|• 20-F • EX-4.2 • EX-4.14 • EX-4.15 • EX-4.16 • EX-4.17 • EX-4.18 • EX-8.1 • EX-12.1 • EX-12.2 • EX-13.1|
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
¨ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR(g) OF THE
SECURITIES EXCHANGE ACT OF 1934
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 2012
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
¨ SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 333-179839
D.E MASTER BLENDERS 1753 N.V.
(Exact name of Registrant as specified in its charter)
(Translation of Registrants name into English)
(Jurisdiction of incorporation or organization)
1011 DK Amsterdam
(Address of principal executive offices)
(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)
Securities registered or to be registered pursuant to Section 12(b) of the Act.
Securities registered or to be registered pursuant to Section 12(g) of the Act.
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.
(Title of Class)
Indicate the number of outstanding shares of each of the issuers classes of capital or common stock as of the close of the period covered by the annual report: 594,859,274 common shares
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act ¨ Yes No x
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. ¨ Yes No x
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 requirement for the past 90 days. x Yes No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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 No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act
¨ Large accelerated filer ¨ Accelerated filer x Non-accelerated filer
Indicate by checkmark which basis of accounting the registrant has used to prepare the financial statements included in this filing
¨ U.S. GAAP x International Financial Reporting Standards as issued by the International Accounting Standards Board ¨ Other
If other has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow. ¨ Item 17 ¨ Item 18
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes No x
TABLE OF CONTENTS
PRESENTATION OF CERTAIN INFORMATION
D.E MASTER BLENDERS 1753 N.V. is referred to in this Annual Report on Form 20-F as D.E MASTER BLENDERS and D.E MASTER BLENDERS together with its member companies are together referred to as the D.E MASTER BLENDERS Group or the Group. For such purposes, member companies means, in relation to D.E MASTER BLENDERS 1753 N.V., those companies that are required to be consolidated in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB) and in conformity with IFRS as adopted by the European Union. References to the NYSE Euronext Amsterdam are to NYSE Euronext in Amsterdam. References to the SEC are to the Securities and Exchange Commission.
In this Annual Report on Form 20-F, references to EUR, euro and are to the lawful currency of the member states of the European Monetary Union that have adopted the single currency in accordance with the Treaty establishing the European Community, as amended by the Treaty on European Union. References to $, USD, US$ and US dollars are to the lawful currency of the United States of America, references to GBP, pound sterling and the UK pound are to the lawful currency of the United Kingdom, references to AUD, A$ and Australian dollars are to the lawful currency of Australia and references to BRL, R$ and Brazilian real are to the lawful currency of the Federative Republic of Brazil.
Unless the context otherwise requires, all references herein to we, our, us, the Company and refer to D.E MASTER BLENDERS (i) after the conversion of D.E MASTER BLENDERS B.V. from a private limited liability company (besloten vennootschap met beperkte aansprakelijkheid) to a public company with limited liability (naamloze vennootschap) and following the separation, and (ii) prior to the separation of D.E MASTER BLENDERS on June 28, 2012 from the Sara Lee Corporation, they refer to Sara Lee Corporations international coffee and tea businesses. All references herein to Hillshire Brands Company, Hillshire, Sara Lee Corporation and Sara Lee refer to Hillshire Brands Company, which was formerly known as Sara Lee Corporation. All references herein to the distribution refer to the distribution to the shareholders of Hillshire of all of the shares of common stock of DE US, Inc. All references herein to the merger refer to the merger of a wholly owned subsidiary of D.E MASTER BLENDERS with and into DE US, Inc. pursuant to which each outstanding share of DE US, Inc. common stock was exchanged for one ordinary share of D.E MASTER BLENDERS and DE US, Inc. became a subsidiary of D.E MASTER BLENDERS. All references herein to the spin-off or separation refer to the merger, distribution and other transactions contemplated thereby, collectively.
FORWARD LOOKING STATEMENTS
This Annual Report includes forward-looking statements. All statements other than statements of historical fact included in this Annual Report regarding our business, financial condition, results of operations and certain of our plans, objectives, assumptions, projections, expectations or beliefs with respect to these items and statements regarding other future events or prospects, are forward-looking statements. These statements include, without limitation, those concerning: the expected benefits of the separation from Sara Lee Corporation; our access to credit markets; and the funding of pension plans. These statements may be preceded by terms such as expects, anticipates, projects or believes. In addition, this Annual Report includes forward-looking statements relating to our potential exposure to various types of market risks, such as commodity price risks, foreign exchange rate risks, interest rate risks and other risks related to financial assets and liabilities. We have based these forward-looking statements on our managements current view with respect to future events and financial performance. These forward-looking statements are based on currently available competitive, financial and economic data, as well as managements views and assumptions regarding future events, and are inherently uncertain. Although we believe that the estimates reflected in the forward-looking statements are reasonable, such estimates may prove to be incorrect. By their nature, forward-looking statements involve risk and uncertainty because they relate to events and depend on circumstances that will occur in the future. There are a number of factors that could cause actual results and developments to differ materially from those expressed or implied by these forward-looking statements. These factors include, among other things, the Companys ability to transition successfully to a stand-alone operation, ongoing trends in the marketplace that affect the price and demand for the Companys products, the cost and availability of raw materials, the outcome of the Companys internal investigation relating to its operations in Brazil and the impact of the restatement of the historical financial statements as well as those listed in the section entitled Risk Factors in Item 3D.
We urge you to read the sections of this Annual Report entitled Risk Factors, Operating and Financial Review and Prospects, Industry Overview and Business Overview for a discussion of the factors that could affect our future performance and the industry in which we operate. Additionally, new risk factors can emerge from time to time, and it is not possible for us to predict all such risk factors. Given these risks and uncertainties, you should not place undue reliance on forward-looking statements as a prediction of actual results.
All forward-looking statements included in this Annual Report are based on information available to us on the date of this Annual Report. We undertake no obligation to update publicly or revise any forward-looking statement, whether as a result of new information, future events or otherwise, except as may be required by applicable law. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained throughout this Annual Report.
MARKET, ECONOMIC AND INDUSTRY DATA
In this Annual Report, we make certain statements regarding our competitive and market position. We believe these statements to be true based on market data, industry statistics and publicly available information. Information regarding markets, market size, market share, market position, growth rates and other industry data pertaining to our business contained in this Annual Report consists of estimates based on data and reports compiled by professional organizations and analysts, on data from other external sources, and on our knowledge of our sales and markets. The information in this Annual Report that has been sourced from independent sources has been accurately reproduced and, as far as we are aware and able to ascertain from the information published by that independent source, no facts have been omitted that would render the reproduced information inaccurate or misleading. We have not independently verified these data or determined the reasonableness of the assumptions used by their compilers, nor have data from independent sources been audited in any manner. In many cases, including with respect to information regarding our competitive position in the Out of Home market, there is no readily available external information (whether from trade associations, government bodies or other organizations) to validate market-related analyses and estimates, requiring us to rely on internally developed estimates, which have not been verified by any independent sources. All of the assumptions, estimates and expectations underlying our statements have been based on careful analysis and are our reasonable beliefs.
3A Selected financial data
A summary of historical financial data as of June 30, 2012, July 2, 2011 and July 3, 2010 and for the years then ended have been derived from our audited financial statements included elsewhere herein. The selected financial data as of June 27, 2009 and for the year then ended have been derived from our historical financial statements after adjusting the financial statements for the impact of the restatement impacts as discussed below. Our financial statements have been prepared in accordance with IFRS as adopted by the International Accounting Standards Board and adopted by the European Union.
