamb Weston BSW, businesses acquired in the fourth quarter of fiscal 2008 and the second quarter of fiscal 2009, respectively, contributed $119 million to net sales in fiscal 2009.

 

Profit Contribution Margin (PCM)

(Net Sales less Cost of Goods Sold and Advertising and Promotion Expense)

($ in millions)

 

 

Consumer Foods PCM for fiscal 2009 was $1.66 billion, an increase of $32 million, or 2%, compared to fiscal 2008. The increase in PCM reflected improved net pricing and mix and significant supply chain productivity savings, partially offset by significantly higher input costs in all subsegments. Consumer Foods PCM in fiscal 2008 included approximately $28 million of costs related to the recalls of pot pie and peanut butter products. Highlights by subsegment are as follows:

 

Grocery Foods North America

 

Grocery Foods North America PCM was $729 million, an increase of 6% compared to fiscal 2008. Results reflected increased volume of 3%, increased net pricing that more than offset higher input costs, and significant supply chain savings. The strengthening of the U.S. dollar relative to foreign currencies resulted in a reduction of PCM of approximately $17 million, net of the benefit of economic foreign currency hedges. Advertising and promotion costs were $14 million higher in fiscal 2009 than in fiscal 2008. PCM included costs of $6 million related to the peanut butter recall in fiscal 2008.

 

Frozen Foods

 

Frozen Foods PCM was $349 million, an increase of 7% compared to fiscal 2008. Results reflected increased volume of 5% and improved pricing and mix that more than offset higher input costs. Advertising and promotion costs were $16 million higher in fiscal 2009 than in fiscal 2008. PCM included costs of $21 million related to the pot pie recall in fiscal 2008.

 

Snacks and Store Brands

 

Snacks and Store Brands PCM was $324 million, an increase of 10% compared to fiscal 2008. Results reflected decreased volume of 7% and improved pricing and mix that more than offset higher input costs. The improvement in PCM, despite the decrease in volume reflects the elimination of certain low-margin ACT II^® sales in favor of more focus behind higher margin Orville Redenbacher’s^® popcorn.

 

Enabler Brands

 

Enabler Brands PCM was $215 million, a decrease of 5% compared to fiscal 2008. Results reflected decreased volume of 1%. Increases in net pricing were more than offset by the impact of higher input costs across the portfolio of brands, primarily due to an increase in the cost of edible oils.

 

Domestic Export

 

Domestic Export PCM was $47 million, an increase of 34% compared to fiscal 2008. Results reflected decreased volume of 12%. The impact of improved net pricing and mix was more than offset by the impact of higher input costs. Fiscal 2009 PCM was also favorably impacted by a $9 million decrease in advertising and promotion expense.

 

Other

 

Other Consumer Foods PCM included $48 million and $63 million of realized and unrealized net losses and gains, respectively, on derivative instruments used to economically hedge anticipated commodity input costs in fiscal 2009 and 2008, respectively.

 

Commercial Foods PCM was $789 million for fiscal 2009, an increase of $80 million, or 11%, compared to fiscal 2008. All major businesses in this segment experienced significantly higher input costs in fiscal 2009 than in fiscal 2008 and increased pricing to offset these higher costs. Improved results reflected increased PCM of $25 million in our flour milling operations due to high quality wheat crops and improved flour conversion margins. Our Lamb Weston specialty potato business achieved increased PCM of $46 million in fiscal 2009, reflecting PCM of $28 million from the Watts Brothers business acquired in late fiscal 2008 and the Lamb Weston BSW business acquired in the second quarter of fiscal 2009, as well as increased pricing that more than offset increased input costs and lower volume.

 

Selling, General and Administrative Expenses (includes General Corporate Expense) (“SG&A”)

 

SG&A expenses totaled $1.69 billion for fiscal 2009, a decrease of 4% compared to fiscal 2008. We estimate that the inclusion of an extra week in the fiscal 2009 results increased SG&A expenses by approximately 2%.

 

Selling, general and administrative expenses for fiscal 2009 reflected the following:

 

 

Included in SG&A expenses for fiscal 2008 were the following items:

 

 

Operating Profit

(Earnings before general corporate expense, interest expense, net, income taxes, and equity method investment earnings)

($ in millions)

 

 

Consumer Foods operating profit increased $126 million in fiscal 2009 versus the prior year to $956 million. The increase was reflective of the increased PCM, discussed above, and was influenced by a number of factors, including:

 

 

Commercial Foods operating profit increased $72 million to $584 million in fiscal 2009. Operating profit improvement was principally driven by the improved PCM, as discussed above.

 

Interest Expense, Net

 

In fiscal 2009, net interest expense was $186 million, a decrease of $67 million, or 26%, from fiscal 2008. The reduction in net interest expense reflects interest income of $78 million in fiscal 2009, largely due to the payment-in-kind notes received in June 2008 in connection with the divestiture of our trading and merchandising operations.

 

Equity Method Investment Earnings

 

We include our share of the earnings of certain affiliates based on our economic ownership interest in the affiliates. Significant affiliates produce and market potato products for retail and foodservice customers. Our share of earnings from our equity method investments were $24 million ($3 million in the Consumer Foods segment and $21 million in the Commercial Foods segment) and $50 million ($1 million in the Consumer Foods segment and $49 million in the Commercial Foods segment) in fiscal 2009 and 2008, respectively. The decrease in equity method investment earnings in Commercial Foods was driven by the reduced profits of a foreign potato venture, resulting primarily from excess supply of potato products in the venture’s market.

 

Results of Discontinued Operations

 

Our discontinued operations generated after-tax earnings of $332 million in fiscal 2009. In fiscal 2009, we completed the sale of the trading and merchandising operations and recognized an after-tax gain on the disposition of approximately $301 million. In the fourth quarter of fiscal 2009, we made a decision to sell certain small foodservice brands. The sale of these brands was completed in June 2009, subsequent to our fiscal 2009. We recognized after-tax impairment charges of $6 million in anticipation of this divestiture.

 

Our discontinued operations generated after-tax earnings of $412 million in fiscal 2008.

Income Taxes and Net Income

 

Our income tax expense was $337 million in fiscal 2009. The effective tax rate (calculated as the ratio of income tax expense to pre-tax income from continuing operations, inclusive of equity method investment earnings) was 34% for fiscal 2009.

