Sara Lee 2008 Annual Report Download - page 38

Financial review
Note 21 to the Consolidated Financial Statements, titled “Income
Taxes,” sets out the factors which caused the corporation’s effective
tax rate to vary from the statutory rate and certain of these factors
result from finalization of tax audits and review and changes in
estimates and assumptions regarding tax obligations and benefits.
Contingent Asset The corporation sold its European cut tobacco
business in 1999. Under the terms of that agreement, the corporation
can receive an annual cash payment of 95 million euros if tobacco
continues to be a legal product in the Netherlands, Germany and
Belgium through July 2009. If tobacco ceases to be a legal product
at any time during this period, the corporation forfeits the receipt of
all future amounts related to that country. Payments of 95 million
euros were received in 2008, 2007 and 2006 that were equivalent
to $130 million, $120 million and $114 million, respectively. Any
future contingent payments received will be recognized in the corpo-
ration’s earnings on a separate line in the income statement when
received. The future receipt of any payments is dependent upon fac-
tors outside of the control of the corporation, including legislation in
foreign countries, and the corporation cannot predict such actions.
Stock Compensation The corporation issues restricted stock units
(RSUs) to employees and non-employee directors and issues stock
options to employees. See Note 8 to the Consolidated Financial
Statements regarding stock-based compensation for further infor-
mation on these awards. The cost of RSUs and stock option awards
is equal to the fair value of the award at the date of grant, and com-
pensation expense is recognized for those awards earned over the
service period. Certain of the RSUs vest based upon the employee
achieving certain defined performance measures. During the service
period, management estimates the number of awards that will meet
the defined performance measures. With regard to stock options, at
the date of grant, the corporation determines the fair value of the
award using the Black-Scholes option pricing formula. Management
estimates the period of time the employee will hold the option prior
to exercise and the expected volatility of the corporation’s stock, each
of which impacts the fair value of the stock options. The corporation
believes that changes in the estimates and assumptions associated
with prior grants are not reasonably likely to have a material impact
on future operating results.
Defined Benefit Pension Plans See Note 19 to the Consolidated
Financial Statements, titled “Defined Benefit Pension Plans,”
for information regarding plan obligations, plan assets and the
measurements of these amounts, as well as the net periodic
benefit cost and the reasons for changes in this cost.
Pension costs and obligations are dependent on assumptions
used in calculating such amounts. These assumptions include
estimates of the present value of projected future pension payments
to all plan participants, taking into consideration the likelihood of
potential future events such as salary increases and demographic
experience. The assumptions used in developing the required
estimates include the following key factors: discount rates, salary
growth, expected return on plan assets, retirement rates and mortality.
In determining the discount rate, the corporation utilizes the
yield on high-quality fixed-income investments that have a AA bond
rating and match the average duration of pension obligations.
Salary increase assumptions are based on historical experience
and anticipated future management actions. In determining the
long-term rate of return on plan assets, the corporation assumes
that the historical long-term compound growth rate of equity and
fixed-income securities will predict the future returns of similar
investments in the plan portfolio. Investment management and other
fees paid out of plan assets are factored into the determination
of asset return assumptions. Retirement rates are based primarily
on actual plan experience, while standard actuarial tables are used
to estimate mortality. Results that differ from these assumptions
are accumulated and amortized over future periods and, therefore,
generally affect the net periodic benefit cost in future periods.
Net periodic benefit costs for the corporation’s defined benefit
pension plans was $107 million in 2008, $141 million in 2007
and $181 million in 2006, and the projected benefit obligation was
$4,744 million at the end of 2008 and $4,926 million at the end
of 2007. The following information illustrates the sensitivity of these
amounts to a change in the discount rate and return on plan assets.
Amounts relating to foreign plans are translated at the spot rate at
the close of 2008. The sensitivities reflect the impact of changing
one assumption at a time and are specific to base conditions at the
end of 2008. It should be noted that economic factors and conditions
often affect multiple assumptions simultaneously and that the effects
of changes in assumptions are not necessarily linear.
Increase/(Decrease) in
2008
2009 Projected
Net Periodic Benefit
Assumption Change Benefit Cost Obligation
Discount rate 1% increase $(28) $(612)
Discount rate 1% decrease 64 755
Asset return 1% increase (44) –
Asset return 1% decrease 44 –
36 Sara Lee Corporation and Subsidiaries