Our financial statements for the periods prior to June 28, 2012 represent combined financial statements, as the Sara Lee international coffee and tea business was not held by a single parent company prior to the separation. The combined financial statements were prepared on a carve-out basis for purposes of presenting our financial position, results of our operations and cash flows. Prior to June 28, 2012, the Group did not operate as a stand-alone entity and accordingly the selected financial data presented herein are not necessarily indicative of our future performance and do not reflect what our financial performance would have been had we operated as an independent publicly traded company during the periods presented.
In connection with the Groups first year-end financial closing process as an independent company, the Group identified accounting irregularities and certain other errors related to its previously reported historical financial carve-out financial statements for fiscal years 2009 through 2011. Outside legal counsel and independent forensic accountants conducted a comprehensive investigation into the irregularities, confirming that the irregularities in Brazil began prior to 2009 and continued until identified in July 2012. The historical financial statements have been restated to include the effects of the accounting irregularities and certain other errors.
You should read the selected financial data in conjunction with our historical financial statements and related notes and Operating and Financial Review and Prospects included in Item 5. Our historical results do not necessarily indicate our expected results for any future periods.
For the periods prior to separation, our financing cash flows reflect distributions to Hillshire of 566.8 million in fiscal 2010 and contributions from Hillshire of 80.4 million in fiscal 2012 and 342.6 million in fiscal 2011 and 335.9 million to Hillshire in 2009.
The components of operating working capital are derived from our financial statements; however, this is not a measure calculated in accordance with IFRS and may not be comparable to similar measures presented by other companies. Accordingly, operating working capital should not be considered as an alternative to operating cash flow.
We present our financial statements in euro. We make no representation that any euro or U.S. dollar amount could have been, or could be, converted into U.S. dollars or euro, as the case may be, at the rates stated below or at all.
The following table sets forth information concerning exchange rates between the euro and the U.S. dollar for the periods indicated.
Source: Federal Reserve (https://www.federalreserve.gov)
On June 29, 2012, the noon buying rate in The City of New York for cable transfers of euro as certified for customs purposes by the Federal Reserve was 1.00 to U.S. $1.2668.
3B Capitalization and indebtedness
3C Reasons for the offer and use of proceeds
3D Risk factors
Risks Related to our Business
The following discusses some of the key risk factors that could affect D.E MASTER BLENDERS business and operations, as well as other risk factors that are particularly relevant to us in the current period of significant economic and market disruption. Additional risks to which we are subject include, but are not limited to, the factors mentioned under Forward-Looking Statements above and the risks of our businesses described elsewhere in this Annual Report. Other factors besides those discussed below or elsewhere in this Annual Report also could adversely affect our business and operations, and the following risk factors should not be considered a complete list of potential risks that may affect D.E MASTER BLENDERS and the Group.
Increases in the cost of green coffee, tea or other commodities could reduce our gross margin and profit.
Our primary raw material is green coffee, an agricultural commodity. Green coffee is subject to volatile price fluctuations. Speculation in the commodities markets, weather, seasonal fluctuations, real or perceived shortages, pest or other crop damage, land usage, the political climate in the producing nations, competitive pressures, labor actions, currency fluctuations, armed conflict and government actions, including treaties and trade controls by or between coffee producing nations, can affect the price of green coffee. Certain types of premium or sustainable coffees sell at higher prices than other green coffees due, among other things, to the inability of producers to increase supply in the short run to meet rising demand. As a result of the continued increase in demand for premium coffees, the price spread between premium coffee and non-premium coffee is likely to widen. We experienced significant increases in the price of green coffee in fiscal 2012. Additionally, although less material to our operations than green coffee, other commodities including tea leaves, packaging materials, other coffee drink inputs and energy, are important to our operations.
Green coffee and other commodity price increases impact our business by increasing the costs of raw materials used to make our products and the costs to manufacture, package and ship our products. Decreases in commodity prices impact our business by creating pressure to decrease our sales prices. We use commodity financial derivative instruments and forward purchase contracts to hedge some of our commodity price exposure, consistent with our overall risk management program. Over time, if commodity costs increase, our operating costs will increase despite our commodity hedging program. The time period of the forward purchase contracts do not necessarily match the time period of the agreements we enter into with customers to sell our products, so our hedging strategies may not effectively reduce our exposure to commodity price increases. If we are not able to increase our product sales prices to sufficiently offset increased raw material costs, as a result of consumer sensitivity to pricing or otherwise, or if unit volume sales are significantly reduced due to price increases, it could have an adverse effect on our profitability.
Current economic conditions may negatively impact demand for our products, which could adversely impact our sales and operating profit.
Economic and market conditions have deteriorated significantly in many countries in which we operate, and these conditions have deteriorated further as a result of the current crisis in Europe, which has created uncertainty with respect to the ability of certain countries in the European Union, which we refer to as the EU, to continue to service their sovereign debt obligations. Since our sales are concentrated in Western Europe, these conditions have had, and are likely to continue to have, a negative impact on our business and on global economic activity and financial markets. If these conditions persist, our business, results of operations and financial position could be materially adversely affected.
We believe that economic uncertainty may create a shift in consumer preference toward private label products. This may result in increased pressure to reduce prices of our products and/or limit our ability to increase or maintain prices. Purchases of discretionary items by consumers, including some of our products, could decline during times of economic uncertainty. In addition, at the same time that we have been experiencing
pressure from customers and consumers to reduce our prices, we have seen sharp increases in our operating costs as a result of changing commodity prices. If these unfavorable economic conditions continue, our sales and profitability could be adversely affected.
Our pension costs could substantially increase as a result of volatility in the equity markets or interest rates.
The difference between plan obligations and assets, or the funded status of the plans, is a significant factor in determining the net periodic benefit costs of our pension plans. Changes in interest rates and the market value of plan assets can impact the funded status of these plans and cause volatility in the net periodic benefit cost. Cash funding requirements are set by different rules but are also subject to volatility due to changes in interest rates and the market value of plan assets. The exact amount of cash contributions made to pension plans in any year is dependent upon a number of factors, including minimum funding requirements in the jurisdictions in which we operate, the tax deductibility of amounts funded and arrangements made with the trustees of certain pension plans. In some jurisdictions cash funding requirements are partly the result of determinations by separate boards which act independently of the Company. Our Dutch pension plan currently operates under a recovery plan as required by the Dutch Central Bank when a pension fund has a coverage ratio below its required solvency level. For more information on the recovery plan, see Management and EmployeesPension SchemesPension plans in the Netherlands in Item 6. A significant increase in our pension funding requirements could have a negative impact on our results of operations or cash flow.
Our profitability may suffer as a result of competition in our markets.
The coffee and tea industries are intensely competitive. To maintain and increase our market positions, we may need to increase expenditures on media, advertising, promotions and trade spend, and introduce new products and line extensions, which may require new production methods and new machinery. Due to inherent risks in the marketplace associated with advertising and new product introductions, including uncertainties about trade and consumer acceptance, increased expenditures may not prove successful in maintaining or increasing our market share and could result in lower sales and profits.
Our consumer products also are subject to significant price competition. From time to time, we may need to reduce the prices for some of our products to respond to competitive and customer pressures and to maintain market share. Additionally, our retail customers may reduce the prices of our products in order to increase consumer traffic into their stores or may not increase prices to consumers as costs to produce our products increase. Such pressures may restrict our ability to increase prices in response to raw material and other cost increases. Any reduction in prices as a result of competitive pressures, or any failure to increase prices when raw material costs increase, would harm profit margins and, if our sales volumes fail to grow sufficiently to offset any reduction in margins, our results of operations will suffer. This occurred in fiscal 2011 and the first half of fiscal 2012 when the price of green coffee increased significantly and we were unable to increase our prices in certain markets quickly enough to compensate for the increased cost of green coffee. Additionally, the delay between the time commodity costs increase and the time we are able to increase our prices entails the risk that, before such price increases are passed on to our customers, the commodity prices may fall again, in which case we would be unlikely to recover losses caused by such temporary increases in commodity costs.