 

During fiscal 2008, we adjusted our estimates of income taxes payable due to increased benefits from a domestic manufacturing deduction and lower foreign income taxes, resulting in a lower than normal effective tax rate of 30%.

 

The Company expects its effective tax rate in fiscal 2010, exclusive of any unusual transactions or tax events, to be in the range of 34% to 35%.

 

Net income was $978 million, or $2.15 per diluted share, in fiscal 2009, compared to $931 million, or $1.90 per diluted share, in fiscal 2008.

 

2008 vs. 2007

 

Net Sales

($ in millions)

 

 

Overall, our net sales increased $1.07 billion to $11.56 billion in fiscal 2008, reflecting increased pricing in the milling and specialty potato operations of the Commercial Foods segment and increased volume and pricing in the Consumer Foods segment.

 

Consumer Foods net sales for fiscal 2008 were $7.44 billion, an increase of 5% compared to fiscal 2007. Results reflect an increase of three percentage points from improved net pricing and product mix and two percentage points of improvement from higher volumes. We initiated a peanut butter recall in the third quarter of fiscal 2007 and reintroduced Peter Pan^® peanut butter products in August 2007. Sales of all peanut butter products, including both branded and private label, in fiscal 2008 were $14 million lower than comparable amounts in fiscal 2007. Consumer Foods net sales were also adversely impacted by the recall of Banquet^® and private label pot pies in the second quarter of fiscal 2008. Net sales of pot pies were lower by approximately $22 million in fiscal 2008, relative to fiscal 2007, primarily due to product returns and lost sales of Banquet^® and private label pot pies. Highlights by subsegment are as follows:

 

Grocery Foods North America

 

Grocery Foods North America net sales were $2.69 billion, an increase of 5% compared to fiscal 2007. Results reflected increased sales of approximately 4% due to volume and mix. The strengthening of foreign currencies relative to the U.S. dollar accounted for approximately 1% of the increase in sales. Net pricing was essentially flat. Net sales of some of the subsegment’s most significant brands, including Chef Boyardee^®, Egg Beaters^®, Hebrew National^®, Hunt’s^®, Manwich^®, Ro*Tel^®, Rosarita^®, and Snack Pack^®, grew in fiscal 2008. Sales of Reddi-wip^® and Swiss Miss^® declined in fiscal 2008.

 

Frozen Foods

 

Frozen Foods net sales were $1.73 billion, an increase of 4% compared to fiscal 2007. Results reflected increased sales of approximately 2% due to volume and mix and net pricing increases of approximately 2%. Sales of Healthy Choice^® and Marie Callender’s^® branded products increased, offset by net sales declines in the Banquet^® and Kid Cuisine^® product lines. Net sales from the Alexia^® business, acquired in fiscal 2008, resulted in an increase of $35 million in net sales in fiscal 2008. Banquet^® net sales were lower by $10 million in fiscal 2008 primarily due to the pot pie recall.

 

Snacks and Store Brands

 

Snacks and Store Brands net sales were $1.40 billion, an increase of 1% compared to fiscal 2007. Results reflected decreased sales of approximately 1% from lower volume and mix, offset by improved net pricing of approximately 2%. Sales of the Orville Redenbacher’s^® brand increased, offset by sales declines in ACT II^®, Pemmican^®, and Slim Jim^®. Net sales from the Lincoln Snacks business, acquired during fiscal 2008, resulted in a $30 million increase as compared to fiscal 2007. The peanut butter and pot pie recalls, which included store brands, negatively impacted this subsegment’s net sales by $23 million in fiscal 2008 compared to fiscal 2007.

 

Enabler Brands

 

Enabler Brands net sales were $1.43 billion, an increase of 10% compared to fiscal 2007. Results reflect increases of approximately 7% due to net pricing and approximately 3% due to volume and mix. Sales of Wesson^®, Blue Bonnet^®, Libby’s^®, Wolf^®, and The Max^® brands increased. These increases were offset by net sales declines in Angela Mia^® and Parkay^®. A refrigerated pizza business, sold during fiscal 2007, generated sales of $17 million in fiscal 2007.

 

Domestic Export

 

Domestic Export net sales were $193 million, an increase of 15% compared to fiscal 2007. These results reflected a 15% increase principally due to volume and mix. The net pricing impact was flat.

 

Commercial Foods net sales were $4.13 billion in fiscal 2008, an increase of $706 million, or 21%. Increased sales are reflective of higher sales prices in our milling operations due to higher grain prices, and price and volume increases in our specialty potato and dehydrated vegetable operations. The fiscal 2007 divestiture of an oat milling operation resulted in a reduction of sales of $27 million for fiscal 2008, partially offset by increased sales of $18 million from the acquisition of Watts Brothers in February 2008.

 

Profit Contribution Margin (PCM)

(Net Sales less Cost of Goods Sold and Advertising and Promotion Expense)

($ in millions)

 

 

Consumer Foods PCM for fiscal 2008 was $1.63 billion, a decrease of $62 million, or 4%, from the prior year. The decrease in PCM reflected significantly higher input costs, partially offset by improved net pricing, mix, and volume. The increased input costs were partially offset by productivity improvements and gains on derivatives held

to economically hedge current and future input costs. The factors impacting comparability of Consumer Foods net sales also impact the comparability of Consumer Foods PCM. Due to the peanut butter recall that was initiated in the third quarter of fiscal 2007 and the subsequent reintroduction of Peter Pan^® peanut butter products in August 2007, PCM in the Consumer Foods segment is not comparable across periods. Consumer Foods PCM from all peanut butter products, including both branded and private label, in fiscal 2008 was $23 million lower than comparable amounts in fiscal 2007. Consumer Foods PCM on Banquet^® and private label pot pies products were lower by approximately $22 million in fiscal 2008, relative to fiscal 2007, primarily due to product returns and lost sales. Newly acquired businesses contributed $13 million to PCM in fiscal 2008. Costs of implementing our restructuring plans reduced Consumer Foods PCM for fiscal 2008 and 2007 by $4 million and $45 million, respectively. Highlights by subsegment are as follows:

 

Grocery Foods North America

 

Grocery Foods North America PCM was $685 million, a decrease of 11%. Increased sales were offset by higher input costs across the portfolio of brands that decreased PCM by approximately 19%. Advertising and promotion costs were in line with prior year levels. The change in PCM includes a benefit of approximately $11 million due to favorable foreign currency exchange rate changes. Peter Pan^® PCM was lower by $21 million in fiscal 2008 as compared to fiscal 2007 primarily due to the peanut butter recall that was initiated in the third quarter of fiscal 2007. Peter Pan^® peanut butter products were reintroduced in August 2007, affecting the year-over-year results of the operations.

