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 o  No þ

 

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 (232.405 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 27, 2009 (the last business day of the Registrant’s most recently completed second fiscal quarter) was approximately $9,826,639,222 based upon the closing sale price on the New York Stock Exchange on such date.

 

At June 27, 2010, 442,764,069 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 2010 Annual Meeting of Stockholders (the “2010 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 96% of America’s households. ConAgra Foods also has a strong business-to-business presence, supplying frozen potato and sweet potato products, as well as other vegetable, spice, and grain products to a variety of well-known restaurants, foodservice operators, and commercial customers.

 

ConAgra Foods is focused on growing sales, 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, 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 on the following initiatives, designed to enhance the performance of our five strategic product groups: 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, 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, private label, and customized 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.

 

Major brands include: Alexia^®, ACT II^®, Banquet^®, Blue Bonnet^®, Chef Boyardee^®, DAVID^®, Egg Beaters^®, Healthy Choice^®, Hebrew National^®, Hunt’s^®, Marie Callender’s^®, Orville Redenbacher’s^®, PAM^®, Peter Pan^®, Reddi-wip^®, Slim Jim^®, Snack Pack^®, Swiss Miss^®, Van Camp’s^®, and Wesson^®.

 

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^®, 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

 

In June 2010, subsequent to the end of our fiscal 2010, we acquired the assets of American Pie, LLC, a manufacturer of frozen fruit pies, thaw and serve pies, fruit cobblers, and pie crusts under the licensed Marie Callender’s^® and Claim Jumper^® trade names, as well as frozen dinners, pot pies, and appetizers under the Claim Jumper^® trade name. This business is included in the Consumer Foods segment.

 

On April 12, 2010, we acquired Elan Nutrition, Inc. (“Elan”), a privately held formulator and manufacturer of snack and nutrition bars. This business is included in the Consumer Foods segment.

 

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

 

Also during 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 fiscal 2008, we acquired:

 

 

Divestitures

 

In July 2010, subsequent to the end of our fiscal 2010, we completed the sale of substantially all of the assets of Gilroy Foods & Flavors^tm dehydrated garlic, onion, capsicum and Controlled Moisture^tm, GardenFrost^®, Redi-Made^tm, and fresh vegetable operations for $250 million in cash, subject to final working capital adjustments. We reflected the results of these operations as discontinued operations for all periods presented. The assets and liabilities of the discontinued Gilroy Foods & Flavors^tm dehydrated vegetable business have been reclassified as assets and liabilities held for sale within our consolidated balance sheets for all periods presented.

 

In the first quarter of fiscal 2010, we completed the divestiture of the Fernando’s^® foodservice brand. 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 prior to the divestiture.

 

During fiscal 2009, we completed the sale of our Pemmican^® beef jerky business. Due to our continuing involvement with the business through providing sales and distribution support to the buyer, the results of operations of the Pemmican^® business have not been reclassified as discontinued operations.

 

During fiscal 2009, 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 fiscal 2008, we completed the 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.

 

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 and value-added consumer products. We also manufacture and sell private label 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 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 $78 million, $78 million, and $67 million in fiscal 2010, 2009, and 2008, 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 of backlog orders 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 18%, 17%, and 15% of consolidated net sales for fiscal 2010, 2009, and 2008, respectively.

 

At May 30, 2010, ConAgra Foods and its subsidiaries had approximately 24,400 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 25% are parties to collective bargaining agreements that are scheduled to expire during fiscal 2011. We believe that our relationships with employees and their representative organizations are good.

 

 

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 from July 2004 to January 2009. 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, in February 2008, she

was named Senior Vice President, General Counsel and Corporate Secretary, and in September 2009, she was named Executive 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.

 

Robert F. Sharpe, Jr. has served ConAgra Foods as Executive Vice President, Chief Administrative Officer and President, Commercial Foods since October of 2009. Previously, he served ConAgra Foods as Executive Vice President, External Affairs and President, Commercial Foods from June 2008 until October 2009; 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 22, 2010

 

 

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 (an accounting firm).

 

Nicole B. Theophilus joined ConAgra Foods in April 2006 as Vice President, Chief Employment Counsel. In 2008, in addition to her legal duties, she assumed the role of Vice President, Human Resources for Commercial Foods. In November 2009, she was named to her current position. Prior to joining ConAgra Foods, she was an attorney and partner with Blackwell Sanders Peper Martin LLP (a law firm) from 1999 until 2006.

 

 

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 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 risks and uncertainties could affect our operating results and should be considered in evaluating us. While we believe we have identified and discussed below the key risk factors affecting our business, there may be additional risks and uncertainties that are not presently known or that are not currently believed to be significant that may adversely affect our business, performance, or financial condition in the future.

