XLON:0Q8H Annual Report 20-F Filing - 6/30/2012

Effective Date 6/30/2012

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 20-F

 

 

(Mark One)

¨    REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR(g) OF THE

SECURITIES EXCHANGE ACT OF 1934

OR

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

OR

¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

OR

¨    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)

 

 

Not Applicable

(Translation of Registrant’s name into English)

The Netherlands

(Jurisdiction of incorporation or organization)

Oosterdoksstraat 80

1011 DK Amsterdam

The Netherlands

+31 20-558-1753

(Address of principal executive offices)

 

Robin Jansen

Vice President Investor Relations

Oosterdoksstraat 80

1011 DK Amsterdam

The Netherlands

+31 20-558-1753

Investor-relations@DEMB.com

 

Onno van Klinken

General Counsel and Corporate Secretary

Oosterdoksstraat 80

1011 DK Amsterdam

The Netherlands

+ 31 20-558-1753

corporate.secretary@DEMB.com

(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.

Not applicable

Securities registered or to be registered pursuant to Section 12(g) of the Act.

Not applicable

(Title of Class)

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.

 

Title of each class

 

Name of each exchange on which registered

Ordinary shares, par value €0.12 per share   NYSE Euronext Amsterdam

(Title of Class)

Indicate the number of outstanding shares of each of the issuer’s 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

 

         

Page

Item 1

   Identity of Directors, Senior Management and Advisors    1

Item 2

   Offer Statistics and Expected Timetable    1

Item 3

   Key Information    1

Item 4

   Information on the Company    28

Item 4A

   Unresolved Staff Comments    49

Item 5

   Operating and Financial Review and Prospects    49

Item 6

   Directors, Senior Management and Employees    72

Item 7

   Major Shareholders and Related Party Transactions    92

Item 8

   Financial Information    98

Item 9

   The Offer and Listing    101

Item 10

   Additional Information    102

Item 11

   Quantitative and Qualitative Disclosure about Market Risk    121

Item 12

   Description of Securities other than Equity Securities    121

Item 13

   Defaults, Dividend Arrearages and Delinquencies    121

Item 14

   Material Modifications to the Rights of Security Holders and Use of Proceeds    121

Item 15

   Controls and Procedures    123

Item 16A

   Audit Committee Financial Expert    124

Item 16B

   Code of Ethics    124

Item 16C

   Principal Accountant Fees and Services    124

Item 16D

   Exemptions from the Listing Standards for Audit Committees    125

Item 16E

   Purchases of Equity Securities by the Issuer and Affiliated Purchasers    125

Item 16F

   Change in Registrant’s Certifying Accountant    125

Item 16G

   Corporate Governance    125

Item 16H

   Mine Safety Disclosure    126

Item 17

   Financial Statements    126

Item 18

   Financial Statements    F-1

Item 19

   Exhibits    II-9
  

Signatures

   II-11

 

i


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 Corporation’s 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.

 

ii


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 management’s 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 management’s 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 Company’s ability to transition successfully to a stand-alone operation, ongoing trends in the marketplace that affect the price and demand for the Company’s products, the cost and availability of raw materials, the outcome of the Company’s 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.

 

iii


PART I

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISORS

Not applicable

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

Not applicable

ITEM 3. KEY INFORMATION

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.

 

1


     Fiscal Year Ended  
     June 30, 2012     July 2,  2011
Restated
    July 3,  2010(1)
Restated
    June 27,  2009
Restated
 
     (amounts in millions of euro, except percentages and per share
amounts)
 

Income Statement Data

        

Sales

     2,795.0        2,593.3        2,313.4        2,218.3   

Cost of sales

     1,787.1        1,611.6        1,347.7        1,333.1   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     1,007.9        981.7        965.7        885.2   

Selling, general and administrative expenses

     898.2        656.4        623.8        554.3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating profit

     109.7        325.3        341.9        330.9   

Finance income, net

     132.2        91.8        55.3        128.1   

Finance costs, net

     17.4        (45.4     14.7        (12.1

Share of profit from associates

     0.2        2.2        2.7        3.4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Profit before income taxes

     259.5        373.9        414.6        450.3   

Income tax expense

     127.3        110.7        174.9        127.3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Profit for the period

     132.2        263.2        239.7        323.0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per Ordinary Share-Basic and Diluted(2)

     0.22        0.44        0.40        0.54   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted Average Shares Outstanding-Basic and Diluted (in millions of shares)

     595        595        595        595   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance Sheet Data

        

Cash and cash equivalents

     220.3        1,342.6        663.8        506.4   

Trade receivables

     282.3        250.0        228.7        226.8   

Inventories

     404.9        437.5        308.8        275.7   

Trade payables

     282.1        264.7        198.3        185.5   

Property, plant and equipment

     377.4        369.9        365.6        372.6   

Total borrowings

     557.4        363.1        330.8        308.0   

Total parent’s net investment(3)

     —          3,271.1        2,518.9        2,808.1   

Total shareholders’ equity(3)

     317.6        —          —          —     

Cash Flow Data

        

Cash generated from (used in) operating activities(4)

     102.5        281.7        364.8        194.0   

Cash generated from (used in) investing activities(5)

     456.7        70.8        353.8        (70.6

Cash generated from (used in) financing activities(5)

     (1,685.9     340.2        (564.1     (346.3

Other Financial Data

        

Sales growth

     7.8     12.1     4.3     n/a   

Like for like sales growth(6)

     7.5     9.2     0.5     n/a   

EBIT(7)

     109.9        327.5        344.6        334.3   

EBIT margin(8)

     3.9     12.6     14.9     15.1

Adjusted EBIT(7)

     321.8        357.2        366.1        339.6   

Adjusted EBIT margin(8)

     11.5     13.8     15.8     15.3

Working capital(9)

     63.6        2,200.6        2,361.4        2,577.7   

Operating working capital(9)

     405.1        422.8        339.2        317.0   

Operating working capital as a percentage of sales(9)

     14.5     16.3     14.7     14.3

Free cash flow(10)

     5.2        204.2        299.1        76.5   

Net cash(11)

     —          979.5        333.0        198.4   

Net debt(11)

     337.1        —          —          —     

Capital expenditures

     97.3        77.5        65.7        117.5   

 

2


(1) Our fiscal year ends on the Saturday closest to June 30. Fiscal years 2012, 2011 and 2009 were 52-week and 2010 was a 53-week year.

 

(2) Earnings per share is computed by dividing profit for the period by the weighted average number of common shares outstanding for the period. The earnings per share for the periods prior to the separation were computed as if the shares issued at separation, which equal the shares outstanding at June 30, 2012, were outstanding for all periods presented.

 

(3) As the entities within Sara Lee’s international coffee and tea operations were not held by a single legal entity prior to the separation we presented parent’s net investment instead of shareholders’ equity. Upon the international coffee and tea operations becoming owned by the Company, the parent’s net investment was converted into shareholders’ equity.

 

(4) For the periods prior to separation, we have assumed all taxes were settled by Hillshire, and as a result there are no cash taxes reflected in our operating cash flows. As a consequence, our future operating cash flows will be reduced by tax payments that are currently reflected as distributions to Hillshire in financing activities in the statement of cash flow.

 

(5) For the periods prior to separation, our investing cash flows reflect cash inflows of €685.2 million, €156.9 million and €402.6 million in the fiscal years 2012, 2011 and 2010, respectively, and cash outflows of €30.3 million in fiscal year 2009 related to loans provided by us to Hillshire and the associated interest income. These loans were settled in connection with the spin-off.

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.

 

(6) We define like for like sales as sales calculated at a constant exchange rate and adjusted to eliminate the 53rd week and acquisitions during the period. We have included like for like sales to provide the investor a more clear understanding of our sales growth on a comparable basis. Like for like sales is not a measure in accordance with IFRS and accordingly should not be considered as an alternative to sales. The following table provides reconciliation from sales to like for like sales:

 

     Fiscal Year Ended  
     June 30, 2012     July 2,  2011
Restated
    July 3,  2010
Restated
    June 27,  2009
Restated
 
     (amounts in millions of euro, except percentages)  

Sales

     2,795.0        2,593.3        2,313.4        2,218.3   

Adjustments

        

Foreign Exchange(a)

     2.7        (16.0     73.9        117.7   

53rd week

     n/a        n/a        (34.6     n/a   

Café Moka acquisition

     (19.7     (24.6     (36.1     (31.7

Café Damasco acquisition

     (45.6     (24.0     n/a        n/a   

Coffee Company acquisition

     (5.7     n/a        n/a        n/a   

Tea Forté acquisition

     (5.2     n/a        n/a        n/a   

House of Coffee acquisition

     (2.3     n/a        n/a        n/a   

Expresso.Coffee acquisition

     (0.8     n/a        n/a        n/a   
  

 

 

   

 

 

   

 

 

   

 

 

 

Like for like sales

     2,718.4        2,528.7        2,316.6        2,304.3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Like for like sales growth

     7.5     9.2     0.5     n/a   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

  (a) The foreign exchange adjustments are calculated at the budgeted exchange rate for fiscal 2012. These rates may differ from the average exchange rate for the period. The currencies with the most significant impact are the Australian dollar and the Brazilian Real. The budgeted exchange rates were 1.36 and 1.64 for the Australian Dollar and 2.38 and 2.74 for the Brazilian Real for fiscal 2012 and 2011, respectively.

 

3


(7) EBIT is defined as profit for the period before finance income, finance costs and income taxes. We define adjusted EBIT as EBIT before share of profit from associates and adjusted to exclude items management believes are unrelated to its underlying business and that are excluded from our segment profitability, including restructuring charges, impairment charges, costs associated with businesses no longer owned by us and others. We have included adjusted EBIT as it is a key performance metric used by management across our business. In addition, we believe these are useful measures for investors in understanding the performance of our underlying operations. These profit measures are not financial measures calculated in accordance with IFRS and may not be comparable to similar measures presented by other companies. Accordingly, they should not be considered as an alternative to operating profit or profit for the period. The following tables provide reconciliation from profit for the period to these non-IFRS measures:

 

     Fiscal Year Ended  
     June 30, 2012     July 2,  2011
Restated
    July 3,  2010
Restated
    June 27,  2009
Restated
 
     (amounts in millions of euro)  

Profit for the period

     132.2        263.2        239.7        323.0   

Finance income, net

     (132.2     (91.8     (55.3     (128.1

Finance costs, net(a)

     (17.4     45.4        (14.7     12.1   

Income taxes

     127.3        110.7        174.9        127.3   
  

 

 

   

 

 

   

 

 

   

 

 

 

EBIT

     109.9        327.5        344.6        334.3   

Share of profit from associates

     (0.2     (2.2     (2.7     (3.4

Adjustments

        

Restructuring charges

     57.7        25.2        5.4        36.2   

Restructuring related

     63.0        7.8        9.1        6.8   

Termination of prior Senseo agreement

     55.3        —          —          —     

Curtailment and past service costs

     —          (13.1     —          (23.8

Impairment

     21.3        5.6        —          —     

Gain on sale of assets

     —          —          —          (17.2

Branded apparel costs(b)

     7.9        3.5        7.9        6.7   

Other

     6.9        2.9        1.8        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total adjustments

     212.1        31.9        24.2        8.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBIT

     321.8        357.2        366.1        339.6   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

  (a) The foreign exchange adjustments are calculated at the budgeted exchange rate for fiscal 2012. These rates may differ from the average exchange rate for the period. The currencies with the most significant impact are the Australian dollar and the Brazilian Real. The budgeted exchange rates were 1.36 and 1.64 for the Australian Dollar and 2.38 and 2.74 for the Brazilian Real for fiscal 2012 and 2011, respectively.

 

  (b) We are legally responsible for and managed certain liabilities associated with the branded apparel business Sara Lee sold prior to fiscal 2009. The liabilities, which include pensions, medical claims and environmental liabilities are reflected in our financial statements. We exclude the impact of these items in assessing our profitability as they are unrelated to our ongoing business.

 

(8) EBIT margin and adjusted EBIT margin represent EBIT and adjusted EBIT as defined above divided by sales.

 

(9) Working capital is defined as current assets less current liabilities. We define operating working capital as inventory and trade receivables less trade payables. We have included operating working capital as the components of this measure are controlled by management and we use this measure to set management targets.

 

4


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.

 

(10) We define free cash flow as cash flows from operations less capital expenditures. We have included free cash flow as we believe it is a useful measure for investors. Free cash flow for the fiscal years 2011, 2010 and 2009 is derived from our audited 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, free cash flow should not be considered as an alternative to operating cash flow. The following provides reconciliation from operating cash flow to this non-IFRS measure:

 

     Fiscal Year Ended  
     June 30, 2012     July 2,  2011
Restated
    July 3,  2010
Restated
    June 27,  2009
Restated
 
     (amounts in millions of euro, except percentages)  

Operating Cash Flow

     102.5        281.7        364.8        194.0   

Less: capital expenditures

     (97.3     (77.5     (65.7     (117.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Free Cash Flow

     5.2        204.2        299.1        76.5   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(11) Net cash is defined as total cash and cash equivalents minus total borrowings (the sum of current borrowings and non-current borrowings). Net debt is defined as total borrowings less cash and cash equivalents. For the periods prior to separation we had net cash. Since separation we have net debt as a consequence of various transactions with Hillshire in connection with the separation, our borrowings increased and our cash and cash equivalents decreased. We have included net cash/debt as we believe it is a useful measure for investors.

Exchange Rate

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.

 

     Low      High  
     (U.S.$ per €1.00)  

Month ended:

  

January 31, 2012

     1.2682         1.3192   

February 29, 2012

     1.3087         1.3463   

March 31, 2012

     1.3025         1.3336   

April 30, 2012

     1.3064         1.3337   

May 31, 2012

     1.2364         1.3226   

June 30, 2012

     1.2420         1.2703   

 

     Average  for
Period(1)

Year ended on the Saturday closest to June 30,:

  

2007

   1.3143

2008

   1.4837

2009

   1.3646

2010

   1.3864

2011

   1.3748

2012

   1.3385

 

5


 

Source: Federal Reserve (https://www.federalreserve.gov)

Note:

 

(1) Annual averages are calculated from month-end rates.

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

Not applicable

3C Reasons for the offer and use of proceeds

Not applicable

 

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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

 

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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 Employees—Pension Schemes—Pension 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

 

8


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.

 

9


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

 

10


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 parent’s 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 L’OR 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

 

11


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

 

12


against several of our subsidiaries claiming patent and trademark infringement in connection with our sales of L’OR EspressO and L’aRôme EspressO. Because sales of the L’OR EspressO and L’aRôme 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

 

13


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.

 

14


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.

 

15


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 management’s 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:

 

   

our historical financial results reflect allocations of expenses for services historically provided by Sara Lee, and those allocations may be significantly higher or lower than the comparable expenses we would have incurred as an independent company;

 

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we have historically participated in Sara Lee’s corporate-wide cash management programs, and our cost of debt and other capital may be significantly different from that reflected in our historical financial statements; and

 

   

the historical financial information may not fully reflect the increased costs associated with being an independent public company, including significant changes that will occur in our cost structure, management, financing arrangements and business operations as a result of our separation from Sara Lee, including costs associated with our internal restructuring and all the costs related to being an independent public company.

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 Lee’s 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 Transactions—Agreements with Sara Lee Corporation—Master 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 Hillshire’s 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. Hillshire’s insurers may deny coverage to us for

 

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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 management’s 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 arm’s-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 Transactions—Agreements 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:

 

   

were consummated with the intent to hinder, delay or defraud Hillshire’s existing or future creditors; or

 

   

Hillshire received less than reasonably equivalent value or did not receive fair consideration for the transactions and Hillshire:

 

   

was insolvent or rendered insolvent at the time of the transfers;

 

   

was engaged in a business or transaction for which Sara Lee’s remaining assets constituted unreasonably small capital; or

 

   

Sara Lee intended to incur, or believed that it would incur, debts beyond its ability to pay such debts generally as they mature.

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

 

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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:

 

   

the sum of its debts, including contingent liabilities, was greater than the sum of its property, at a fair valuation;

 

   

the present fair saleable value of its assets was less than the amount that would be required to pay its probable liability on its existing debts, including contingent liabilities, as they become absolute and mature; or

 

   

it could not pay its debts as they become due.

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

 

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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 Lee’s 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 Lee’s 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

 

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MASTER BLENDERS, concerning a party’s 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 party’s plan or intention with respect to actions or operations after the distribution date. See “Related Party Transactions—Agreements with Sara Lee Corporation—Tax 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 Transactions—Agreements with Sara Lee Corporation—Tax 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 Transactions—Agreements with Sara Lee Corporation—Tax 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.

 

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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 Company’s 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 corporation’s “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 Group’s 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 “Taxation—Taxation 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

 

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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 subject to dividend withholding under both U.S. and Dutch law absent an applicable exemption.

Our ability to utilize certain non-U.S. tax attributes is uncertain.

We could lose certain non-U.S. tax attributes, or our ability to utilize such attributes may be limited, if the separation is viewed as a “change of control” under the laws of certain of the jurisdictions in which we have non-U.S. tax attributes. Any such limitations or loss of attributes could have an adverse impact on our financial condition or results of operations.

We may be subject to U.S. and non-U.S. tax risks as a result of post-separation restructuring.

D.E MASTER BLENDERS and DE US, Inc. undertook certain internal restructuring and financing transactions after the separation, which could result in the imposition of U.S. and non-U.S. taxes. Sara Lee received an opinion of counsel to the effect that these transactions should not result in material U.S. federal income tax. The opinion is not binding on the IRS or the courts. If the IRS were to successfully challenge the conclusions stated in the opinion, DE US, Inc. could be subject to a material U.S. federal income tax liability, and DE US, Inc. may be subject to a higher effective tax rate on a going forward basis. Furthermore Sara Lee obtained advance clearance on certain elements of the post-separation restructuring from non-U.S. local tax authorities. Nevertheless, such local tax authorities could successfully challenge at least part of the restructuring, since not all countries and/or elements are covered by these advance agreements.

Risks Related to Our Ordinary Shares

Because the public market for our ordinary shares is relatively new, the market price and trading volume of our ordinary shares may be volatile.

Trading of our ordinary shares on NYSE Euronext Amsterdam began on an as-if-and-when-issued basis and have transitioned to regular way trading on July 9, 2012. The market price of our ordinary shares could fluctuate significantly due to a number of factors, many of which are beyond our control, including:

 

   

fluctuations in our financial results or those of other companies in our industry;

 

   

failures of our financial results to meet the estimates of securities analysts or the expectations of our shareholders or changes by securities analysts in their estimates of our future earnings;

 

   

announcements by us or our customers, suppliers or competitors;

 

   

changes in laws or regulations which adversely affect our industry or us;

 

   

changes in accounting standards, policies, guidance, interpretations or principles;

 

   

general economic, industry and stock market conditions;

 

   

the fact that our ordinary shares will not be listed on a U.S. stock exchange;

 

   

the failure of our ordinary shares to be maintained in the AEX Index, the main index for securities listed on NYSE Euronext Amsterdam, or another similar index;

 

   

future sales of our ordinary shares; and

 

   

the other factors described in these “Risk Factors” and other parts of this Annual Report.

Our ordinary shares will only be transferable on NYSE Euronext Amsterdam if held in a securities account through Euroclear Nederland.

D.E MASTER BLENDERS ordinary shares are listed only on NYSE Euronext Amsterdam. D.E MASTER BLENDERS ordinary shares will be ineligible for sale on NYSE Euronext Amsterdam unless they are held in a

 

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securities account through Euroclear Nederland. To facilitate the transfer of their D.E MASTER BLENDERS ordinary shares into such a Euroclear Nederland-eligible account, shareholders who hold shares directly in the register maintained by the exchange agent must have their D.E MASTER BLENDERS ordinary shares credited to such a securities account by delivering or arranging for delivery of an instruction form to the exchange agent. Shareholders for whom a broker, bank or nominee has been registered as the owner of D.E MASTER BLENDERS ordinary shares on the register maintained by the exchange agent must have this broker, bank or other nominee deliver an instruction form duly executed by the broker, bank or other nominee.

Your percentage ownership in the Company may be diluted in the future.

As with any publicly traded company, your percentage ownership in the Company may be diluted if we issue ordinary shares in connection with acquisitions or other strategic transactions. Your percentage ownership may also be diluted by equity awards that we expect will be granted to our directors, officers and employees. For a description of our stock incentive plan arrangements and the adjustments being made to outstanding Sara Lee equity awards held by individuals who became our directors, officers or employees, see “Treatment of Equity-Based Compensation in Separation” in Item 4.

We cannot assure you that we will pay dividends on our ordinary shares, and our indebtedness or our financial condition could limit our ability to pay dividends on our ordinary shares.

Our general dividend policy is determined by our board of directors and will be discussed with our shareholders at our annual general meeting of shareholders. Within the general dividend policy, our board of directors will determine to what extent profits will be retained by way of a reserve. In making this determination, the board will consider our ability to declare and pay dividends in light of our future operations and earnings, capital expenditure requirements, general financial conditions, legal and contractual restrictions and other factors that it may deem relevant. There can be no assurance that we will pay a dividend in the future or continue to pay any dividend if we do commence the payment of dividends. There can also be no assurance that the combined annual dividends on Sara Lee common stock, if any, and our ordinary shares, if any, will be equal to the annual dividends on Sara Lee common stock prior to the separation. In addition, under Dutch law, we may only pay dividends if our equity exceeds the sum of paid-in and called-up share capital plus the reserves as required to be maintained by Dutch law or by our articles of association, which we refer to as our Articles.

Additionally, indebtedness that we incurred in connection with the debt exchange could have important consequences for holders of our ordinary shares. If we cannot generate sufficient cash flow from operations to meet our debt payment obligations, then our ability to pay dividends, if so determined by the board of directors, will be impaired and we may be required to attempt to restructure or refinance our debt, raise additional capital or take other actions such as selling assets or reducing or delaying capital expenditures. There can be no assurance, however, that any such actions could be effected on satisfactory terms, if at all, or would be permitted by the terms of our new debt or our other credit and contractual arrangements, including the tax sharing agreement.

Any dividend payments on our ordinary shares would be declared in euro, and any shareholder whose principal currency is not the euro would be subject to exchange rate fluctuations.

The ordinary shares are, and any dividends or distributions from the dividend reserve allocated to the ordinary shares to be declared in respect of them, if any, will be, denominated in euro. Shareholders whose principal currency is not the euro will be exposed to foreign currency exchange rate risk. Any depreciation of the euro in relation to such foreign currency will reduce the value of such shareholders’ ordinary shares and any appreciation of the euro will increase the value in foreign currency terms. In addition, we will not offer our shareholders the option to elect to receive dividends, if any, in U.S. dollars. Consequently, our shareholders may be required to arrange their own foreign currency exchange, either through a brokerage house or otherwise, which could incur additional commissions or expenses.

 

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We are subject to Dutch law and the rights of our ordinary shareholders may be different from those rights associated with companies governed by other laws.

As a result of being organized under the laws of the Netherlands, our corporate structure as well as the rights and obligations of our ordinary shareholders may be different from the rights and obligations of shareholders in companies incorporated in other jurisdictions. Resolutions of the general meeting of shareholders may be taken with majorities different from the majorities required for adoption of equivalent resolutions in, for example, Maryland corporations.

Although shareholders will have the right to approve legal mergers or demergers, Dutch law does not grant appraisal rights to a company’s shareholders who wish to challenge the consideration to be paid upon a legal merger or demerger of a company. In addition, if a third-party is liable to a Dutch company, under Dutch law shareholders generally do not have the right to bring an action on behalf of the company or to bring an action on their own behalf to recover damages sustained as a result of a decrease in value, or loss of an increase in value, of their ordinary shares. Only in the event that the cause of liability of such third-party to the company also constitutes a tortious act directly against such shareholder and the damages sustained are permanent, may that shareholder have an individual right of action against such third-party on its own behalf to recover damages. The Dutch Civil Code provides for the possibility to initiate such actions collectively. A foundation or an association whose objective, as stated in its articles of association, is to protect the rights of persons having similar interests may institute a collective action. The collective action cannot result in an order for payment of monetary damages but may result in a declaratory judgment (verklaring voor recht), for example declaring that a party has acted wrongfully or has breached a fiduciary duty. The foundation or association and the defendant are permitted to reach (often on the basis of such declaratory judgment) a settlement which provides for monetary compensation for damages. A designated Dutch court may declare the settlement agreement binding upon all the injured parties with an opt-out choice for an individual injured party. An individual injured party, within the period set by the court, may also individually institute a civil claim for damages if such injured party is not bound by a collective agreement.

The provisions of Dutch corporate law have the effect of concentrating control over certain corporate decisions and transactions in the hands of our board of directors. As a result, holders of our shares may have more difficulty in protecting their interests in the face of actions by members of the board of directors than if we were incorporated in the United States.

In the performance of its duties, our board of directors is required by Dutch law to consider the interests of the Company, our shareholders, our employees and other stakeholders in all cases with reasonableness and fairness. It is possible that some of these parties will have interests that are different from, or in addition to, interests of our shareholders.