 

Frozen Foods

 

Frozen Foods PCM was $326 million, a decrease of 1%. The impact of increased sales and lower advertising and promotion expense was more than offset by higher input costs across the portfolio of brands. Banquet^® PCM was lower by $17 million in fiscal 2008 as compared to fiscal 2007 primarily due to the pot pie recall.

 

Snacks and Store Brands

 

Snacks and Store Brands PCM was $294 million, a decrease of 14%. Increases due to the impact of higher sales and lower advertising and promotion expense were more than offset by higher input costs across the portfolio of brands. The peanut butter and pot pie recalls, which included store brands, negatively impacted this subsegment’s PCM by $7 million in fiscal 2008 compared to fiscal 2007.

 

Enabler Brands

 

Enabler Brands PCM was $228 million, a decrease of 19%. Increases in net sales were more than offset by the impact of higher input costs across the portfolio of brands, primarily due to the increase in cost of edible oils. Advertising and promotion expense was in line with prior year levels.

 

Domestic Export

 

Domestic Export PCM was $35 million, an increase of 30%. The impact of increased sales was offset by the impact of input costs. Fiscal 2008 PCM was also favorably impacted by a decrease in advertising and promotion expense.

 

Other Consumer Foods PCM for fiscal 2008 principally includes net gains on derivatives held to economically hedge current and future input costs, partially offset by restructuring and other expenses not allocated directly to subsegments. For fiscal 2007, Other Consumer Foods PCM principally includes restructuring costs and other expenses not allocated directly to subsegments, partially offset by net gains on derivatives held to economically hedge current and future input costs. These amounts are not reflected in subsequent PCM results.

 

Commercial Foods PCM was $709 million for fiscal 2008, an increase of $131 million, or 23%, over the prior year. Improved results reflected increased PCM of $68 million in our milling operations due to a favorable wheat commodity environment and improved flour conversion margins. We also achieved an increase in PCM of $61 million in our specialty potato business as benefits from pricing, volume growth, and product mix management exceeded the impact of higher input costs. Results also reflected gains on derivatives held to economically hedge current and future input costs as well as profits from wheat derivatives trading.

Selling, General and Administrative Expenses (includes General Corporate Expense) (“SG&A”)

 

SG&A expenses totaled $1.76 billion for fiscal 2008, virtually unchanged from the prior fiscal year.

 

Selling, general and administrative expenses for fiscal 2008 reflected the following:

 

 

Included in SG&A expenses for fiscal 2007 were the following items:

 

 

Operating Profit

(Earnings before general corporate expense, interest expense, net, income taxes, and equity method investment earnings)

($ in millions)

 

 

Consumer Foods operating profit decreased $81 million in fiscal 2008 versus the prior fiscal year to $830 million. The decrease for the fiscal year was reflective of the decreased PCM, discussed above, and was influenced by a number of factors, including:

 

 

Commercial Foods operating profit increased $77 million to $512 million in fiscal 2008. Operating profit improvement was principally driven by the improved PCM, as discussed above. Other factors affecting the increased operating profit included higher selling expense and compensation costs in fiscal 2008, and gains recorded in fiscal 2007 of $18 million related to our sale of an oat milling business and $8 million resulting from a legal settlement related to a fire.

 

Interest Expense, Net

 

In fiscal 2008, net interest expense was $253 million, an increase of $34 million, or 15%, over the prior fiscal year. Increased interest expense reflected our use of commercial paper to finance higher working capital balances in all segments, particularly in the trading and merchandising business which is now presented within discontinued operations. We also earned less interest income due to lower balances of cash on hand in fiscal 2008.

 

Equity Method Investment Earnings

 

We include our share of the earnings of certain affiliates based on our economic ownership interest in the affiliates. Significant affiliates produce and market potato products for retail and foodservice customers. Our share of earnings from our equity method investments was $50 million ($1 million in the Consumer Foods segment and $49 million in the Commercial Foods segment) and $28 million ($2 million in the Consumer Foods segment and $26 million in the Commercial Foods segment) in fiscal 2008 and 2007, respectively. The increase in equity method investment earnings in Commercial Foods was driven by improved performance of a foreign potato venture.

 

Results of Discontinued Operations

 

Income from discontinued operations was $412 million, net of tax, in fiscal 2008. Included in these amounts are:

 

 

Income from discontinued operations was $283 million, net of tax, in fiscal 2007. Included in these amounts are:

 

 

Income Taxes and Net Income

 

The effective tax rate (calculated as the ratio of income tax expense to pre-tax income from continuing operations, inclusive of equity method investment earnings) was 30% for fiscal 2008. During fiscal 2008, we adjusted our estimates of income taxes payable due to increased benefits from a domestic manufacturing deduction and lower foreign income taxes, resulting in a lower than normal effective tax rate. These impacts and tax benefits related to a change in the legal structure of our subsidiaries are the primary contributors to the decrease in the year-to-date effective tax rate from fiscal 2007.

The effective tax rate was 34% in fiscal 2007. In 2007, state income taxes included approximately $24 million of benefits related to the implementation of tax planning strategies and changes in estimates, principally related to state tax jurisdictions. These benefits were offset by the tax impact of an Internal Revenue Service audit settlement.

 

Net income was $931 million, or $1.90 per diluted share, in fiscal 2008, compared to $765 million, or $1.51 per diluted share, in fiscal 2007.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Sources of Liquidity and Capital

 

Our primary financing objective is to maintain a prudent capital structure that provides us flexibility to pursue our growth objectives. We currently use short-term debt principally to finance ongoing operations, including our seasonal requirements for working capital (accounts receivable, prepaid expenses and other current assets, and inventories, less accounts payable, accrued payroll, and other accrued liabilities) and a combination of equity and long-term debt to finance both our base working capital needs and our noncurrent assets.