 

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. In most product categories, we compete not only with other widely advertised branded products, but also with generic and private label products that are generally sold at lower prices. A strong competitive response from one or more of our competitors to our marketplace efforts, or a consumer shift towards private label offerings, could result in us reducing pricing, increasing marketing or other expenditures, or losing market share. 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, including concerns of consumers regarding health and wellness, obesity, product attributes, and ingredients. Introduction of new products and product extensions requires significant development and marketing investment. If our products fail to meet consumer preference, or we fail to introduce new and improved products on a timely basis, 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. Similarly, demand for our products could be affected by consumer concerns regarding the health effects of ingredients such as sodium, trans fats, sugar, processed wheat, or other product ingredients or attributes.

 

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. 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, the health and safety of our employees, and the protection of the environment. 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. Changes in applicable laws or regulations or evolving interpretations thereof, including increased government regulations to limit carbon dioxide and other greenhouse gas emissions as a result of concern over climate change, may result in increased compliance costs, capital expenditures, and other financial obligations for us, which could affect our profitability or impede the production or distribution of our products, which could affect our net operating revenues.

 

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 began implementing new financial and operational information technology systems in fiscal 2008 and placed systems into production during fiscal 2008, 2009, and 2010. Additional changes and enhancements will be placed into production at various times in fiscal 2011. 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 also lease many sales offices mainly in the United States.

 

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.

 

As of July 22, 2010, thirty-nine domestic manufacturing facilities in Arkansas, California, Georgia, Illinois, Indiana, Iowa, Massachusetts, Michigan, Minnesota, Missouri, Nebraska, North Carolina, Ohio, Oregon, Pennsylvania, Tennessee, 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.

 

As of July 22, 2010, forty-one domestic production facilities in Alabama, California, Colorado, Florida, Georgia, Idaho, Illinois, Minnesota, Nebraska, New Jersey, 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 each of Colorado, Minnesota, Washington, and the United Kingdom; one 67% owned manufacturing facility in Puerto Rico, and three 50% owned manufacturing facilities in the Netherlands.

 

In addition, we are currently constructing a potato processing facility near Delhi, Louisiana, which is scheduled to open in the fall of 2010.

 

 

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 us. The litigation includes 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 36 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 clean-up, the known volumetric contribution of Beatrice and other potentially responsible parties, and our experience in remediating sites. The reserves for Beatrice environmental matters totaled $70 million as of May 30, 2010, a majority of which relates to the Superfund and state-equivalent sites referenced above. The reserve for Beatrice environmental matters reflects a reduction in pre-tax expense of approximately $15 million made in the third quarter of fiscal 2010 due to favorable regulatory developments at one of the sites. We expect expenditures for Beatrice environmental matters to continue for 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 million during the third quarter of fiscal 2009 in connection with the disputed coverage with this insurance carrier. During the second quarter of fiscal 2010, a Delaware state court rendered a decision on certain matters in our claim for the disputed coverage favorable to the insurance carrier. We intend to appeal this decision and continue to pursue this matter vigorously.

 

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 of us by the CFTC. The investigation may result in litigation by the CFTC against us. 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 us that it questions whether certain trading activities of the former subsidiary violated the Commodity Exchange Act 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, we believe that both we and the former subsidiary have meritorious defenses. There have been discussions with the CFTC concerning resolution of this matter. We also believe the sale contract with the purchaser 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 our financial condition or results of operations. If litigation ensues, we intend to defend this matter 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.

 

 

 

Our common stock is listed on the New York Stock Exchange where it trades under the ticker symbol: CAG. At June 27, 2010, there were approximately 24,600 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 2010, 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:

 

 

 

 

 

 

 

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 30, 2010 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 96% 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 frozen potato and sweet potato products, as well as other vegetable, spice, and grain products to a variety of well-known restaurants, foodservice operators, and commercial customers.

 

Fiscal 2010 diluted earnings per share were $1.62, including $1.67 per diluted share of income from continuing operations and a loss of $0.05 per diluted share from discontinued operations. Fiscal 2009 diluted earnings per share were $2.15, including income from continuing operations of $1.36 per diluted share and income from discontinued operations of $0.79 per diluted share. Several items affect the comparability of results, as discussed below.

 

Items Impacting Comparability

 

Items of note impacting comparability for fiscal 2010 included the following:

 

Reported within Continuing Operations

 

 

Reported within Discontinued Operations

 

 

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

 

Reported within Continuing Operations

 

 

In addition, fiscal 2009 diluted income per share benefited by approximately $0.03 as a result of the fiscal year including 53 weeks.

 

Recent developments in our strategies and action plans include:

 

Garner, North Carolina Accident

 

On June 9, 2009, an accidental explosion occurred at our manufacturing facility in Garner, North Carolina (the “Garner accident”). This facility was the primary production facility for our Slim Jim^® branded meat snacks. 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 anticipated losses arising from this accident.

 

The costs incurred and insurance recoveries recognized, to date, are reflected in our consolidated financial statements, as follows:

 

 

The amounts in the table, above, exclude lost profits due to the interruption of the business, as well as any related business interruption insurance recoveries.

 

Through May 30, 2010, we had received payment advances from the insurers of approximately $85 million for our initial insurance claims for this matter, $58 million of which has been recognized as a reduction to selling, general and administrative expenses. We anticipate final settlement of the claim will occur in fiscal 2011. Based on management’s current assessment of production options, the expected level of insurance proceeds, and the estimated potential amount of losses and impact on the Slim Jim^® brand, we do not believe that the accident will have a material adverse effect on our results of operations, financial condition, or liquidity. We expect Slim Jim^® profitability to reach pre-accident levels by fiscal 2012.