In addition, Dutch law provides certain obligations on companies that are domiciled in the Netherlands and whose shares are admitted to trading on a “regulated market,” as well as on certain shareholders of such companies. NYSE Euronext Amsterdam qualifies as a regulated market and these laws will apply to us and certain of our shareholders. Among other things, these laws may require shareholders to notify the AFM of their holding of ordinary shares and changes to their holding if they increase or decrease their shareholding over or below 5% (a legislative proposal is expected to be adopted, which would introduce an initial threshold of 3%), 10%, 15%, 20%, 25%, 30%, 40%, 50%, 60%, 75% and 95% of our ordinary shares and may require certain shareholders that acquire 30% or more of the voting rights attached to our ordinary shares, subject to certain exceptions, acting alone or in concert with others, to make a public offer for all of our ordinary shares. See “Articles of Association and Dutch Law” in Item 10B.

As a foreign private issuer listed solely on NYSE Euronext Amsterdam, we will rely on certain Dutch corporate governance and disclosure practices rather than corresponding U.S. practices.

We are a foreign private issuer and are listed solely on NYSE Euronext Amsterdam. As a company based in the Netherlands, we rely on Dutch corporate governance requirements rather than the corresponding

 

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requirements of U.S. exchanges for domestic issuers. We comply with each of the requirements of the Dutch Corporate Governance Code (except for the best practice provision limiting remuneration in the case of dismissal to no more than one year’s salary and the best practice provision prescribing that the board of directors states that the internal risk management and control systems provide a reasonable assurance that the financial reporting does not contain any errors of material importance and that the risk management and control systems worked properly in the year under review). Set forth below are the material Dutch corporate governance practices that we follow and that differ from practices common among U.S.-listed issuers.

 

   

Our Articles do not provide quorum requirements applicable to resolutions proposed to the general meeting of shareholders by the board of directors.

 

   

Our general meeting of shareholders must adopt a general policy in respect of the remuneration of the board of directors. In accordance with our Articles, the remuneration of our executive directors is determined by the board of directors upon the recommendation of our remuneration committee, with due observance of the remuneration policy adopted by the general meeting of shareholders. In accordance with our Articles, the remuneration of our non-executive directors is determined by our general meeting of shareholders, with due observance of the remuneration policy.

 

   

Under Dutch law, there is no regulatory regime for the solicitation of proxies and the solicitation of proxies is not a generally accepted business practice in the Netherlands. We therefore do not intend to comply with the rules and regulations under the Securities Exchange Act of 1934, as amended, which we refer to as the Exchange Act, related to the furnishing and content of proxy statements.

Accordingly, you may not have the same protections afforded to shareholders of companies that are not foreign private issuers.

You may be unable to enforce judgments obtained against us in U.S. courts.

We are incorporated under the laws of the Netherlands, and all or a substantial portion of our assets are located outside of the United States and certain of our directors and officers and certain other persons named in this Report are, and will continue to be, non-residents of the United States. As a result, although we have appointed an agent for service of process in the United States, it may be difficult or impossible for United States investors to effect service of process within the United States upon us or our non-U.S. resident directors and officers or certain other persons named in this Annual Report or to enforce in the United States any judgment against us or them including for civil liabilities under the United States securities laws. A judgment obtained in the United States federal or state court against us or them may need to be enforced in the courts of the Netherlands, or such other foreign country as may have jurisdiction against us or them (or our/their assets). In the case of the Netherlands, because there is no treaty on the reciprocal recognition and enforcement of judgments in civil and commercial matters between the United States and the Netherlands, courts in the Netherlands will not necessarily recognize and enforce a final judgment rendered by a United States federal or state court, and in any case will not automatically do so. For a United States judgment to be recognized and enforceable in the Netherlands, a judgment creditor must bring proceedings before a Dutch court of competent jurisdiction and seek a Dutch judgment recognizing and enforcing the liability of the relevant defendant/judgment debtor. Nevertheless, based on the current practice of the Dutch courts, it appears that a final money judgment rendered by a United States federal or state court after a substantive review of the merits (i.e., not by mere “default judgment”) will be entitled to recognition by a Dutch court upon a showing that: (A) the final judgment resulted from legal proceedings compatible with Dutch notions of due process, (B) the final judgment did not contravene any public policy of the Netherlands and (C) the United States federal or state court exercised personal jurisdiction over the relevant defendant/judgment debtor based on grounds that were internationally acceptable. Investors should not assume, however, that the courts of the Netherlands, or any other foreign jurisdiction, would enforce judgments of United States courts obtained against us or our directors and officers (or other persons named in this Annual Report) predicated solely upon the civil liability provisions of the United States securities laws or that such foreign courts would enforce, in original actions, liabilities against us or them predicated solely upon such laws.

 

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Subject to the foregoing and service of process in accordance with applicable treaties, investors may be able to enforce in the Netherlands judgments in civil and commercial matters obtained from U.S. federal or state courts. We believe that U.S. investors may originate actions in a Dutch court. However, in such original actions, investors should not assume that a Dutch court would enforce liabilities predicated solely upon U.S. securities laws.

We have appointed Law Debenture Corporate Services Inc., located at 400 Madison Avenue 4 Floor New York, New York 10017, United States, as our agent to receive service of process with respect to any action brought against us in the United States District Court for the Southern District of New York under the federal securities laws of the United States or of any State of the United States or any action brought against us in the Supreme Court of the State of New York in the County of New York under the securities laws of the State of New York.

Failure to remain included in the AEX index may increase volatility in our share price, may reduce liquidity and may negatively impact our share price.

D.E MASTER BLENDERS has been included in Euronext Amsterdam’s main stock index, the AEX index, as of September 24, 2012. The AEX index is composed of the 25 most actively traded stocks on Euronext Amsterdam. Inclusion in the AEX index strengthens a company’s investment profile and increases its visibility in the financial markets. Certain investors, such as some index-tracking investment funds, track the performance of the AEX index by directly or indirectly investing in all stocks of which it is constituted.

If we were no longer to be included in the index, this could increase the volatility of our shares. It could also reduce the liquidity of our shares on Euronext Amsterdam. As a result our removal from the index could have a negative effect on the price of our shares.

As of 2011, AEX index composition is reviewed four times a year—with a full “annual” review occurring in March and interim “quarterly” reviews occurring in June, September and December. Changes made to the AEX index as a result of the reviews take effect on the third Friday of the month.

Association of Securities holders (Vereniging van Effectenbezitters) might undertake legal action.

The Association of Securities holders (Vereniging van Effectenbezitters, or VEB), a Dutch association representing interests of investors, has written to the Company in connection with the accounting irregularities in Brazil. In its letter, the VEB expresses the view that these accounting irregularities should have been disclosed in the prospectus that was published at the time of the separation from Sara Lee. The VEB alleges that the non-disclosure in the prospectus has harmed certain unnamed shareholders of the Company. The VEB states that it does not exclude initiating litigation if it cannot reach an amicable arrangement with us on this issue. The VEB has not specified the amount of damages that it is seeking from us. We disagree with the VEB. We believe the prospectus was prepared in accordance with the required standards of care and that we are not liable for any damages caused. Interested parties other than the VEB, including regulatory authorities, may also decide to initiate proceedings against us in connection with the accounting irregularities in Brazil. If proceedings are brought against us, this may distract our management from running our business operations. If we were to lose a case brought against us, we could be made to indemnify shareholders for damages they incurred which might have a negative effect on the price of our stock.

 

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ITEM 4. INFORMATION ON THE COMPANY

4A History and development of D.E MASTER BLENDERS

General

D.E MASTER BLENDERS 1753 N.V. is a public limited liability company (naamloze vennootschap) incorporated in the Netherlands, with its corporate seat in Joure (Skasterlân), the Netherlands and with its business address at Oosterdoksstraat 80, 1011 DK Amsterdam, the Netherlands.

In January 2011, Sara Lee announced that its board of directors had agreed in principle to the separation of Sara Lee into two publicly traded companies. In connection with the separation, we became an independent, publicly traded company that holds, through our subsidiaries, the assets and liabilities associated with Sara Lee’s international coffee and tea businesses, which are headquartered in the Netherlands.

D.E MASTER BLENDERS B.V. was incorporated on February 27, 2012 as a private company with limited liability (besloten vennootschap met beperkte aansprakelijkheid) by Sara Lee International B.V., a private company with limited liability (besloten vennootschap met beperkte aansprakelijkheid). On April 4, 2012, we changed our name to D.E MASTER BLENDERS 1753 B.V. and moved our corporate seat to Joure (Skasterlân), the Netherlands. On June 21, 2012, Sara Lee International B.V. changed our name to D.E MASTER BLENDERS 1753 N.V., converted us into a public company with limited liability (naamloze vennootschap) incorporated under the laws of the Netherlands and amended our articles of association. Our shares are listed on NYSE Euronext in Amsterdam, which we refer to as NYSE Euronext Amsterdam, under the symbol “DE,” with the ISIN Code NL0010157558 and the common code 078049103.

The separation from Sara Lee was comprised of the distribution and the merger, and certain related transactions. These related transactions are described in the section of this Annual Report entitled “Separation-Related Financing” in Item 4A and include the issuance of the new Sara Lee notes, exchanges of Sara Lee debt (including the new Sara Lee notes) for DE US, Inc. debt securities, the entry into bridge financing by DE US, Inc. and DEMB International B.V., as well as the payment by DE US, Inc. of the DE US, Inc. Special Dividend after the distribution and prior to the merger. These transactions were designed to facilitate the separation in a manner that was efficient and that focuses on the long-term success of both the Company and Sara Lee after the separation. We believe, and Sara Lee has informed us that it believes, that the separation-related financing transactions provide both the Company and Sara Lee with flexible capital structures, in terms of their respective operational and financial needs and risk profiles. Specifically, DE US, Inc.’s and DEMB International B.V.’s entry into bridge financing and D.E MASTER BLENDERS’ entry into the revolving credit facility, together with the exchange of DE US, Inc. debt securities for certain Sara Lee debt, including the new Sara Lee notes, in the debt exchange are expected to provide us with a flexible capital structure comprised of short-term and long-term debt with which we will be more capable of responding to market conditions on a going forward basis.

The separation occurred through Sara Lee’s distribution to Sara Lee’s shareholders of all of the outstanding shares of DE US, Inc. common stock and the subsequent exchange in the merger of such shares for 100% of D.E MASTER BLENDERS’ ordinary shares outstanding immediately prior to the merger. In addition, DE US, Inc. declared a special cash dividend of $3.00 per share to each holder of record of DE US, Inc. common stock immediately following the distribution that was paid after the distribution and prior to the merger. We refer herein to this dividend as the DE US, Inc. Special Dividend. Each of the holders of Sara Lee common stock, who are also the beneficial owners of DE US, Inc. common stock following the distribution, received one ordinary share of D.E MASTER BLENDERS in respect of each share of Sara Lee common stock held at the close of business on June 14, 2012, the record date for the distribution.

Our agent for service in the U.S. is Law Debenture Corporate Services Inc., 400 Madison Avenue, 4 Floor, New York, New York 10017.

 

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Our headquarters are located at:

Oosterdoksstraat 80

1011 DK Amsterdam

The Netherlands

Telephone number: +31 20-558-1753

Internet site: www.demasterblenders1753.com

Industry Overview

In the past decade, the coffee industry has seen growth from both the value and premium sectors as coffee consumption increased globally. Recently in developed countries, however, the primary growth in the coffee industry has come from the premium coffee category, including demand for single-serve coffee. We believe that this growth has been driven by the wider availability of high-quality coffee, the emergence of upscale coffee shops throughout the world and the general level of consumer knowledge of, and appreciation for, coffee quality and variety. According to J.P. Morgan Cazenove, single-serve coffee now accounts for approximately 25% of the roast and ground coffee market in Western Europe. In emerging market and coffee producing countries, coffee consumption has steadily increased over the past decade. P&A Marketing International, which we refer to as P&A, has predicted that by 2020, emerging market and coffee producing countries will account for more than 50% of all coffee consumed globally. Of these countries, Brazil is currently the largest coffee consumer. Coffee consumption in Brazil has increased by approximately 45% in the past decade and the country now accounts for approximately 60% of the Latin American coffee market, according to the Brazilian Coffee Industry Association and J.P. Morgan Cazenove. P&A believes that approximately 85% of the coffee consumption increase between now and 2020 will come from Brazil and other coffee producing countries and emerging markets. Given these trends, we believe that, in order to successfully compete in the global coffee industry in the future, we must be able to capitalize on the growth in both the premium coffee market and in emerging market countries.

The global tea industry has also increased significantly in value over the past decade, but much of the growth has not come from new or developing tea markets. Rather, traditional tea drinking countries like Russia and China continue to drive most of the growth in the tea industry, according to Euromonitor International Ltd., which we refer to as Euromonitor. In Europe, we believe that growth in the tea industry will come from premium, healthy teas. In order to continue to compete in the global tea industry, we must be able to offer high quality, premium tea in traditional flavors, as well as in newer concepts, formats and varieties that appeal to consumers.

The most significant cost item in the production of coffee products is the price of green coffee beans, which are purchased from tradehouses, cooperatives and farmers in various countries. Most coffee companies purchase both Arabica coffee beans and Robusta coffee beans for use in the blending and roasting processes to create different types of coffee products. Brazil is the largest global producer of Arabica coffee, while Vietnam is the world leader in Robusta production.

Purchasing green coffee is a complex undertaking that involves market research, maintaining close contact with existing suppliers, identifying and selecting potential suppliers and coffee types required to produce blends, as well as negotiating and agreeing on purchase terms with suppliers. The price of green coffee is subject to fluctuations based upon 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. In addition, certain types of premium or sustainable coffees sell at a premium to other green coffees due to the inability of producers to increase supply in the short run to meet rising demand. As consumers and certain customers become increasingly interested in purchasing sustainable or fair trade coffee, more coffee companies are seeking to purchase larger quantities of certified sustainable or fair trade green coffee. Because the supply of coffee certifiable as sustainable or fair trade is limited, the cost of acquiring such coffee may increase significantly in the future and coffee producers could experience difficulty producing adequate quantities to meet the increased demand.

 

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Fiscal 2011 saw a significant increase in the price of green coffee. In fiscal 2011, the price of green coffee increased by more than 50% over the prior year, reaching its highest level since 1997. After a downwards correction in fiscal 2012, we expect our average level of commodity costs to decline in fiscal 2013 compared to fiscal 2012, and prices are expected to remain volatile for the foreseeable future. To combat the substantial price increases in fiscal 2011, and the volatility in the green coffee commodities market generally, many coffee companies, including us, have employed certain hedging mechanisms, such as futures or options, to lock in prices for future deliveries of green coffee. In addition, we, along with many of our competitors, occasionally raise prices to our retail customers to offset increases in our cost of goods. If commodity costs decline, we may face pressure from our customers to decrease our prices.

In connection with the rising commodity prices over the past several years, our retail and Out of Home customers have exhibited price sensitivity. In our retail segments, where we sell our products to retail outlets, we believe this has been a response to weakened consumer confidence as global economic conditions have worsened. Consumer confidence levels remained weak in fiscal year 2012 and consumers are expected to remain price-conscious in fiscal 2013. In the Out of Home segment, where the customer is typically a business, hospital or hotel, we believe customer price sensitivity has been a result of efforts to reduce overhead costs. In some markets, price sensitivity has made it difficult to increase prices to cover increased green coffee costs.

Recent developments and capital expenditures and divestments

Please see the section of this Annual Report entitled “Separation from Sara Lee” under Item 5 for a detailed description of the steps comprising D.E MASTER BLENDERS spin-off from Sara Lee. Please see Notes 6, 7, 8 and 13 of our financial statements for further information on capital expenditures and divestments.

Separation-Related Financing

On May 15, 2012, Sara Lee issued approximately $650 million principal amount of notes, which we refer to as the new Sara Lee notes, in a private placement. In connection with the contribution of Sara Lee’s international coffee and tea businesses to DE US, Inc., Sara Lee received approximately $2.1 billion principal amount of DE US, Inc. debt securities, which are guaranteed by D.E MASTER BLENDERS. In connection with the distribution and in accordance with the terms of the new Sara Lee notes, Sara Lee satisfied its obligations under the new Sara Lee notes by transferring a portion of such DE US, Inc. debt securities to the holders of the new Sara Lee notes. Such DE US, Inc. debt securities were issued by DE US, Inc. and guaranteed by D.E MASTER BLENDERS pursuant to a note purchase and guarantee deed. Sara Lee transferred the remaining DE US, Inc. debt securities to certain subsidiaries of DE US, Inc. in satisfaction of Sara Lee’s debt obligations to such subsidiaries of DE US, Inc. For more information regarding D.E MASTER BLENDERS guarantee of the DE US, Inc. debt securities, see the section of this Annual Report entitled “Description of Certain Indebtedness—Note Purchase and Guarantee Deed” under Item 10B.

On May 29, 2012, each of DE US, Inc. and our subsidiary, DEMB International B.V., entered into an agreement with third party lenders for approximately $1.8 billion of bridge financing, consisting of an initial bridge loan and a second bridge loan, each of approximately $1.8 billion. The initial bridge loan was repaid shortly after the distribution of the DE US, Inc. Special Cash Dividend with the proceeds of the second bridge loan. The second bridge loan was repaid shortly after the separation with cash on hand at the time of the separation. For further information regarding the bridge loans, see the section of this Annual Report entitled “Description of Certain Indebtedness—Bridge Financing” under Item 10B.

In connection with the separation, on May 22, 2012, D.E MASTER BLENDERS and DE US, Inc. entered into a revolving credit facility to provide available financing to D.E MASTER BLENDERS in future periods. For further information regarding the revolving credit facility, see the section of this Annual Report entitled “Description of Certain Indebtedness—Revolving Credit Facility Agreement” under Item 10B.

 

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As a consequence of various transactions, including those described above, between us and Sara Lee in connection with the separation, our borrowings have increased to approximately €557 million and our cash and cash equivalents have decreased to approximately €220 million.

Treatment of Equity-Based Compensation in Separation

Prior to the separation, Sara Lee, D.E MASTER BLENDERS and D.E US Inc. entered into an employee matters agreement (the “Employee Matters Agreement”) describing the treatment of Sara Lee equity awards held by employees who are now employed by D.E US Inc. and by the Company, or who are former employees of the D.E US Inc. business but who held equity awards at the time of the distribution, which we collectively refer to as D.E MASTER BLENDERS Employees, and by non-employee directors who serve on the board of directors of the Company. For purposes of this discussion, “Sara Lee RSUs” refers to Sara Lee restricted stock units and “Sara Lee PSUs” refers to Sara Lee performance share units. Below we describe the treatment of Sara Lee stock that is converted into D.E MASTER BLENDERS stock.

For the actual number of D.E MASTER BLENDERS stock held by directors and senior management after conversion, reference is made to “Item 6—Directors, Senior Management and Employees”.

Adjustment of Sara Lee Equity Awards

Sara Lee RSUs and Sara Lee PSUs outstanding immediately prior to June 28, 2012 the distribution date were adjusted to account for the distribution and the CoffeeCo (i.e. DE US Inc.) Special Dividend.

Sara Lee RSUs

With respect to Sara Lee RSUs granted on January 26, 2012 to our Non-Executive Chairman in his role as Executive Chairman of the board of directors of Sara Lee, which we refer to as the Chairman 2012 RSUs, one-half of such Chairman 2012 RSUs vested on the distribution date. The remaining one-half of the Chairman 2012 RSUs were cancelled. The Chairman 2012 RSUs that vested, settled for a number of D.E MASTER BLENDERS ordinary shares determined by multiplying the number of shares of Sara Lee common stock subject to such vested Chairman 2012 RSUs by the D.E MASTER BLENDERS Ratio, and rounding down to the nearest whole share. “D.E MASTER BLENDERS Ratio” is a fraction, the numerator of which is the volume weighted average price of shares of Sara Lee common stock trading the regular way on the New York Stock Exchange on June 27 and 28, 2012 and the denominator of which is the volume weighted average price of the D.E MASTER BLENDERS ordinary shares trading in the as-if-and-when issued market on NYSE Euronext Amsterdam on June 29, 2012 and July 2, 2012 (as converted into U.S. dollars in accordance with the currency exchange rate published by the Federal Reserve Bank of New York for the distribution date).

Sara Lee RSUs granted on January 26, 2012 to our Chief Executive Officer in his role as Executive Vice President and Chief Executive Officer of Sara Lee’s Coffee and Tea (formerly International Beverage) segment vested in full on the distribution date and were settled for a number of D.E MASTER BLENDERS ordinary shares determined by multiplying the number of shares of Sara Lee common stock subject to RSUs by the D.E MASTER BLENDERS Ratio, and rounding down to the nearest whole share.

Sara Lee PSUs

With respect to Sara Lee PSUs granted on or following November 4, 2011 (other than the Chairman 2012 PSUs, as described below), and held immediately prior to the distribution by employees who became D.E MASTER BLENDERS Employees on the consummation of the merger, such Sara Lee PSUs were earned as follows, which we refer to as the “Earned PSUs”: the achievement of the performance goals were determined as of the distribution date based on actual performance through the distribution date with respect to the portion of the fiscal year 2012 that had occurred prior to the distribution date and based on target-level performance with respect to the portion of the fiscal year that had not yet occurred as of the distribution date.

 

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Upon consummation of the merger, the Earned PSUs were assumed by D.E MASTER BLENDERS and converted into a number of PSUs denominated in ordinary shares of the Company, the number of which was determined by multiplying the number of shares of Sara Lee common stock subject to the Sara Lee PSU immediately prior to the distribution by the D.E MASTER BLENDERS Ratio.

Sara Lee PSUs granted on January 26, 2012 to our Non-Executive Chairman in his role as Executive Chairman of the board of directors of Sara Lee, which we refer to as the Chairman 2012 PSUs, were earned as follows: the achievement of the performance goals were determined as of the distribution date based on actual performance through the distribution date with respect to the portion of Sara Lee’s fiscal year 2012 that had occurred prior to the distribution date and based on target-level performance with respect to the portion of Sara Lee’s fiscal year 2012 that had not yet occurred as of the distribution date. One-half of the Chairman 2012 PSUs that were earned pursuant to the previous sentence vested on the distribution date. The remaining one-half of the Chairman 2012 PSUs were cancelled. The Chairman 2012 PSUs that vested pursuant to the foregoing settled for a number of D.E MASTER BLENDERS ordinary shares determined by multiplying the number of shares of Sara Lee common stock subject to such vested Chairman 2012 PSUs by the D.E MASTER BLENDERS Ratio, and rounding down to the nearest whole share.

RSUs Held by Non-Employee Directors

Each non-employee director of Sara Lee who serves as a non-employee director of D.E MASTER BLENDERS and who held a Sara Lee RSU immediately prior to the distribution, continues to hold such Sara Lee RSU and was also granted a new RSU award denominated in ordinary shares of the Company, which we refer to as a D.E MASTER BLENDERS RSU, with the number of D.E MASTER BLENDERS shares subject to such D.E MASTER BLENDERS RSU determined by multiplying the number of Sara Lee shares subject to the Sara Lee RSU immediately prior to the distribution by a fraction, the numerator of which is the difference between the volume weighted average price of the Sara Lee shares trading the regular way on the New York Stock Exchange over June 27 and 28, 2012 and the volume weighted average price of shares of Sara Lee common stock on the New York Stock Exchange over June 29, 2012 and July 2, 2012 and the denominator of which is the volume weighted average price of the D.E MASTER BLENDERS ordinary shares trading in the as-if-and-when issued market on NYSE Euronext Amsterdam over June 29, 2012 and July 2, 2012 (as converted into U.S. dollars in accordance with the currency exchange rate published by the Federal Reserve Bank of New York for the distribution date).

Each Sara Lee RSU and D.E MASTER BLENDERS RSU held by a non-employee director who serves on the D.E MASTER BLENDERS board of directors after the distribution and consummation of the merger settled for shares of Sara Lee and the Company, respectively, on the date that is six months following the distribution date.

Material U.S. Federal Income Tax Consequences Relating to Section 7874 of the Code

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 corporation’s “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. D.E MASTER BLENDERS should be treated as a foreign corporation for U.S. federal income tax purposes under Section 7874 of the Code

 

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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 Group’s 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. 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 “Taxation—Taxation 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 subject to dividend withholding under both U.S. and Dutch law absent an applicable exemption.

Please see the section of this Annual Report entitled “Selected Financial Data” for the amount of D.E MASTER BLENDERS capital expenditures and divestitures for the last three fiscal years.

Property, plant and equipment

The total capital expenditures in property, plant and equipment amount to €97 million, €78 million and €66 million for fiscal years 2012, 2011 and 2010, respectively, and relate mainly to investments in machinery and equipment of €43 million, €37 million and €31 million in fiscal years 2012, 2011 and 2010, respectively, and construction in progress of €52 million, €39 million and €32 million in fiscal years 2012, 2011 and 2010, respectively.

Total disposals, including impairment, amount to €18 million, €15 million and €16 million in fiscal years 2012, 2011 and 2010, respectively.

 

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Intangible fixed assets

The total capital expenditures in intangible assets amount to €135 million, €8 million and €4 million in fiscal years 2012, 2011 and 2010, respectively. In March 2012 the Group entered into agreements to pay €115 million to Philips Electronics, which we refer to as Philips, to acquire its ownership interest in the Senseo coffee trademark. This acquisition provided the Group with full ownership of the Senseo trademark, which was previously co-owned with Philips.