 

Commercial paper borrowings (usually less than 30 days maturity) are reflected in our consolidated balance sheets within notes payable. At May 31, 2009, we had a $1.5 billion multi-year revolving credit facility with a syndicate of financial institutions which matures in December 2011. The multi-year facility has historically been used solely as a back-up facility for our commercial paper program. As of May 31, 2009, there were no outstanding borrowings under the facility. Borrowings under the multi-year facility bear interest at or below prime rate and may be prepaid without penalty. The multi-year facility requires that our consolidated funded debt not exceed 65% of our consolidated capital base, and that our fixed charges coverage ratio be greater than 1.75 to 1.0. As of the end of fiscal 2009, the Company was in compliance with these financial covenants.

 

As of the end of fiscal 2009, our senior long-term debt ratings were all investment grade. A significant downgrade in our credit ratings would not affect our ability to borrow amounts under the revolving credit facility, although borrowing costs would increase. A downgrade of our short-term credit ratings would impact our ability to borrow under our commercial paper program by negatively impacting borrowing costs and causing shorter durations, as well as making access to commercial paper more difficult.

 

During the fourth quarter of fiscal 2009, we issued $1 billion aggregate principal amount of senior notes ($500 million maturing in 2014 and $500 million maturing in 2019), with an average blended interest rate of approximately 6.4%. We subsequently repaid approximately $900 million aggregate principal amount of senior notes with maturities of 2010, 2011, and 2027. We incurred charges of $50 million for the premium paid and transaction costs associated with the debt retirement. We also contributed $100 million to our pension plans in order to improve the funded status of the plans.

 

We have repurchased our shares of common stock from time to time based on repurchase limits authorized by our Board of Directors and market conditions. During fiscal 2008 we repurchased $188 million of our shares. During fiscal 2009, we executed an accelerated share repurchase, buying back approximately 44 million shares of our common stock at a cost of $900 million. At May 31, 2009, our current share repurchase authorization was essentially exhausted.

 

During the first quarter of fiscal 2009, we sold our trading and merchandising operations for proceeds of: 1) approximately $2.2 billion in cash, net of transaction costs, 2) $550 million (face value) of payment-in-kind debt securities issued by the purchaser (the “Notes”) which was recorded at an initial estimated fair value of $479 million, 3) a short-term receivable of $37 million due from the purchaser (which was subsequently collected), and 4) a four-year warrant to acquire approximately 5% of the issued common equity of the parent company of the divested operations, which has been recorded at an estimated fair value of $1.8 million. The Notes, which are classified as other assets, had a carrying value of $522 million at May 31, 2009.

Cash Flows

 

In fiscal 2009, we generated $72 million of cash, which was the net result of $124 million generated from operating activities, $1.79 billion generated from investing activities, and $1.83 billion used in financing activities.

 

Cash generated from operating activities of continuing operations totaled $978 million for fiscal 2009 as compared to $371 million generated in fiscal 2008. In fiscal 2008, cash flows from income of continuing operations were largely absorbed by increased working capital requirements, particularly due to increased quantities and unit costs of inventory. In fiscal 2009, improved income from continuing operations and working capital management efforts resulted in significantly improved cash flows from operating activities of continuing operations. Specifically, we improved the speed of our collection of accounts receivable and converted derivative positions used in our economic hedging activities to cash, which more than offset the increase in crop-based inventory balances in our Commercial Foods businesses. The increased inventory balances in our Commercial Foods businesses are largely due to the purchase of strong potato and garlic crops, coupled with lower demand in the foodservice channel. We also contributed $112 million to our Company-sponsored pension plans in fiscal 2009. Cash used in operating activities of discontinued operations was $854 million in fiscal 2009, primarily due to the increase in commodity inventory balances and derivative assets in the trading and merchandising business during the brief period we held that business prior to its divestiture in June 2008. Cash used in operating activities of discontinued operations was $278 million in fiscal 2008.

 

Cash used in investing activities of continuing operations totaled $467 million in fiscal 2009 and $676 million in fiscal 2008. Investing activities of continuing operations in fiscal 2009 consisted primarily of capital expenditures of $442 million and acquisitions of businesses (including Lamb Weston BSW) and intangible assets totaling $84 million, partially offset by sales of businesses (including the Pemmican^® business) and fixed assets. Investing activities of continuing operations in fiscal 2008 consisted primarily of expenditures of $255 million related to the acquisition of businesses (see Note 3 to the consolidated financial statements) and capital expenditures of $489 million, which included approximately $39 million of expenditures related to the purchase of certain warehouse facilities from our lessors (these warehouses were sold for proceeds of approximately $36 million to unrelated third parties immediately thereafter), offset by $30 million of proceeds from the sale of property, plant, and equipment. We generated $2.26 billion of cash from investing activities of discontinued operations in fiscal 2009 from the disposition of the trading and merchandising business. We generated $32 million from investing activities from discontinued operations in fiscal 2008, primarily from the sale of the Knott’s Berry Farm^® jams and jellies brand and operations.

 

Cash used in financing activities totaled $1.83 billion in fiscal 2009, as compared to cash used in financing activities of $22 million in fiscal 2008. During fiscal 2009, we repurchased $900 million of our common stock as part of our share repurchase program, we reduced our short-term borrowings by $578 million, and paid dividends of $348 million. We refinanced certain of our long-term debt in fiscal 2009, issuing $1 billion aggregate principal amount of senior notes ($500 million maturing in 2014 and $500 million maturing in 2019.) We repaid $950 million aggregate principal amount of senior and subordinated notes throughout the year (net losses of $49 million on the retirement of debt are also reflected as financing cash outflows). During fiscal 2008, we repurchased $188 million of our common stock as part of our share repurchase program and paid dividends of $362 million. As part of the Watts Brothers acquisition, we repaid $64 million of assumed long-term debt subsequent to the acquisition. In addition to these early retirements of debt, we made scheduled principal payments of debt and payments of lease financing obligations during fiscal 2008, reducing long-term debt by $21 million. Also, during fiscal 2008, we increased our short-term borrowings by $577 million, primarily reflecting the financing of significantly increased working capital.

 

We estimate our capital expenditures in fiscal 2010 will be approximately $475 million. Management believes that existing cash balances, cash flows from operations, existing credit facilities, and access to capital markets will provide sufficient liquidity to meet our working capital needs, planned capital expenditures, and payment of anticipated quarterly dividends for at least the next twelve months.