Changes in our relationships with our major customers, or in the trade terms required by such customers, may reduce sales and profits.
Because of the competitive environment, many of our retail customers have increasingly sought to improve their profitability through pricing concessions and increased promotional programs, more favorable trade terms and increased emphasis on private label products. This trend has become more pronounced with the increased purchasing power of buying groups and the rise of hard discounters in Europe. Our three largest customers in Western Europe represented an aggregate of approximately 16% of our total sales in fiscal 2012. As these customers gain leverage through consolidation, it has become more difficult to pass on increases in commodity
prices to these customers. For example, in France, we have occasionally been forced to stop trading for limited periods with certain retail customers because of our disagreements on price. Additionally, our Out of Home customers are increasingly focused on price and we could lose contracts with those customers if our competitors offer lower prices. To the extent we provide concessions or trade terms that are favorable to our retail and Out of Home customers, our margins will be reduced. Further, if we are unable to continue to offer terms that are acceptable to our customers, or our customers determine that they need less inventory, they could reduce purchases of our products or may increase purchases from our competitors, which would harm our sales and profitability.
Sales of certain of our branded products are significant to our financial performance. Declining sales of these products would adversely affect our results of operations.
A significant percentage of our total revenue has been attributable to sales of our Douwe Egberts and Pilão branded products and our Senseo single-serve pads. Sales of Douwe Egberts products (excluding products co-branded Douwe Egberts), Senseo products (and related accessories) and Pilão products represented 23%, 16% and 10%, respectively, of our total sales in 2012. Our financial performance may be significantly affected by changes in consumer perceptions of these brands. We experienced declining sales volumes of the Senseo coffee pads in fiscal 2012 and may be unable to compensate for the loss of these sales volumes through our planned innovations. Additionally, the Senseo single-cup brewing system is an open system, which allows competitors to produce single-serve pads that compete with our Senseo single-serve pads. If we cannot convince customers and/or consumers that our Senseo coffee pads are superior to the single-serve pads produced by our competitors for the Senseo system, we may lose customers and/or consumers to our competitors. Any significant decline in the sales volumes of our Senseo single-serve pads, and any significant decline in the sales of Douwe Egberts or Pilão, would materially adversely affect our results of operations.
We may not achieve our product development goals, which could adversely impact our sales, operating profit and the price of our ordinary shares.
We have announced that we intend to renew our product line within the next 24 months and to launch a new Senseo machine annually. Our ability to achieve these goals is, and must necessarily be, based on a variety of assumptions. We may not be able to achieve these goals, or to achieve them within our announced timeframe, in some cases for reasons beyond our control. Our failure to achieve these or any other product development goals could adversely impact our sales, operating profit and the price of our ordinary shares.
We are reliant on certain key manufacturers for the production of our brewing machines and certain packaging materials.
A significant portion of the Cafitesse liquid roast brewing machines for the Out of Home market is supplied by one manufacturer. The Senseo single-cup brewing machines marketed under our prior development agreement with Philips are, and the brewing machines using the Senseo trademark that are manufactured under the terms of our existing agreement or any future development agreements with Philips are anticipated to be, manufactured by Philips. We rely on these manufacturers to produce high-quality brewing machines in adequate quantities to meet customer demands. Any decline in quality, disruption in production or inability of the manufacturers to produce the machines in sufficient quantities, whether as a result of a natural disaster or other causes, could materially adversely affect our sales of liquid roast coffee and Senseo single-serve coffee pads. Since sales of liquid roast coffee and Senseo single-serve pads are material to our operating results, such a disruption could result in a material adverse effect on our business, results of operations and financial position. In addition, certain of our packaging materials are sourced from a limited number of suppliers. If those suppliers discontinue or suspend operations because of bankruptcy or other financial difficulties we may not be able to identify alternate sources in a timely fashion which would likely result in increased expenses and operational delays.
Certain of our products are sourced from single manufacturing sites.
We have consolidated our production capacity for certain of our product lines into single manufacturing sites. We could experience an interruption in or a loss of operations at these or any of our manufacturing sites resulting in a reduction or elimination of the availability of some of our products. For example, our manufacturing facility in Nava Nakorn, Thailand was damaged by flooding in October 2011. This facility was fully operational at the start of fiscal 2013. If upon an interruption of a loss of operations we are not able to obtain alternate production capability in a timely manner, we could experience a material adverse effect on our business, results of operations and financial position.
Our efforts to secure an adequate supply of quality or sustainable coffees may be unsuccessful.
We depend on the availability of an adequate supply of green coffee beans at the required quality levels or with the required sustainability certifications from our coffee brokers, exporters, cooperatives and growers. If any of our relationships with coffee brokers, exporters, cooperatives or growers deteriorate, we may be unable to procure a sufficient quantity of coffee beans at prices acceptable to us. In the case of a shortage of supply or unacceptable quality levels or prices, we may not be able to fulfill the demand of our existing customers or supply new customers with quality product at acceptable prices. A raw material shortage could force us to use alternative coffee beans or discontinue certain blends, could impair our ability to expand our business and could adversely affect our results of operations.
Maintaining a steady supply of green coffee is essential to keep inventory levels low and secure sufficient stock to meet customer needs. To help ensure future supplies, we purchase coffee on forward contracts for delivery in the future. Non-performance by suppliers could expose us to credit and supply risk. Additionally, entering into such future commitments exposes us to purchase price risk. Because we are not always able to pass price changes through to our customers due to competitive pressures and we are not always able to adequately hedge against changes in commodity prices, unpredictable price changes can have an immediate effect on operating results that cannot be corrected in the short run.
Additionally, we expect to purchase certified sustainable coffee representing 20% of our annual coffee volume by 2015, which would significantly increase our sustainable green coffee purchases. Certain of our competitors have announced similar plans to purchase a significant amount of sustainable coffee. Because the supply of coffee certifiable as sustainable is limited, the cost of acquiring such coffee may increase significantly, which would have an adverse effect on our results of operations. If we are unable to achieve our planned level of sustainable coffee purchases, that could negatively impact consumer perception of our brands, which would have an adverse effect on our business.
If we are unable to improve our inventory management and forecasting systems to make our supply chain more efficient, our business, results of operations and financial position may be adversely affected.
We are implementing improvements to our inventory management systems in order to provide better forecasts and to enhance the efficiency of our supply chain. Improved forecasts will assist our ability to meet our internal targets for operating working capital. Accurate forecasts of demand for our coffee and tea products are necessary to avoid losing potential sales of popular products or producing excess inventory of products that we would be unable to sell without a price discount. We are also working to improve the alignment between our forecasts of demand for coffee and tea volume and our forecasts of future sales prices for our products, which would also improve our ability to achieve our internal targets for sales growth and adjusted EBIT margin. If we do not successfully implement our plans to improve our inventory management and forecasting systems, our business, results of operations and financial position may be adversely affected.
Our internal control over financial reporting may not be effective
In connection with our first year-end financial closing process as a separate company, our management identified accounting irregularities and certain other errors related to its previously reported historical financial
statements. The errors caused by accounting irregularities involved our Brazilian operations and required us to record provisions, including additional tax provisions, and restate our historical financial statements. These accounting irregularities included the overstatement of accounts receivable due to the failure to write off uncollectible customer discounts, improper recognition of sales revenues prior to shipments to customers, the understatement of provisions for various litigation issues, unsupported expense reversals and postponements, moving inventory out of warehouses that were about to be verified by internal and external auditors, the failure to write-off certain obsolete inventory and other inventory valuation issues.