Total disposals, including impairment, are €13 million, €2 million and €1 million in fiscal years 2012, 2011 and 2010, respectively.

Acquisitions during the fiscal year 2012

In December 2011, the Group acquired CoffeeCompany, a leading Dutch café store operator in the Netherlands; Tea Forte, a producer of ultra premium teas that are principally sold in the United States and Canada, and the Denmark operations of House of Coffee, a leading out of home provider of coffee and tea products in Norway and Denmark. In April 2012 the Group acquired Expresso Coffee Automacao de Bebidas Quentes Ltda, an out of home provider that offers its customers a full service concept (machines, coffee and service) mainly in the Sao Paulo area. The total consideration for these acquisitions was €23.4 million, including a perfomance-based contingent purchase price payment of €1 million, which was recognised as a liability. As of June 2012, the Group has estimated the contingent payment to be €1 million. As a result of the transactions, goodwill and other intangible assets of €25 million were recognised.

Divestments during the fiscal year 2012

There have been no divestments during the fiscal year 2012.

As of the date of this Annual Report, there has been no indication of any public takeover offer by any third party in respect of our ordinary shares, or by us in respect of other companies’ shares.

4B Business overview

General

We are a leading, focused pure-play coffee and tea company that offers an extensive range of high-quality, innovative coffee and tea products that are well-known in retail and out of home markets across Europe, Brazil, Australia and Thailand. According to Euromonitor, the global coffee and tea industry had aggregate revenues of approximately €78.3 billion in calendar year 2011. We are one of the largest companies (based on revenues) operating purely in the coffee and tea industry.

Our History

The roots of our Company go back to 1753 in Joure, the Netherlands, when the Douwe Egberts brand was founded as a grocery business and grew to specialize in coffee and tea. In 1948, Douwe Egberts expanded its business and began exporting its products to other European countries. Sara Lee acquired the Douwe Egberts business through a series of investments beginning in 1978. As part of Sara Lee, the Company expanded its geographic reach and increased its focus on innovation. In 1998, the Company entered the Brazilian coffee market through a series of acquisitions, most recently Café Moka in 2008 and Café Damasco in 2010. We started to aggressively grow the Cafitesse proprietary liquid coffee systems for the foodservice industry in the 1990s and introduced the Senseo single-serve coffee system in partnership with Philips in 2001. In 2010, the Company launched the L’OR EspressO capsules compatible with the Nespresso® single-serve system.

 

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Our Brands

We have a portfolio of leading coffee and tea brands that address the needs of both our retail and out of home customers in our markets. According to AC Nielsen, as of December 31, 2011, we held the top market position in the Netherlands, Brazil, Belgium, Denmark and Hungary, the number two position in France, Australia and Spain, based on the total retail coffee market, including multi-serve, single-serve and instant. In fiscal 2012, approximately 72% of our total sales were derived from markets where we held the number one or two market position. Each of our brands has a particular consumer or regional positioning that distinguishes it from its competitors and guides advertising and new product development.

Douwe Egberts is our largest and most established brand in the multi-serve category. With more than 250 years of experience in the coffee and tea industry, Douwe Egberts is the best-selling coffee brand in the Netherlands and Belgium and also has solid market positions in the United Kingdom and Hungary. In addition to Douwe Egberts, our multi-serve coffee is sold under the following brands: L’OR and Maison du Café in France, Marcilla in Spain, Merrild in Denmark, Harris in Australia, Kanis & Gunnink in the Netherlands, Jacqmotte in Belgium, Prima in Poland, and Pilão, Caboclo, Damasco and Moka in Brazil. Our single-serve coffee is sold under the brand name Senseo which is generally co-branded, such as Douwe Egberts Senseo and L’OR Senseo, in the Netherlands, Belgium, France, Germany, Spain and select other countries. In April 2010, we launched the L’OR EspressO capsules brand in France, and L’OR EspressO has subsequently been successfully launched in the Netherlands and Belgium. In May 2011, we successfully launched our capsules brand in Spain as L’aRôme EspressO. Our instant coffee is primarily sold under the Moccona brand in Australia and Thailand, under the Douwe Egberts brand in the United Kingdom and under local brands in certain of our markets. Our tea is sold under the brand names Pickwick in the Netherlands, Belgium, the Czech Republic, Hungary and Denmark and Hornimans in Spain. Our Out of Home segment primarily operates under the Cafitesse umbrella brand, which is principally co-branded Douwe Egberts Cafitesse, for our liquid roast coffee products and machines and under our Piazza D’Oro brand for premium espresso products and machines.

Our Competitive Strengths

Pure-Play Coffee and Tea Company. We are one of the largest companies (based on revenues) operating purely in the coffee and tea industry. We believe that our focus on the coffee and tea business enables us to introduce innovative new products and concepts tailored to the preferences of our consumers and customers. We believe that our scale and diversity of operations in key markets provides us with greater marketing resources, production efficiencies and purchasing expertise, broader research and development capabilities and deeper consumer knowledge and understanding than our smaller regional and local competitors. Further, we expect that our streamlined organization will optimize time-to-market of new product innovations.

Strong Brands with Leading Market Positions. Our brands have a strong heritage in the coffee and tea industry, and we possess a portfolio of well-known and trusted brands with leading positions in key markets. According to AC Nielsen, our coffee brands occupy the number one retail market position in the Netherlands, Brazil, Belgium, Hungary and Denmark, the number two position in France and Australia and the number three position in Spain, based on total retail coffee market revenues, including multi-serve, single-serve and instant. Our Douwe Egberts brand is the number one coffee brand in the Netherlands and Belgium. Pilão enjoys the number one position in Brazil and Merrild is the leading coffee brand in Denmark. The Senseo brand of single-serve coffee pads and our L’OR EspressO and L’aRôme EspressO single-serve capsules are recognized by consumers for quality, and we continue to expand our single-serve offerings into new markets. In the tea category, Pickwick is a well-known brand in the Netherlands, the Czech Republic, Hungary and Denmark and Hornimans currently enjoys a strong market position in Spain. Further, in our Out of Home segment, we believe based on our internal estimates and analysis that we hold the number one or two market position in six countries. The strength of our brands in these markets allows us to test and introduce new products quickly, further improving our ability to adapt to industry trends and changing consumer preferences.

 

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Knowledge and Innovation. Our business model is centered around our deep consumer knowledge and understanding, our technology and our strong innovation capabilities. Based on the unique consumer and customer insights we have gained over numerous decades, we have a deep understanding of the coffee and tea category and the preferences of its consumers and customers. This, coupled with our strong research and development capabilities, has positioned us well to launch new products and concepts that reflect the preferences of our consumers and customers. In 2001, for instance, we introduced the Senseo single-serve coffee system in partnership with Philips. Our launch in April 2010 of L’OR EspressO capsules compatible with the Nespresso® single-serve system marked our entry into the single-serve espresso category. We intend to increase our presence with further innovations in this category in the coming years. In the Out of Home segment, we have built superior knowledge, expertise and capabilities in the liquid roast category, creating an easy-to-use premium coffee experience with our Cafitesse liquid roast products and systems.

Strong Management Team. Our company has a centuries-long rich tradition in the coffee and tea industry and over the course of our long history, our organization has developed superior coffee expertise. We believe this gives us a competitive advantage throughout the entire coffee value chain and in particular in coffee blending, coffee and tea sourcing and developing technological innovations that will enhance the coffee experience for our consumers. In connection with our separation from Sara Lee, we have hired new management with experience outside the coffee and tea industry who have extensive experience expanding businesses in existing consumer markets and into new consumer markets. These individuals bring a strong track record of managerial and marketing capabilities to the Company. We believe that the combination of our coffee and tea industry experience and employee expertise with our growth driven management will be a powerful combination for the Company.

Key Business Strategies

Our aspiration is to be a leading, international coffee and tea company by enhancing the coffee and tea experience of our consumers through innovative products, concepts and systems that are based on our in-depth consumer knowledge and technology expertise, with a focus on the premium coffee and tea sectors. We intend to leverage our category and consumer expertise and knowledge across borders while tailoring our high-quality product offering to local preferences.

Enhance our Marketing Efforts. Our marketing strategy is to create added value by translating customer and consumer insights into effective innovations and brand visions. We are implementing a new innovation strategy designed to address consumer needs identified through preference mapping and other research. We intend to combine these insights with our rich heritage and expertise in the coffee and tea industry to create memorable coffee and tea experiences for our consumers and to strengthen our relationships with our customers. We plan to use the strength and consumer awareness of our key brands to allow us to introduce our innovations into the market quickly.

Our Out of Home segment plays an important role in building brand presence. To date, this has been an important but secondary role of the segment. Going forward, we expect that our Out of Home segment will play an increasing role in brand building by targeting select customers with broad consumer visibility, for example at cafés, gas stations and airports.

We also plan to increase our focus on digital and new media, which we believe will allow us to interact more effectively with our consumers in each of our markets. For example, the launch of the L’OR EspressO product line involved a mix of traditional print and television advertising campaigns, as well as digital media advertising, and our L’OR EspressO sales increased in the fiscal quarter in which these campaigns launched. We also seek to increase brand and product awareness by placing our products in as many customer channels as possible. Additionally, we currently have a successful loyalty building program in the Netherlands, which we are in the process of modernizing. We plan to build on that success to continue to improve our connection with our consumers in all of our markets.

 

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Revitalize Product Lines to Enhance the Coffee and Tea Experience. We intend to renew our product line in 24 months, with the majority of such innovations expected to come to market in the second half of fiscal 2013, as described below:

Re-Invent Multi-Serve. We see multi-serve as an opportunity to refresh a category that has been stable for a long period of time. We intend to engage new and existing consumers with a differentiated product line presented in a contemporary fashion. We expect that this will include a broader product range, new premium offerings and new packaging concepts that address diverse consumer preferences.

Revitalize Pads. Philips and Sara Lee were pioneers in expanding the single-serve category. With over 33 million Senseo machines sold as of February 1, 2012, the market position of our coffee pads provides us with a solid foundation in this category. Our retail sales of coffee pads increased by 20% between fiscal 2008 and fiscal 2012, and we had €434 million in sales of coffee pads in fiscal 2012, with approximately 95% of such sales from the Netherlands, Belgium, France and Germany. Going forward, we intend to pursue geographic expansion and machine and coffee pad innovations and we intend to address a broader range of consumer segments, with more varied and contemporary product offerings. To this end, on March 30, 2012 we entered into a partnership agreement and a trademark transfer agreement with Philips to strengthen our relationship with Philips and acquire the full rights to the Senseo trademark. In the future, we intend to use Senseo as our new master brand for any future high-tech product offerings and we expect to launch a new Senseo machine annually.

Differentiate Capsules. Our L’OR EspressO and L’aRôme EspressO capsules have experienced significant success and sales growth since the launch of L’OR EspressO in France in April 2010, with revenues from such sales exceeding €110 million in fiscal 2012. We intend to expand our capsule sales by establishing more differentiated brand positioning and extending our range to better address varied consumer preferences.

Build on Leading Position in Out of Home and Focus on Synergies with Retail. Through our proprietary liquid roast coffee technology and our Cafitesse brand, we lead the liquid roast category for out of home consumption (based on internal estimates and analysis). We intend to expand our liquid roast coffee business and, to further this goal, we are developing new, premium liquid roast products. We also intend to broaden our business base to include many of the more visible customer segments where roast and ground and espresso products are key to success. To this end, we recently acquired CoffeeCompany, a dynamic café operator targeting young urban consumers in the Netherlands. Our intent is to gain inspiration and consumer connection experiences with the goal of expanding the visibility of, and becoming more effective in showcasing, our retail brands. We also intend to use the cafés as a test market to test new products and concepts before a full-scale launch. However, we do not intend to become a global café operator.

Expand our Presence in Instants into Existing Markets. We have a strong market position in premium freeze-dried instant coffee in Australia with the Moccona brand and have been gaining instant coffee market share in the United Kingdom with the Douwe Egberts brand. We plan to build on our instant coffee expertise through further innovations and increased marketing in countries where we already have strong multi-serve footholds.

Reinvigorate Tea. We believe that we have a strong platform from which to expand in the tea category with our Pickwick brand, which is well-known in the Netherlands, Hungary, Denmark and the Czech Republic, our Hornimans brand, which is a leader in Spain, and our recently acquired Tea Forte brand, a premium tea brand principally sold in the United States and Canada. We intend to expand our presence in the tea market through innovative new concepts and a sustained marketing effort designed to create more premium positioning for our tea activities.

Expand Geographically. As a part of Sara Lee, we historically derived a large percentage of our sales and profits from Western Europe. As an independent company, we intend to pursue growth in our Western European markets, including the Netherlands, France, Spain, Belgium and Denmark, through effective marketing,

 

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innovation and increased penetration of our products in these markets. We also intend to pursue growth in the emerging markets in which we currently operate, including Brazil, Eastern Europe and Thailand, and expansion into new markets through extensions of our own product innovations and through selective acquisitions, where appropriate and with a high level of discipline. Additionally, we believe that our Senseo single-serve coffee system and our L’OR EspressO capsules, already well-known in their existing markets, can contribute to our expansion into new markets. We are in the process of developing new products for both Senseo and L’OR EspressO to further increase consumer interest and bring our products into more households in both our existing and new markets.

Our Segments

Our business is currently organized into three operating segments, Retail—Western Europe, Retail—Rest of World and Out of Home. The following table sets forth our total sales and the percentage of our sales attributable to each of our operating segments for fiscal years 2012, 2011 and 2010:

 

     2012   2011   2010

Total Sales

   €2.8 billion   €2.6 billion   €2.3 billion

Retail—Western Europe

   45%   43%   46%

Retail—Rest of World

   27%   25%   25%

Out of Home

   23%   24%   27%

Unallocated

   5%   8%   2%

Within our Retail—Western Europe and our Retail—Rest of World segments, our principal products are multi-serve coffee, single-serve coffee pads and capsules, instant coffee and tea. We sell these products predominantly to supermarkets, hypermarkets and through international buying groups. In our Out of Home segment, we offer a full range of hot beverage products but focus on our liquid roast products and related coffee machines. Our products and the related machines in the Out of Home segment are sold either directly to businesses, hotels, hospitals and restaurants or to foodservice distributors for distribution to the customer.

Retail—Western Europe

In our Retail—Western Europe segment, we have been active in four categories: multi-serve, single-serve, instant and tea, for the past three fiscal years. In addition, the cafés we operate in the Netherlands following our acquisition of CoffeeCompany report through our Retail—Western Europe segment. Our multi-serve coffee is principally sold under the following brands: Douwe Egberts in the Netherlands, Belgium and the United Kingdom, L’OR and Maison du Café in France, Marcilla in Spain, Merrild in Denmark, Kanis & Gunnink in the Netherlands and Jacqmotte in Belgium. Our single-serve coffee is principally sold under the brand names Senseo which is generally co-branded, such as Douwe Egberts Senseo and Maison du Café Senseo, in the Netherlands, Belgium, France, Germany, Spain and select other countries, L’OR EspressO in France, the Netherlands and Belgium and L’aRôme EspressO in Spain. Our instant coffee is sold under the Douwe Egberts brand in United Kingdom and under local brands in certain of our Western European markets. Our tea is sold under the brand names Pickwick in the Netherlands, Belgium and Denmark and Hornimans in Spain. Retail—Western Europe covers the following countries: the Netherlands, Belgium, France, Denmark, Greece, Germany, the United Kingdom and Spain.

Retail—Rest of World

In our Retail—Rest of World segment, we have also been active in four categories: multi-serve, single-serve, instant and tea, for the past three fiscal years. Our multi-serve coffee is principally sold under the following brands: Pilão, Caboclo, Damasco and Moka in Brazil, Harris in Australia and Prima in Poland. Our single-serve coffee is sold in Brazil under the Senseo brand name, co-branded as Pilão Senseo. Our instant coffee is primarily sold under the Moccona brand in Australia and Thailand. Our tea is sold under the brand name

 

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Pickwick in the Czech Republic and Hungary. Retail—Rest of World covers the following countries: Brazil, Hungary, the Czech Republic, Poland, Australia, Thailand and Russia.

Out of Home

For the past three fiscal years, our Out of Home segment has been concentrated in the Netherlands and has provided liquid roast coffee products and the machines that dispense these products, as well as multi-serve coffee, instant coffee and tea and related products, to businesses, hospitals, hotels and restaurants worldwide. Approximately half of our Out of Home sales are made directly to such customers, while we also work with distributors who distribute our products to the customer in certain markets. Through our Cafitesse umbrella brand, we offer a line of products to be used in the liquid roast machines that we sell, lease or provide free of charge to our customers. Additionally, through our Piazza D’Oro brand we offer premium espresso coffee products and machines. We develop the proprietary coffee machines in house and employ suppliers to produce the machines. We also employ service technicians in most of our major markets who we train to service our machines in the field. According to Euromonitor, in 2011, we were the largest supplier by volume of coffee for the out of home market in the Netherlands, Denmark and Belgium. Based on internal estimates and analysis, we estimate that we serve approximately 80% of the worldwide liquid roast market, based on number of cups consumed. As of June 30, 2012 we operated over 248,000 machines in businesses, hospitals, hotels and restaurants in our markets of which more than 60% are Cafitesse liquid roast machines. On October 24, 2011, Sara Lee entered into an asset purchase agreement with the J.M. Smucker Company, which we refer to as Smucker’s, in connection with its sale to Smucker’s of its liquid coffee business in the United States, Canada, Mexico, and most of the Caribbean. Under the terms of this agreement, we agreed not to engage in the business of manufacturing, marketing, selling or distributing liquid coffee concentrate products in the out of home channel in such territories for ten years.

Research and Product Development

Our research and development teams are responsible for the technical development of our coffee and tea products, packaging systems and new equipment and manufacturing methods. The research and development department works with the legal team to protect our innovations through patents and trademarks, where possible, and to ensure compliance with applicable regulations. Our teams adapt technological innovations to existing product lines and new product introductions. We strive for innovation across all product categories and devote significant resources to each segment.

In our Out of Home segment, we are the leader in liquid roast technology. We develop and produce our proprietary liquid roast coffee products and the technology for our proprietary liquid roast coffee machines in-house. We are constantly innovating in this category and previously announced that we have developed ambient liquid roast coffee that will allow our customers to store this coffee prior to use at room temperature, eliminating the need for frozen storage. This new product was released in the Netherlands and Germany in fiscal 2012. We are also working to upgrade our liquid roast quality to match the taste of espresso.

Our research and development product teams also work closely with our marketing, supply chain and procurement teams in identifying trends, developing new products and modifying existing products for all of our product lines, enabling us to quickly and efficiently respond to changing consumer needs. The research and development department is also integral to the launch of new products where they work with marketing to ensure a smooth product launch. An example of this collaboration was the development and launch of the L’OR EspressO product line in France in April 2010, which consists of proprietary L’OR EspressO capsules compatible with the Nespresso® single-serve system. Our multidisciplinary development approach has led to proprietary capsule technology which, together with innovative manufacturing technology, is the basis for our high quality L’OR EspressO and L’aRôme EspressO products. Less than two years after its inception, the L’OR EspressO and L’aRôme EspressO product line now consists of more than fifteen different product variants, with aggregate revenues from sales of these products exceeding €110 million in fiscal 2012 in France, the

 

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Netherlands, Belgium and Spain. Further research and development has also resulted in the addition of various Espresso and Lungo ranges to our capsule product lines.

Additionally, we conduct research and development with partners in certain ventures. Our most significant development partner is Philips. We continue to collaborate with Philips on innovations to the Senseo single-serve coffee system product line, including the ongoing development of new Senseo machine designs to appeal to a range of customer tastes. On March 30, 2012, we entered into a new partnership agreement with Philips pursuant to which Philips will be our exclusive partner for the commercialization of coffee systems in the consumer field, including those to be developed under the Senseo trademark. We also collaborate on a limited basis with certain national and international coffee trade associations in an effort to promote the beneficial effects of coffee consumption and support external research by universities to study these effects.

At the core of our research and development capabilities is a team of approximately 125 people. Our research and development facilities are located in Utrecht, the Netherlands.

Spending on research and development for fiscal 2012, 2011 and 2010 was approximately €25 million, €21 million and €18 million, respectively. On average, approximately one-third of our research and development budget is devoted to single-serve product development, one-third to liquid roast and approximately one-third is devoted to all other categories. In addition to our investments in traditional research and development activities and in developing new manufacturing processes, we actively invest in our manufacturing facilities.

Marketing

Our global marketing team is organized around six categories: multi-serve, single-serve pads, portioned espresso capsules, instant, liquid roast coffee and tea. In our retail segments, our national marketing teams work closely with our global team and our research and development team to ensure that we present a consistent message for each brand that effectively conveys the attributes of our brands. The national marketing personnel then work closely with their key retail channel entities on product plans, placement and initiatives, marketing programs and other product sales support. In the tea category, our marketing team both works directly with our retail customers to design and implement in-store promotional activities and uses television commercials and print and internet advertisements to target specific audiences. In our Out of Home segment, our goal is to understand the customers’ needs and build a tailored proposition specifically for each customer. For example, for a hotel customer we could offer a liquid coffee system for their high volume conference needs, as well as instant, multi-serve or single-serve coffee for their in-room needs. Our goal is to synergize our marketing and sales departments in both retail and Out of Home to create a clear message in each of our categories and to emphasize our premium products and brands.

Customers

In fiscal 2012, approximately 65% of our sales were derived from Western Europe, 21% from South America, 6% from Central and Eastern Europe and 8% from Asia/Pacific. In fiscal 2012, approximately 45% of our sales came from our Retail—Western Europe segment, approximately 27% of our sales came from our Retail—Rest of World segment and approximately 23% of our sales came from our Out of Home segment. In our retail segments we sell directly to food and beverage retailers as well as to wholesalers. In our Out of Home segment we sell directly to businesses, hospitals, hotels and restaurants as well as to third party distributors who distribute our products to customers in certain markets. In fiscal 2012, approximately, 46% of our sales were derived from multi-serve coffee products, 20% from sales of single-serve coffee products, 7% from sales of liquid roast coffee products, 9% from sales of instant coffee, 5% from sales of tea and 13% from sales of other coffee and tea related products.

In our retail segments, our largest customers are large supermarket retailers and international buying groups, which are composed of regional supermarket retailers that join together to increase their purchasing leverage. In

 

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our Retail—Western Europe segment, our three largest customers are Carrefour, Coopernic (an international buying group) and EMD (an international buying group), which represented an aggregate of approximately 16% of the Company’s sales in fiscal 2012. In our Retail—Rest of World segment, our three largest customers accounted for an aggregate of approximately 5% of our sales in fiscal 2012. With certain of our large international supermarket customers and with our buying group customers, we sign overarching international contracts with an average length of two years, as well as annual contracts on the national or individual level.

In the Out of Home segment, we sell our liquid roast products and equipment directly to businesses, hospitals, hotels and restaurants as well as to third party distributors who then distribute our products to customers. No single customer has accounted for more than 5% of our Out of Home sales in any of the past three years. Our Out of Home customer contracts are generally for terms of three or more years with pricing terms that are reviewed at least annually, and we have long-term relationships with many of our customers. We have long-term contracts with our third party distributors with pricing terms that are reviewed annually.

Operations and Supply Chain

Our operations group manages our integrated supply chain for our European operations from the Netherlands, the Netherlands in close collaboration with Decotrade GmbH in Zug, Switzerland and Decotrade do Brasil in Santos, Brazil, the green coffee and tea procurement arms of our business. Our operations in Brazil, Australia and Thailand are managed autonomously by our operations groups in those countries in collaboration with Decotrade do Brasil, using principles and processes similar to those described below. Our instant coffee sold in Australia is supplied from our European operations.

Raw materials

Our primary commodity is green coffee. We buy both Arabica and Robusta coffee beans for use in different regional markets and blends across our product lines. Decotrade GmbH buys coffee from multiple coffee-producing regions around the world both on the coffee markets and on a negotiated basis. Decotrade do Brasil buys coffee in Brazil through direct relationships with cooperatives, cooperative groups, farms and estates to meet our domestic coffee needs in the large and growing Brazilian market. Additionally, in recent years, Decotrade do Brasil has bought and sorted green coffee to sell to Decotrade GmbH as well as to third parties, including competitor coffee companies and coffee traders. In future periods, we intend to significantly reduce the amount of green coffee that we buy for sorting and resale to third parties.

The supply and price of green coffee are subject to fluctuations. Supply and price of all coffee grades are affected by multiple factors, such as 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. Cyclical swings in commodity markets are common and the most recent years have been especially volatile for both the “C” price of coffee (the price for Arabica coffee quoted by the Intercontinental Exchange in New York) and the “Liffe” price of coffee (the price for Robusta coffee quoted by the Exchange in London).

Both Arabica and Robusta prices increased by approximately 20% between 2011 and 2012. After a downwards correction in fiscal 2012, we expect our commodity costs to decline in fiscal 2013 versus fiscal 2012, although we expect that coffee prices will remain volatile for the foreseeable future. We buy Arabica and Robusta coffees which are traded at a premium or discount to the New York “ICE” and London “Liffe” price quotations, reflecting their intrinsic quality value and availability. Premiums and discounts are subject to significant variations.