 

In the fourth quarter of fiscal 2010, we determined that certain additional equipment located in the facility, with a carrying value of approximately $12 million, was impaired (impairment included in the table above). We expect to be reimbursed by our insurers for the cost of replacing these assets, and we have recognized a $12 million insurance recovery in fiscal 2010 (included in the table above), representing the carrying value of these destroyed assets.

 

Restructuring Plans

 

In March 2010, we announced a plan, authorized by our Board of Directors, related to the long-term production of our meat snack products. The plan provides for the closure of our meat snacks production facility in Garner, North Carolina, and the movement of production to our existing facility in Troy, Ohio. Since the Garner accident, the Troy facility has been producing a portion of our meat snack products. Upon completion of the plan’s implementation, which is expected to be in the second quarter of fiscal 2012, the Troy facility will be our primary meat snacks production facility. This plan is expected to result in the termination of approximately 500 employee positions in Garner and the creation of approximately 200 employee positions in Troy.

In May 2010, we made a decision to move certain administrative functions from Edina, Minnesota, to Naperville, Illinois. We expect to complete the transition of these functions in the first half of fiscal 2011. This plan, together with the plan to move production of our meat snacks from Garner, North Carolina to Troy, Ohio, are collectively referred to as the 2010 restructuring plan (“2010 plan”). In connection with the 2010 plan, we expect to incur pre-tax cash and non-cash charges for asset impairments, accelerated depreciation, severance, relocation, and site closure costs of $67 million. In fiscal 2010, we recognized charges of approximately $39 million in relation to these plans.

 

As part of a focus on cost reduction, we previously initiated restructuring plans focused on streamlining our supply chain, reducing selling, general, and administrative costs (“2006-2008 restructuring plan”), and streamlining the Consumer Foods international operations (“2008-2009 restructuring plan”). As part of the 2006-2008 restructuring plan, we began construction of a new production facility in fiscal 2007. As a result of an updated assessment of manufacturing strategies and the related impact on this partially completed production facility, we decided to divest this facility. Accordingly, in the fourth quarter of fiscal 2010, we recognized a non-cash impairment charge of $33 million, representing a write-down of the carrying value of the assets to fair value based on anticipated proceeds from the sale. This charge is reflected in selling, general and administrative expenses within the Consumer Foods segment.

 

Acquisitions

 

In June 2010, subsequent to the end of our fiscal 2010, we acquired the assets of American Pie, LLC, a manufacturer of frozen fruit pies, thaw and serve pies, fruit cobblers, and pie crusts under the licensed Marie Callender’s^® and Claim Jumper^® trade names, as well as frozen dinners, pot pies, and appetizers under the Claim Jumper^® trade name. This business is included in the Consumer Foods segment.

 

During the fourth quarter of fiscal 2010, we completed the acquisition of Elan Nutrition (“Elan”), a privately held formulator and manufacturer of private label snack and nutrition bars, for approximately $103 million in cash. We expect the acquisition to add approximately $100 million to our Consumer Foods segment net sales in fiscal 2011, and we expect this acquisition to be accretive to operating cash flows immediately.

 

Divestiture of Gilroy Dehydrated Vegetable Business

 

In July 2010, subsequent to the end of our fiscal 2010, we completed the sale of substantially all of the assets of Gilroy Foods & Flavors^tm dehydrated garlic, onion, capsicum and Controlled Moisture^tm, GardenFrost^®, Redi-Made^tm, and fresh vegetable operations for $250 million in cash, subject to final working capital adjustments. Based on our estimate of proceeds from the sale of this business, we recognized impairment and related charges totaling $59 million ($40 million after-tax) in the fourth quarter of fiscal 2010. We reflected the results of these operations as discontinued operations for all periods presented.

 

Sweet Potato Investment

 

In August 2009, we announced plans to build a new, environmentally friendly potato processing facility near Delhi, Louisiana, designed primarily to process sweet potatoes from the region into french fries and related products. As anticipated, the new facility is scheduled to open in the fall of 2010.

 

SEGMENT REVIEW

 

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

 

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.

During fiscal 2010, we completed the transition of the direct management of the Consumer Foods reporting segment from the Chief Executive Officer to the Consumer Foods President position. In conjunction with this organizational change, beginning in fiscal 2010, we have aligned our segment reporting to be consistent with the manner in which our operating results are presented to, and reviewed by, our Chief Executive Officer. All prior periods have been recast to reflect this change.

 

In February 2010, we completed the sale of our Luck’s^® brand for proceeds of approximately $22 million in cash, resulting in a pre-tax gain of $14 million ($9 million after-tax), reflected in selling, general and administrative expenses.

 

In June 2009, we completed the divestiture of the Fernando’s^® foodservice business for proceeds of $6 million in cash. We reflect 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 prior to divestiture.