The material weakness with respect to our Brazilian operations relates to an ineffective control environment over financial reporting maintained by management in Brazil which began prior to 2009 through 2012 that permitted to go undetected during that period, intentional overrides of certain internal controls, as well as cross-functional collusion by management in Brazil and communication and actions by senior management in Brazil that contributed to a lack of adherence to existing internal control procedures and IFRS. The errors reduced parents net investment by 22 million for the fiscal year 2011 and the impact to the first half of fiscal year 2012 is insignificant. See Note 1 of our financial statements for more detail on the impact of these adjustments. While we have put in place redesigned processes intended to enhance our internal control over financial reporting, until we have been able to test the operating effectiveness of these remediated internal controls, there can be no assurance that we will not discover additional deficiencies and weaknesses in our internal control over financial reporting any of which could have a material and adverse effect on our results of operations and financial condition and our ability to comply with applicable financial reporting requirements.
We are subject to foreign currency exchange rate fluctuations.
Operating in international markets involves exposure to movements in currency exchange rates, which are volatile at times. Movements in foreign exchange rates can affect our supply costs because a significant portion of our revenues are in euros, but we source green coffee, tea and other commodities in currencies other than the euro. The impact on us of currency fluctuations may be substantial because we purchase coffee on forward contracts for delivery in the future, and such contracts are not generally adjusted for fluctuations in currency prior to the delivery date. Further, our currency hedges may not successfully reduce our exposure to currency exchange rate fluctuations. Accordingly, a depreciation of non-euro currencies relative to the euro, or changes in the relative value of any two currencies that we use for transactions, could have a material adverse effect on our financial condition and results of operations.
We depend on sales from the Netherlands for a substantial portion of our sales in any fiscal period. Sales in this country have recently declined and may continue to decline.
Our financial performance is highly dependent on sales in the Netherlands, which comprised approximately 26% of our sales in fiscal 2012. Additionally, we rely on a small number of customers in the Netherlands for all of our sales in that country. Our financial performance may be affected by changes in the regulatory and economic environment in the Netherlands and in Western Europe generally or by financial difficulties experienced by key customers in the Netherlands or elsewhere. We have occasionally experienced decreases in sales in this country, which has adversely affected our operating results. For example, our sales in the Netherlands decreased from fiscal 2009 to fiscal 2012. This was due in part to low spending on advertising and promotion in the Netherlands during those years and our decision to introduce innovations, such as LOR EspressO, outside the Netherlands before we introduced such innovations in the Netherlands. If sales in the Netherlands continue to decline, our business and financial results will be adversely affected.
An impairment in the carrying value of goodwill or other acquired intangible assets could negatively affect our results of operations and shareholders equity.
The carrying value of goodwill represents the fair value of acquired businesses in excess of identifiable assets and liabilities as of the acquisition date. The carrying value of other intangible assets represents the fair value of trademarks, trade names and other acquired intangible assets as of the acquisition date. Goodwill and
other acquired intangible assets expected to contribute indefinitely to our cash flows are not amortized, but are evaluated for impairment by our management at least annually. If the carrying value exceeds the recoverable amount as determined based on the higher of the discounted future cash flows of the related businesses and the fair value less costs to sell, the goodwill or other intangible asset is considered impaired and is reduced to the recoverable amount via a non-cash charge to earnings. Events and conditions that could result in impairment charges include further economic instability, further significant commodity price fluctuations, increased competition, or other factors leading to reduction in sales or profitability. In addition, in January 2012, the Brazilian government revised the tax laws related to the export of green coffee. This may negatively impact the ability of our Brazilian business to achieve targeted profit levels, which could trigger an impairment to the 32.2 million of goodwill that was allocated to this cash generating unit at the end of fiscal 2011. We subsequently made a decision to reduce our green coffee export business significantly. If the value of goodwill or other acquired intangible assets is impaired, our results of operations and shareholders equity could be adversely affected.
The success of our business depends substantially on consumer perceptions of our brands.
We believe that maintaining and continually enhancing the value of our brands is critical to the success of our business. Brand value is based in large part on consumer perceptions. Success in promoting and enhancing brand value depends in large part on our ability to provide high quality products and continued innovation. Brand value could diminish significantly as a result of a number of factors, such as if we fail to preserve the quality of our products, if we are perceived to act in an irresponsible manner, if we or our brands otherwise receive negative publicity, if the brands fail to deliver a consistently positive consumer experience or if the products become unavailable to consumers. If our brand values are diminished, our revenues and operating results could be materially adversely affected.
Our financial results and achievement of our growth strategy is dependent on our ability to maintain the strong brand image of our existing products, our ability to successfully develop and launch new products and product extensions and on marketing of existing products.
Achievement of our growth strategy is dependent, among other things, on our ability to maintain the strong brand image of our existing products, our ability to successfully develop and launch new products and product extensions and on marketing of existing products. Although we devote significant focus to the development of new products, we may not be successful in developing innovative new products or our new products may not be commercially successful. Our financial results and our ability to maintain or improve our competitive position will depend on our ability to effectively gauge the direction of our key markets and successfully identify, develop, manufacture, market and sell new or improved products in these changing markets.
The future growth of our business may be adversely affected if we are unable to effectively expand in international and emerging markets.
Our growth strategy includes the expansion of our sales in our existing markets and new international markets, including emerging markets. Expansion in emerging markets, including expansion of our sales and operations in Brazil, involves significant business and legal risks. These risks include, but are not limited to: changes in economic, political or regulatory conditions; difficulties in managing geographically diverse operations; changes in business regulation; effects of foreign currency movements; difficulties in enforcing contracts and cultural and language barriers. If we fail to address one or more of these challenges, our business and financial performance may be materially adversely affected.
We are subject to intellectual property infringement risk that could adversely affect our business.
Our existing products or our introduction of new products or product extensions may generate litigation or other legal proceedings against us by competitors claiming infringement or other violation of their intellectual property rights, which could negatively impact our results of operations. For example, Nestlé has filed suit
against several of our subsidiaries claiming patent and trademark infringement in connection with our sales of LOR EspressO and LaRôme EspressO. Because sales of the LOR EspressO and LaRôme EspressO single-serve capsules have served as a significant source of our sales growth in recent periods, our results of operations may be adversely affected by a negative outcome in this litigation. For more information on the Nestlé litigation, see the section of this Annual Report entitled Legal Proceedings in Item 8. Intellectual property litigation can be complex and expensive, and outcomes are difficult to predict. An adverse result in an intellectual property litigation could subject us to liabilities and/or require us to seek licenses from third parties, which may not be available on satisfactory terms. As a result, intellectual property challenges against us could have an adverse effect on our business, operating results and financial condition.
Failure to maximize or to successfully assert our intellectual property rights could impact our competitiveness.
We rely on trademark, trade secret, patent and copyright laws to protect our intellectual property rights. We cannot be sure that these intellectual property rights will be maximized or that they can be successfully maintained or asserted. There is a risk that we will not be able to obtain, maintain and perfect our own or, where appropriate, license intellectual property rights necessary to support our current products and new product introductions. Accordingly, our products, product development efforts and new product introductions may not be protected or protectable pursuant to intellectual property rights. In addition, we cannot be sure that these rights will not be invalidated, circumvented or challenged. Further, even if such rights are obtained in the United States, the EU, or individual European countries, the laws of some of the countries in which our products are or may be sold may not protect our intellectual property rights to the same extent as the laws of the United States, the EU or individual European countries.