Green coffee price increases impact our business by increasing our costs to make our coffee products and we are often not able to increase our prices to our customers concurrently with increases in green coffee prices. Decreases in the price of green coffee impact our business by creating pressure to decrease our sales prices.

 

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Because of the volatility in the price of green coffee, we employ hedging mechanisms to lock in prices for future green coffee deliveries, consistent with our overall risk management program. While we typically enter into forward contracts for shorter periods, certain of these contracts may be made up to 12 months in advance of delivery. Since coffee trades are made on a U.S. dollar basis and we make our sales principally in euros, we also employ currency hedges to manage our currency risks. Our hedging strategies are principally focused on obtaining price stability and mitigating market risk.

Customers and consumers have become increasingly interested in purchasing certified sustainable coffee. To meet that demand, 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.

We purchase our tea requirements (black and green teas) directly from numerous importers and growers in Asia and Africa. Unlike in the coffee market, no regulated futures markets exist for the tea market. This means that we do not employ derivative tools for tea price risk mitigation. Unlike our recent experience in the green coffee market, the tea market has not been subject to significant volatility in recent years. The average annual price volatility range over the past several years has been approximately 20% and varies from region to region and from quality segment to quality segment. As the international tea business also trades on a U.S. dollar basis, the Company faces the same currency exposure as for green coffee and we employ a similar currency hedging strategy.

Manufacturing

Our manufacturing units are responsible for the production of our coffee and tea products and packaging. The manufacturing units receive forecasts from our marketing and sales teams and use these forecasts to make optimal production plans to manufacture the required end-products and send them to the appropriate country warehouse for ultimate distribution to the customer. We own manufacturing facilities in the Netherlands, Belgium, France, Hungary, Spain, Greece, Poland, Thailand and Brazil, and we lease manufacturing facilities in Australia and Spain. Because of the significant variation in the packaging of our diverse product lines, our manufacturing facilities are typically designed to handle a specific type of packaging, as well as production of certain coffee products. For example, our Senseo coffee pads are produced in our Grimbergen, Belgium and Utrecht, the Netherlands facilities, while we manufacture all of our L’OR EspressO capsules in Andrézieux, France. Our tea products are produced in Joure, the Netherlands and Budapest, Hungary. Historically, our liquid roast and instant coffee products were produced at facilities in Joure, the Netherlands, Nava Nakorn, Thailand and Virginia, United States. The facility in Virginia was sold as part of Sara Lee’s sale of its North American foodservice business to Smucker’s, and these products are now produced at a single site in Joure. In fiscal 2010 and 2011, we made significant investments in certain of our manufacturing facilities to improve our blending and production capabilities for a total amount of €36 million. Many of our manufacturing facilities meet the standards of the International Organization for Standardization, an international industrial and commercial standard-setting body.

Inventory

Our integrated supply chain, combined with our enterprise resource planning software capabilities, and steered by our standardized sales and operation planning (S&OP) process, enables us to have available sufficient quantities of desired finished products while minimizing our inventory stocks throughout the supply chain.

The supply chain is triggered by the demand for products from each of the countries in which we operate. The monthly S&OP consensus forecast is submitted by the marketing and sales units in each country directly to the factories, and the aggregate of these forecasts is used as the basis for our production planning. Because there is full stock transparency in our supply chain, factories can optimize their production planning, while ensuring

 

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service levels. The current flexibility in the factories makes it possible to produce the required amount of finished product for the high demand SKUs representing approximately 75% of our total sales volume on a weekly basis.

Decotrade translates these forecasts, together with its mid-term and long-term forecasts, into purchasing orders for the different types and qualities of green coffee and tea needed. To assist Decotrade in this process, we employ a proprietary algorithm that works with our flex-blending system to systematically adjust recipes and blending requirements according to customer and manufacturing unit needs and the current prices and availability of various types of green coffee.

Before purchase and before shipment, green coffee and tea samples are taken in the source country and sent to Decotrade for testing to ensure that the coffee or tea is of the expected type and quality. Typically, we then take possession of green coffee and tea meeting our requirements at the point of shipment. The raw materials are shipped to us via either our central hub in Antwerp, Belgium or our hub in Hamburg, Germany. Our third party hub managers process the shipments of green coffee and tea and coordinate delivery of the raw material shipments to the appropriate factories for further processing. Finished products are sent directly to warehouses in each country in which we sell our products. These warehouses are leased and managed for us by third party warehousing service providers. We sign three year contracts with these service providers, with whom we typically have long-term relationships.

Country Supply Chain Organizations

Our country supply chain organizations support our marketing and sales units with a goal of achieving maximum product availability while minimizing our inventory stock. Our country supply chain organizations also take care of the full “order to cash” cycle, including the delivery of the products to our customers. Additionally, our country supply chain manages our relationship with our logistics service providers, to which we have outsourced storage and transport of finished products and raw materials.

Distribution

We principally distribute our multi-serve, single-serve, instant and tea products in our Retail—Western Europe segment directly to our retail customers through supply contracts that we sign with individual retail customers or with buying groups that are generally composed of regional retailers. We also employ wholesalers on a limited basis to distribute our products in certain areas where our retail customers are less geographically concentrated. In the Retail—Rest of World segment, we distribute our products both directly to the major supermarket retailers, as well as to wholesalers and distributors who assist us in getting our products into smaller, independent retailers. Our retail contracts with individual retail customers are typically for one year, while our contracts with buying groups are generally for one or two years. We have long-term contracts with our wholesale customers with pricing terms that are reviewed annually.

In our Out of Home segment, we sell our Cafitesse liquid roast products, multi-serve and instant coffees directly to businesses, hospitals, hotels and restaurants. Approximately half of our sales are made via direct sale to the customer. We provide free of charge, sell or lease our Cafitesse machines to customers and then provide the customers with their liquid coffee requirements for use in the machines. We also sell service contracts for the coffee machines, which provide timely customer service via our own service engineers or third party service engineers in certain geographic markets. Additionally, we contract with distributors to sell our products to customers. We have long-term contracts with our third party distributors with pricing terms that are reviewed annually.

Competition

The coffee and tea industry in which we operate is highly competitive, with an emphasis on product quality and taste, price, reputation, brand differentiation, variety of product offerings, advertising, product packaging and

 

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package design, supermarket and grocery shelf space and alternative distribution channels. We compete with other large international and national coffee and tea companies as well as smaller regional and specialty coffee and tea companies, private label coffee and tea brands and hard discounters. Consumer preferences as to the blend or flavor and convenience of purchases continue to change, with differing preferences around the world.

We are the third largest global coffee company by coffee volume but we aspire to become the number two coffee and tea company in the world. Our largest competitors are Nestlé S.A., Kraft Foods, Inc. and private label producers. We also compete against Tchibo GmbH, Strauss Group Ltd. and a range of other local competitors in most countries where we have a presence. Our largest tea competitor in our markets is Unilever. Our major global competitors in our Out of Home segment are Kraft Foods, Inc. and Nestlé S.A. In the Netherlands, our Out of Home brands compete against Autobar Group and Maas International, and in each of our Out of Home markets we compete against many small competitors.

We expect competition in coffee and tea to remain intense, both within our existing customer base and as we expand into new countries and regions in the future. In the coffee and tea industry, we compete primarily by providing high-quality, premium coffee and tea, including a full range of coffee products across all subcategories of the coffee industry, easy access to our products through retail and out of home outlets and superior consumer insight. We also believe that the strength of our brands and our diverse product offering sets us apart from our competitors because we offer a wide array of coffee and tea products from well-known and trusted brands with impressive market penetration. While we believe we currently compete favorably with respect to all of these factors, there can be no assurance that we will be able to compete successfully in the future.

Seasonality

Historically, we have not experienced significant seasonal variations in our total sales.

Intellectual Property

We market our products under hundreds of trademarks, service marks and trade names in Europe and in other countries in our markets, the most widely-recognized being Douwe Egberts, Senseo, Maison du Café, Marcilla, Merrild, L’OR, Pickwick, Pilão, Hornimans, Moccona and Cafitesse. We also benefit from our portfolio of patents, registered designs, copyrights, know-how and domain names. Specifically, we have patent positions protecting our products and technologies for key product categories in single-serve, portioned espresso, and out of home coffee, including liquid coffee. We also license certain intellectual property from third-parties and to third parties. Our business is not dependent on any one patent, although the loss of certain trademarks could have a material adverse effect on our business. We use all appropriate efforts to protect our brands, trademarks, and technologies.

Though laws vary by jurisdiction, trademarks generally remain valid as long as they are in use and/or their registrations are properly maintained and have not been found to have become generic or otherwise are successfully challenged by third parties. Most of the trademarks in our portfolio, including all of our core brands, are covered by trademark registrations in the countries of the world in which we do business. Trademark registrations generally can be renewed indefinitely as long as the trademarks are in use. We actively register, renew, protect and maintain our core trademarks. However, trademark registrations for the Douwe Egberts brand in certain countries in the Middle East are held on our behalf by another party with whom we are currently in a dispute. We plan to continue to use all of our core trademarks and plan to renew the registrations for such trademarks for as long as we continue to use them.

For more than a decade, we have worked together with Philips on an exclusive basis on the development, manufacturing, sale and distribution of the Senseo coffee pad system. On March 30, 2012, we terminated the agreement that had governed our relationship with Philips against payment of a termination fee. Concurrently with terminating the prior agreement, we and Philips entered into a new partnership agreement and a trademark

 

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transfer agreement, which redefined our relationship in several significant respects. Philips transferred to us all its rights, title and interest in the Senseo trademark against payment of a one-time trademark transfer fee, and we entered into a new partnership agreement with Philips, pursuant to which Philips will be our exclusive partner for the commercialization of coffee systems in the consumer field, including those to be developed under the trademark Senseo and commercialized by both parties under our license of the Senseo trademark to Philips and Philips’ license of the Philips trademark to us. The termination and trademark transfer fees totaled €170 million. The new partnership agreement and trademark transfer agreement became effective as of January 1, 2012 and the partnership agreement expires (unless renewed) on December 31, 2020. Under the partnership agreement, each party is anticipated to be responsible for its own profits and losses, and we are not obliged to pay to Philips any royalty payments.

On January 3, 2012, Sara Lee entered into a license and services agreement with JMS Foodservice, LLC, an affiliate of Smucker’s, which we refer to as JMS, in connection with the sale of our liquid coffee products to JMS. Under the terms of this agreement and the related sale of assets, we assumed the rights and obligations of Sara Lee pursuant to the license and services agreement. The licenses granted under such agreement apply to the United States, Canada, Mexico, and most of the Caribbean, and relate to JMS commercializing our liquid coffee products and technology in such territory. Under the agreement, we granted to JMS non-exclusive licenses to our existing technology used in the manufacturing, dispensing, or packaging of our coffee business, exclusive licenses to our future technology used in the manufacturing, dispensing or packaging of our coffee business and exclusive, royalty-free licenses in and to certain of our trademarks, including the Douwe Egberts, Pickwick and Cafitesse trademarks, in each case for use in the foodservice trade channel in such territory. The license to the Douwe Egberts and Pickwick trademarks lasts until January 3, 2019. The license to the Cafitesse trademark lasts until January 3, 2022 and thereafter converts into a perpetual, non-exclusive license.

Government and Trade Regulation

We are subject to 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. On November 22, 2011, the EU enacted a new Food Information Regulation, which will require us to change the labels on certain of our products prior to December 13, 2014 to provide additional nutrition and ingredient information. With respect to environmental regulation, our operations and properties, past and present, are subject to a wide variety of EU regulations and directives and local laws and regulations in the jurisdictions in which we do business. The legislative framework in the EU, as well as in other jurisdictions in which we operate, which we refer to as ESH laws, covers topics such as 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; the remediation of contamination, and occupational safety and health. The following ESH laws are among the most significant to our business: the EU integrated pollution control and prevention directive, the EU packaging waste directive, the EU waste directive, the EU waste of electrical and electronic equipment directive, the EU regulations on the use of certain hazardous substances and the EU greenhouse gas emission allowance trading scheme. EU-level legislation, including the ESH laws and the Food Information Regulation, is also implemented in national legislation in the EU member states and we are therefore subject to regulation by both the EU and a large number of national and local regulatory bodies.

Our operations are also subject to various international trade agreements and regulations. Our competitive and marketplace conduct is principally regulated by rules of competition as set forth in articles 101 and 102 of the Treaty on the functioning of the European Union, the regulations and directives issued by the European Commission, decisions of the European Court of First Instance, the European Court of Justice and the European Commission and notices issued by the European Commission, as well as the translations and/or implementations thereof in the respective laws and regulations of the different member states. We rely on legal and operational

 

45


compliance programs, as well as local in-house and external counsel, to guide our businesses in complying with the applicable laws and regulations of the jurisdictions in which we operate.

Financial Targets

We have established the financial targets set forth below to measure our operational and managerial performance on a company-wide level. The financial targets set forth below are our internal targets for sales growth, adjusted EBIT margin, operating working capital and capital expenditures for future periods. Certain of these financial targets are presented as “mid-term” targets. We have not defined, and do not intend to define, “mid-term,” and the mid-term financial targets set forth below should not be read as indicating that we are targeting such metrics for any particular fiscal year. Our ability to achieve these financial targets is inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the control of the Company, and upon assumptions with respect to future business decisions that are subject to change. As a result, our actual results will vary from the financial targets set forth below, and those variations may be material. Many of these business, economic and competitive uncertainties and contingencies are described in the section of this Annual Report entitled “Risk Factors”. We do not intend to publish revised financial targets to reflect events or circumstances existing or arising after the date of this Annual Report or to reflect the occurrence of unanticipated events. The financial targets should not be regarded as a representation by the Company or any other person that we will achieve these targets in the time period indicated (in the case of operating working capital or capital expenditures) or in any time period. Readers are cautioned not to place undue reliance on the financial targets.

Subject to the foregoing, we are targeting the following for purposes of measuring operational and managerial performance on a company-wide level:

 

   

Sales growth of approximately 5% to 7% in the mid-term

 

   

Adjusted EBIT margin of approximately 15% to 17% in the mid-term

 

   

Capital expenditures, as a percentage of total sales, of approximately 4% to 5% in fiscal 2013 and fiscal 2014

 

   

Capital expenditures, as a percentage of total sales, of approximately 3% to 4% in fiscal 2015

 

   

Operating working capital, as a percentage of total sales, of approximately 10% in fiscal 2015, with a target of reaching 5% in the future

Adjusted EBIT margin and operating working capital are defined in “Selected Financial Data.” Adjusted EBIT and operating working capital are not measures calculated in accordance with IFRS and may not be comparable to similarly named measures used by other companies. Adjusted EBIT should not be considered as an alternative to operating profit or profit for the period, and operating working capital should not be considered as an alternative to operating cash flow.

The PricewaterhouseCoopers Accountants N.V. report included in this Annual Report relates solely to the Company’s historical financial statements. It does not extend to the financial targets and should not be read to do so. As the financial targets were prepared to measure the Company’s operational and managerial performance, they were not prepared with a view toward compliance with published guidelines of the SEC or the guidelines established by the American Institute of Certified Public Accountants for preparation and presentation of prospective financial information.

4C Organizational Structure

D.E MASTER BLENDERS’ business is carried out through a number of operating subsidiaries around the world. A list of the Company’s principal operating subsidiaries, all of which are 100% owned, directly or indirectly, is attached hereto as Exhibit 21.1. In addition, D.E MASTER BLENDERS has a 45% non-controlling interest in Kaffehuset Friele A/S, which is treated as an associate.

 

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4D Property, Plants and Equipment

We own most of our manufacturing plants and lease our warehouses. Additionally, we have service contracts with the hub managers at our central distribution hubs in Antwerp, Belgium and Hamburg, Germany. Our leased warehouse facilities are generally subject to lease terms of three years. Management believes that our facilities are maintained in good condition and are generally suitable and of sufficient capacity to support our current business operations. We intend to spend approximately €150 million on tangible fixed assets for the period through June 30, 2013.

Our manufacturing facility in Nava Nakorn, Thailand was damaged by the flooding in Thailand in October, 2011. As of the start of fiscal 2013, the facility is fully operational again. Our expenses related to the flooding of our facility in Thailand, including lost business income, are covered by our insurance policies.

The table below sets forth the location, principal use and size of our material facilities. Each of these facilities is in use and owned directly or indirectly by D.E MASTER BLENDERS. D.E MASTER BLENDERS’ property in the Netherlands has been pledged with a lien of €23.8 million in favor of Stichting VUDE, a foundation which guarantees the payment of early retirement allowances and payments according to social plans in the Netherlands.

Owned Facilities

 

Location

  

Principal Use

   Fiscal 2012  Production
Volume

(in thousands of tons)
    Size (in thousands  of
square feet)
 

Joure, The Netherlands

   Manufacturing      27        752.6   

Jundiai, Brazil

   Manufacturing      135        432.4   

Utrecht, The Netherlands

   Manufacturing      55        346.9   

Grimbergen, Belgium

   Manufacturing      40        177.5   

Budapest, Hungary

   Manufacturing      13        144.0   

Andrézieux, France

   Manufacturing      20        121.9   

Sulaszewo, Poland

   Manufacturing      20        80.2   

Salvador, Brazil

   Manufacturing      15        49.5   

Athens/Aigaleo, Greece*

   Manufacturing      <5        47.2   

Nava Nakorn, Thailand

   Manufacturing      10        55.9   

Oinofyta, Greece*

   Manufacturing      <5        7.6   

Mollet, Spain

   Manufacturing      10 **      36.3   

Budapest, Hungary

   Warehouse        104.4   

Piumhi, Brazil

   Warehouse/Processing        76.1   

Utrecht, The Netherlands

   Office        364.1   

Grimbergen, Belgium

   Office        124.2   

Joure, The Netherlands

   Office        91.8   

Utrecht, The Netherlands

   Office        56.6   

 

  * Production to be consolidated into Oinofyta facility in 2013.
  ** Production split across owned and leased portions of the facility.

 

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Leased Facilities

 

Location

  

Principal Use

  

Lease Term

   Fiscal 2012  Production
Volume

(in thousands of tons)
    Size (in thousands
of square feet)
 

Kingsgove, Australia

   Manufacturing    June 30, 2017      <5        45.1   

Mollet, Spain

   Manufacturing    December 31, 2020      10 (1)      137.3   

Grimbergen, Belgium

   Office    240 Months        124.2   

Barcelona, Spain

   Office    July 1, 2014        86.5   

Barueri, Brazil

   Office    March 23, 2013        52.6   

Villepinte, France

   Office    September 30,  2012(2)        88.6   

Paris, France

   Office    September 30, 2024        53.8   

Middelfart, Denmark

   Office    September 30, 2017        61.7   

Amsterdam, The Netherlands

   Office    June 30, 2022        56.45   

 

(1) Production split across owned and leased portions of the facility.
(2) After June 30, 2012, the lease contract for the Villepinte office was not extended. Instead, another facility of 54,400 square feet is leased in Paris, France with a lease term until August 31, 2014.

We also lease our approximately 56,450 square-foot headquarters located in Amsterdam, the Netherlands. Our headquarters houses our various sales, marketing, operational and corporate business functions.

 

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ITEM 4A. UNRESOLVED STAFF COMMENTS

Not applicable

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

OPERATING AND FINANCIAL REVIEW

The following information should be read in conjunction with the historical financial statements and with the financial information presented in the section entitled “Selected Financial Data” included elsewhere in this Annual Report. Our financial statements are prepared in accordance with IFRS as issued by the International Accounting Standards Board and adopted by the European Union. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Such statements are based upon current expectations that involve risks and uncertainties. Any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. For example, the words “believes”, “anticipates”, “plans”, “expects”, “intends” and similar expressions are intended to identify forward-looking statements. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that might cause such a discrepancy include, but are not limited to, those discussed in “Liquidity and Capital Resources” below and “Risk Factors” above. All forward-looking statements in this Annual Report are based on information available to us as of the date of this Annual Report and we assume no obligation to update any such forward-looking statements. See “Forward Looking Statements”.

As discussed in Note 1 of our audited financial statements included in this Annual Report, our historical financial statements were restated for accounting irregularities and certain other errors involving previous financial results for our Brazilian operations. The accounting irregularities identified in the Brazil operations 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 expenses reversals and postponements, moving inventory out of warehouses that were about to be verified by internal and external auditors, the failure to write-off obsolete inventory and other inventory valuation issues. The financial information for the fiscal years 2010 and 2011 included in this operating and financial review section is based on these restated financial statements.

Overview

We are a leading, focused pure-play coffee and tea company that offers an extensive range of high-quality, innovative coffee and tea products that are well-known in retail and out of home markets across Europe, Brazil, Australia and Thailand. Our business is currently organized into three operating segments, Retail—Western Europe, Retail—Rest of World and Out of Home.

Within our Retail—Western Europe and our Retail—Rest of World segments, our principal products are roast and ground multi-serve coffee, roast and ground single-serve coffee pads and capsules, instant coffee and tea. We sell these products predominantly to supermarkets, hypermarkets and through international buying groups. In our Out of Home segment, we offer a full range of hot beverage products but focus on our liquid roast products and related coffee machines. Our products and the related machines in the Out of Home segment are sold either directly to businesses, hotels, hospitals and restaurants or to foodservice distributors for distribution to the customer.

In our Retail—Western Europe segment, our multi-serve coffee is principally sold under the following brands: Douwe Egberts in the Netherlands, Belgium and the United Kingdom, L’OR and Maison du Café in France, Marcilla in Spain, Merrild in Denmark, Kanis & Gunnink in the Netherlands and Jacqmotte in Belgium. Our single-serve coffee is principally sold under the brand name Senseo, which is generally co-branded, such as Douwe Egberts Senseo and L’OR Senseo, in the Netherlands, Belgium, France, Germany and Spain and select other countries, L’OR EspressO in France, the Netherlands and Belgium and L’aRôme EspressO in Spain. Our

 

49


instant coffee is sold under the Douwe Egberts brand in the United Kingdom and under local brands in certain of our Western European markets. Our tea is sold under the brand names Pickwick in the Netherlands, Belgium and Denmark and Hornimans in Spain. Retail—Western Europe covers the following countries: the Netherlands, Belgium, France, Spain, Denmark, Greece, Germany and the United Kingdom.

In our Retail—Rest of World segment, our multi-serve coffee is principally sold under the following brands: Pilão, Caboclo, Damasco and Moka in Brazil, Harris in Australia and Prima in Poland. Our single-serve coffee is sold in Brazil under the Senseo brand name, co-branded as Pilão Senseo. Our instant coffee is primarily sold under the Moccona brand in Australia and Thailand. Our tea is sold under the brand name Pickwick in the Czech Republic and Hungary. Retail—Rest of World covers the following countries: Brazil, Hungary, the Czech Republic, Poland, Australia, Thailand and Russia.

Our Out of Home segment is concentrated in the Netherlands. Approximately half of our Out of Home sales are made directly to businesses, hospitals, hotels and restaurants, while we also work with distributors who distribute our product to the customer in certain markets. Through our Cafitesse umbrella brand, we offer a line of products to be used in the liquid roast machines that we sell, lease or provide free of charge to our customers. Additionally, through our Piazza D’Oro brand we offer premium espresso coffee products and machines. We develop the proprietary coffee machines in-house and employ suppliers to produce the machines. We also employ service technicians in most of our major markets who we train to service our machines in the field.

Our senior management reviews the performance of each segment individually, based on segment sales and adjusted EBIT. Segment adjusted EBIT represents segment operating profit excluding the impact of restructuring charges and restructuring-related costs, costs associated with Sara Lee’s branded apparel business disposed prior to fiscal 2009, impairment, gains and losses on the sale of assets, curtailment and past service costs and other costs management believes are unrelated to our underlying business. In addition, we do not allocate certain sales and costs to the segments. These unallocated items include the sale of green coffee beans to third parties, corporate overhead costs and unrealized mark-to-market gains and losses on commodity derivative financial instruments.

Key performance indicators

We monitor the performance of our operations against strategic objectives on a regular basis. We assess our performance against the strategy, budget and forecasts using various financial measures including the following:

 

     Fiscal Year Ended  
     June 30, 2012     July 2, 2011     July 3, 2010  
           restated     restated  
     (all amounts in millions of euro, except
percentages)
 

Like for like sales growth(a)

     7.4     10.5     n/a   

EBIT(a)

   109.9      327.5      344.6   

EBIT margin(a)

     3.9     12.6     14.9

Adjusted EBIT(a)

   321.8      357.2      366.1   

Adjusted EBIT margin(a)

     11.5     13.8     15.8

 

(a) These amounts are not measures determined in accordance with IFRS. See “Selected Financial Data” for a definition of the measure, a reconciliation of the measure to IFRS and a discussion regarding the limitation of the use of such measures.

Key factors affecting results of operations

Our results of operations are driven by a combination of factors affecting our industry as a whole and various operating factors specific to us. The following is an overview of the key factors affecting our results during the years presented.

 

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Separation from Sara Lee. On June 28, 2012, the international coffee and tea business of then Sara Lee Corporation was spun off and through a series of transactions became owned by D.E Master Blenders 1753 N.V., a separate publicly traded company. Prior to the separation we operated as a part of a larger group of companies controlled by Sara Lee.