 

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, and a variety of vegetable products, seasonings, blends, and flavors, which are sold under brands such as ConAgra Mills^®, Lamb Weston^®, and Spicetec^®.

 

During the first quarter of fiscal 2010, we transferred the management of the Alexia^® frozen food operations from the Consumer Foods segment to the Commercial Foods segment. Segment results have been recast to reflect this change.

 

As discussed above, we reflected the results of the Gilroy Foods & Flavors^TM operations as discontinued operations for all periods presented. The assets and liabilities of the divested Gilroy Foods & Flavors^TM dehydrated vegetable business have been reclassified as assets and liabilities held for sale within our consolidated balance sheets for all periods presented.

 

Presentation of Derivative Gains (Losses) for Economic Hedges of Forecasted Cash Flows in Segment Results

 

In fiscal 2009, following the sale of our trading and merchandising operations and related organizational changes, 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 economically 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 economically 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.

 

Foreign currency derivatives used to manage foreign currency risk of forecasted cash flows are not designated for hedge accounting treatment. We believe these derivatives provide economic hedges of the foreign currency risk of certain forecasted transactions. 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.

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

 

 

Based on our forecasts of the timing of recognition of the underlying hedged items, we expect to reclassify losses of $5 million and gains of $2 million to segment operating results in fiscal 2011 and 2012 and thereafter, respectively. Amounts allocated, or to be allocated, to segment operating results during fiscal 2010 and 2011 include $5 million of losses incurred during fiscal 2009.

 

During fiscal 2008, derivative instruments used to create economic hedges of such commodity inputs were marked-to-market each period with both realized and unrealized changes in market value immediately included in cost of goods sold within segment operating profit. In fiscal 2008, net derivative gains from economic hedges of forecasted commodity consumption and foreign currency risk of certain forecasted transactions were $63 million in the Consumer Foods segment and $23 million in the Commercial Foods segment.

 

2010 vs. 2009

 

Net Sales

($ in millions)

 

 

Overall, our net sales decreased $347 million to $12.08 billion in fiscal 2010, primarily driven by fiscal 2009 including 53 weeks, as well as lower flour milling net sales in fiscal 2010 resulting from lower underlying wheat costs passed on to customers. This decrease was partially offset by improved pricing and mix in the Consumer Foods segment and the Lamb Weston^® specialty potato products business in the Commercial Foods segment. Volume reflected a benefit of approximately 2% in fiscal 2009 due to the inclusion of the additional week of results.

 

Consumer Foods net sales for fiscal 2010 were $8.0 billion, basically flat as compared to fiscal 2009. Results reflected flat volume and essentially unchanged net pricing and mix. Volume reflected a benefit of approximately 2% in fiscal 2009 due to the inclusion of the additional week of results. Excluding the impact of the additional week, volume increased 2% in fiscal 2010, reflecting successful innovation and marketing.

 

Sales of products associated with some of our other most significant brands, including Chef Boyardee^®, Healthy Choice^®, Hunt’s^®, Marie Callender’s^®, Orville Redenbacher’s^®, Reddi-wip^®, and Snack Pack^® grew in fiscal 2010. Sales of Blue Bonnet^® and Wesson^® declined by 19% and 7%, respectively, in fiscal 2010, as compared to fiscal 2009, largely due to the impact of passing through lower vegetable oil costs. Other significant brands whose products experienced sales declines in fiscal 2010 include ACT II^®, Banquet^®, Egg Beaters^®, Kid Cuisine^®, Libby’s^®, PAM^®, and Slim Jim^®.

Commercial Foods net sales were $4.08 billion in fiscal 2010, a decrease of $370 million, or 8% compared to fiscal 2009. Net sales in our flour milling business were approximately $330 million lower in fiscal 2010 than in fiscal 2009, principally reflecting the pass-through of lower wheat prices. Results also reflected a slight decrease in sales in our Lamb Weston^® specialty potato products business, reflecting lower volume of approximately 2%, partially offset by improved pricing and mix. Volume reflected a benefit of approximately 2% in fiscal 2009 due to the inclusion of the additional week of results. Excluding the impact of the additional week, volume was essentially unchanged in fiscal 2010, as compared to fiscal 2009.

 

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

 

SG&A expenses totaled $1.82 billion for fiscal 2010, an increase of 8% compared to fiscal 2009. We estimate that the inclusion of the extra week in the fiscal 2009 results increased SG&A expenses by approximately 2% in that fiscal year.