Additionally, in certain jurisdictions rights in trademarks are derived from registration of such trademarks in such jurisdiction. Trademark registrations for the Aroma Lady logo, which appears on our Douwe Egberts branded products, and the Cafitesse brand in certain countries in the Middle East are held on our behalf by another party with whom we are currently in a dispute and, accordingly, our ability to sell products under these brands into such Middle Eastern countries may be materially adversely affected by this dispute. For more information on these disputes, see the section of this Annual Report entitled Legal Proceedings in Item 8. Our failure to perfect or successfully assert our intellectual property rights could make us less competitive and could have an adverse effect on our business, operating results and financial condition.
Many of our production processes are not proprietary, so competitors may be able to duplicate them, which could harm our competitive position.
We consider the production methods for many of our products essential to the quality, flavor and richness of our coffees and, therefore, essential to our brands. Because these methods are not patented, we would be unable to prevent competitors from copying these methods if such methods became known. If our competitors copy our methods, the value of our brands may be diminished, and we may lose customers to our competitors. In addition, competitors may be able to develop production methods that are more advanced than our production methods, which may also harm our competitive position.
Our business operations could be disrupted if our information technology systems fail to perform adequately.
We rely on our information technology systems to effectively manage and operate many of our key business functions, including our supply management, product manufacturing and distribution, order processing and other business processes. The failure of our information technology systems to perform could disrupt our business and result in supply management errors, production inefficiencies and the loss of sales and customers, causing our business and results of operations to suffer. In addition, our information technology systems may be vulnerable to
damage or interruption from circumstances beyond our control, including fire, natural disasters, system failures, security breaches and viruses. Any such damage or interruption could have a material adverse effect on our business.
Our operating results may have significant fluctuations from period to period which could have a negative effect on our stock price.
Our operating results may fluctuate from period to period or within certain periods as a result of a number of factors, including fluctuations in the price and supply of green coffee and tea, fluctuations in the selling prices of our products, currency fluctuations, the success of our green coffee and currency hedging strategies, competition from existing or new competitors in our industry, changes in consumer preferences, and our ability to manage inventory and fulfillment operations and maintain gross margins. Fluctuations in our operating results as a result of these factors or for any other reason could cause our stock price to decline. Accordingly, we believe that period-to-period comparisons of our operating results are not necessarily meaningful, and such comparisons should not be relied upon as indicators of future performance.
Adverse public or medical opinions about caffeine or reports of incidents involving food-borne illness and tampering may harm our business.
Coffee and tea contain caffeine and other active compounds, the health effects of some of which are not fully understood. A number of research studies conclude or suggest that excessive consumption of caffeine may lead to increased adverse health effects. Caffeine levels vary between blends and we may be restricted in the production of certain blends due to the level of caffeine in the blends. Additional unfavorable reports on the health effects of caffeine or other compounds present in coffee or tea could significantly reduce the demand for coffee or tea, which could harm our business and reduce our sales.
If our products become contaminated or mislabeled, we might need to recall those items and may experience product liability claims if consumers are injured.
We may need to recall some of our products if they spoil, become contaminated, are tampered with or are mislabeled. A widespread product recall could result in adverse publicity, an inability to maintain sufficient stocks of our products, damage to our reputation and a loss of consumer confidence in our products, which could have a material adverse effect on our business results and the value of our brands. We also may be subject to liability if our products or operations violate applicable laws or regulations, or in the event our products cause injury, illness or death. In addition, we could be the target of claims that our advertising is false or deceptive under the laws of the jurisdictions in which we operate, including consumer protection laws. Even if a product liability or consumer fraud claim is unsuccessful or is without merit, the negative publicity surrounding such assertions regarding our products could adversely affect our reputation and brand images.
Changes in consumer preferences could adversely affect our business.
Our continued success depends, in part, upon the demand for coffee and tea. Competition from other beverages may dilute the demand for coffee and tea. Consumers who choose soft drinks, juices, bottled water and other beverages may reduce spending on coffee and tea. Because we are highly dependent on consumer demand for coffee and tea, a shift in consumer preferences away from coffee and tea would harm our business more than if we had more diversified product offerings.
Our success depends largely on the continued availability of certain personnel.
Much of our future success depends on the continued availability of skilled personnel and other key employees with historical knowledge of our Company, our industry and coffee purchasing and blending. If we are unable to attract and retain such talented, highly qualified skilled personnel and other key employees, our business may be adversely affected.
Severe weather patterns may increase commodity costs, damage our facilities and impact or disrupt our production capabilities and supply chain.
There is increasing concern that a gradual increase in global average temperatures has caused and will continue to cause significant changes in weather patterns around the globe and an increase in the frequency and severity of extreme weather events. Major weather phenomena have dramatically affected and may continue to affect coffee growing countries. The wet and dry seasons are becoming unpredictable in timing and duration, causing improper development of the coffee berries. Changing weather patterns may affect the quality, limit availability or increase the cost of key agricultural commodities, such as green coffee and tea, which are the key raw materials for our products. Increased frequency or duration of extreme weather conditions could also damage our facilities, impair production capabilities or disrupt our supply chain. As a result, the effects of climate change could have a long-term adverse impact on our business and results of operations.
In addition, increased government regulations or demands from key retailers 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. We use natural gas, diesel fuel, and electricity in the manufacturing and distribution of our products. Legislation or regulation affecting these inputs could materially adversely affect our profitability. In addition, climate change could affect our ability to procure needed commodities at costs and in quantities currently available to us and may require us to make additional unplanned capital expenditures.
Changes in regulations or failure to comply with existing regulations could affect our product sales, financial condition and results of operations.
As a manufacturer of products intended for human consumption, we are subject to extensive legislation and regulation in the EU and in each of the countries in which we do business with respect to: product composition, manufacturing, storage, handling, packaging, labeling, advertising and the safety of our products; the health, safety and working conditions of our employees; our pensions; and our competitive and marketplace conduct. We perform laboratory analyses on incoming ingredient shipments for the purpose of assuring that they meet our quality standards as well as those of the EU and each of the countries in which we do business. Our operations and properties, past and present, are also subject to a wide variety of EU and local laws and regulations governing: air emissions, waste water discharge, noise levels, energy efficiency; the presence, use, storage, handling, generation, treatment, emission, release, discharge and disposal of hazardous materials, substances and wastes; and the remediation of contamination to the environment. Existing legislation and modification to existing legislation and/or regulation and the introduction of new legislative and regulatory initiatives may affect our operations and the conduct of our businesses, and the cost of complying with such legislation or modified and/or new legislation or regulation or the effects of such legislation or modified and/or new legislation or regulation may have an adverse effect on our product sales, financial condition and results of operations. Additionally, our selling practices are regulated by competition authorities in the jurisdictions in which we operate. A finding that we are in violation of, or out of compliance with, applicable laws or regulations could subject us to civil remedies, including fines, damages, injunctions or product recalls, or criminal sanctions, any of which could adversely affect our business.
We are dependent upon access to external sources of capital to grow our business.
Our business strategy contemplates future access to debt and equity financing to fund the expansion of our business. Recent events in the financial markets have had an adverse impact on the credit markets and equity securities which have exhibited a high degree of volatility. The inability to obtain sufficient capital to fund the expansion of our business or to refinance debt as it comes due could have a material adverse effect on us. In addition, a downgrade in our credit rating could make it difficult or prohibitively expensive to borrow, which could have a material adverse effect on us.
If we pursue strategic acquisitions or divestitures, we may not be able to successfully consummate favorable transactions or successfully integrate acquired businesses.