Our financial statements prior to separation have been prepared on a “carve-out” basis from the Sara Lee consolidated financial statements using the historical results of operations, assets and liabilities attributable to the international coffee and tea operations of Sara Lee, and certain other assets and liabilities that we retained in connection with the separation as described further in Note 1 to our historical financial statements.

As we have not previously operated independently, as described above, the income statements discussed herein are not necessarily indicative of our future performance and do not necessarily reflect what our financial performance would have been had we been an independent, publicly traded company during the periods presented.

There are limitations inherent in the preparation of all carve-out financial statements due to the fact that our business was previously part of a larger group. The basis of preparation included in our financial statements provides a detailed description of the treatment of historical transactions. Our profits have been most notably impacted by the following consequences of carve-out accounting:

 

   

Our income statement includes within total selling, general and administrative expenses an allocation to us from Sara Lee for the services provided by various Sara Lee functions including, but not limited to, executive oversight, legal, finance, human resources, internal audit, financial reporting, tax planning and investor relations. Upon our separation we became directly responsible for these functions. Accordingly, the amounts of costs reflected in our income statements are not necessarily indicative of our future costs. The total amount allocated to us by Sara Lee was €23.7 million, €25.4 million and €23.7 million in fiscal 2012, 2011 and 2010, respectively.

In addition, we incurred additional direct corporate overhead costs during the periods presented. Based on current financial plans our management estimates that our total corporate overhead costs will be approximately €45 - €50 million on an annual basis after separation. Assuming total corporate overhead costs of €45 - €50 million, this would result in an increase of approximately €5 million from the amounts reflected in our fiscal 2012 income statement. This estimate is based on assumptions management believes are reasonable, however the actual amount may vary from this estimate.

 

   

Our income tax expense for periods prior to separation is computed on a separate company basis, as if we operated as a stand-alone entity or a separate consolidated group in each material jurisdiction in which we operate. In jurisdictions which permitted fiscal unity, our operations were typically included with other Sara Lee operations in a consolidated group tax filing. As a result of this, the impact of the new business model discussed below and potential future tax planning, our income tax expense may not be indicative of our future expected tax rate. Although we are targeting an effective tax rate of approximately 30% in fiscal year 2013 and 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, for purposes of our financial statements, we have assumed all taxes were settled by Sara Lee, and as result there are no cash taxes reflected in our operating cash flows. Consequently, our future operating cash flows will be reduced by tax payments which are reflected as distributions to Sara Lee in financing activities in the combined statement of cash flow.

 

   

We historically provided financing to Sara Lee. Our financial statements prior to the separation reflected loans receivable and the associated interest income. In connection with the separation, these loans were settled with Sara Lee.

 

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As a consequence of various transactions between us and Sara Lee in connection with the separation, including the payment of a special dividend, our cash and cash equivalents were significantly reduced from the balance at the end of fiscal 2011. In addition, our outstanding indebtedness increased upon the separation. These changes were offset by a corresponding decrease on our combined statement of financial position in parent’s net investment. The additional indebtedness, along with any additional borrowings entered into in the future, will increase interest expense in future periods as described below in “Operating and Financial Review—Liquidity and Capital Resources” beginning on page 65.

 

   

The entities within Sara Lee’s international coffee and tea business have certain legal liabilities related to Sara Lee’s branded apparel business that was sold prior to fiscal 2009. These liabilities, while unrelated to our business, will be retained following the separation. The most significant of these relate to pensions and medical claims related to injuries caused to prior employees as a result of noise induced hearing loss and asbestos exposure, which may result in payments to those individuals for their related medical expenses. These liabilities are reflected in our combined balance sheets and the associated costs are reflected in our combined income statements.

In addition, as part of the separation, the Group assumed € 241.6 million of certain liabilities related to businesses previously disposed of by Sara Lee. The liabilities primarily relate to Sara Lee’s household and body care business and its international bakery business. These liabilities include certain legal claims and restructuring obligations, tax indemnifications, and retirement benefit obligations, which are unrelated to the Group’s operations. Additionally, we entered into various arrangements in connection with the spin-off, including, but not limited to, certain indemnification agreements that subject us to contingent liabilities.

Lastly, as part of the separation we will implement a new business model that will modify the way we manage our product through our value chain. This modification will not impact our pre-tax profit; however we may experience a shift in profitability between operating segments. Management is also still in the process of modeling the organizational structure, which could also result in a change in our segment structure. As part of implementing our new business model, we incurred costs of €29.3 million in fiscal 2012 and expect to spend approximately €24.9 million over fiscal 2013 primarily related to changes in our information technology platform and other implementation costs. A portion of those costs will be capitalized (€8.1 million in fiscal 2012 and €6.4 million in fiscal 2013) on our statement of financial position with the remainder expensed primarily as restructuring related costs in the period incurred.

Based on the impacts of the separation discussed above, our operating expenses and cash outflows will increase in future periods. We intend to implement various restructuring actions to offset these increases and to optimize our structure. The amounts discussed represent our best estimates; however, the actual amounts may vary from these estimates.

Commodity prices. The most significant cost item in the production of coffee products is the price of green coffee beans, which are purchased from farmers and coffee bean vendors in various countries around the world. Green coffee is subject to volatile price fluctuations. The price of green coffee fluctuates based upon various factors including, but not limited to, weather, real or perceived shortages, the political climate in the producing nations, competitive pressures, currency fluctuations and speculation in the commodities markets. The price of green coffee beans increased significantly in fiscal 2011 compared to fiscal 2010. During fiscal 2012, the market commodity prices decreased from the level at the end of fiscal 2011. We expect to see continued volatility in the commodity market prices in future periods. Excluding the impact of the change in foreign currency translation, our total commodity costs increased by €237.5 million from fiscal 2011 to fiscal 2012. The commodity increase of €237.5 million between fiscal 2011 and 2012 includes a €2.6 million benefit related to commodity derivatives.

We manage the risk associated with commodity price fluctuations through the use of commodity options and futures. Through these derivative options and futures, we are able to fix a portion of our price for anticipated future deliveries of green coffee for a specified period of time. Given the price increases during fiscal 2011 we have modified our risk management strategy to increase the length of this period for Arabica green coffee while

 

52


continuing to use short term derivatives for our other green coffee purchases. On average we fix prices for deliveries to our European operations for an advanced period of up to six to nine months. This period is six to eight weeks in case of deliveries to our Brazilian operation. As a result of our risk management strategy, there is a lag between a change in the commodity market prices and the impact on our results and consequently we did not fully benefit during fiscal 2012 from the decline in commodity prices.

During the second half of fiscal 2011, we successfully raised sales prices to offset a portion of the increase in the price of green coffee beans. These sales price increases were partially offset by an increase in trade promotions in response to competitor actions on pricing and as a result of agreements with resellers. Due to the intense competition in our industry, including the impact of private label products, and the timing lag between commodity cost increases and sales price increases, these sales price increases did not fully offset the significant increase in the price of green coffee beans that occurred in fiscal 2011. As a result, the higher commodity costs resulted in a decrease to our gross profit of €19.6 million in fiscal 2011 and €0.7 million in fiscal 2012. Due to the commodity costs decline, we may face pressure in the future from our customers to decrease our prices.

Impact of disposals by Sara Lee. We historically shared Sara Lee’s European corporate headquarters and various shared service centers with other Sara Lee businesses. These headquarters provided various corporate services such as treasury, legal, information technology and certain tax services to the international businesses of Sara Lee. The shared service centers, located in various countries, provided such services as payroll processing, receivables and payables processing and various other accounting functions. With the disposals of Sara Lee’s other international businesses, which were completed by February 2012, we were the only remaining international business of Sara Lee. In connection with the terms of our separation, we now bear the full cost of all stranded international corporate overhead and shared service costs after separation. Our best estimate of these stranded costs is that they are approximately €30 million on an annualized basis.

The disposal by Sara Lee of its other international businesses primarily occurred during fiscal 2011 and the first half of fiscal 2012. In addition, Sara Lee entered into transition services agreements in connection with certain of the disposals, under which the shared service centers provided services. As such, the timing of the impact of these stranded costs on our results is generally linked to the timing of the disposals by Sara Lee and the length of any transition services agreements. As a consequence, we began absorbing a portion of these stranded costs in fiscal 2011. The amount of stranded costs we have absorbed continued to increase through fiscal 2012 due to (a) the finalization of additional dispositions and (b) the lost income from the expiration of certain transition services agreements without the ability to reduce our costs within the same time frame.

In connection with the business disposals by Sara Lee, we began taking certain actions to reduce these stranded costs including, but not limited to, renegotiation of our information technology contracts and reduction of corporate staff. Due to the time necessary to implement such cost reductions stranded costs increased our operating expenses in the second half of fiscal 2012 and we expect stranded costs will increase our operating expenses through part of fiscal 2013 in comparison to fiscal 2011. We believe these actions and the actions described below regarding restructuring charges will allow us to reduce the impact of stranded costs, to the extent possible.

The actual timing of the full absorption of these costs, and any cost reductions resulting from the actions described above, will vary.

Foreign exchange movements. Our results are exposed to transaction and translation risk associated with foreign currency movements.

Transaction risk—We operate internationally and as a result are exposed to foreign exchange risk arising from various currency exposures, primarily with respect to the U.S. dollar, Brazilian real, British pound, Danish krone, Hungarian forint, Polish zloty, Thai baht, Russian ruble and Australian dollar against the European euro.

 

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Foreign exchange risk arises primarily from commercial transactions such as the purchase of commodities, recognized monetary assets and liabilities. As a consequence of the global economic downturn, currency rates have become more volatile, increasing our exposure to this risk specifically in Eastern European markets.

We use forward exchange and option contracts to reduce the effect of fluctuating foreign currencies on known foreign currency exposures. Gains and losses on these derivative instruments are intended to offset gains and losses on the related transactions in an effort to reduce the earnings volatility resulting from fluctuating foreign currency exchange rates. We have not designated any of our foreign exchange derivatives as hedges for accounting purposes and, as a result, the change in fair value is recognized directly through profit.

We had foreign currency gains of €42.5 million and €40.2 million during fiscal 2012 and 2010, respectively, and foreign currency losses of €40.9 million during fiscal 2011. These were offset by a loss on foreign currency derivatives of €5.6 million and €9.8 million in fiscal 2012 and 2010, respectively, and a gain on foreign currency derivatives of €15.5 million in fiscal 2011. These gains and losses are included in finance costs in our combined income statement, excluding those related to commodities that are included in cost of sales, and do not impact our segment profitability.

Translation risk—The functional currency of a number of our subsidiaries is a currency other than the euro and as a result the income statement and statement of financial position of each of those subsidiaries must be translated for purposes of preparing our financial statements. Each period the financial statements of our non-euro functional subsidiaries are translated to the euro by applying the closing rate to the statement of financial position and an average rate to the income statement. As a consequence, our combined results are impacted by these currency movements. This resulted in foreign currency translation gains of €47.5 million and €111.9 million in fiscal 2012 and 2010, respectively, and a foreign currency translation loss of €2.2 million in fiscal 2011. These foreign currency translation gains and losses are reflected in total equity/parent’s net investment in our statement of financial position.

Launch of new products and rationalization of existing SKUs. Based on the unique consumer and customer insights we have gained over numerous decades, we have a deep understanding of the coffee and tea category and the preferences of its consumers and customers. This, coupled with our strong research and development capabilities, has positioned us well to launch new products and concepts that reflect the preferences of our consumers and customers.

During fiscal 2012, 2011 and 2010, we launched various new products. The most significant product launched during this time was L’OR EspressO single-serve capsules in France in April 2010. These capsules, which are compatible with the Nespresso® single-serve system, marked our entry into the single-serve espresso market. We have subsequently introduced these capsules in the Netherlands and Belgium, and in Spain, where the product is sold as L’aRôme EspressO.

The launch of new products results in focused advertising and promotion costs in the period for those products and markets in which they are sold. We believe these costs are recovered in future periods through the increased sales resulting from the new products.

In addition, we incur upfront costs in anticipation of new products and when considering entering new markets. There are certain instances where after further research we may make a decision not to continue with the product introduction or expansion into that market. For example, during fiscal 2011 we made a decision not to continue a planned expansion of our operations in the Russian market and as a result we impaired assets of €4.6 million. In fiscal 2012, we began using a distributor business model in Russia.

We expect to accelerate the development of new products and the introduction of new products in future periods, including Senseo Sarista. Therefore, we may experience an increase in our research and development costs, capital expenditures related to supporting the research and development and increased advertising costs related to new product introductions.

 

54


As we continue to monitor our portfolio of brands, we expect to eliminate certain SKUs in future periods.

Restructuring. During the periods presented, we have taken a number of actions to maximize the efficiency of our operations. These actions included:

 

   

Outsourcing of certain elements of our shared service function related to procurement, accounting and information technology;

 

   

Reducing our overall cost structure to align our corporate overhead to our current organizational structure and business strategy;

 

   

Headcount reductions to align with new management’s expectations of staffing needs as a stand-alone company;

 

   

Renegotiating global IT contracts to align with our organizational structure; and

 

   

Optimizing our manufacturing capacity. In connection with this, we rationalized our manufacturing footprint through the closure of our Denmark manufacturing facility and the transfer of this production to the Netherlands.

In connection with these actions, and in order to achieve the savings associated with these actions, we planned to eliminate the positions of approximately 1,136 employees. Of these employees, contracts of 1,039 employees were terminated as of June 30, 2012.

In connection with these actions, we recorded restructuring charges of €57.7 million, €25.2 million and €5.4 million in fiscal 2012, 2011 and 2010, respectively. The majority of the outstanding provision of €41.2 million at June 30, 2012 is expected to be paid out within the next 12 months with certain payments extending out five years.

Our restructuring charge for fiscal 2012 includes €25.8 million for contractual termination fees related to certain IT contracts that were renegotiated to align with our organizational structure.

As a result of IT restructuring actions and certain other actions taken in fiscal 2012, along with the additional capital expenditures, we estimate the annual cost savings of €55 - €75 million by the end of fiscal 2015.

Sale of green coffee beans to third parties. During fiscal 2012, 2011 and 2010, we sold green coffee beans to third parties in Brazil. These sales were ancillary to our business and as a consequence not included in our segment results. In fiscal 2012, 2011 and 2010, our green coffee bean sales were €134.4 million, €186.5 million and €78.3 million, respectively, or €126.0 million, €170.5 million and €55.8 million, respectively, excluding the impact of changes in foreign currency exchange rates, and had margins that were significantly lower than our normal sales. Our green coffee bean sales to third parties decreased in fiscal 2012. During fiscal 2011, we took advantage of a system of taxes and rebates payable on trades of green coffee from Brazil that caused sales to increase. The increase was driven by the increase in overall green coffee market prices and an increased volume of sales. In January 2012, the Brazilian government ended this favorable tax treatment and as a result, we made a strategic decision to reduce our green coffee export sales in fiscal 2012. We expect that our green coffee export sales will continue to decrease in future periods and will be approximately €45 - €50 million going forward.

Business combinations. We have made strategic acquisitions to strengthen our presence in several markets. In fiscal 2012, we acquired CoffeeCompany, a leading Dutch café store operator in the Netherlands; Tea Forté, a producer of ultra-premium teas that are principally sold in the United States and Canada; the Denmark operations of House of Coffee, a leading out of home provider of coffee and tea products in Norway and Denmark; and Expresso Coffee Automacao de Bebidas Quentes Ltda an out of home provider in Brazil. In fiscal 2011, we acquired Café Damasco, which provides us with a stronger presence in southern Brazil, where Café Damasco has a strong market position. Our focus over the next twelve months will be implementing actions to strengthen the Company organically, but we will continue to evaluate acquisition opportunities.

 

55


Impact of 53rd week. Our fiscal year ends on the Saturday closest to June 30. Fiscal years 2012 and 2011 were 52-week years and 2010 was a 53-week year. Excluding the 53rd week in fiscal 2010, we would have had €34.6 million less in sales and €16.0 million of lower gross profit.

Results of Operations

Throughout the results of operations we discuss the effect of the change in foreign currency exchange rates on our results and exclude this effect from the discussion of the change between periods. We have determined the impact of the change in foreign currency rates by applying our budgeted fiscal 2012 euro conversion rate to all annual periods. The currencies with the most significant impact on our income statements are the Brazilian real and the Australian dollar. The budgeted exchange rates were 2.38 for the Brazilian real and 1.36 for the Australian dollar for fiscal 2012, respectively.

Description of key line items

Sales—Sales comprises the fair value of the consideration received or receivable for the sale of goods and services in the ordinary course of our activities. We recognize sales when the amount of sales can be reliably measured, it is probable that future economic benefits will flow to the entity and when specific criteria have been met for each of our activities as described below. We base our estimates on historical results, taking into consideration the type of customer, the type of transaction and the specifics of each arrangement.

We primarily generate sales from the sale of product. Sales of product are generally recognized when title and risk of loss of the products pass to distributors, resellers or end customers. In particular, title usually transfers upon receipt of the product at the customers’ locations, or upon shipment, as determined by the specific sales terms of the transactions.

We also recognize lease revenue from the leasing of our coffee machines and maintenance fees associated with maintaining the coffee machines.

We provide a variety of sales incentives to resellers and consumers of our products such as discounts, rebates and cooperative advertising. These sales incentives are recorded as a reduction of sales.

Cost of sales—Cost of sales consists of costs incurred from the time raw materials are purchased to when the finished goods are delivered to their location immediately prior to external sale. Cost of sales also includes sales incentives offered in the form of free product. Gains and losses arising from changes in the fair value of inventory-related derivative financial instruments included in the fair value through profit or loss category are also recorded in cost of sales.

Selling, general and administrative expenses—Selling, general and administrative expenses consist of advertising and promotion, distribution costs, selling and marketing expenses, research and development and other administrative functions. These costs include amounts associated with our restructuring actions and certain other items that management believes are unrelated to our ongoing operations.

Finance income, net—Finance income primarily represents income that we receive on our cash equivalents and loans to Sara Lee and finance income generated from our defined benefit pension plans.

Finance costs, net—Finance costs are generally comprised of interest expense on borrowings and overdrafts and the interest consequence of unwinding discounted provisions, foreign exchange gains and losses, excluding those related to commodities, and the change in fair value of our foreign currency and interest rate derivative financial instruments.

Share of profit from associates—This represents the share of profit from our investment in associates, which consists primarily of a 45% investment in Friele, a Norwegian company that produces coffee for distribution to out of home and retail customers.

 

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Income tax expense—Income tax expense is comprised of current and deferred tax expenses. For further information see our accounting policies in Note 2 to financial statements.

 

    Fiscal Year Ended     Change  
    June 30, 2012     July 2,  2011
restated
    July 3,  2010
restated
    2012 vs. 2011     2011 vs. 2010
restated
 
          Actual     %     Actual     %  
    (amounts in millions of euro, except percentages)  

Sales

  2,795.0      2,593.3      2,313.4      201.7        7.8      279.9        12.1   

Cost of sales

    1,787.1        1,611.6        1,347.7        175.5        10.9        263.9        19.6   
 

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

Gross profit

    1,007.9        981.7        965.7        26.2        2.7        16.0        1.7   

Selling, general and administrative expenses

    898.2        656.4        623.8        241.8        36.8        32.7        5.2   
 

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

Operating profit

    109.7        325.3        341.9        (215.6     (66.3     (16.6     (4.9

Finance income, net

    132.2        91.8        55.3        40.4        44.0        36.5        66.0   

Finance expenses, net

    17.4        (45.4     14.7        62.8        (138.4     (60.1     (408.8

Share of profit (loss) from associate

    0.2        2.2        2.7        (2.0     (90.9     (0.5     (18.5
 

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

Profit before income taxes

    259.5        373.9        414.6        (114.4     (30.6     (40.7     (9.8

Income tax expense

    127.3        110.7        174.9        16.6        15.0        (64.2     (36.7
 

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

Profit for the year

  132.2      263.2      239.7        (131.0     (49.8   23.5        9.8   
 

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

Fiscal 2012 Compared Fiscal 2011

Sales

Sales for fiscal 2012 decreased by €21.1 million due to changes in foreign currency exchange rates, primarily driven by the Brazilian real and Australian dollar. In addition, our sales for fiscal 2012 decreased by €39.9 million related to the Company’s strategic decision to gradually phase out its green coffee export activities. These decreases were offset by a €35.7 million increase resulting from a full year Café Damasco’s operations as compared to the seven months in the fiscal 2011 and the impact from the fiscal 2012 acquisitions.

After excluding the items listed above, our sales increased by €227.0 million. This increase was predominantly a result of higher net sales prices that increased sales by €248.1 million. Our higher net sales prices primarily resulted from the full year effect of price increases implemented in the second half of fiscal 2011 that were directly related to passing on a substantial portion of our commodity cost increases to customers.

In addition to sales prices, sales also increased by the continued growth of our single-serve capsules in our Retail—Western Europe segment which was offset by an unfavorable change in mix and lower volumes of other products in certain markets. These lower volumes included a decline that resulted from damage to our manufacturing facility in Thailand, which was caused by flooding in October 2011 resulting in a volume decrease of €14.8 million, and from the discontinuation of our private label multi-serve business in France in fiscal 2011, which reduced sales by €13.3 million.

Gross profit

Gross profit increased by €26.2 million and our gross margin percentage declined from 37.9% in fiscal 2011 to 36.1% in fiscal 2012.

 

57


Our gross profit was favorably impacted by €12.8 million of gross profit from the full year of Café Damasco’s operations as compared to the seven months in the fiscal 2011 and gross profit from the fiscal 2012 acquisitions. Our gross profit was also favorably impacted by foreign currency movement of €7.7 million. These increases were partially offset by a lower gross profit on green coffee sales.

Excluding these items, the increase in gross profit was €7.7 million. The increase in gross profit primarily resulted from an increase in sales of our higher margin single-serve capsules. This was partially offset by sales volume decreases, including an impact of €4.6 million related to the Thailand flood, and a general increase in our cost of sales not related to commodities. During fiscal 2012 we increased our net sales prices by €248.1 million however this was fully offset by an increase in commodity costs.

Selling, general and administrative expenses

Our total selling, general and administrative expenses, which we refer to as SG&A, increased by €241.8 million in fiscal 2012. We have presented SG&A as adjusted to exclude certain expenses we believe are unrelated to our underlying business and that are excluded from our segment profitability measure. Excluding these adjustments, our SG&A increased €61.7 million. The table below presents SG&A and SG&A excluding adjustments:

 

     Fiscal Year Ended  
     June 30, 2012      July 2,  2011
restated
    Change  
        Actual     %  
     (amounts in millions of euro, except percentages)  

SG&A

   898.2       656.5      241.8        36.8   

Adjustments:

         

Restructuring charges

     57.7         25.2        32.5        129.0   

Restructuring related

     63.0         7.8        55.2        707.7   

Termination prior Senseo agreement

     55.3         —          55.3        100.0   

Curtailment and past service costs

     —           (13.1     (13.1     (100.0

Impairment

     21.3         5.6        15.7        280.4   

Branded apparel costs

     7.9         3.5        4.4        125.7   

Other

     6.9         3.0        3.9        130.0   
  

 

 

    

 

 

   

 

 

   

Total adjustments

     212.1         32.0        180.1        562.8   
  

 

 

    

 

 

   

 

 

   

SG&A excluding adjustments

   686.1       624.4      61.7        9.9   
  

 

 

    

 

 

   

 

 

   

The increase in our SG&A excluding adjustments of €61.7 million includes approximately €2.3 million related to favorable foreign exchange impacts. Excluding the impact of foreign exchange rates, the increase was €63.9 million. This increase is primarily due to the impact of absorbing stranded costs and additional costs as a result of being a stand-alone company. In addition, during the period we increased our advertising and promotion costs and selling and marketing costs by €17.7 million. The increase in our advertising and promotion costs primarily related to continued promotion of our single-serve capsules in France and Spain and costs associated with launching the single-serve capsules in new markets. The increase in our selling and marketing costs is primarily related to expanding our selling and marketing function as part of being a stand-alone company.

In fiscal 2011, we had restructuring charges of €25.2 million that primarily related to the alignment of shared service centers to our current structure, which was partially in response to the divestment of businesses by Sara Lee. During fiscal 2012, we had restructuring charges of €57.7 million. The restructuring charge in fiscal 2012 includes €25.8 million associated with contractual termination fees for IT contracts that were renegotiated in connection with the planned separation and the establishment of additional redundancy provisions primarily related to the separation and becoming a stand-alone company.

 

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The restructuring related expense recorded during fiscal 2012 relates primarily to consulting costs associated with the planned implementation of our new business model and other incremental costs resulting from actions being taken in connection with the separation.

During fiscal 2012, we incurred a €55.3 million contract termination fee to terminate the prior Senseo global partnership agreement with Philips and to reimburse Philips for other project costs.

In fiscal 2012, we recognized an impairment charge of €21.3 million which primarily related to the write-off of certain IT software licenses for €13.8 million in connection with IT contract termination. The impairment charge also included €5.6 million for machines related to the discontinuation of certain production lines and €1.9 million for our former corporate offices in Utrecht. During fiscal 2011, we elected to abandon certain assets upon our decision not to expand our operations in Russia, which resulted in an impairment of €5.6 million.