 

Selling, general and administrative expenses for fiscal 2010 reflected the following:

 

 

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

 

 

Operating Profit

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

($ in millions)

 

 

Consumer Foods operating profit increased $164 million in fiscal 2010 versus the prior year to $1.1 billion. Gross profits were $262 million higher in fiscal 2010 than in fiscal 2009 driven by the impact of lower commodity input costs and the benefit of supply chain cost savings initiatives. Consumer Foods SG&A expenses were higher in fiscal 2010 than in fiscal 2009, reflecting a $35 million increase in incentive compensation expenses and a $22 million increase in advertising and promotion expenses. The Consumer Foods segment recognized a $14 million gain on the sale of the Luck’s^® brand in fiscal 2010. Charges totaling $36 million were recognized in the Consumer Foods segment in fiscal 2010 in connection with our 2010 plan, including charges related to our decision to move manufacturing activities in Garner, North Carolina to Troy, Ohio, and our decision to move administrative functions in Edina, Minnesota to Naperville, Illinois. An additional charge of $33 million was recognized in connection with the impairment of a production facility, as we made a decision to divest the partially completed facility. The Consumer Foods segment recognized a $19 million gain on the sale of the Pemmican^® brand, incurred costs of product recalls classified as SG&A expense of $11 million, and incurred costs of $8 million in connection with our restructuring plans in fiscal 2009. The impact of foreign currencies, including related economic hedges, resulted in a reduction of operating profit of approximately $9 million in fiscal 2010, as compared to fiscal 2009.

 

The Garner accident in June 2009 resulted in charges within SG&A totaling $47 million for the impairment of property, plant and equipment, workers’ compensation, site clean-up, and other related costs in fiscal 2010 (in addition to inventory write-downs and other related costs of $12 million recognized in cost of goods sold). The impact of these charges was offset by insurance recoveries of $58 million in fiscal 2010 for the involuntary conversion of assets. Gross profits from Slim Jim^® branded products were $25 million and $51 million in fiscal 2010 and 2009, respectively, reflecting the impact of the disruption of production due to the accident.

 

Commercial Foods operating profit decreased $4 million in fiscal 2010 versus the prior year to $539 million. Improved gross profits in the flour milling business were partially offset by reduced gross profits in the specialty blend and flavorings business and the specialty potato business. Gross profits continued to be negatively impacted by challenging conditions in the foodservice channel as well as high production costs associated with a high cost and poor quality potato crop in our specialty potato business. Commercial Foods SG&A expenses were higher in fiscal 2010 than in fiscal 2009, reflecting a $5 million increase in incentive compensation expenses. Commercial Foods operating profit for fiscal 2009 reflected the benefit of the additional week of operations.

 

Interest Expense, Net

 

In fiscal 2010, net interest expense was $160 million, a decrease of $26 million, or 14%, from fiscal 2009. The reduction in net interest expense is primarily the result of increased capitalized interest and increased interest income in fiscal 2010. Interest income includes $83 million and $73 million in fiscal 2010 and 2009, respectively, from the payment-in-kind notes received in June 2008 in connection with the divestiture of our trading and merchandising operations.

 

Income Taxes

 

Our income tax expense was $362 million and $319 million in fiscal 2010 and 2009, respectively. 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 33% for fiscal 2010 and 34% in fiscal 2009. The lower effective tax rate in fiscal 2010 was reflective of favorable changes in estimates and audit settlements, as well as certain income tax

credits and deductions identified in fiscal 2010 that related to prior periods. These benefits were offset, in part, by unfavorable tax consequences of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010.

 

The Company expects its effective tax rate in fiscal 2011, exclusive of any unusual transactions or tax events, to be approximately 34%.

 

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 $22 million ($2 million in the Consumer Foods segment and $20 million in the Commercial Foods segment) and $24 million ($3 million in the Consumer Foods segment and $21 million in the Commercial Foods segment) in fiscal 2010 and 2009, respectively. Equity method investment earnings in the Commercial Foods segment reflects continued difficult market conditions for our foreign and domestic potato ventures.

 

Results of Discontinued Operations

 

Our discontinued operations generated an after-tax loss of $22 million in fiscal 2010 and earnings of $361 million in fiscal 2009. In fiscal 2010, we decided to divest our dehydrated vegetable operations. As a result of this decision, we recognized an after-tax impairment charge of $40 million in fiscal 2010, representing a write-down of the carrying value of the related long-lived assets to fair value, based on the anticipated sales proceeds. 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 decided to sell certain small foodservice brands. The sale of these brands was completed in June 2009. We recognized after-tax impairment charges of $6 million in fiscal 2009, in anticipation of this divestiture.

 

Earnings Per Share

 

Our diluted earnings per share in fiscal 2010 were $1.62 (including earnings of $1.67 per diluted share from continuing operations and a loss of $0.05 per diluted share from discontinued operations). Our diluted earnings per share in fiscal 2009 were $2.15 (including earnings of $1.36 per diluted share from continuing operations and $0.79 per diluted share from discontinued operations) See “Items Impacting Comparability” above as several other significant items affected the comparability of year-over-year results of operations.

 

2009 vs. 2008

 

Net Sales

($ in millions)

 

 

Overall, our net sales increased $1.18 billion to $12.43 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, as well as an additional week in fiscal 2009.

 

Consumer Foods net sales for fiscal 2009 were $7.98 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.