We may consider acquisitions, joint ventures and divestitures as a means of enhancing shareholder value and furthering our strategic objectives. Acquisitions and joint ventures involve financial and operational risks and uncertainties, including difficulty identifying suitable candidates or consummating a transaction on terms that are favorable to us; inability to achieve expected returns that justify the investments made; potential impairment resulting from overpayment for an acquisition; difficulties integrating acquired companies and operating joint ventures, retaining the acquired businesses customers and brands, and achieving the expected financial results and benefits of the transaction, such as cost savings and revenue growth from geographic expansion or product extensions; inability to implement and maintain consistent standards, controls, procedures and information systems; and diversion of managements attention from our core businesses.
The global nature of our business and the resolution of tax disputes will create volatility in our effective tax rate.
As a global business, our tax rate from period to period will be affected by many factors, including changes in tax legislation and the manner in which such legislation is interpreted or enforced, our global mix of earnings, the tax characteristics of our income, the timing and recognition of goodwill impairments, acquisitions and dispositions, adjustments to our reserves related to uncertain tax positions, changes in valuation allowances and the portion of the income of non-U.S. subsidiaries that we expect to remit to DE US, Inc. and that will be taxable. Although we are targeting an effective tax rate of approximately 25% in fiscal years 2014 and 2015, no assurances can be made in this regard. A higher than anticipated effective tax rate could have an adverse impact on our financial condition and results of operations.
In addition, significant judgment will be required in determining our effective tax rate and in evaluating our tax positions. We will establish a reserve for certain tax contingencies when, despite the belief that our tax return positions are fully supported, we believe that certain positions will be challenged and may not be fully sustained. The tax reserve will be adjusted in light of changing facts and circumstances, such as the progress of tax audits, case law and emerging legislation. Our effective tax rate will include the impact of tax reserve and changes to the reserve, including related interest and penalties, as considered appropriate by management. When particular matters arise, a number of years may elapse before such matters are audited and finally resolved. Unfavorable resolution of any particular issue could increase the effective tax rate and may require the use of cash in the year of resolution. We are currently disputing notices received from tax authorities in jurisdictions, including Brazil, alleging underpayment of certain taxes. Although we believe that our positions with respect to these matters are correct, there can be no assurance that we will prevail or that any such amounts if ultimately determined to be payable by us will not have a material and adverse effect on our results of operations or cash flows.
Risks Related to the Separation
As of the end of our fiscal year 2012, we had no operating history as an independent, publicly traded company and our historical financial information is not necessarily indicative of our future financial condition, future results of operations or future cash flows nor does it reflect what our financial condition, results of operations or cash flows would have been as an independent public company during the periods presented.
Our business separated from the other businesses of Sara Lee on June 28, 2012. The historical financial information set forth herein for the fiscal years ended June 30, 2012, July 2, 2011 and July 3, 2010 does not reflect what our financial condition, results of operations or cash flows would have been as an independent public company during those periods and is not necessarily indicative of our future financial condition, future results of operations or future cash flows. This is primarily a result of the following factors:
We may be unable to achieve some or all of the benefits that we expect to achieve as an independent, publicly traded company.
By separating from Sara Lee there is a risk that we may be more susceptible to market fluctuations and other adverse events than we would have otherwise been were we still a part of Sara Lee. In addition, we incurred significant costs in connection with our separation from Sara Lee, which may ultimately exceed our estimates. As part of Sara Lee, we were able to enjoy certain benefits from Sara Lees operating diversity and purchasing leverage, as well as its economies of scope and scale in costs, employees, vendor relationships and customer relationships. If we are unable to achieve these benefits, that would have an adverse effect on our results of operations.
Potential indemnification liabilities to Hillshire and liabilities related to divestures assumed pursuant to the separation agreements could materially and adversely affect our business, financial condition, results of operations and liquidity.
In connection with the separation, we entered into a master separation agreement with Hillshire that provided for, among other things, the principal corporate transactions required to effect the separation, certain conditions to the separation and provisions governing the relationship between the Company and Hillshire with respect to and resulting from the separation. For a description of the master separation agreement, see Related Party TransactionsAgreements with Sara Lee CorporationMaster Separation Agreement located in Item 7B. Among other things, the master separation agreement provides for indemnification obligations and obligations to assume liabilities towards third parties designed to make us financially responsible for substantially all liabilities that may exist relating to our downstream business activities, whether incurred prior to or after the separation, as well as those obligations of Hillshire assumed by us pursuant to the master separation agreement, including certain liabilities related to divestitures made by Hillshire prior to the separation, including the divestitures of its former household and body care and international bakery businesses. In connection with the separation, we have also entered into other agreements with Hillshire that impose indemnification and other obligations on us. If we are required to indemnify Hillshire or third parties, we may be subject to substantial liabilities, which may have a material adverse effect on our business, financial condition, results of operations and liquidity.
In connection with our separation from Hillshire, Hillshire will indemnify us for certain liabilities. However, there can be no assurance that the indemnity will be sufficient to insure us against the full amount of such liabilities, or that Hillshires ability to satisfy its indemnification obligation will not be impaired in the future.
Pursuant to the master separation agreement, Hillshire has agreed to indemnify us for certain liabilities. However, third parties could seek to hold us responsible for any of the liabilities that Hillshire has agreed to retain, and there can be no assurance that the indemnity from Hillshire will be sufficient to protect us against the full amount, or any, of such liabilities, or that Hillshire will be able to satisfy its indemnification obligations. Moreover, even if we ultimately succeed in recovering from Hillshire any amounts for which we are held liable, we may be temporarily required to bear these losses ourselves. Hillshires insurers may deny coverage to us for
liabilities associated with occurrences prior to the separation. Even if we ultimately succeed in recovering from such insurance providers, we may be required to temporarily bear such loss of coverage. If Hillshire is unable to satisfy its indemnification obligations or if insurers deny coverage, the underlying liabilities could have a material adverse effect on our business, financial condition, results of operations and liquidity.
We may be unable to make, on a timely or cost-effective basis, the changes necessary to operate as an independent, publicly owned company subject to the reporting requirements of the SEC and Dutch law.
Our business has historically relied on Hillshire for various financial, treasury, tax and other corporate services and information technology systems to support our operations. Since the separation, Hillshire continues to supply us certain of these services and systems, generally on a short-term transitional basis. However, we are required to establish the necessary infrastructure and systems to supply these services and systems on an ongoing basis. We may not be able to replace these services and systems provided by Hillshire in a timely or cost-effective manner or on terms and conditions as favorable as those we receive from Hillshire.
In addition, as a public entity, we are subject to the reporting requirements of the SEC. In addition to the annual and current reports that we are required to file with the SEC, Dutch law requires that we file annual, semi-annual and interim reports with respect to our business and financial condition. We implemented additional procedures and processes for the purpose of addressing the standards and requirements applicable to Dutch public companies listed on NYSE Euronext Amsterdam and companies subject to SEC reporting requirements. These activities may divert managements attention from other business concerns, which could have a material adverse effect on our business, financial position, results of operations or cash flows.
We may have been able to receive better terms from unaffiliated third parties than the terms we receive in our agreements with Hillshire.
The agreements related to the separation were negotiated in the context of our separation from Hillshire while we were still part of Hillshire. Accordingly, these agreements may not reflect terms that would have resulted from arms-length negotiations among unaffiliated third parties. The terms of the agreements negotiated in the context of our separation were related to, among other things, allocations of assets, liabilities, rights, indemnifications and other obligations among Hillshire and us. We may have received better terms from third parties because third parties may have competed with each other to win our business. see Related Party TransactionsAgreements with Sara Lee Corporation located in Item 7B.
Under the U.S. federal bankruptcy law and similar provisions of state fraudulent transfer laws, a court could deem the separation or certain related internal restructuring transactions as fraudulent transfers.