Finance income, net

Finance income increased primarily due to an €11.3 million penalty received from Sara Lee as the result of an early repayment of a loan receivable, increased pension finance income for the period, and interest earned on loans to Sara Lee.

Finance costs, net

The change in finance costs is primarily due to a shift in our foreign exchange gain/loss from a foreign exchange loss of €40.9 million in fiscal 2011 to a foreign exchange gain of €44.7 million in fiscal 2012. The foreign exchange gains and losses are primarily related to intercompany loans and cash held in non-euro currencies. This was partially offset by a corresponding movement in our foreign currency derivatives from a gain of €15.5 million in fiscal 2011 to a loss of €5.6 million in fiscal 2012.

Share of profit from associate

Share of profit from associate decreased due to a decrease in Friele’s profits, which was primarily due to lower sales volumes, increased commodity costs, and increased product costs.

Income tax expense

Our effective tax rate increased to 49.1% in fiscal 2012 compared to 29.6% in fiscal 2011. The increase in our effective tax rate was primarily due to higher income tax expense associated with income we intend to repatriate in future periods and an associated increase in our tax liabilities.

Fiscal 2011 Compared Fiscal 2010

Sales

Sales in fiscal 2011 benefited from changes in foreign currency exchange rates, which increased sales by €67.6 million, primarily driven by the Brazilian real and Australian dollar, and from the acquisition of Café Damasco in fiscal 2011, which increased sales by €23.8 million. These increases were offset by a decline in sales of €34.6 million due to one less week of sales in fiscal 2011.

After excluding the items listed above, our sales increased by €223.1 million. This increase was predominantly a result of price increases of €201.0 million. These price increases, which took place in all segments, were directly related to passing on commodity cost increases to customers. The price increases were partially offset by an increase in trade promotions of €44.5 million, primarily in the retail segments, in response to increased competition and market pressures. Our sales were also positively impacted by the sales of our L’OR EspressO single-serve capsule in our Retail—Western Europe segment, which increased sales by €42.0 million

 

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in fiscal 2011. These increases were offset by a decrease that was primarily due to lower volume in our multi-serve product that was linked to the continued shift towards premiumization in a significant number of our markets.

In addition, our sales were increased by an additional €109.6 million of green coffee beans sold compared to fiscal 2010 as we took advantage of a system of taxes and rebates payable on trades of green coffee from Brazil. This increase was driven by the increase in overall green coffee market prices and an increased volume of sales which we planned for in determining our purchasing volumes. The Brazilian government ended this favorable tax treatment in January 2012, and we expect that our green coffee export sales will decrease considerably in future periods.

Gross profit

Gross profit increased by €16.0 million and our gross margin percentage declined from 41.7% in fiscal 2010 to 37.9% in fiscal 2011.

Our gross profit was favorably impacted by foreign currency movements of €28.9 million as well as €6.7 million of gross profit from the Café Damasco acquisition. These increases were partially offset by one less week of sales in fiscal 2011, which decreased gross profit by €16.0 million.

Excluding these items, gross profit remained consistent with fiscal 2010, with a decrease of €3.6 million. Our gross profit declined due to commodity price increases of €176.1 million, offset by net sales price increases of €156.5 million and a further reduction in gross profit due to volume declines. These declines were partially offset by a favorable change in our product mix, primarily related to the launch of our higher margin L’OR EspressO capsules and the gross profit of €11.6 million from the increase in our green coffee bean sales.

While our fiscal 2011 gross profit is consistent with fiscal 2010, our gross margin has decreased, primarily as a result of the green coffee bean sales to third parties which have a lower margin than our normal product sales.

Selling, general and administrative expenses

Our SG&A increased by €32.7 million in fiscal 2011. We have presented SG&A as adjusted to exclude certain expenses we believe are unrelated to our underlying business and that are excluded from our segment profitability measure. Excluding these adjustments, our SG&A increased €24.8 million. The table below presents SG&A and SG&A excluding adjustments:

 

     Fiscal Year Ended  
     July 2,  2011
restated
    July 3,  2010
restated
     Change  
          Actual     %  
     (amounts in millions of euro, except percentages)  

SG&A

   656.4      623.8         €32.7        5.2   

Adjustments:

         

Restructuring charges

     25.2        5.4         19.8        366.7   

Restructuring related

     7.8        9.1         (1.3     (14.3

Curtailment and past service costs

     (13.1     —           (13.1     (100.0

Impairment

     5.6        —           5.6        100.0   

Branded apparel costs

     3.5        7.9         (4.4     (55.7

Other

     2.9        1.8         1.2        66.7   
  

 

 

   

 

 

    

 

 

   

Total adjustments

     31.9        24.2         7.8        32.2   
  

 

 

   

 

 

    

 

 

   

SG&A excluding adjustments

   624.5      599.6         €24.8        4.1   
  

 

 

   

 

 

    

 

 

   

 

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The increase in our SG&A excluding adjustments of €24.8 million includes approximately €12.2 million related to unfavorable foreign exchange impacts. The remaining increase in our SG&A excluding adjustments, of €12.6 million was due to an increase in our distribution costs of €6.0 million. The increase in our distribution costs is primarily attributable to the increased proportion of our sales from single-serve products, which have a higher distribution cost per kilogram than multi-serve products, and the impact of our expanded geographical presence in Brazil. In addition, we increased our selling, marketing and advertising costs expenditures by €4.4 million to drive sales of our new products and expansion of existing products in certain markets, which was partially offset by one less week of costs in fiscal 2011.

The increase in our restructuring expenses and costs directly associated with those restructuring charges during fiscal 2011 primarily related to redundancy payments made in connection with the alignment of corporate overhead to our current structure, which was partially in response to the divestment of businesses by Sara Lee. We also elected to abandon certain assets upon our decision not to expand our operations in Russia, which resulted in an impairment of €4.6 million.

The increase in curtailment and past service cost is primarily due to a change in the grant of post-employment benefits to employees in the Netherlands.

Finance income, net

Finance income increased due to an increase in pension finance income of €19.3 million, which resulted from a favorable downward movement in our interest costs due to improved return on assets, as well as an increase in interest income from loans to Sara Lee.

Finance costs, net

The change in finance costs is primarily due to a shift in our foreign exchange gain/loss from a foreign exchange gain of €40.2 million in fiscal 2010 to a foreign exchange loss of €40.9 million in fiscal 2011. The foreign exchange gains and losses are primarily related to intercompany loans and cash held in non-euro currencies. This was partially offset by a corresponding movement in our foreign currency derivatives from a loss of €9.8 million in fiscal 2010 to a gain of €15.5 million in fiscal 2011. Additionally, we had an increase in interest expense resulting from additional Brazilian real denominated borrowings associated with the acquisition of Café Damasco in fiscal 2011.

Share of profit from associate

Share of profit from associate decreased due to a decrease in Friele’s profits. Friele’s operations were impacted by the market increase in commodity prices that also impacted our business, which resulted in a decline in gross profit. In addition, they increased marketing and advertising expenditure in an increasingly competitive market.

Income tax expense

Our effective tax rate decreased to 29.6% in fiscal 2011 compared to 42.2% in fiscal 2010. The decrease in our rate was due to the recognition of additional tax expense in fiscal 2010 related to specific tax events with no such items in fiscal 2011. In fiscal 2010, we recognized €50.8 million of additional tax expense as a result of our decision to repatriate certain income that will result in recapture taxes and an increase in our tax reserves of €31.7 million for a tax claim in Belgium. In addition, we recorded additional tax expense associated with a change in tax reserves recorded in prior years of €30.7 million. These increases in fiscal 2010 were partially offset by a reduction in our effective tax rate due to the recognition of deferred tax assets previously not recognized.

 

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Segment Results

Retail—Western Europe

 

     Fiscal Year Ended     Change  
     June 30, 2012     July 2,  2011
restated
    July 3,  2010
restated
    2012 vs. 2011     2011 vs.  2010
restated
 
     (amounts in millions of euro, except percentages)  

Sales

     €1,264.2        €1,125.3        €1,053.4        €138.9        €71.9   

Sales growth

     12.3     6.8     n/a       

Adjusted EBIT

     €209.7        €218.1        €253.3        €(8.4     €(35.2

Adjusted EBIT Margin

     16.6     19.4     24.0    

Fiscal 2012 Compared Fiscal 2011

Sales

Sales in our Retail—Western Europe segment increased €138.9 million from fiscal 2011 to fiscal 2012. The increase was achieved primarily through higher net prices and an increase in our single-serve capsules.

The higher sales prices relate primarily to the full year impact of sales price increases implemented in the second half of fiscal 2011 in response to rising commodity costs. In many of our markets, sales price increases resulted in increased trade promotion activity to respond to the competitive pressure and maintain sales volume.

The increase attributable to single-serve capsules was primarily related to the continued growth in volume of our single-serve capsules in the Netherlands, France, Spain and Belgium.

These increases were offset by a decrease in sales that was primarily due to a decrease in sales volumes of multi-serve products. The volume declines resulted from the discontinuation of our private label multi-serve business in France in fiscal 2011 and a continuing shift in sales from multi-serve to single-serve products. This shift, combined with sales price increases from rising commodity costs and increased competition, contributed to the decrease in volumes for multi-serve products during the year.

Adjusted EBIT

Adjusted EBIT decreased €8.4 million from fiscal 2011 to fiscal 2012, which represented an increase in our gross profit offset by an increase in SG&A. The increase in our gross profit was due to higher net sales prices and a favorable shift in our product mix. This gross profit increase was partially offset by commodity price increases and by volume declines.

The increase in our SG&A includes an increase in our advertising and promotion costs, which primarily related to the continued promotion of our single serve capsules in the Netherlands and Spain, and an increase in our selling and marketing costs which was primarily related to expanding our outreach as a result of the acquisition of CoffeeCompany. In addition, we experienced an increase in administrative costs resulting primarily from the impact of absorbing a higher amount of stranded costs, and the impact of being a stand-alone company.

Fiscal 2011 Compared to Fiscal 2010

Sales

The increase in sales of €71.9 million was achieved primarily through net price increases and an increase of €42.0 million from a full year impact of our L’OR EspressO single-serve capsules which were launched in France in April 2010. These increases were partially offset by one less week of sales in fiscal 2011, which reduced sales by €18.3 million. The remaining decrease was primarily due to a decrease in sales volumes of multi-serve products.

 

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The increase in sales related to pricing is due to multiple sales price increases that we implemented throughout fiscal 2011 in response to rising commodity costs. In many of our markets, sales price increases resulted in increased trade promotion activity to maintain volume.

Throughout the segment, we have also seen a continuing shift in sales from multi-serve to single-serve products. This shift, combined with sales price increases from rising commodity costs and increased competition, contributed to the decrease in volumes for multi-serve products during the year. The continued success of L’OR EspressO single-serve capsules in France highlights a shift towards premiumization.

Adjusted EBIT

Adjusted EBIT decreased €35.2 million from fiscal 2010 to fiscal 2011. During fiscal 2011, adjusted EBIT declined due to a decrease in segment gross profit attributable to a one less week in fiscal 2011 of €8.4 million, a decline in multi-serve volume, and commodity price increases that were partially offset by sales price increases. In addition, our adjusted EBIT was negatively impacted by an increase in our production costs. This decline in adjusted EBIT was partially offset by increased sales of our higher margin single-serve capsules.

Retail—Rest of World

 

     Fiscal Year Ended     Change
     June 30, 2012     July 2,  2011
restated
    July 3,  2010
restated
    2012 vs. 2011    2011 vs.  2010
restated
     (amounts in millions of euro, except percentages)

Sales

   759.6      647.0      567.8      112.6       79.2

Sales growth

     17.4     13.5     n/a        

Adjusted EBIT

     49.6        45.0        36.3        €4.6       8.7

Adjusted EBIT Margin

     6.5     7.0     6.4     

Fiscal 2012 Compared Fiscal 2011

Sales

Sales in our Retail—Rest of World segment increased €112.6 million from fiscal 2011 to fiscal 2012. Our sales in fiscal 2012 include €6.0 million of sales from the fiscal 2012 acquisitions and €21.6 million from a full period of results for Café Damasco, which was acquired on November 30, 2010. This increase was partially offset by unfavorable exchange rate impacts of €17.7 million. Excluding the impact of these items, sales increased by €102.1 million.

Our sales reflect the impact of higher net sales price increases that were primarily implemented in the second half of fiscal 2011, which were partly offset by trade promotions. The sales price increases were in response to rising commodity costs.

The increase in sales also reflects an increase in volumes in certain markets that was almost fully offset by a decline in volume that resulted from damage to our manufacturing facility in Thailand caused by flooding in October 2011. The higher net sales prices were also offset by a slightly unfavorable shift in our product mix.

Adjusted EBIT

Adjusted EBIT increased €4.6 million from fiscal 2011 to fiscal 2012. The change in adjusted EBIT includes an increase of €3.6 million related to the businesses acquired in fiscal 2012 and €5.1 million related to a full year of Café Damasco operations.

Excluding these impacts, adjusted EBIT decreased €4.1 million, which represents an increase in our SG&A, partially offset by an increase in our gross profit. Our gross profit increased due to higher net sales prices offset by increased commodity costs.

 

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Our SG&A increased due to an increase in our distribution costs and an increase in selling and marketing costs as a result of expanding our geographic reach due to our acquisitions. In addition, our administrative costs have increased due to the absorption of a higher amount of stranded costs and general inflationary increases.

Fiscal 2011 Compared to Fiscal 2010

Sales

Sales in our Retail—Rest of World segment increased €79.2 million from fiscal 2010 to fiscal 2011. Our sales in fiscal 2011 benefited from favorable exchange rate impacts of €48.9 million and the acquisition of Café Damasco, which increased sales €23.8 million. These increases were offset by one less week of sales of €5.6 million. Excluding the impact of these items, sales increased by €12.2 million.

This increase of €12.2 million was the result of net sales price increases that were implemented throughout fiscal 2011 in response to rising commodity costs, which were partially offset by increased trade promotion activity.

These net sales price increases were offset by various factors including a decrease in volumes in all markets except Thailand and Australia. The volume decreases were most significant in Brazil where the increase in sales prices impacted our volumes more significantly due to competitive pressures. In addition, our sales decreased due to our shift in our business model in Russia and an unfavorable shift in our product mix.

Adjusted EBIT

Adjusted EBIT increased €8.7 million from fiscal 2010 to fiscal 2011. The change in adjusted EBIT includes €16.0 million in favorable foreign currency impacts. Excluding the foreign currency impact, adjusted EBIT decreased by €7.3 million due to various offsetting factors.

Our adjusted EBIT increased due to price increases resulting from passing on commodity price increases to our customers. In addition, our adjusted EBIT increased due to a favorable change in our product mix to single-serve capsules and various other factors.

This was offset by increased commodity costs, which were primarily the result of the market increases in prices, a decrease in volumes, and an increase in marketing and advertising costs. The marketing and advertising increase is primarily attributable to Brazil where we have increased our spending in response to strong competition.

Out of Home

 

     Fiscal Year Ended     Change  
     June 30, 2012     July 2,  2011
restated
    July 3,  2010
restated
    2012 vs. 2011     2011 vs.  2010
restated
 
     (amounts in millions of euro, except percentages)  

Sales

   636.9      634.4      613.8        €2.5      20.6   

Sales growth

     0.4     3.4     n/a       

Adjusted EBIT

   99.8      109.8      108.9      (10.0   0.9   

Adjusted EBIT Margin

     15.7     17.3     17.7    

 

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Fiscal 2012 Compared Fiscal 2011

Sales

Sales in our Out of Home segment increased by €2.5 million from fiscal 2011 to fiscal 2012. The sales, excluding the favorable impact of foreign currency exchange rates of €3.3 million and the impact of the fiscal 2012 acquisitions of €3.1 million, decreased by €3.9 million. This decrease in sales of €3.9 million is due to the sales price increases that resulted from passing on higher commodity costs to customers, which were offset by a decline in both our multi-serve and liquid roast coffee products as well as lower machine and operating related revenue.

Adjusted EBIT

Adjusted EBIT decreased €10.0 million in fiscal 2012, primarily due to a decline in our gross profit. This decline in gross profit represents the sales price increases, offset by the commodity price increases and the lower gross profit attributable to our machines and operating business.

Fiscal 2011 Compared to Fiscal 2010

Sales

Sales in our Out of Home segment increased €20.6 million from fiscal 2010 to fiscal 2011 including the favorable impact of foreign currency exchange rates of €7.8 million. This was offset by one less week of sales compared to fiscal 2010, which resulted in a decrease in sales of €10.7 million.

The increase in sales, excluding the items listed above, was €23.5 million. This increase was predominantly due to sales price increases that resulted from passing on higher commodity costs to customers, which was partially offset by a decline in our multi-serve and liquid roast coffee product. The decrease in multi-serve and liquid roast coffee was due in part to the overall weakness in the European economy, which resulted in lower sales of these products to businesses.

Adjusted EBIT

Adjusted EBIT increased €0.9 million in fiscal 2011, which was the result of various offsetting factors.

Our adjusted EBIT increased during the period due to sales price increases along with a decrease in our cost of sales and administrative costs. These improvements were almost fully offset by an increase in our commodity prices and a decline in volume of our multi-serve and liquid roast products.

Liquidity and Capital Resources

Our primary source of funds for our short-term and long-term liquidity needs will be the cash flows generated from operations along with borrowings under our 2012 revolving credit facility.

Prior to the separation, we financed our operations through cash flows generated by our operations. We also used available cash to provide financing to Sara Lee. We have not historically received any significant financing from Sara Lee nor have we participated in any joint borrowings or benefited from borrowings held by Sara Lee.

In connection with the separation, we issued $2.1 billion of debt securities to Sara Lee. Additionally, we entered into a debt exchange with Sara Lee, whereby approximately $1.5 billion of these debt securities were settled and a corresponding amount of the loans receivable from Sara Lee were settled. Sara Lee transferred the remaining debt securities to a third party in settlement of its own debt obligations.

Furthermore, as part of the separation, we paid a special cash dividend of $3.00 per share to each of our shareholders of record, as of June 28, 2012. This resulted in a cash payment of approximately $1.8 billion (approximately €1.4 billion).

 

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In addition, we entered into a €750 million revolving credit facility on May 22, 2012 to provide available borrowing to fund any short-term working capital requirements. As of the end of fiscal 2012 there are no amounts outstanding under this agreement.

As a consequence of these separation transactions, as of June 30, 2012, our borrowings increased to €557.4 million, our cash and cash equivalents decreased to €220.3 million, our net debt was €337.1 million, and our total current assets was €1.1 billion.

We monitor our liquidity in various ways, including reviewing available cash balances on a daily basis and, on a weekly basis, reviewing short-term cash forecasts obtained from our operating entities. Additionally, we monitor liquidity using the following cash flow metrics:

 

     Fiscal Year Ended  
     June  30,
2012
    July 2, 2011
restated
    July 3, 2010
restated
 
     (amounts in millions of euro, except
percentages)
 

Cash generated from operating activities(a)

   102.5      281.7      364.8   

Working Capital

     63.6        2,200.6        2,361.4   

Operating Working Capital(b)

     405.1        422.8        339.2   

Operating Working Capital as a percentage of sales(b)

     14.5     16.3     14.7

Free Cash Flow(b)

   5.2      204.2      299.1   

Net (Debt)/Cash(b)

     (337.1     979.5        333.0   

Capital Expenditures

     97.3        77.5        65.7   

 

(a) For purposes of periods prior to the spin-off, we have assumed all taxes were settled by Sara Lee, and as a result there are no cash taxes reflected in our cash generated from operating activities. As a consequence, our future operating cash flows will be reduced by tax payments which are reflected as distributions to Sara Lee in financing activities in the statement of cash flows.

 

(b) These amounts are not measures determined in accordance with IFRS. See “Selected Financial Data” for a definition of the measure, a reconciliation of the measure to IFRS and a discussion regarding the limitation of the use of such measures.

We expect to finance our obligations through cash on hand, cash flow from operations and borrowings under our credit facility. Our principal uses of cash in the future will be to fund our operations, capital expenditures, purchase commitments and repayment of borrowings.

Based on our current cash and cash equivalents position, cash flows from operations, and the availability of borrowings under a €750 million revolving credit facility, we believe that our source of funds will provide sufficient liquidity to fund current obligations, expected working capital requirements and capital spending for a period that includes the next twelve months.

 

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Cash Flows

The following table summarizes the changes to cash flows from operating, investing and financing activities.

 

     Fiscal Year Ended  
      June 30, 2012     July 2, 2011
restated
    July 3, 2010
restated
 
     (amounts in millions of euro)  

Cash provided by (used in):

      

Operating activities

   102.5      281.7      364.8   

Investing activities

     456.7        70.8        353.8   

Financing activities

     (1,685.9     340.2        (564.1

Effects of exchange rate changes

     2.9        (11.7     0.4   
  

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

   (1,123.8   681.0      154.9   
  

 

 

   

 

 

   

 

 

 

Fiscal 2012 Compared Fiscal 2011

Operating activities

We generated cash flows from operations of €102.5 million in fiscal 2012 compared to €281.7 million in fiscal 2011. Cash generated from operations before changes in operating assets and liabilities was €313.3 million in fiscal 2012 and €466.2 million in fiscal 2011. Cash used to finance working capital increased to €210.9 million in fiscal 2012 from €184.5 million in fiscal 2011.

Cash used to finance working capital in fiscal 2012 resulted from the increase in trade and other receivables, a decrease in cash from derivative instruments, and the use of cash for payments for pensions and provisions. This was slightly offset by cash inflows resulting from an increase in trade and other payables and a decrease in our inventories. The decrease in our inventories was due to a planned effort to reduce raw materials as a result of being a stand-alone company. The pension payments include one-time payments related to a change in pension plan terms and the provision payments related to redundancies.

Investing activities

Net cash generated from investing activities increased from €70.8 million in fiscal 2011 to €456.7 million in fiscal 2012. This change is primarily due to the net cash inflows related to repayments of loans made to Sara Lee. These net cash inflows were partially offset by the purchase of the Senseo brand from Philips.

Financing activities

Our cash used in financing activities was €1.7 billion in fiscal 2012 compared to cash generated from financing activities of €340.2 million in fiscal 2011. This increase in cash spent on financing activities from fiscal 2011 to fiscal 2012 primarily relates to various transactions pertaining to our separation from Sara Lee, including the issuance of debt securities for the international coffee and tea business and the payment of the $3.00 per share special cash dividend.

Fiscal 2011 Compared to Fiscal 2010

Operating activities

We generated cash flows from operations of €281.7 million in fiscal 2011 compared to €364.8 million in fiscal 2010. Cash generated from operations before changes in operating assets and liabilities was €466.2 million in fiscal 2011 and €465.9 million in fiscal 2010. Cash used to finance working capital increased to €184.5 million

 

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in fiscal 2011 from €101.1 million in fiscal 2010. This was primarily due to a significant increase in inventories and trade and other receivables, which was partially offset by an increase in trade and other payables and cash generated from derivative financial instruments.

These changes in working capital are all directly linked to the higher commodity costs in fiscal 2011 and a proactive extension of payments terms.

Investing activities

Net cash generated from investing activities decreased from €353.8 million in fiscal 2010 to €70.8 million in fiscal 2011. This change is primarily due to a higher net increase in loans provided to Sara Lee in fiscal 2010 compared to fiscal 2011, offset by cash used to finance the acquisition of Café Damasco in fiscal 2011.

Financing activities

We generated cash from financing activities of €340.2 million in fiscal 2011 compared to cash used in financing activities of €564.1 million in fiscal 2010. This change is almost entirely a result of a change from distributions to Sara Lee in fiscal 2010 of €566.8 million to cash transfers to us from Sara Lee of €342.6 million in fiscal 2011.

Contractual obligations

The following table summarizes our future contractual obligations as of July 2, 2011. These amounts have not been adjusted to reflect the impacts of the separation, including any additional borrowings resulting from the separation.

 

     Total      < 1 Year      1 - 3 Years      3 - 5 Years      > 5 Years  
     (amounts in millions of euro)  

Borrowings:

              

Senior notes

   691.8       20.0       40.0       40.0       591.8   

Other borrowings(a)

   204.6       28.5       5.9       1.2       169.0   

Operating lease commitments

     77.4         18.1         27.7         8.0         23.6   

Purchase commitments(b)

     144.2         144.2         —           —           —     

UK Pension obligation(d)

     260.5         44.4         97.5         61.8         56.8   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total(d)

     1,378.5         255.2         171.1         111.0         841.2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(a) The borrowings include future interest payments. The senior notes and a portion of the other borrowings are denominated in a currency other than the euro. As a result actual payments may differ from these amounts due to changes in foreign currency rates.

 

(b) Purchase commitments predominantly consist of commitments related to the purchases of green coffee.

 

(c) Our defined benefit liability recorded on our balance sheet includes obligations related to pension plans in the United Kingdom. During fiscal 2006, we entered into an agreement with the plan trustee to fully fund certain of these United Kingdom pension obligations by 2015. This amount represents the minimum payments required under these agreements. The final payment will vary based on changes in the actual pension experience. The amounts are payable in British pounds and the actual amounts paid may vary due to exchange rate fluctuations.