Sales of some of the segment’s most significant brands, including Banquet^®, Blue Bonnet^®, Chef Boyardee^®, Crunch ’N Munch^®, DAVID^®, Healthy Choice^®, Hebrew National^®, Hunt’s^®, Kid Cuisine^®, La Choy^®, Libby’s^®, Manwich^®, Marie Callender’s^®, Peter Pan^®, Orville Redenbacher’s^®, Reddi-wip^®, Rosarita^®, Ro*Tel^®, Slim Jim^®, Snack Pack^®, Swiss Miss^®, The Max^®, Van Camp’s^®, and Wesson^® grew in fiscal 2009. Sales of ACT II^®, Egg Beaters^®, and Pemmican^® declined in fiscal 2009.

 

Commercial Foods net sales were $4.45 billion in fiscal 2009, an increase of $599 million, or 16% 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.

 

SG&A Expenses (includes General Corporate Expense) (“SG&A”)

 

SG&A expenses totaled $1.68 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%.

 

SG&A expenses for fiscal 2009 reflected the following:

 

 

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

 

 

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

($ in millions)

 

 

Consumer Foods operating profit increased $119 million in fiscal 2009 versus the prior year to $949 million. Consumer Foods gross profit for fiscal 2009 was $2.03 billion, an increase of $45 million, or 2%, compared to fiscal 2008. The increase in gross profit reflected improved net pricing and mix and significant supply chain productivity savings, partially offset by significantly higher input costs. Consumer Foods gross profit in fiscal 2008 included approximately $28 million of costs related to the recalls of pot pie and peanut butter products. The increase in operating profit was also reflective of a number of other factors, including:

 

 

Commercial Foods operating profit increased $77 million to $543 million in fiscal 2009. Operating profit improvement was principally driven by the improved gross profit. Commercial Foods gross profit was $758 million for fiscal 2009, an increase of $90 million, or 13%, 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 gross profit in our flour milling operations due to high quality wheat crops and improved flour conversion margins. Our Lamb Weston BSW specialty potato business achieved increased gross profit in fiscal 2009, reflecting gross profit 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.

 

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.

 

Income Taxes

 

Our income tax expense was $319 million and $210 million in fiscal 2009 and 2008, respectively. 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 and 30% in 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.

 

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 foreign potato venture’s market.

 

Results of Discontinued Operations

 

Our discontinued operations generated after-tax earnings of $361 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 decided to divest 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 fiscal 2009, in anticipation of this divestiture.

 

Our discontinued operations generated after-tax earnings of $439 million in fiscal 2008.

 

Earnings Per Share

 

Our diluted earnings per share in fiscal 2009 were $2.15 (including earnings of $1.36 per diluted share from continuing operations and $0.79 per diluted share from discontinued operations). Our diluted earnings per share in fiscal 2008 were $1.90 (including earnings of $1.00 per diluted share from continuing operations and $0.90 per diluted share from discontinued operations).

 

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. If necessary, we 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 30, 2010, 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 principally as a back-up facility for our commercial paper program. As of May 30, 2010, 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 2010, the Company was in compliance with these financial covenants.

 

As of the end of fiscal 2010, 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.

 

We have repurchased shares of our common stock from time to time after considering market conditions as well as repurchase limits authorized by our Board of Directors. In February 2010, our Board of Directors approved a $500 million share repurchase program with no expiration date. We repurchased approximately 4 million shares of our common stock for approximately $100 million under this program in the fourth quarter of fiscal 2010. We completed an accelerated share repurchase program during fiscal 2009. We paid $900 million and received 38.4 million shares in the first quarter of fiscal 2009 when the program was initiated and an additional 5.6 million shares in the fourth quarter of fiscal 2009 under this program.

 

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.

 

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 (original principal amount) of payment-in-kind debt securities issued by the purchaser that were recorded at an initial estimated fair value of $479 million (the “Notes”), 3) a short-term receivable of $37 million due from the purchaser (which was subsequently collected in December 2008), 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. In May 2010, we received $115 million as payment in full of all principal and interest due on the first tranche of notes from the purchaser, in advance of the scheduled June 19, 2010 maturity date. The remaining Notes had a carrying value of $490 million at May 30, 2010.

 

During the fourth quarter of fiscal 2010, we completed the sale of approximately 17,600 acres of farmland to an unrelated buyer and immediately entered into a long-term lease of the land with an affiliate of the buyer. We received proceeds of approximately $75 million in cash, removed the land from our balance sheet, and recorded a deferred gain of approximately $30 million (reflected primarily in noncurrent liabilities). The lease agreement has an initial term of ten years and two five-year renewal options. This lease will be accounted for as an operating lease. We will recognize the deferred gain as a reduction of rent expense over the lease term.

 

In July 2010, subsequent to the end of our fiscal 2010, we completed the sale of substantially all of the assets of Gilroy Foods & Flavors^tm dehydrated garlic, onion, capsicum and Controlled Moisture^tm, GardenFrost^®, Redi-Made^tm, and fresh vegetable operations for $250 million in cash, subject to final working capital adjustments.

 

Cash Flows

 

In fiscal 2010, we generated $710 million of cash, which was the net result of $1.47 billion generated from operating activities, $355 million used in investing activities, and $405 million used in financing activities.