Under the U.S. federal bankruptcy law and similar provisions of state fraudulent transfer laws, a court could deem the separation or certain related internal restructuring transactions as fraudulent transfers, if the court held that such transactions:
A court likely would find that Hillshire did not receive reasonably equivalent value or fair consideration for the transfers related to the separation. The issue, therefore, will be whether at the time of the transfers Sara Lee
was insolvent or rendered insolvent, was left with unreasonably small capital or was unable to pay its debts when they become due. The measures of insolvency for purposes of these fraudulent transfer laws will vary depending upon the law applied in any proceeding to determine whether a fraudulent transfer has occurred. Generally, however, a party would be considered insolvent if:
We cannot be sure what standard a court would apply in making these determinations. The remedy for a fraudulent transfer is to void the transfer and return the property to the transferor.
Certain of our directors and officers may have actual or potential conflicts of interest because of their equity ownership in Sara Lee.
Because of their current or former positions with Hillshire or Sara Lee, certain of our directors and executive officers own shares of Hillshire common stock or hold other equity interests or options to acquire shares of Hillshire. These officers and directors may continue to own shares of Hillshire Brands common stock or other Hillshire equity interests and the individual holdings may be significant for some of these individuals compared to their total assets. This ownership may create, or may create the appearance of, conflicts of interest when these directors and officers are faced with decisions that could have different implications for Sara Lee and the Company.
For example, potential conflicts of interest could arise in connection with the resolution of any dispute that may arise between us and Sara Lee regarding the terms of the agreements governing the separation and the relationship thereafter between the companies. Potential conflicts of interest could also arise if we and Sara Lee enter into additional commercial arrangements with each other in the future.
Concerns about our prospects as a stand-alone company could affect our ability to retain employees.
The separation represented a substantial organizational and operational change and our employees might have concerns about our prospects as a stand-alone company, including our ability to successfully operate the new entity and our ability to maintain our independence. If we are not successful in assuring our employees of our prospects as an independent company, our employees might seek other employment, which could materially adversely affect our business.
If the distribution does not qualify as tax-free for U.S. federal income tax purposes, tax could be imposed on Sara Lee and Sara Lee shareholders; DE US, Inc. may be required to indemnify Sara Lee for the tax, and DE US, Inc.s potential indemnification liabilities to Sara Lee could materially and adversely affect D.E MASTER BLENDERS business, financial condition, results of operations and liquidity.
Sara Lee received from the U.S. Internal Revenue Service (the IRS) a private letter ruling (the IRS Ruling) to the effect that the distribution and certain related transactions, including the debt exchange, qualified as tax-free to Sara Lee, DE US, Inc., which became a wholly-owned subsidiary of the Company as part of the separation-and Sara Lee shareholders for U.S. federal income tax purposes under Sections 355, 368(a) (1)(D) and 361 of the U.S. Internal Revenue Code of 1986 (the Code). Sara Lee also received an opinion of counsel that the distribution and certain related transactions should qualify as tax-free to Sara Lee, DE US, Inc. and Sara Lee shareholders under Sections 355, 368(a)(1)(D) and 361 of the Code. However, if the factual representations or
assumptions made in connection with the IRS Ruling or opinion of counsel are untrue or incomplete in any material respect, or any material forward-looking covenants or undertakings are not complied with, or if the applicable law on which the IRS Ruling and opinion of counsel are based is changed with retroactive effect, then Sara Lee would not be able to rely on the IRS Ruling or the opinion of counsel. If the distribution failed to qualify as tax-free under the aforementioned Code provisions, then Sara Lee would recognize a substantial gain for U.S. federal income tax purposes and Sara Lee shareholders would recognize substantial taxable income.
As described above, the distribution was also conditioned upon the receipt by Sara Lee of an opinion of counsel to the effect that the distribution and certain related transactions, including the debt exchange, would qualify as tax-free to Sara Lee, DE US, Inc. and Sara Lee shareholders under Sections 355, 368(a)(1)(D), and 361 and related provisions of the Code. Sara Lee received such opinion, along with the opinions addressing Sections 367, 368 and 7874 of the Code, at the effective time of the distribution. The opinions relied on the IRS Ruling as to matters covered by the IRS Ruling. The tax opinions also are based on, among other things, assumptions and representations that have been received from Sara Lee, DE US, Inc. and the company, including those representations contained in certificates of officers of Sara Lee, DE US, Inc. and the company, as requested by counsel. If any of those factual representations or assumptions were to be untrue or incomplete in any material respect, any undertaking was not complied with, or the facts upon which the opinions are and will be based were to be materially different from the facts at the time of the distribution, the distribution may not qualify under Sections 355, 368(a)(1)(D) and 361 of the Code.
The conclusions in the tax opinion from counsel are based on then-existing legal authority. With respect to certain conclusions as to which there is no authority directly on point, such conclusions are based upon a reasoned analysis and interpretation of relevant analogous authorities. The opinion is not binding on the IRS or the courts, and there can be no assurance that the IRS or the courts would not challenge the conclusions stated in the opinion or that any such challenge would not prevail. Thus, notwithstanding the receipt by Sara Lee of the IRS Ruling and an opinion of counsel, the IRS could assert that the distribution should be treated as a taxable transaction in whole or in part, if, among other things, it determines that any of the representations, assumptions or undertakings that were included in the request for the IRS Ruling is untrue or has not been complied with or if it disagrees with the conclusions in the opinion that are not covered by the IRS Ruling. If the IRS were to prevail in such challenge, the tax consequences to Sara Lee or the Sara Lee shareholders could be material. DE US, Inc. is not aware of any facts or circumstances that would cause any such factual statements or representations in the IRS Ruling or the tax opinion to be incomplete or untrue or cause the facts on which the IRS Ruling is based, or the tax opinion is be based, to be materially different from the facts at the time of the distribution.
Even if the distribution were otherwise to qualify as tax-free under Sections 355, 368(a)(1)(D) and 361 of the Code, it may be taxable to Sara Lee (but not to Sara Lees shareholders) under Section 355(e) of the Code, if the distribution were later deemed to be part of a plan (or series of related transactions) pursuant to which one or more persons acquire, directly or indirectly, stock representing a 50% or greater interest in Sara Lee or DE US, Inc.. For this purpose, any acquisitions of Sara Lee stock, DE US, Inc. common stock, or D.E MASTER BLENDERS common stock within the period beginning two years before the distribution and ending two years after the distribution are presumed to be part of such a plan, although DE US, Inc. or Sara Lee may be able to rebut that presumption. For this purpose, the acquisitions of DE US, Inc. common stock by D.E MASTER BLENDERS and of D.E MASTER BLENDERS common stock by Sara Lees shareholders, in the merger should not be treated as acquisitions.
Although any taxes resulting from the distribution not qualifying under Sections 355, 368(a)(1)(D) and 361 of the Code generally would be imposed on Sara Lee shareholders and Sara Lee, under the tax sharing agreement, DE US, Inc. would be required to indemnify Sara Lee and its affiliates against all tax-related liabilities caused by the failure of the distribution to so qualify (including as a result of Section 355(e) of the Code) to the extent these liabilities arise as a result of any action (or failure to act) of DE US, Inc. or of its affiliates, including D.E MASTER BLENDERS, following the distribution or otherwise result from any breach of certain representations, covenants or obligations of DE US, Inc. or any of its affiliates, including D.E
MASTER BLENDERS, concerning a partys plan or intention with respect to actions or operations after the distribution date. Further, under the tax sharing agreement, DE US, Inc. would be required to indemnify Sara Lee and its affiliates against 50% of all tax-related liabilities caused by the failure of the distribution to qualify under Sections 355, 368(a)(1)(D) and 361 of the Code to the extent these liabilities (1) do not arise as a result of any action (or failure to act) of Sara Lee, DE US, Inc. or any of their respective affiliates, following the distribution and do not otherwise result from any breach of any representation, covenant or obligation of Sara Lee, DE US, Inc. or any of their respective affiliates, or (2) arise due to an action (or failure to act), misrepresentation or omission of Sara Lee, DE US, Inc. or their respective affiliates prior to the date of the distribution not concerning a partys plan or intention with respect to actions or operations after the distribution date. See Related Party TransactionsAgreements with Sara Lee CorporationTax Sharing Agreement located in Item 7B. DE US, Inc.s indemnification obligations to Sara Lee and its affiliates are not limited in amount or subject to any cap. It is expected that any amount of such taxes to Sara Lee would be substantial. If the above-mentioned tax-related risks materialize this could have a material adverse effect on our liquidity and financial position.