 

(d)

This table does not contain normal purchase obligations made in the ordinary course of business. In addition, deferred taxes, other non-current liabilities and remaining pension obligations (excluding the minimum United Kingdom pension obligation disclosed above) have been excluded as the timing of the payments, other than the minimum United Kingdom pension funding, are not fixed. Guarantees are also not

 

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  included as these obligations typically arise as a result of contracts under which we agree to indemnify a third-party against losses arising from a breach of representation and covenants related to matters such as title to assets sold, collectability of receivables, specified environmental matters, lease obligations assumed and certain tax matters. In each of these matters, payment is conditioned on the other party making a claim pursuant to the procedures specified in the contract and it is therefore not possible to predict the maximum potential amount of future payments under these agreements.

Quantitative and qualitative disclosures about market risk

Our activities expose us to market risk associated with foreign exchange movements, commodity prices and interest rate fluctuations. All of these risks arise in the normal course of business. Our overall risk management program focuses on the unpredictability of financial markets and seeks to minimize potential adverse effects on our performance. To mitigate the risk from interest rate, foreign currency exchange rate and commodity price fluctuations, we use various derivative financial instruments. We do not use financial instruments for trading purposes and are not a party to any leveraged derivatives.

Commodity price risk—Commodity price risk arises primarily from transactions on the world commodity markets for securing the supply of green coffee beans. Our objective is to minimize the impact of commodity price fluctuations. The commodity price risk exposure of anticipated future purchases is managed primarily using derivative futures and options. As a result of our short product business cycle, the majority of the anticipated future raw material transactions outstanding at the balance sheets date are expected to occur in the next year.

We generally enter into commodity futures and options contracts that are traded on established, well-recognized exchanges that offer high liquidity, transparent pricing, daily cash settlement and collateralization through margin requirements.

Foreign exchange risk—We operate internationally and are exposed to foreign exchange risk arising from various currency exposures, primarily with respect to the U.S. dollar, Brazilian real, British pound, Danish kroner, Hungarian forint and Australian dollar against the euro. Foreign exchange risk arises primarily from commercial transactions such as the purchase of commodities, recognized monetary assets and liabilities, net investments in foreign operations and from foreign currency borrowings.

We use forward exchange and option contracts to reduce the effect of fluctuating foreign currencies on short-term foreign-currency-denominated intergroup transactions, third-party product-sourcing transactions, foreign-denominated investments (including subsidiary net assets), foreign currency denominated debt and other known foreign currency exposures. Gains and losses on the derivative instruments are intended to offset gains and losses on the associated transaction in an effort to reduce the earnings volatility resulting from fluctuating foreign currency exchange rates. Forward currency exchange contracts mature at the anticipated cash requirement date of the associated transaction, generally within 12 to 18 months. As of fiscal 2012, 2011 and 2010, we have not designated any of our foreign exchange derivatives as hedges for accounting purposes and, as a result, the change in fair value is recognized directly to the income statements.

Using the exchange rates as of the reporting dates, the net euro equivalent of commitments to purchase and sell foreign currencies is €1.7 billion and €1.7 billion, respectively, as of fiscal year 2012, €1.2 billion and €1.2 billion, respectively, as of fiscal year 2011 and €1.1 billion and €1.0 billion, respectively as of fiscal year 2010. We enter into derivative financial instruments to manage the exposure for virtually all foreign exchange risk derived from recorded transactions and firm commitments and anticipated transactions where the exposure is potentially significant.

Interest rate risk—We are exposed to interest price risk that results from borrowings at fixed rates and the interest cash flow risk that results from borrowings at variable rates. Prior to our separation from Hillshire, the interest rate price risk was managed by entering into interest rate swaps to effectively convert its fixed-rated debt

 

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instruments into floating-rate debt instruments. We have now established a policy under which we assess the current market environment and our leverage ratio in determining the need for interest swaps or hedging instruments to manage our risk. At end of fiscal 2012 we had primarily fixed rate debt and based on these criteria made a decision not to enter into any interest rate swaps associated with these borrowings. Subsequent to the end of fiscal 2012, we entered into fixed-to-fixed rate cross currency swaps to effectively convert its fixed rate USD debt in to fixed rate EUR debt.

Risk management—We maintain risk management control systems to monitor the foreign exchange, interest rate and commodity price risk and our offsetting hedge positions. We utilize a sensitivity analysis technique to evaluate the effect of any changes in interest rate, commodity prices and foreign currencies and the associated risk derivatives.

 

   

Commodities—As of fiscal years 2012, 2011 and 2010, if fair value of our commodity derivative instruments changed by 10% our profit would have changed by €7.5 million, €4.3 million and €6.1 million, respectively.

 

   

Interest rate swaps—We have minimal exposure to interest rate movements due to the amount of outstanding borrowings during the periods presented. We had minimal exposure to interest rate movements due to the amount of outstanding borrowings throughout fiscal 2012, 2011 and 2010 and the majority of the outstanding borrowings were at fixed rates during these periods. As noted above, in prior periods we converted our fixed rate third party borrowing into variable rate debt through the use of derivative financial instruments. A 10 basis point change in the fair value of the interest rate derivatives in place during fiscal years 2011 and 2010 would have changed profit by €0.4 million and €0.7 million, respectively.

 

   

Foreign currency—As noted above, we have a foreign currency transaction exposure. We manage this risk through the use of derivative financial instruments. During fiscal years 2012, 2011 and 2010, if the fair value of the foreign currency derivatives changed by 10%, our profit for the period would have changed by €47.1 million, €52.8 million and €23.6 million, respectively. In addition, during fiscal year 2011 we had foreign currency options, which if the fair value changed by 10% would have changed profit by €1.0 million.

Credit risk

Credit risk arises because a counterparty may fail to perform its obligations. We are exposed to credit risk on financial instruments such as cash, derivative assets and trade receivables. We avoid the concentration of credit risk on our liquid assets by spreading them over several institutions and sectors.

In relation to derivative financial instruments, we enter into financial instrument agreements only with counterparties meeting very stringent credit standards (a credit rating of A/A2 or better), limiting the amount of agreements or contracts it enters into with any one party and, where legally available, executing master netting agreements. These positions are continually monitored. While we may be exposed to credit losses in the event of non-performance by individual counterparties or the entire group of counterparties, we have not recognized any losses with these counterparties in the past and do not anticipate material losses in the future.

Our derivative instruments are governed by International Swaps and Derivatives Association master agreements

Our trade receivables are subject to credit limits, controls and approval procedures. Due to the large geographic base and number of customers, we are not exposed to material concentrations of credit risk on our trade receivables. Nevertheless, commercial counterparties are constantly monitored.

The maximum exposure to credit risk resulting from financial activities, without considering netting agreements and without taking into account any collateral held or other credit enhancements, is equal to the carrying amount of our financial assets.

 

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Liquidity risk

Liquidity risk arises when a company encounters difficulties to meet commitments associated with liabilities and other payment obligations. Such risk may result from inadequate market depth or disruption or refinancing problems. Our treasurer has established the liquidity risk management framework for the management of short-, medium- and long-term funding and liquidity management requirements. Liquidity risk is managed by maintaining adequate reserves and banking facilities and by closely monitoring forecasted and actual cash flows and, where possible, matching the maturity profiles of financial assets and liabilities. In order to maintain adequate banking facilities, we entered into a revolving credit facility, which will provide available financing to us in future periods.

See Note 3 of our financial statements for further information.

Off-balance sheet transactions

We use customary off-balance sheet arrangements, such as operating leases, guarantees and letters of credit, to finance our business. None of these arrangements has had or is likely to have a material effect on our results of operations, financial condition or liquidity.

Research and Development

Our research and development teams are responsible for the technical development of coffee and tea beverage products, packaging systems and new equipment and manufacturing methods. At the core of our research and development capabilities is a team of approximately 125 professionals. Our research and development facilities are located in Utrecht, the Netherlands.

Our research and development expense for fiscal 2012, 2011 and 2010 was approximately €25 million, €21 million and €18 million, respectively. On average, approximately one-third of our research and development budget is devoted to single-serve product development, one-third to liquid roast and approximately one-third is devoted to all other categories. In addition to our investments in traditional research and development activities and in developing new manufacturing processes, we actively invest in our manufacturing facilities.

Critical accounting policies

Reference is made to Note 4 of the financial statements.

Recent accounting pronouncements

Reference is made to pages F-24 through F-26 of the financial statements.

 

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ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

The following description sets forth certain information about our management and management-related matters.

Introduction

We have a single-tier board of directors, consisting of executive and non-executive directors. The number of executive and non-executive directors is determined by the board of directors. Our single-tier board structure consists of one executive director and six non-executive directors, as described below. We intend to nominate two additional individuals for election to the board of directors at the next general meeting of shareholders, which would bring the total number of directors to nine. Our sole executive director, Mr. Herkemij, was appointed as Chief Executive Officer on February 27, 2012.

In the view of the board of directors, all its six non-executive directors are independent within the meaning of best practice provision III.2.2 of the Dutch Corporate Governance Code.

Board of directors

The following table lists the names, positions and ages of the members of our board of directors. Each of our directors have been elected.

 

Name

  

Position

  

Age

Jan Bennink

   Non-Executive Chairman    56

Michiel J. Herkemij

   Chief Executive Officer, Executive Director    48

Maria Mercedes M. Corrales

   Non-Executive Director    63

Andrea Illy

   Non-Executive Director    48

Cornelis J.A. van Lede

   Non-Executive Director    69

Norman R. Sorensen

   Non-Executive Director    67

Sandra E. Taylor

   Non-Executive Director    62

The business address of our directors is at our registered offices located at Oosterdoksstraat 80, 1011 DK Amsterdam, the Netherlands.

Senior management

The following table lists the names, positions and ages of the members of our senior management.

 

Name

  

Position

  

Age

 

Michel M.G. Cup

   Chief Financial Officer      43   

Harm-Jan van Pelt

   Chief Operating Officer, Retail—Rest of World      50   

Nick J. Snow*

   Chief Operating Officer, Out of Home      48   

Eugenio Minvielle

   Chief Operating Officer, Retail—Western Europe      48   

 

* On September 11, 2012 Nick J. Snow left D.E MASTER BLENDERS.

The business address of all members of our senior management is at our registered offices located at Oosterdoksstraat 80, 1011 DK Amsterdam, the Netherlands.

 

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The principal functions and experience of each of our directors and the members of our senior management are set out below:

Board of directors

Michiel J. Herkemij

Michiel J. Herkemij, our Chief Executive Officer and chairman of our executive committee, has been our executive director since February 27, 2012. Mr. Herkemij joined the Company as Executive Vice President and Chief Executive Officer of the Coffee and Tea (formerly International Beverage) segment on December 1, 2011. Mr. Herkemij joined Sara Lee from Heineken N.V., where he served as President and Chief Executive Officer of Cuauhtémoc Moctezuma in Mexico. Previously, he was Chief Executive Officer of Heineken’s Nigerian subsidiary, a publicly-listed company. Prior to Heineken, Mr. Herkemij held multiple managerial positions with Royal Friesland Campina N.V., where he worked in the Benelux region, Greater China and Nigeria. He began his business career with British American Tobacco in the United Kingdom and Iberia (Spain & Portugal) and ABN AMRO Bank N.V. and previously served as a lieutenant in the Dutch Royal Navy.

Jan Bennink

Jan Bennink has been a non-executive director and our Chairman since February 27, 2012. Mr. Bennink joined the Company as Executive Chairman of the board of directors of Sara Lee Corporation in January 2011. From 2002 to 2007, Mr. Bennink served as Chief Executive Officer of Royal Numico N.V. (baby food and clinical nutrition). From 1995 to 2002, Mr. Bennink was employed by Groupe Danone (a global producer of cultured dairy products and bottled water) and served as Senior Vice President and then President of the Dairy Division and member of the Executive Committee. Mr. Bennink has also held management positions with Benckiser GmbH (manufacturer of cleaning supplies and cosmetics) from 1989 to 1995 and with The Procter & Gamble Company (branded consumer goods) from 1982 to 1988. Mr. Bennink currently serves on the board of directors of Coca-Cola Enterprises, Inc. He previously served on the advisory board of ABN AMRO Bank N.V., as well as on the boards of directors of Boots Company plc, Dalli-Werke GmbH & Co KG, and Kraft Foods, Inc.

Maria Mercedes M. Corrales

Maria Mercedes M. Corrales serves on our board of directors as a non-executive director. Mrs. Corrales served as Senior Vice President, Starbucks Corporation and President of Starbucks Coffee Asia Pacific Ltd. from 2009 to 2010. From 2006 to 2009, Mrs. Corrales was the Representative Director, Chief Executive Officer/Chief Operating Officer of Starbucks Coffee Japan. Mrs. Corrales also held a number of management positions with Levi Strauss and Co. in her 32-year career with the Company, including Representative Director and President of Levi Strauss Japan, Regional Vice President for North Asia and Regional General Manager for South America. Mrs. Corrales is currently a non-executive director of Fraser and Neave, Limited, Huhtamaki OYJ and serves on the board and as member of the executive committee of Times Publishing United. Additionally, Mrs. Corrales has served on the board of directors of Coffee Concepts Hongkong, Starbucks Coffee South Korea and Starbucks Coffee Malaysia.

Andrea Illy

Andrea Illy serves on our board of directors as a non-executive director. Mr. Illy is Chairman and Chief Executive Officer of illycaffè SpA and serves on the board of directors of Gruppo Illy SpA. Mr. Illy has held these positions since 2007. Mr. Illy has also held management positions with Ilko Coffee International (Chairman) and Fondazione Altagamma (Vice Chairman). Additionally, Mr. Illy has served on the board of directors of the Association Scientifique Internationale pour le Cafè, Illycaffè Shanghai Co. Ltd., and illy caffè North America, Inc.

 

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Cornelis J.A. van Lede

Cornelis J.A. van Lede serves on our board of directors as a non-executive director and Vice Chairman. Mr. Van Lede is the retired Chairman of the Board of Management and Chief Executive Officer of Akzo Nobel N.V. He held these positions from May 1994 to 2003. Mr. Van Lede also held the following management positions: Akzo Nobel (member of the Board of Management, Vice Chairman of the Board of Management), Union of Industrial and Employers’ Confederations of Europe (Vice President) and the Federation of Netherlands Industry (Chairman). Mr. Van Lede served on the board of directors of Sara Lee since October 2002 and resigned from the board of directors of Sara Lee when the separation was completed. He also serves as Chairman of the Supervisory Board of Heineken N.V. and as a member of the Supervisory Board of Royal Philips Electronics. He is a non-executive director of Air France-KLM Holding and Air Liquide. Mr. Van Lede previously served as a non-executive director of Elsevier Group plc and as a member of the Supervisory Board of Akzo Nobel N.V. and Stork B.V.

Norman R. Sorensen

Norman R. Sorensen serves on our board of directors as a non-executive director. Mr. Sorensen served as Chairman of Principal International from March 2011 to February 2012 and President, International Asset Management and Accumulation, of the Principal Financial Group from February 2010 to February 2012, and he currently serves as Chairman of the International Advisory Council, as a non-executive director of Encore Capital Group of the US, and as chairman of the International Insurance Society. He also served as Executive Vice President of Principal Financial Group, Inc. and Executive Vice President of Principal Life Insurance Company from 2007 to 2012 and as President and Chief Executive Officer of Principal International, Inc. from 2001 to 2011. Mr. Sorensen has also held the following management positions: Principal Financial Group, Inc. (Senior Vice President), Principal Life Insurance Company (Senior Vice President) and American International Group, Inc. (senior executive). He has served on the board of directors of Sara Lee since 2007 from which he resigned upon consummation of the separation.

Sandra E. Taylor

Sandra E. Taylor serves on our board of directors as a non-executive director. Mrs. Taylor is President and Chief Executive Officer of Sustainable Business International LLC, a consulting firm specializing in social responsibility for global business, which she founded in February 2008. From 2003 to January 2008, Mrs. Taylor served as Senior Vice President, Corporate Social Responsibility of Starbucks Corporation. Mrs. Taylor has also held management positions with Eastman Kodak Company (Vice President, International Public Affairs), ICI Americas (Vice President, Public Affairs and Director, Government Relations), and the European Community Chamber of Commerce, US (Executive Director). From 2006 to 2011, Mrs. Taylor served on the board of directors and the Governance Committee and Compensation Committee of Capella Education Company, Inc.

Senior management

Michel M.G. Cup

Michel M.G. Cup joined Sara Lee as Chief Financial Officer of the Coffee and Tea (formerly International Beverage) segment on December 1, 2011. He continues as the Chief Financial Officer of the Company and as a member of our executive committee. Mr. Cup joined Sara Lee from Dutch-based Provimi, where he was Chief Financial Officer and a board member of the Company. Previously, he was Finance Director of Decorative Paint Continental Europe for AkzoNobel NV. Prior to AkzoNobel, he held multiple finance managerial positions, including as Regional Vice President of Finance—Asia/Pacific, with Royal Numico N.V. He began his business career with Deloitte Accountants in the Netherlands.

Harm-Jan van Pelt

Harm-Jan van Pelt joined Sara Lee in 1998, beginning as Marketing Director for Douwe Egberts Netherlands and working up to his current position as our Chief Operating Officer—Retail—Rest of World.

 

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Mr. Van Pelt served as a member of the executive committee of Sara Lee’s Coffee and Tea (formerly International Beverage) segment. Mr. Van Pelt joined Sara Lee from Henkel KGaA, where he held various marketing and sales positions in Germany and Benelux.

Nick J. Snow

Nick J. Snow serves as Chief Operating Officer—Out of Home and as a member of the executive committee. Mr. Snow joined Sara Lee as Senior Vice President of its International Foodservice Segment effective January 2006. Mr. Snow joined Sara Lee from JohnsonDiversey, where he was commercial Managing Director. Previously, he was commercial Managing Director Australia/Asia for Unilever (Diversey/Lever). On September 11, 2012 Mr. Snow left D.E MASTER BLENDERS.

Eugenio Minvielle

Eugenio Minvielle currently serves as Chief Operating Officer—Retail—Western Europe and as a member of the executive committee, both positions he also held at Sara Lee’s Coffee and Tea (formerly International Beverage) segment. Mr. Minvielle joined Sara Lee on June 5, 2012 from Unilever where he served, beginning in April 2010, as Chief Executive Officer—North America, overseeing Unilever’s operations in the USA, Canada and the Caribbean. Previously, he was President and Chief Executive Officer of Nestlé France, Mexico and Venezuela. Prior to Nestlé, Mr. Minvielle held a variety of management positions and worked for Procter & Gamble in Spain and Canon in Japan.

During the last five years, none of the members of our board of directors and/or our senior management (1) have been convicted of fraudulent offenses, (2) have served as a director or officer of any entity subject to bankruptcy proceedings, receivership or liquidation or (3) have been subject to any official public incrimination and/or sanctions by statutory or regulatory authorities (including designated professional bodies), or disqualification by a court from acting as a member of the administrative, management or supervisory body of an issuer or from acting in the management or conduct of the affairs of any issuer.

Board Powers and Function

Under Dutch law, the board of directors is collectively responsible for the general affairs of the company. Pursuant to our Articles, our board of directors may divide its duties among the directors, with the day-to-day management of the Company entrusted to the executive directors. The non-executive directors have the task of supervising the executive directors and providing them with advice. In addition, both executive and non-executive directors must perform such duties as are assigned to them pursuant to our Articles. Each director has a duty towards the Company to properly perform the duties assigned to him or her. Furthermore, each director has a duty to act in the corporate interest of the Company. Under Dutch law, the corporate interest extends to the interests of all corporate stakeholders, such as shareholders, creditors, employees and other stakeholders. The duty to act in the corporate interest also applies in the event of a proposed sale or break-up of D.E MASTER BLENDERS, whereby the circumstances generally dictate how such duty is to be applied.

Mr. Van Lede, one of the non-executive directors, was appointed as Vice Chairman of the board of directors.

Mr. Sorensen, one of the non-executive directors, was appointed as Senior Independent Director. The duties of the Senior Independent Director include acting as the contact for our shareholders with concerns that have not been resolved or are not appropriate to be resolved through the normal channels of the Chairman, the Chief Executive Officer or the Chief Financial Officer and supervising the evaluation of the performance of the Chairman.

Pursuant to Dutch law, an executive director may not be allocated the tasks of (A) serving as chairman of the board, (B) fixing the remuneration of the directors or (C) nominating directors for appointment. Nor may an executive director participate in the adoption of resolutions (including any deliberations in respect of such

 

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resolutions) related to the remuneration of executive directors. Tasks that have not been specifically allocated fall within the power of the board as a whole. These principles are reflected in our Articles and board rules. All directors remain collectively responsible for proper management regardless of the allocation of tasks.

Board Meetings and Decisions

Pursuant to our board rules, in principle, the board of directors can only adopt resolutions if at least a majority of the directors are present. If possible, resolutions are adopted unanimously. If a unanimous vote is not possible, a resolution will be adopted by majority vote. In the event of a tie vote, the chairman will cast the deciding vote.

Pursuant to our board rules, resolutions can also be adopted without holding a meeting, provided that such resolutions are adopted in writing and all voting directors are in favor of the proposal concerned.

In accordance with Dutch law, our Articles stipulate that the general meeting of shareholders has the right to approve resolutions of the board of directors with regard to a significant change in our identity or business. This includes: (A) the transfer of all or substantially all of our business to a third party; (B) the entry into or termination of a long-term cooperation with another legal entity, company or partnership by us or any of our subsidiaries, or as a fully-liable partner in a limited or general partnership, if such cooperation or termination is of material importance to us; or (C) the acquisition or disposal by us or one of our subsidiaries of a participating interest in the capital of a company with a value greater than or equal to one-third of our assets as shown on the balance sheet included in our most recently adopted annual accounts.

Appointment of directors

Pursuant to our Articles, directors will be appointed at our general meeting of shareholders upon a binding nomination by the board of directors. A resolution to appoint a director nominated by the board of directors may be adopted by a simple majority of votes cast. Under our Articles, the board of directors must make a list of candidates for each vacancy consisting of at least the number of persons for each vacancy to be filled as prescribed by law (currently two). Pursuant to newly adopted Dutch legislation will enter into effect on January 1, 2013, the requirement that a binding nomination for the appointment of a member of the management board or supervisory board of an N.V. or a B.V. consist of at least two persons for each vacancy will be abolished. Our Articles stipulate that the general meeting of shareholders may at all times overrule the binding nature of such a nomination by a resolution adopted by a simple majority of the votes cast, provided that the majority represents more than one-third of our issued share capital. The board of directors may then make a new binding nomination, for at least the number of persons required by law, which will be subject to the procedure described above. If a nomination has not been made or has not been made in time, this must be stated in the notice and the general meeting of shareholders will be free to appoint a director at its discretion. The latter resolution of the general meeting of shareholders must also be adopted by at least a simple majority of the votes cast, provided that the majority represents more than one-third of our issued share capital. Additionally, our board of directors has the power to make non-binding nominations for directors. Resolutions to appoint a director by a non-binding nomination of the board are adopted by a simple majority.

Pursuant to newly adopted Dutch legislation will enter into effect on January 1, 2013, the general meeting of shareholders will also decide whether a director is appointed as an executive or as a non-executive director. This provision has already been implemented in our Articles. In addition, the legal relationship between a director and the company will not be considered an employment agreement. In the absence of an employment agreement with us, the director will not have certain employee rights under Dutch labor law.

Director Terms

Pursuant to our Articles, the members of our board of directors will serve for a term of one year from appointment, except that the initial term of our first directors will end on the day of our annual general meeting in 2014. The term of office for each director will end when his or her successor is elected and qualified, unless the

 

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number of directors has been reduced so there is no vacancy on the board of directors, or until his or her earlier death, resignation or removal. A director is not available for reappointment if he has been in office for ten years.

Removal of Directors

In accordance with Dutch law, our Articles stipulate that our general meeting of shareholders has the authority to suspend or remove members of the board of directors at any time, with or without cause, by means of a resolution for suspension or removal passed by a simple majority of the votes cast, with such votes cast representing at least one-third of our issued share capital. Currently, Dutch law does not allow executive directors to be suspended by the board of directors. Newly adopted Dutch legislation taking effect on January 1, 2013 will allow for executive directors to be suspended by the board of directors. Pursuant to our Articles, our executive director can be suspended by the board of directors if permitted by Dutch law.

Director Qualifications

The board of directors seeks to ensure that the board is composed of members whose particular experience, qualifications, attributes and skills, when taken together, will allow the board to satisfy its oversight responsibilities effectively. More specifically, in identifying candidates for membership of the board, the nomination committee takes into account (1) threshold individual qualifications, such as strength of character, mature judgment and industry knowledge or experience and (2) all other factors it considers appropriate, including alignment with our shareholders. In addition, the board will maintain a formal diversity policy governing the nomination of its members, as described below.