OFF-BALANCE SHEET ARRANGEMENTS

 

We use off-balance sheet arrangements (e.g., operating leases) where the economics and sound business principles warrant their use. We periodically enter into guarantees and other similar arrangements as part of transactions in the ordinary course of business. These are described further in “Obligations and Commitments,” below.

 

In September 2008, we formed a potato processing venture, Lamb Weston BSW, with Ochoa Ag Unlimited Foods, Inc. We provide all sales and marketing services to the venture. We have determined that Lamb Weston BSW is a variable interest entity and that we are the primary beneficiary of the entity. Accordingly, we consolidate the financial statements of Lamb Weston BSW. We also consolidate the assets and liabilities of several entities from which we lease corporate aircraft. Each of these entities has been determined to be a variable interest entity and we have been determined to be the primary beneficiary of each of these entities.

 

Due to the consolidation of the variable interest entities, we reflected in our balance sheets:

 

 

The liabilities recognized as a result of consolidating these entities do not represent additional claims on the general assets of the Company. The creditors of these entities have claims only on the assets of the specific variable interest entities to which they have advanced credit.

 

OBLIGATIONS AND COMMITMENTS

 

As part of our ongoing operations, we enter into arrangements that obligate us to make future payments under contracts such as debt agreements, lease agreements, and unconditional purchase obligations (i.e., obligations to transfer funds in the future for fixed or minimum quantities of goods or services at fixed or minimum prices, such as “take-or-pay” contracts). The unconditional purchase obligation arrangements are entered into in our normal course of business in order to ensure adequate levels of sourced product are available. Of these items, debt and capital lease obligations, which totaled $3.6 billion as of May 31, 2009, were recognized as liabilities in our consolidated balance sheet. Operating lease obligations and unconditional purchase obligations, which totaled approximately $1.0 billion as of May 31, 2009, in accordance with generally accepted accounting principles, were not recognized as liabilities in our consolidated balance sheet.

A summary of our contractual obligations at the end of fiscal 2009 was as follows (including obligations of discontinued operations):

 

 

We are also contractually obligated to pay interest on our long-term debt and capital lease obligations. The weighted average interest rate of the long-term debt obligations outstanding as of May 31, 2009 was approximately 7.0%.

 

We consolidate the assets and liabilities of certain entities that have been determined to be variable interest entities and for which we have been determined to be the primary beneficiary of these entities. The amounts reflected in contractual obligations of long-term debt, in the table above, include $89 million of liabilities of these variable interest entities to the creditors of such entities. The long-term debt recognized as a result of consolidating these entities does not represent additional claims on our general assets. The creditors of these entities have claims only on the assets of the specific variable interest entities. As of May 31, 2009, we were obligated to make rental payments of $60 million to the variable interest entities, of which $7 million is due in less than one year, $23 million is due in one to three years, and $30 million is due in three to five years. Such amounts are not reflected in the table above.

 

The purchase obligations noted in the table above do not reflect approximately $474 million of open purchase orders, some of which are not legally binding. These purchase orders will be settled in the ordinary course of business in less than one year.

 

As part of our ongoing operations, we also enter into arrangements that obligate us to make future cash payments only upon the occurrence of a future event (e.g., guarantee debt or lease payments of a third party should the third party be unable to perform). In accordance with generally accepted accounting principles, the following commercial commitments are not recognized as liabilities in our consolidated balance sheet. A summary of our commitments, including commitments associated with equity method investments, as of the end of fiscal 2009, was as follows:

 

 

In certain limited situations, we will guarantee an obligation of an unconsolidated entity. We have outstanding guarantees of certain railcar leases of the divested trading and merchandising business (now operating as the Gavilon Group, LLC (“Gavilon”)); the railcar leases were in place prior to the divestiture and the parties are working with the lessors to secure our release. The remaining terms of these lease agreements do not exceed two years and the maximum amount of future payments we have guaranteed was $3 million as of May 31, 2009. We have not established a liability for these guarantees, which are included in the table above, as we have determined that the likelihood of our required performance under the guarantees is remote.

 

We guarantee certain leases and other commercial obligations resulting from our fresh beef and pork divestiture. The remaining terms of these arrangements do not exceed seven years and the maximum amount of future payments we have guaranteed was approximately $18 million as of May 31, 2009. We have also

guaranteed the performance of the divested fresh beef and pork business with respect to a hog purchase contract. The hog purchase contract requires the divested fresh beef and pork business to purchase a minimum of approximately 1.2 million hogs annually through 2014. The contract stipulates minimum price commitments, based in part on market prices, and in certain circumstances also includes price adjustments based on certain inputs.

 

We are a party to various potato supply agreements. Under the terms of certain such potato supply agreements, we have guaranteed repayment of short-term bank loans of the potato suppliers, under certain conditions. At May 31, 2009, the amount of supplier loans effectively guaranteed by us was approximately $40 million, included in the table above. We have not established a liability for these guarantees, as we have determined that the likelihood of our required performance under the guarantees is remote.

 

We are a party to a supply agreement with an onion processing company. We have guaranteed repayment of a loan of this supplier, under certain conditions. At May 31, 2009, the amount of this loan was $25 million, included in the table above. In the event of default on this loan by the supplier, we have the contractual right to purchase the loan from the lender, thereby giving us the rights to underlying collateral. We have not established a liability in connection with this guarantee, as we believe the likelihood of financial exposure to us under this agreement is remote.

 

The obligations and commitments tables above do not include any reserves for income taxes under FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (as amended), as we are unable to reasonably estimate the ultimate timing of settlement of our reserves for income taxes. The liability for gross unrecognized tax benefits at May 31, 2009 was $75 million.

 

CRITICAL ACCOUNTING ESTIMATES

 

The process of preparing financial statements requires the use of estimates on the part of management. The estimates used by management are based on our historical experiences combined with management’s understanding of current facts and circumstances. Certain of our accounting estimates are considered critical as they are both important to the portrayal of our financial condition and results and require significant or complex judgment on the part of management. The following is a summary of certain accounting estimates considered critical by management.

 

Our Audit Committee has reviewed management’s development, selection, and disclosure of the critical accounting estimates.