 

Cash generated from operating activities of continuing operations totaled $1.44 billion for fiscal 2010 as compared to $987 million generated in fiscal 2009, reflecting increased income from continuing operations in fiscal 2010 and successful execution of our working capital management initiatives. Improvement in our accounts payable and inventory balances reflect the impact of our working capital initiatives as well as lower commodity costs in our flour milling business. The year-over-year improvement in operating cash flows also reflects lower incentive payments made in fiscal 2010 (earned in fiscal 2009), than those made in fiscal 2009. We also contributed $123 million to our Company-sponsored pension plans in fiscal 2010. Also included in cash generated from operating activities of continuing operations are insurance advances of $50 million for reimbursement of out-of-pocket expenses and foregone profits associated with the Garner, North Carolina accident. Cash generated from operating activities of discontinued operations was $30 million in fiscal 2010, primarily reflecting income from operations of the discontinued Gilroy Foods & Flavors^tm dehydrated vegetable business and reduced inventory balances within that business. Cash used in operating activities of discontinued operations was $863 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 investing activities of continuing operations totaled $353 million in fiscal 2010 and $461 million in fiscal 2009. Investing activities of continuing operations in fiscal 2010 consisted primarily of capital expenditures of $483 million and acquisitions of businesses and intangibles (including Elan) totaling $107 million, partially offset by sales of businesses and brands (including the Luck’s^® brand) of $22 million and sales of property, plant and equipment of $88 million. Also included in investing activities of continuing operations in fiscal 2010 was a cash inflow of $92 million (of the total receipt of $115 million) representing the payment in full of all principal and interest due on the first tranche of Notes from Gavilon, LLC, in advance of the scheduled maturity date (the remaining $23 million is reflected as cash generated from operating activities of continuing operations), and insurance advances of $35 million for the replacement of property, plant and equipment destroyed in the Garner accident. Investing activities of continuing operations in fiscal 2009 consisted primarily of capital expenditures of $430 million and expenditures of $80 million for acquisition of businesses and intangible assets. We generated

$2.25 billion of cash from investing activities of discontinued operations in fiscal 2009 from the disposition of the trading and merchandising business.

 

Cash used in financing activities totaled $405 million in fiscal 2010, as compared to cash used in financing activities of $1.83 billion in fiscal 2009. During fiscal 2010, we paid dividends of $347 million and repurchased approximately 4 million shares of our common stock for $100 million. During fiscal 2010, we also received net proceeds of $55 million from employees exercising stock options and tax payments related to issuance of stock awards. 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).

 

We estimate our capital expenditures in fiscal 2011 will be approximately $525 million, which will be partly offset by anticipated insurance proceeds related to the Garner accident. 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 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 (in millions):

 

 

The liabilities recognized as a result of consolidating Lamb Weston BSW do not represent additional claims on our general assets. The creditors of Lamb Weston BSW have claims only on the assets of the specific variable

interest entity to which they have advanced credit. The assets recognized as a result of consolidating Lamb Weston BSW are the property of the venture and are not available to us for any other purpose.

 

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 30, 2010, were recognized as liabilities in our consolidated balance sheet. Operating lease obligations and unconditional purchase obligations, which totaled approximately $692 million as of May 30, 2010, were not recognized as liabilities in our consolidated balance sheet, in accordance with generally accepted accounting principles.

 

A summary of our contractual obligations at the end of fiscal 2010 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 30, 2010 was approximately 6.9%.

 

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 from long-term debt, in the table above, include $83 million of liabilities of these variable interest entities to the creditors of such entities. The long-term debt recognized as a result of consolidating Lamb Weston BSW entity does not represent additional claims on our general assets. The creditors of Lamb Weston BSW have claims only on the assets of the specific variable interest entity.

 

The purchase obligations noted in the table above do not reflect approximately $458 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 2010, is as follows:

 

In certain limited situations, we will guarantee an obligation of an unconsolidated entity. We guarantee certain leases and other commercial obligations resulting from the 2002 divestiture of our fresh beef and pork operations. The remaining terms of these arrangements do not exceed six years and the maximum amount of future payments we have guaranteed was approximately $16 million as of May 30, 2010. 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 30, 2010, the amount of supplier loans effectively guaranteed by us was approximately $29 million. 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 portion of a loan of this supplier, under certain conditions. At May 30, 2010, the term of the loan is 14 years. The amount of our guaranty was $25 million as of May 30, 2010. 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 guaranty, as we believe the likelihood of financial exposure to us under this agreement is remote.

 

Federal income tax credits were generated related to our sweet potato production facility currently under construction in Delhi, Louisiana. Third parties invested in certain of these income tax credits. We have guaranteed these third parties the face value of these income tax credits over their statutory lives, a period of seven years, in the event that the income tax credits are recaptured or reduced. The face value of the income tax credits was $21 million as of May 30, 2010. We believe the likelihood of the recapture or reduction of the income tax credits is remote, and therefore we have not established a liability in connection with this guarantee.

 

The obligations and commitments tables above do not include any reserves for uncertainties in income taxes, 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 30, 2010 was $53 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, customer incentives, and consumer incentives. We recognize the cost of each of these types of marketing activities as incurred, 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 customers, management must continually assess the likelihood of the customer 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.