D.E MASTER BLENDERS and DE US, Inc. are subject to certain restrictions as a result of the separation in order to preserve the tax-free treatment of the distribution, which may reduce D.E MASTER BLENDERS strategic and operating flexibility.
The covenants in, and DE US, Inc.s indemnity obligations under, the tax sharing agreement may limit the ability of D.E MASTER BLENDERS and DE US, Inc. to pursue strategic transactions or engage in new business or other transactions that may maximize the value of its business. The covenants in, and DE US, Inc.s indemnity obligations under, the tax sharing agreement will also limit its ability to modify the terms of, prepay, or otherwise acquire any of the DE US, Inc. debt securities.
D.E MASTER BLENDERS and DE US, Inc. agreed not to enter into any transaction that could reasonably be expected to cause any portion of the distribution to be taxable to Sara Lee, including under Section 355(e) of the Code as mentioned above. DE US, Inc. also agreed to indemnify Sara Lee for any tax liabilities resulting from any such transactions. The amount of any such indemnification could be substantial. Further, as it relates to Section 355(e) of the Code specifically, these covenants and indemnity obligations might discourage, delay or prevent a change of control that D.E MASTER BLENDERS shareholders may consider favorable. For additional detail, see Related Party TransactionsAgreements with Sara Lee CorporationTax Sharing Agreement located in Item 7B.
Our ability to repurchase our shares is limited as a result of the separation.
In connection with both the IRS Ruling and the tax opinion of counsel, we represented that we had no plan or intention to redeem, repurchase or otherwise acquire more than 20% of our outstanding stock. The covenants in, and DE US, Inc.s indemnity obligations under, the tax sharing agreement limits our ability to redeem, repurchase or otherwise acquire more than 20% of our outstanding stock as part of a plan that includes the distribution.
DE US, Inc. is subject to continuing contingent liabilities of Sara Lee.
There are several significant areas where the liabilities of Sara Lee may become DE US, Inc.s obligations. For example, under the Code and the related rules and applicable Treasury Regulations, each corporation that was a member of the Sara Lee consolidated tax reporting group during any taxable period or portion of any taxable period ending on or before the effective time of the distribution is severally liable for the U.S. federal income tax liability of the entire Sara Lee consolidated tax reporting group for that taxable period. In connection with the separation, DE US, Inc. entered into a tax sharing agreement with Sara Lee that allocates the responsibility for prior period taxes of the Sara Lee consolidated tax reporting group between DE US, Inc. and Sara Lee. See Related Party TransactionsAgreements with Sara Lee CorporationTax Sharing Agreement located in Item 7B. If Sara Lee is unable to pay any prior period taxes for which it is responsible, DE US, Inc.
could be required to pay the entire amount of such taxes. Other provisions of federal law establish similar liability for other matters, including laws governing tax-qualified pension plans as well as other contingent liabilities. If DE US, Inc. is subject to any such liabilities, that may have a material adverse effect on the Companys business, financial condition, results of operations and liquidity.
D.E MASTER BLENDERS may be treated as a U.S. corporation for U.S. federal income tax purposes following the merger of its subsidiary with DE US, Inc.
For U.S. federal income tax purposes, a corporation generally is considered tax resident in the place of its incorporation. Because D.E MASTER BLENDERS is incorporated under Dutch law, it should be deemed a Dutch corporation under this general rule. However, Section 7874 of the Code generally provides that a corporation incorporated outside the United States that acquires substantially all of the assets of a corporation incorporated in the United States will be treated as a U.S. corporation (and, therefore, a U.S. tax resident) for U.S. federal income tax purposes if shareholders of the acquired U.S. corporation own at least 80 percent (of either the voting power or the value) of the stock of the acquiring foreign corporation group after the acquisition and the acquiring foreign corporations expanded affiliated group does not have substantial business activities in the country in which the acquiring foreign corporation is organized. Pursuant to the merger, D.E MASTER BLENDERS acquired all of DE US, Inc.s assets, and DE US, Inc. shareholders hold 100 percent of D.E MASTER BLENDERS by virtue of their stock ownership of DE US, Inc. As a result, D.E MASTER BLENDERS should be treated as a foreign corporation for U.S. federal income tax purposes under Section 7874 of the Code provided that the D.E MASTER BLENDERS group has substantial business activities in the Netherlands. Under the rules applicable to D.E MASTER BLENDERS, at the time of the merger, there was no specific guidance as to what constitutes substantial business activities. Based on the historical conduct of the coffee and tea business in the Netherlands, the relative amount of assets, employees and sales located in the Netherlands, the substantial managerial activities by officers and employees in the Netherlands, and the Dutch business activities that are material to the Groups overall business activities, in each case at the time of the merger, D.E MASTER BLENDERS believes that its expanded affiliated group should have substantial business activities in the Netherlands. As a result, D.E MASTER BLENDERS should not be treated as a U.S. corporation for U.S. federal income tax purposes under Section 7874 of the Code following the merger, and the Company obtained an opinion of counsel to that effect. Nevertheless, it is possible that the IRS would interpret Section 7874 of the Code to treat D.E MASTER BLENDERS as a U.S. corporation after the merger. Moreover, the U.S. Congress or the IRS and Treasury Department may enact new statutory or regulatory provisions that could adversely affect D.E MASTER BLENDERS status as a foreign corporation. Retroactive statutory or regulatory actions have occurred in the past, and there can be no assurance that any such provisions, if enacted or promulgated, would not have retroactive application to D.E MASTER BLENDERS.
If it were determined that D.E MASTER BLENDERS is properly treated as a U.S. corporation for U.S. federal income tax purposes, D.E MASTER BLENDERS could be liable for substantial additional U.S. federal income tax. For Dutch corporate income tax and dividend withholding tax purposes, D.E MASTER BLENDERS will, regardless of any application of Section 7874 of the Code, be treated as a Dutch resident company since D.E MASTER BLENDERS is incorporated under Dutch law. The Tax Convention concluded between the Netherlands and the United States will not fully limit the ability of the Netherlands to levy such taxes. Consequently, the Company might be liable for both Dutch and U.S. taxes, which would have a material adverse effect on our financial condition and results of operations.
Additionally, D.E MASTER BLENDERS shareholders could face certain adverse tax consequences if it were determined that the Company were properly treated as a U.S. corporation for U.S. federal income tax purposes. With respect to U.S. Holders, the U.S. consequences of owning and disposing of shares of D.E MASTER BLENDERS generally would be the same as those of owning and disposing of shares of a foreign corporation, as described in TaxationTaxation in the United States in Item 10E. However, U.S. Holders generally would not be able to claim a U.S. foreign tax credit with respect to any Dutch taxes withheld by the Company on distributions unless the U.S. Holder had other foreign source income. With respect to shareholders
that are not U.S. Holders, because the Company would continue to be treated as a Dutch corporation for Dutch withholding tax purposes, such shareholders could be subj