 

Marketing Costs—We incur certain costs to promote our products through marketing programs, which include advertising, retailer incentives, and consumer incentives. We recognize the cost of each of these types of marketing activities in accordance with generally accepted accounting principles. The judgment required in determining when marketing costs are incurred can be significant. For volume-based incentives provided to retailers, management must continually assess the likelihood of the retailer achieving the specified targets. Similarly, for consumer coupons, management must estimate the level at which coupons will be redeemed by consumers in the future. Estimates made by management in accounting for marketing costs are based primarily on our historical experience with marketing programs with consideration given to current circumstances and industry trends. As these factors change, management’s estimates could change and we could recognize different amounts of marketing costs over different periods of time.

 

In fiscal 2009, we entered into approximately 120,000 individual marketing programs with customers, resulting in annual costs in excess of $2.5 billion, which are reflected as a reduction of net sales. Changes in the assumptions used in estimating the cost of any of the individual customer marketing programs would not result in a material change in our results of operations or cash flows.

 

Advertising and promotion expenses of continuing operations totaled $399 million, $393 million, and $451 million in fiscal 2009, 2008, and 2007, respectively.

 

Income Taxes—Our income tax expense is based on our income, statutory tax rates, and tax planning opportunities available in the various jurisdictions in which we operate. Tax laws are complex and subject to different interpretations by the taxpayer and respective governmental taxing authorities. Significant judgment is

required in determining our income tax expense and in evaluating our tax positions, including evaluating uncertainties under Financial Accounting Standards Board Interpretation (FIN) 48, Accounting for Uncertainty in Income Taxes. Management reviews our tax positions quarterly and adjusts the balances as new information becomes available. Deferred income tax assets represent amounts available to reduce income taxes payable on taxable income in future years. Such assets arise because of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from net operating loss and tax credit carryforwards. Management evaluates the recoverability of these future tax deductions by assessing the adequacy of future expected taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings and available tax planning strategies. These estimates of future taxable income inherently require significant judgment. Management uses historical experience and short and long-range business forecasts to develop such estimates. Further, we employ various prudent and feasible tax planning strategies to facilitate the recoverability of future deductions. To the extent management does not consider it more likely than not that a deferred tax asset will be recovered, a valuation allowance is established.

 

Further information on income taxes is provided in Note 15 to the consolidated financial statements.

 

Environmental Liabilities—Environmental liabilities are accrued when it is probable that obligations have been incurred and the associated amounts can be reasonably estimated. Management works with independent third-party specialists in order to effectively assess our environmental liabilities. Management estimates our environmental liabilities based on evaluation of investigatory studies, extent of required cleanup, our known volumetric contribution, other potentially responsible parties, and our experience in remediating sites. Environmental liability estimates may be affected by changing governmental or other external determinations of what constitutes an environmental liability or an acceptable level of cleanup. Management’s estimate as to our potential liability is independent of any potential recovery of insurance proceeds or indemnification arrangements. Insurance companies and other indemnitors are notified of any potential claims and periodically updated as to the general status of known claims. We do not discount our environmental liabilities as the timing of the anticipated cash payments is not fixed or readily determinable. To the extent that there are changes in the evaluation factors identified above, management’s estimate of environmental liabilities may also change.

 

We have recognized a reserve of approximately $89 million for environmental liabilities as of May 31, 2009. Historically, the underlying assumptions utilized in estimating this reserve have been appropriate as actual payments have neither differed materially from the previously estimated reserve balances, nor have significant adjustments to this reserve balance been necessary. The reserve for each site is determined based on an assessment of the most likely required remedy and a related estimate of the costs required to effect such remedy.

 

Employment-Related Benefits—We incur certain employment-related expenses associated with pensions, postretirement health care benefits, and workers’ compensation. In order to measure the expense associated with these employment-related benefits, management must make a variety of estimates including discount rates used to measure the present value of certain liabilities, assumed rates of return on assets set aside to fund these expenses, compensation increases, employee turnover rates, anticipated mortality rates, anticipated health care costs, and employee accidents incurred but not yet reported to us. The estimates used by management are based on our historical experience as well as current facts and circumstances. We use third-party specialists to assist management in appropriately measuring the expense associated with these employment-related benefits. Different estimates used by management could result in us recognizing different amounts of expense over different periods of time.

 

We recognized pension expense from Company plans of $38 million, $56 million, and $75 million in fiscal years 2009, 2008, and 2007, respectively, which reflected expected returns on plan assets of $159 million, $149 million, and $134 million, respectively. We contributed $112 million, $8 million, and $172 million to our pension plans in fiscal years 2009, 2008, and 2007, respectively. We anticipate contributing approximately $34 million to our pension plans in fiscal 2010.

 

One significant assumption for pension plan accounting is the discount rate. We select a discount rate each year (as of our fiscal year-end measurement date for fiscal 2008 and thereafter) for our plans based upon a hypothetical bond portfolio for which the cash flows from coupons and maturities match the year-by-year projected benefit cash flows for our pension plans. The hypothetical bond portfolio is comprised of high-quality fixed income debt instruments (usually Moody’s Aa) available at the measurement date. Based on this information, the discount rate

selected by us for determination of pension expense was 6.6% for fiscal year 2009 and 5.75% for fiscal 2008 and 2007. We selected a discount rate of 6.9% for determination of pension expense for fiscal 2010. A 25 basis point increase in our discount rate assumption as of the beginning of fiscal 2009 would decrease pension expense for our pension plans by $1.4 million for the year. A 25 basis point decrease in our discount rate assumption as of the beginning of fiscal 2009 would increase pension expense for our pension plans by $1.5 million for the year. A 25 basis point increase in the discount rate would decrease pension expense by approximately $1.6 million for fiscal 2010. A 25 basis point decrease in the discount rate would increase pension expense by approximately $1.7 million for fiscal 2010. For our year-end pension obligation determination, we selected a discount rate of 6.9% and 6.6% for fiscal year 2009 and 2008, respectively.

 

Another significant assumption used to account for our pension plans is the expected long-term rate of return on plan assets. In developing the assumed long-term rate of return on plan assets for determining pension expense, we consider long-term historical returns (arithmetic average) of the plan’s investments, the asset allocation among types of investments, estimated long-term returns by investment type from external sources, and the current economic environment. Based on this information, we selected 7.75% for the long-term rate of return on plan assets for determining our fiscal 2009 pension expense. A 25 basis point increase/decrease in our expected long-term rate of return assumption as of the beginning of fiscal 2009 would decrease/increase annual pension expense for our pension plans by approximately $5 million. We selected an expected rate of return on plan assets of 7.75% to be used to determine our pension expense for fiscal 2010. A 25 basis point increase/decrease in our expected long-term rate of return assumption as of the beginning of fiscal 2010 would decrease/increase annual pension expense for our pension plans by approximately $5 million.