During fiscal 2010, we entered into over 120,000 individual marketing programs with customers and consumers, resulting in costs in excess of $2.5 billion. These costs 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 $409 million, $381 million, and $377 million in fiscal 2010, 2009, and 2008, 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. Management reviews tax positions at least 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 16 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 $71 million for environmental liabilities as of May 30, 2010. 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. 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. In fiscal 2010, based on changes in the regulatory environment applicable to a particular site, we reduced the recognized environmental liability by approximately $15 million.

 

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 had recognized a pension liability of

$470 million and $317 million, a postretirement liability of $321 million and $281 million, and a workers’ compensation liability of $73 million and $76 million, as of the end of fiscal 2010 and 2009, respectively.

 

We recognized pension expense from Company plans of $47 million, $38 million, and $56 million in fiscal years 2010, 2009, and 2008, respectively, which reflected expected returns on plan assets of $161 million, $159 million, and $149 million, respectively. We contributed $123 million, $112 million, and $8 million to our pension plans in fiscal years 2010, 2009, and 2008, respectively. We anticipate contributing approximately $116 million to our pension plans in fiscal 2011.

 

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 2009 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 6.9% for fiscal year 2010, 6.6% for fiscal 2009, and 5.75% for fiscal 2008. We selected a discount rate of 5.8% for determination of pension expense for fiscal 2011. A 25 basis point increase in our discount rate assumption as of the beginning of fiscal 2010 would decrease pension expense for our pension plans by $1.6 million for the year. A 25 basis point decrease in our discount rate assumption as of the beginning of fiscal 2010 would increase pension expense for our pension plans by $1.7 million for the year. A 25 basis point increase in the discount rate would decrease pension expense by approximately $8.3 million for fiscal 2011. A 25 basis point decrease in the discount rate would increase pension expense by approximately $8.9 million for fiscal 2011. For our year-end pension obligation determination, we selected a discount rate of 5.8% and 6.9% for fiscal years 2010 and 2009, 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 2010 pension expense. 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. We selected an expected rate of return on plan assets of 7.75% to be used to determine our pension expense for fiscal 2011. A 25 basis point increase/decrease in our expected long-term rate of return assumption as of the beginning of fiscal 2011 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 2010 was $232 million higher 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 2010 and 2009 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 2010, 2009, and 2008. A 25 basis point increase in our rate of compensation increase assumption as of the beginning of fiscal 2010 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 2010 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 2011. A 25 basis point increase/decrease in our rate of compensation increase assumption as of the beginning of fiscal 2011 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 $9 million, $15 million, and $23 million in fiscal 2010, 2009, and 2008, respectively. We reflected liabilities of

$321 million and $281 million in our balance sheets as of May 30, 2010 and May 31, 2009, respectively. We anticipate contributing approximately $36 million to our postretirement health care plans in fiscal 2011.

 

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 6.6% for fiscal year 2010, 6.4% for fiscal 2009, and 5.5% for fiscal 2008. We have selected a discount rate of 5.4% for determination of postretirement expense for fiscal 2011. A 25 basis point increase/decrease in our discount rate assumption as of the beginning of fiscal 2010 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 8.0%, with the trend rate decreasing to 5.0% by 2016. 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 30, 2010 was 3.75%. 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 Financial Accounting Standards Board issued guidance that requires 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 guidance are effective as of the beginning of our fiscal 2011. Earlier application is prohibited. We are currently evaluating the impact of adopting this guidance.

 

RELATED-PARTY TRANSACTIONS

 

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 $0.3 million and $0.4 million in fiscal 2010 and fiscal 2009, respectively.

 

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; the impact of the accident at the Garner, North Carolina manufacturing facility, including the ultimate costs incurred and the amounts received under insurance policies; 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 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, including the Patient Protection and Affordable Care Act; the amount and timing of repurchases of our common stock, if any; 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 2010 and 2009 were exposures to price fluctuations of commodity and energy inputs, interest rates, and foreign currencies. These fluctuations impacted 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. During the fourth quarter of fiscal 2010, we entered into interest rate swap contracts used to hedge the fair value of certain of our senior long-term debt. The maximum potential loss from a hypothetical change of 1% in interest rates was approximately $24 million. At the end of fiscal 2009, we did not have any interest rate swap agreements outstanding.

 

As of May 30, 2010 and May 31, 2009, the fair value of our fixed rate debt was estimated at $4.1 billion and $3.7 billion, respectively, based on current market rates primarily provided by outside investment advisors. As of May 30, 2010 and May 31, 2009, a one percentage point increase in interest rates would decrease the fair value of our fixed rate debt by approximately $234 million and $196 million, respectively, while a one percentage point decrease in interest rates would increase the fair value of our fixed rate debt by approximately $256 million and $307 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

 

CONAGRA FOODS, INC. AND SUBSIDIARIES

 

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.

CONSOLIDATED BALANCE SHEETS

Dollars in millions except share data

 

 

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

CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS’ EQUITY