 

When calculating expected return on plan assets for pension plans, we use a market-related value of assets that spreads asset gains and losses (differences between actual return and expected return) over five years. The market-related value of assets used in the calculation of expected return on plan assets for fiscal 2009 was $266 million lower than the actual fair value of plan assets.

 

The rate of compensation increase is another significant assumption used in the development of accounting information for pension plans. We determine this assumption based on our long-term plans for compensation increases and current economic conditions. Based on this information, we selected 4.25% for fiscal years 2009 and 2008 as the rate of compensation increase for determining our year-end pension obligation. We selected 4.25% for the rate of compensation increase for determination of pension expense for fiscal 2009, 2008, and 2007. A 25 basis point increase in our rate of compensation increase assumption as of the beginning of fiscal 2009 would increase pension expense for our pension plans by approximately $1 million for the year. A 25 basis point decrease in our rate of compensation increase assumption as of the beginning of fiscal 2009 would decrease pension expense for our pension plans by approximately $1 million for the year. We selected a rate of 4.25% for the rate of compensation increase to be used to determine our pension expense for fiscal 2010. A 25 basis point increase/decrease in our rate of compensation increase assumption as of the beginning of fiscal 2010 would increase/decrease pension expense for our pension plans by approximately $1 million for the year.

 

We also provide certain postretirement health care benefits. We recognized postretirement benefit expense of $15 million, $23 million, and $10 million in fiscal 2009, 2008, and 2007, respectively. We reflected liabilities of $281 million and $378 million in our balance sheets as of May 31, 2009 and May 25, 2008, respectively. We anticipate contributing approximately $34 million to our postretirement health care plans in fiscal 2010.

 

The postretirement benefit expense and obligation are also dependent on our assumptions used for the actuarially determined amounts. These assumptions include discount rates (discussed above), health care cost trend rates, inflation rates, retirement rates, mortality rates, and other factors. The health care cost trend assumptions are developed based on historical cost data, the near-term outlook, and an assessment of likely long-term trends. Assumed inflation rates are based on an evaluation of external market indicators. Retirement and mortality rates are based primarily on actual plan experience. The discount rate we selected for determination of postretirement expense was 6.4% for fiscal year 2009 and 5.5% for fiscal 2008 and 2007. We have selected a discount rate of 6.6% for determination of postretirement expense for fiscal 2010. A 25 basis point increase/decrease in our discount rate assumption as of the beginning of fiscal 2009 would not have resulted in a material change to postretirement expense for our plans. We have assumed the initial year increase in cost of health care to be 8.5%, with the trend rate

decreasing to 5.5% by 2013. A one percentage point change in the assumed health care cost trend rate would have the following effect:

 

 

We provide workers’ compensation benefits to our employees. The measurement of the liability for our cost of providing these benefits is largely based upon actuarial analysis of costs. One significant assumption we make is the discount rate used to calculate the present value of our obligation. The discount rate used at May 31, 2009 was 4.2%. A 25 basis point increase/decrease in the discount rate assumption would not have a material impact on workers’ compensation expense.

 

Impairment of Long-Lived Assets (including property, plant and equipment), Goodwill and Identifiable Intangible Assets—We reduce the carrying amounts of long-lived assets, goodwill and identifiable intangible assets to their fair values when the fair value of such assets is determined to be less than their carrying amounts (i.e., assets are deemed to be impaired). Fair value is typically estimated using a discounted cash flow analysis, which requires us to estimate the future cash flows anticipated to be generated by the particular asset(s) being tested for impairment as well as to select a discount rate to measure the present value of the anticipated cash flows. When determining future cash flow estimates, we consider historical results adjusted to reflect current and anticipated operating conditions. Estimating future cash flows requires significant judgment by management in such areas as future economic conditions, industry-specific conditions, product pricing, and necessary capital expenditures. The use of different assumptions or estimates for future cash flows could produce different impairment amounts (or none at all) for long-lived assets, goodwill, and identifiable intangible assets.

 

We utilize a “relief from royalty” methodology in evaluating impairment of our indefinite lived brands/trademarks. The methodology determines the fair value of each brand through use of a discounted cash flow model that incorporates an estimated “royalty rate” we would be able to charge a third party for the use of the particular brand. When determining the future cash flow estimates, we must estimate future net sales and a fair market royalty rate for each applicable brand and an appropriate discount rate to measure the present value of the anticipated cash flows. Estimating future net sales requires significant judgment by management in such areas as future economic conditions, product pricing, and consumer trends.

 

In determining an appropriate discount rate to apply to the estimated future cash flows, we consider the current interest rate environment and our estimated cost of capital. As the calculated fair value of our goodwill and other identifiable intangible assets generally significantly exceeds the carrying amount of these assets, a one percentage point increase in the discount rate assumptions used to estimate the fair values of our goodwill and other identifiable intangible assets would not result in a material impairment charge.

 

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

In June 2009, the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R). This statement amends FIN 46(R) to require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity. This analysis identifies the primary beneficiary of a variable interest entity as the enterprise that has both of the following characteristics: the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance, and the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity or the right to receive benefits from the entity that could potentially be significant to the variable interest entity. The provisions of this statement are effective as of the beginning of our fiscal 2011. Earlier application is prohibited. We are currently evaluating the impact of adopting SFAS No. 167.

 

In June 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities. FSP EITF 03-6-1 requires that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are participating securities and must be included in the computation of earnings per share under the two-class method. FSP EITF 03-6-1 is effective as of

the beginning of our fiscal 2010. We do not expect the adoption of this FSP to have a material impact on our financial statements.

 

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51. This statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest (minority interest) in a subsidiary and for the deconsolidation of a subsidiary. Upon its adoption, effective as of the beginning of our fiscal 2010, noncontrolling interests will be classified as equity in our financial statements and income and comprehensive income attributed to the noncontrolling interest will be included in our income and comprehensive income. The provisions of this standard must be applied prospectively, except for the presentation and disclosure requirements. The presentation and disclosure requirements of this standard must be applied retrospectively upon adoption. We are currently evaluating the impact of the adoption of SFAS No. 160 on our consolidated financial position and results of operations.

 

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS No. 141(R)”). SFAS No. 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures the assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree. The provisions of SFAS No. 141(R) are effective for our business combinations occurring on or after June 1, 2009.

 

RELATED PARTY TRANSACTIONS

 

Sales to affiliates (equity method investees) of $1.6 million, $4.2 million, and $3.8 million for fiscal 2009, 2008, and 2007, respectively, were included in net sales. We received management fees from affiliates of $17.8 million, $16.3 million, and $14.8 million in fiscal 2009, 2008, and 2007, respectively. Accounts receivable from affiliates totaled $2.7 million and $3.2 million at May 31, 2009 and May 25, 2008, respectively, of which $3.0 million was included in current assets held for sale at May 25, 2008. Accounts payable to affiliates totaled $14.3 million and $15.6 million at May 31, 2009 and May 25, 2008, respectively.

 

During the first quarter of fiscal 2007, we sold an aircraft for proceeds of approximately $8.1 million to a company on whose board of directors one of the Company’s directors sits. We recognized a gain of approximately $3.0 million on the transaction.

 

From time to time, one of our business units has engaged an environmental and agricultural engineering services firm. The firm is a subsidiary of an entity whose chief executive officer serves on our Board of Directors. Payments to this firm for environmental and agricultural engineering services and structures acquired totaled $0.4 million in each of fiscal 2009 and fiscal 2008.

 

FORWARD-LOOKING STATEMENTS

 

This report, including Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements. These statements are based on management’s current views and assumptions of future events and financial performance and are subject to uncertainty and changes in circumstances. Readers of this report should understand that these statements are not guarantees of performance or results. Many factors could affect our actual financial results and cause them to vary materially from the expectations contained in the forward-looking statements, including those set forth in this report. These factors include, among other things, availability and prices of raw materials; product pricing; future economic circumstances; industry conditions; our ability to execute our operating plans; the success of our innovation, marketing and cost-savings initiatives; the impact of the accident at the Garner manufacturing facility, including the ultimate costs incurred and the amounts received under insurance policies; the competitive environment and related market conditions; operating efficiencies; the ultimate impact of recalls; access to capital; actions of governments and regulatory factors affecting our businesses; and other risks described in our reports filed with the Securities and Exchange Commission. We caution readers not to place undue reliance on any forward-looking statements included in this report, which speak only as of the date of this report.

 

The principal market risks affecting us during fiscal 2009 and 2008 were exposures to price fluctuations of commodity and energy inputs, interest rates, and foreign currencies. These fluctuations impacted raw material and energy costs of all reporting segments, as well as our trading and merchandising activities, which are presented as discontinued operations for all periods presented in our financial statements.

 

Commodities—We purchase commodity inputs such as wheat, corn, oats, soybean meal, soybean oil, meat, dairy products, sugar, natural gas, electricity, and packaging materials to be used in our operations. These commodities are subject to price fluctuations that may create price risk. We enter into commodity hedges to manage this price risk using physical forward contracts or derivative instruments. We have policies governing the hedging instruments our businesses may use. These policies include limiting the dollar risk exposure for each of our businesses. We also monitor the amount of associated counter-party credit risk for all non-exchange-traded transactions. In addition, during our ownership of the trading and merchandising business (divested during quarter one of fiscal 2009), we purchased and sold certain commodities, such as wheat, corn, soybeans, soybean meal, soybean oil, oats, natural gas, and crude oil (presented in discontinued operations).

 

The following table presents one measure of market risk exposure using sensitivity analysis. Sensitivity analysis is the measurement of potential loss of fair value resulting from a hypothetical change of 10% in market prices. Actual changes in market prices may differ from hypothetical changes. In practice, as markets move, we actively manage our risk and adjust hedging strategies as appropriate.

 

Fair value was determined using quoted market prices and was based on our net derivative position by commodity at each quarter-end during the fiscal year.

 

The market risk exposure analysis excludes the underlying commodity positions that are being hedged. The values of commodities hedged have a high inverse correlation to price changes of the derivative commodity instrument.

 

Effect of 10% change in market prices:

 

 

Interest Rates—We may use interest rate swaps to manage the effect of interest rate changes on the fair value of our existing debt as well as the forecasted interest payments for the anticipated issuance of debt. At the end of fiscal 2009 and 2008, we did not have any interest rate swap agreements outstanding.

 

As of May 31, 2009 and May 25, 2008, the fair value of our fixed rate debt was estimated at $3.7 billion, based on current market rates primarily provided by outside investment advisors. As of May 31, 2009 and May 25, 2008, a one percentage point increase in interest rates would decrease the fair value of our fixed rate debt by approximately $196 million and $228 million, respectively, while a one percentage point decrease in interest rates would increase the fair value of our fixed rate debt by approximately $307 million and $258 million, respectively.

 

Foreign Operations—In order to reduce exposures related to changes in foreign currency exchange rates, we may enter into forward exchange or option contracts for transactions denominated in a currency other than the functional currency for certain of our processing operations. This activity primarily relates to hedging against foreign currency risk in purchasing inventory, capital equipment, sales of finished goods, and future settlement of foreign denominated assets and liabilities.

The following table presents one measure of market risk exposure using sensitivity analysis for our processing operations. Sensitivity analysis is the measurement of potential loss of fair value resulting from a hypothetical change of 10% in exchange rates. Actual changes in exchange rates may differ from hypothetical changes.

 

Fair value was determined using quoted exchange rates and was based on our net foreign currency position at each quarter-end during the fiscal year.

 

The market risk exposure analysis excludes the underlying foreign denominated transactions that are being hedged. The currencies hedged have a high inverse correlation to exchange rate changes of the foreign currency derivative instrument.

 

Effect of 10% change in exchange rates:

 

 

CONSOLIDATED STATEMENTS OF EARNINGS

Dollars in millions except per share amounts

 

 

The accompanying Notes are an integral part of the consolidated financial statements.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Dollars in millions

 

 

The accompanying Notes are an integral part of the consolidated financial statements.

 

 

The accompanying Notes are an integral part of the consolidated financial statements.