Under Dutch law and our Articles, executive directors may not serve as the chairman of the board. In addition, pursuant to newly adopted Dutch legislation will enter into effect on January 1, 2013, restrictions will apply as to the overall number of board positions that an executive director may hold. Under the new legislation, a person may not be a member of the board if (A) he or she holds more than two supervisory positions with “large companies” as defined under Dutch law, or (B) if he or she acts as chairman of the supervisory board or, in the case of a one-tier board, serves as chairman of the board of a “large company” as defined under Dutch law. The term “supervisory position” refers to the position of supervisory director, non-executive director or member of a supervisory body established by the articles of association. Under Dutch law, a “large company” is a company that meets two of the following criteria, based on its consolidated annual accounts during two subsequent years: (1) the value of the company’s assets according to its balance sheet is, on the basis of the purchase price or manufacturing costs, more than €17.5 million; (2) the net turnover is more than €35.0 million; and (3) the average number of employees is 250 or more.

Diversity Policy

We recognize the importance of a diverse composition of our board. The appointment of Mrs. Géraldine Picaud and Mr. Rob Zwartendijk as non-executive members of the board is an agenda item for the general meeting in November 2012. After appointment of Mrs. Picaud and Mr. Zwartendijk, the board will consist of nine members, of which three are women and thus 33.33% of the seats on our board will be held by women. Consequently, D.E MASTER BLENDERS will be fully compliant with the rules described below.

Newly adopted Dutch legislation will enter into effect on January 1, 2013 which will require us to pursue a policy of having at least 30% of the seats on our board of directors be held by men and at least 30% of the seats on the board of directors be held by women. We will be required to take this allocation of seats into account in connection with the following actions: (1) the appointment, or nomination for the appointment, of executive and non-executive directors; (2) drafting the criteria for the size and composition of the board, as well as the designation, the appointment, the recommendation and the nomination for appointment of non-executive directors; and (3) drafting the criteria for the non-executive directors. Pursuant to the new legislation, should we not comply with the gender diversity rules, we need to explain in our annual report (1) why the seats are not

 

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allocated in a well-balanced manner, (2) how we have attempted to achieve a well-balanced allocation and (3) how we aim to achieve a well-balanced allocation in the future. This rule will cease to have effect on January 1, 2016.

Our board regulations include a policy that the board shall aim, to the extent practicable and appropriate under the circumstances, for a diverse composition of directors in line with the global nature and identity of the Company and its business, in terms of such factors as nationality, background, gender and age.

We also expect to include a diversity policy in the charter for our nomination committee requiring the committee to consider age, gender, nationality, ethnic and racial background in nominating directors. The committee will also be required to review and make recommendations it deems appropriate regarding the composition and size of the board of directors to ensure that the board has the requisite expertise and that its membership consists of persons with sufficiently diverse and independent backgrounds.

The implementation of these diversity policies will rest primarily with the nomination committee as the body responsible for identifying individuals believed to be qualified as candidates to serve on the board of directors and recommending that the board nominate the candidates for all directorships to be filled by shareholders at their general meetings.

As board seats become available, the nomination committee, and the board of directors as a whole, will have the opportunity to assess the effectiveness of the diversity policy and how, if at all, our implementation of the policy or the policy itself, should be changed.

Directors’ Insurance and Indemnification

In order to attract and retain qualified and talented persons to serve as members of our board of directors or our senior management, we currently do and expect to continue to provide such persons with protection through a directors’ and officers’ insurance policy. Under this policy, any of our past, present or future directors and members of our senior management will be insured against any claim made against any one of them for any wrongful act in their respective capacities.

Unless specifically prohibited by law in a particular circumstance, our Articles require us to reimburse the members of our board of directors for damages and various costs and expenses related to claims brought against them in connection with the exercise of their duties. However, there will be no entitlement to reimbursement if and to the extent that (1) a Dutch court has established in a final and conclusive decision that the act or the failure to act of the person concerned may be characterized as willful (opzettelijk), intentionally reckless (bewust roekeloos) or seriously culpable (ernstig verwijtbaar) conduct, unless Dutch law provides otherwise or this would, in view of the circumstances of the case, be unacceptable according to the standards of reasonableness and fairness, or (2) the costs or financial loss of the person concerned are covered by insurance and the insurer has paid out the costs or financial loss.

Executive Committee

Our executive committee was appointed by our Chief Executive Officer and consists of our executive director and senior management, as well as our General Counsel, Chief Marketing Officer, Senior Vice President—Supply Chain Operations and our Senior Vice President—Human Resources.

Powers and function

Our executive committee is entrusted with our day-to-day management. The responsibilities of the executive committee include driving our management agenda, managing the performance of our group, assessing and managing risks connected with our business activities, realization of our operational and financial objectives, structure and management of our systems of internal controls, maintaining and preparing the financial reporting process, compliance with applicable laws and regulations, compliance with and maintaining the corporate

 

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governance structure of the Company, publication of any information required by applicable laws and regulations, considering the corporate social responsibility issues that are relevant to the Company, and rendering advice in connection with the nomination of the external accountant of the Company.

The following subjects remain the responsibility of the board of directors, and consequently, resolutions in respect of such subjects require the approval of the non-executive directors: (1) general policy and strategy; (2) preparation of the annual accounts, the annual budget and significant capital expenditures; (3) issuance of shares in the Company as well as granting rights to subscribe for shares, to limit or exclude pre-emptive rights with respect to an issue of shares, to acquire shares by the Company in its own share capital, as well as to dispose of such shares (if and to the extent that the board of directors has been designated by our general meeting of shareholders as authorized to resolve upon the issue of shares and to limit or exclude pre-emptive rights); (4) issuance of bonds or other debt instruments as well as authorization to enter into medium- and long-term indebtedness; (5) application for quotation or withdrawal of the quotation of the securities in the price list of any stock exchange; (6) transfer of all or substantially all of the enterprise to a third party; (7) the conclusion or cancellation of any long-lasting cooperation by the Company or a subsidiary with any other legal person or Company or as a fully-liable general partner of a limited partnership or a general partnership, if such cooperation or the cancellation thereof is of essential importance to the Company; (8) acquisition or disposal of a participating interest in the capital of a Company with a value of at least one third of the sum of the assets according to the consolidated balance sheet with explanatory notes thereto according to the last adopted annual accounts of the Company, by the Company or a subsidiary; (9) filing a request for bankruptcy (faillissement) or a request for suspension of payment of debts (surséance van betaling); and (10) extending guarantees or indemnities to third parties other than those relating to the obligations of subsidiaries of the Company.

Our board of directors also retains the authority to adopt resolutions within the scope of authority of the executive committee without the participation of the members of the executive committee who are not also members of the board of directors.

Meetings and Decisions

The executive committee can only adopt resolutions in a meeting of the executive committee where at least one third of our executive directors is present or represented. Resolutions of the executive committee require a majority vote comprised of the votes of the majority of the executive directors present or represented, including the vote of our Chief Executive Officer. If there is a tie, the Chief Executive Officer shall have the deciding vote. Currently, the Chief Executive Officer is our sole executive director.

Appointment and removal of members of our executive committee

The members of our executive committee (with the exception of our Chief Executive Officer) are appointed, suspended and dismissed by the Chief Executive Officer, subject to the approval by the nomination committee. The nomination committee is also required to appoint one of the members of our executive committee as the Chief Financial Officer. The members of our executive committee can also be suspended by the board of directors.

Board Committees

While retaining overall responsibilities, our board of directors assigned certain of its responsibilities to permanent committees consisting of directors, and—in relation to the sustainability committee—senior management, appointed by our Chief Executive Officer. Our board of directors has established an audit committee, a remuneration committee, a nomination committee and a sustainability committee, each of which has the responsibilities and composition described below.

Audit committee

Our audit committee consists of three non-executive, independent members of the board of directors appointed by the board. They are Mr. Van Lede, Mrs. Corrales and one vacancy. After appointment of

 

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Mrs. Picaud and Mr. Zwartendijk as non-executive directors by the general meeting of shareholders they will be appointed as members of the audit committee. Upon their appointment, Mrs. Corrales will step down as a member of the audit committee and there will no longer be a vacancy.

Our audit committee supervises and monitors our financial reporting, risk management program and compliance with relevant legislation and regulations. It oversees the preparation of our financial statements, our financial reporting process, our system of internal business controls and risk management, our internal and external audit process and our internal and external auditor’s qualifications, independence and performance. Our audit committee also reviews our annual and interim financial statements and other public disclosures, prior to publication. Our audit committee appoints our external auditors, subject to shareholder vote, and oversee the work of the external and internal audit functions, providing compliance oversight, preapproval of all audit engagement fees and terms, preapproval of audit and permitted non-audit services to be provided by the external auditor, establishing internal auditing policies, discussing the results of the annual audit, critical accounting policies, significant financial reporting issues and judgments made in connection with the preparation of the financial statements and related matters with the external auditor and reviewing earnings press releases and financial information provided to analysts and ratings agencies.

Remuneration committee

Our remuneration committee consists of three non-executive, independent members of the board of directors appointed by the board. They are Mr. Sorensen, Mrs. Corrales and Mrs. Taylor.

Our remuneration committee is responsible for setting, reviewing and evaluating the remuneration, and related performance and objectives, of our executive officers. It is also responsible for recommending to the board of directors the remuneration package for our Chief Executive Officer, with due observance of the remuneration policy adopted by the general meeting of shareholders. It reviews management services contracts entered into with our Chief Executive Officer and employment agreements with members of our executive committee, make recommendations to our board of directors with respect to major employment-related policies and oversee compliance with our employment and compensation-related disclosure obligations under applicable laws.

Nomination committee

Our nomination committee consists of three non-executive, independent members of the board of directors appointed by the board. They are Messrs. Bennink, Van Lede and Sorensen.

Our nomination committee determines selection criteria for members of our board of directors, periodically assess the scope and composition of our board of directors and evaluate the performance of our directors. Furthermore, the nomination committee is responsible for approving the appointment, suspension and dismissal of our executive officers by the Chief Executive Officer and is required to appoint one of the executive officers as the Chief Financial Officer.

Sustainability committee

Our sustainability committee consists of our Chief Executive Officer, General Counsel and two non-executive directors, independent members of the board of directors, Mr. Illy and Mrs. Taylor.

Our sustainability committee evaluates our policies with respect to health, safety, security, environment and social responsibility and supervises our policies with respect to health, safety, security, environment and social responsibility.

Conflict-of-Interest Transactions

Our Articles provide that a director may not participate in any vote on a subject or transaction if he or she has a conflict of interest under Dutch law with us or any of our subsidiaries. Our Articles provide that in the

 

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event that we have a conflict of interest with one or more directors, the Company may still be represented by our board of directors. However, under Dutch law, our general meeting of shareholders may resolve at any time to designate one or more other persons to represent us in the event of a conflict of interest. The rules governing the board’s principles and best practices contain a similar rule related to executive officers.

Newly adopted Dutch legislation on conflicts of interests taking effect on January 1, 2013 no longer contains restrictions on the powers of directors to represent the Company in case of a conflict, but provides that a member of the board of directors may not participate in the adoption of resolutions (including deliberations in respect of these) if he or she has a direct or indirect personal conflict of interest with us and our related enterprise. If all members of the board of directors have a conflict of interest, the resolution concerned will be adopted by the general meeting of shareholders, unless the articles of association provide otherwise. If an executive director or a non-executive director does not comply with the provisions on conflicts of interest, the resolution concerned is subject to nullification (vernietigbaar) and the director concerned may be held liable towards us.

Except for the duties of members of our board of directors to other entities with which they are affiliated and which are described in their biographies, and in particular the duties of Mr. Illy to illycaffè SpA and Gruppo Illy SpA, which could be considered our competitors, we are not aware of any potential conflicts between any duties of members of our board of directors and/or our senior management to the Company and their private interests and/or other duties. In his agreement for services, Mr. Illy confirmed that he will report any conflict of interest as from the date of his appointment to our chairman, with a copy to the corporate secretary. In addition, Mr. Illy will not (i) be involved in or informed of any discussions on possible expansions into Italy and (ii) share any strategic or commercial information on the Illy Group with us and (iii) share any of D.E MASTER BLENDERS’ confidential information with employees of Illy Group.

Remuneration

Under Dutch law, the general meeting of shareholders must adopt a remuneration policy for the board of directors that addresses the following topics: the fixed and variable components of the remuneration (if any), remuneration in the form of shares and severance payments. On June 28, 2012 our remuneration committee adopted the remuneration policy for our Chief Executive Officer (being the sole executive director) as developed and approved by the Compensation and Employee Benefits Committee of Sara Lee. The remuneration of our executive directors is determined by our board of directors observing the provisions of our remuneration policy. Executive directors do not vote upon or participate in the discussions of our board of directors on their own remuneration. The remuneration of non-executive directors is approved by our general meeting of shareholders. Any proposed share or option-based compensation for directors (including the basis for determining any performance conditions relating to such compensation) must be submitted by our board of directors to the general meeting of shareholders for its approval, detailing the number of shares or options over shares that may be awarded to the directors and the criteria that apply to such award or modification thereof.

Executive director

The table below sets forth the annualized remuneration of our executive director, Mr. Herkemij, for fiscal year 2012 in gross euro amounts. The terms and conditions of certain of the payments and benefits set forth in the table and accompanying footnotes below are described in greater detail in the summary of Mr. Herkemij’s management services agreement that follows the table.

 

Name

   Fixed Fee      Variable
Compensation
at 100%1
     PSUs grant
value2
     Pension or
similar
benefits
     Hiring
payment3
     Phantom
RSU
grant4
     Other5  

Michiel J. Herkemij

   900,000       900,000      1,500,000       176,004       600,000       500,000       118,745   

 

1. The information in this document is the information available as per June 30, 2012. After June 30, 2012 the actual bonus pay-out over fiscal year 2012 was determined to be 98.42% of the target bonus of €900,000, where the maximum payout was set at 150%, pro-rated from December 1, 2011 up to June 30, 2012.

 

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2. This grant of performance share units, which we refer to as PSUs, was made in two instalments. One-third of the value of the PSU grant, or €500,000, was made by Sara Lee on January 26, 2012. The percentage of this first PSU instalment to vest, which has a maximum pay-out of 150% of the granted number of PSUs, is based on Sara Lee’s actual operating income for fiscal year 2012 and was determined at 80.06% after June 30, 2012. The remaining two-third was approved by the Compensation and Employee Benefits Committee of Sara Lee and was granted after June 30, 2012. The maximum vesting percentage of the second PSU instalment of the award is 200%. Both instalments of the PSU grant for fiscal year 2012 will vest in full in August 2014 if, and to the extent, predetermined performance goals, as described under the 2012 Long-Term Incentive Share Plan and as applicable for the second instalment, are achieved.

 

3. This amount was negotiated and agreed upon by Sara Lee and paid to Mr. Herkemij in connection with his initial hiring before the incorporation of D.E MASTER BLENDERS.

 

4. This grant of RSUs was denominated in Sara Lee common stock and was converted to D.E MASTER BLENDERS ordinary shares following the merger. This grant was a one-time grant negotiated by Sara Lee made to Mr. Herkemij in connection with his initial hiring.

 

5. The category ‘other’ includes annual fringe benefits (including employer taxes) related to health insurance (€3,073), disability insurance (€29,010), a company car scheme (€39,600), unemployment insurance (€2,331), a representation allowance (€4,080), relocation costs (€22,569) and a relocation allowance (€18,082).

Over fiscal year 2012 no costs were incurred by D.E MASTER BLENDERS on a stand-alone basis. The annualized remuneration paid to our executive director in fiscal year 2012 is also mentioned in our remuneration report that will be published on our website.

Management Services Agreement with Michiel J. Herkemij

Mr. Herkemij entered into a management services agreement with Sara Lee pursuant to which Mr. Herkemij served as Executive Vice President of Sara Lee and Chief Executive Officer of Sara Lee’s Coffee and Tea (formerly International Beverage) segment, and pursuant to which Mr. Herkemij now serves as the Chief Executive Officer of D.E MASTER BLENDERS as a result of the assumption of his management services agreement; therefore, references to the “Company” in this summary of Mr. Herkemij’s management services agreement generally refer to Sara Lee prior to the separation and to D.E MASTER BLENDERS following the separation. The term of the agreement commenced December 1, 2011, which we refer to as the Agreement Commencement Date and ends November 30, 2015, which we refer to as the Agreement End Date, unless earlier terminated by either party, generally upon six months written notice from the Company and three months written notice from Mr. Herkemij, provided that the Company and Mr. Herkemij agree to inform the other no later than six months prior to the Agreement End Date of their intention to continue the agreement for a definite or indefinite period beyond the Agreement End Date.

Certain terms of Mr. Herkemij’s agreement are set forth in the chart above. Under the agreement, if Mr. Herkemij voluntarily resigns from his employment or if he is terminated for cause, in either case prior to the first anniversary of Agreement Commencement Date, he will be required to repay either the net equivalent of the hiring payment or, in the event that the Company cannot recoup certain withholding taxes but Mr. Herkemij could recoup such taxes, the gross amount of the hiring payment.

As set forth in the chart above, for the Company’s fiscal year 2012, Mr. Herkemij is eligible to participate in the Annual Incentive Plan for Fiscal Year 2012, which we refer to as the AIP, pro-rated for the portion of the year Mr. Herkemij is employed by Sara Lee, with a target of 100% of base fee and a maximum of 150% of base fee, based on the operating income, net sales and working capital of the International Beverage business. Any short-term incentive plans applicable to Mr. Herkemij are determined by the board of directors of the Company. Furthermore, during each year of his employment until the Agreement End Date, Mr. Herkemij will be entitled annually to a long-term incentive award with a gross value of €1.5 million. Each long-term incentive award will

 

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be linked to a three-year period and will vest upon the expiration of the three-year period. The grant for the first performance period (fiscal years 2012-2014) is detailed in the chart above. If Mr. Herkemij’s employment is terminated by reason other than urgent cause prior to the Agreement End Date, Mr. Herkemij will be entitled to immediate vesting of his unvested PSUs on a pro rata basis.

If, following a “change in control” (as defined in the addendum to the management services agreement), Mr. Herkemij terminates his management services agreement within three months, or if the Company gives notice of termination of the management services agreement, provided that such notice is not solely or principally due to the acts or omissions of Mr. Herkemij, Mr. Herkemij will be eligible for a severance payment consisting of two-and-a-half (2.5) times the base, bonus and pension compensation (as defined in addendum to the management services agreement). This is in line with the provisions of the Sara Lee Change in Control Plan applicable to Mr. Herkemij when he joined Sara Lee.

Upon expiration of the term of the management services agreement, Mr. Herkemij will be entitled to payment of his base fee for 18 months. If, prior to the expiration of the management services agreement, the Company terminates Mr. Herkemij’s management services agreement other than for urgent cause or Mr. Herkemij terminates the agreement as a result of an urgent cause on the part of the Company, Mr. Herkemij will be entitled to payment of his base fee for 12 months. However, if Mr. Herkemij terminates his management services agreement for any other reason, he is not entitled to any base fee payments.

In addition, for the first 12 months of any permanent and continuous disability of Mr. Herkemij and potentially for an additional six months of any such disability, the agreement will remain in effect and Mr. Herkemij will continue to be entitled to all of the benefits under the agreement. If any such disability continues for longer than 12 months (unless the period is extended by six months because Mr. Herkemij is expected to be able to return to performing his tasks without limitation within such six-month period), then the agreement will terminate and Mr. Herkemij will receive continued payment of his base fee for 12 months. Mr. Herkemij also will be entitled to insurance coverage to cover permanent loss of income in an amount equal to his base fee after the second year of permanent and continuous disability. In addition, if Mr. Herkemij dies while the agreement is still in effect, his spouse or dependent children will be entitled to continued payment of his base fee for the month of his death and for 12 months thereafter, as well as pro rata payments of Mr. Herkemij’s annual and long-term incentive awards and standard maximum payments under the voluntary life-risk insurance (Overlijdensrisicoverzekering), for which the premiums are paid by Mr. Herkemij.

Mr. Herkemij is subject to certain covenants restricting him from competing in the coffee and tea business, interfering with the business relationships of the Company and from inducing employees to terminate their employment with the Company, in each case during and for one year following the termination of his management services agreement.

Non-executive directors

D.E MASTER BLENDERS Remuneration

The non-executive directors who do not chair a committee of the board each receive an annual retainer of €90,000 for their services and non-executive directors who chair a committee receive €110,000 in each case plus a €3,500 travel allowance per meeting for directors who travel transcontinentally to attend the meeting. In each case, 25% of each non-executive director’s annual retainer (after taxes) is expected to be invested in shares of the Company. The chairman of the board receives an annual retainer of €300,000 for his services, 25% (after taxes) of which is expected to be invested in shares of the Company.

Over fiscal year 2012 no costs were incurred by D.E MASTER BLENDERS on a stand-alone basis. The annualised remuneration paid to our non-executive directors in fiscal year 2012, is also mentioned in our remuneration report that will be published on our website.

 

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Sara Lee Compensation

On February 27, 2012, the Corporate Governance, Nominating and Policy Committee of Sara Lee agreed to make a one-time grant of PSUs to the chairman in his role as Executive Chairman of Sara Lee, which grant was documented at the completion of the spin-off, in shares of the Company and has a target award value of €1.75 million as of the date of grant. This one-time grant was made to help ensure a seamless transition for the Company and successful implementation of the Company’s strategy as it moved from being a division of Sara Lee to being an independent, public company. The number of earned PSUs under the one-time award can vary from 0% to 200% and earned PSUs will vest on August 31, 2015. Although this one-time award grant was made by Sara Lee, the applicable terms are similar to the terms of the 2012 Long-Term Incentive Share Plan, described below.

Senior management

The annualized aggregate remuneration of our senior management for fiscal year 2012 is approximately €5,147,961 (including incentives and benefits), not including any remuneration of our Chief Executive Officer.

Pension, retirement or similar benefits

The annualized total amount set aside or accrued for fiscal year 2012 with respect to pension, retirement or similar benefits for our Chief Executive Officer and our other members of senior management is €417,868.

Pension Schemes

We sponsor a number of pension plans around the world to provide retirement benefits. We sponsor defined contribution plans and defined benefits plans. In addition to contributing to pension plans for our continuing operations, we have also agreed to retain certain pension liabilities after certain business dispositions were completed. The exact amount of cash contributions made to pension plans in any year in any country 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 foreign plans.

Expected contributions to post-employment benefit plans for fiscal year 2013 are approximately €82.1 million for pension benefits. This amount includes approximately €33.4 million related to required additional funding of the Dutch pension plan and normal annual contributions. In addition, we have expected contributions of €1.2 million and €0.2 million for the post-employment medical plan and jubilee plan, respectively.

Pension plans in the Netherlands

We currently maintain one pension fund (ondernemingspensioenfonds) in the Netherlands the Stichting Douwe Egberts Pensioenfonds, formerly named Stichting Sara Lee Pensioenfonds Nederland, with plan assets as of July 1, 2012 of approximately €1.4 billion, which we refer to as the Plan. This Plan covers approximately 70% of our employees in the Netherlands. The Plan provides defined benefits based on an average pay system (middelloonregeling) capped at an annual salary of €70,000 per participant and provides defined contributions above such amount. As of June 30, 2012, the Plan had a total of approximately 1,507 active participants, 4,111 deferred pensioners and 3,917 pensioners. As of July 1, 2012, the defined benefit obligations for the active participants amounted to approximately €318 million, the defined benefit obligations for the deferred pensioners amounted to approximately €427 million and the defined benefit obligations for the pensioners amounted to approximately €563 million.

A recovery plan is required by the Dutch Central Bank if a plan’s funded status is below its required solvency level of approximately 114% under local funding rules. The recovery plan has a maximum duration of 15 years and will end when the coverage ratio of a pension plan is in excess of this required solvency level for 3

 

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consecutive quarters. The recovery plan has a short term component if a plan’s funded status is below the minimum required solvency level of approximately 104% under local funding rules. This is currently the case for the Plan. Under the short term part of the recovery plan, additional contributions by the Company equal to the lesser of one third of the deficit or the amount of one year’s regular premium contribution are required. In this context, we made an additional contribution of €25.7 million in fiscal 2012 under the current recovery plan. The end date of the short term part of the existing recovery plan is December 31, 2013.

In 2011, Sara Lee concluded an amended agreement with the Plan pursuant to which the annual contributions to the Plan until 2016 will be based on 26% of each participant’s pensionable salary, which is capped at €70,000 annually per participant. For pensionable salaries in excess of €70,000, a defined contribution plan with age-dependent rates is applicable. As part of this amended agreement, the Company’s contributions are subject to an overall cap of €75 million per new recovery plan entered into after January 1, 2012.

We also sponsor a defined contribution plan at Delta Lloyd N.V. for certain employees working in foodservices and we participate in an industry-wide pension fund that provides defined contributions for certain employees employed by us after the acquisition of CoffeeCompany.

Pension plans in the United Kingdom

We sponsor a defined benefit plan in the United Kingdom. The plan consists of five separate benefit sections, each with plan assets that are ring-fenced to fund each section. During 2006, Sara Lee entered into an agreement with the plan trustee that is aimed at fully funding according to the 2005 rules of the Pension Protection Fund (PFF) two of these sections by March 2016. Under the terms of this agreement, Sara Lee has agreed to make annual pension contributions of 32 million British pounds to these plan sections through March 2016. Subsequent to March 2016, Sara Lee has agreed to keep these sections fully funded in accordance with local funding standards.

In addition, in 2011 Sara Lee entered into an agreement with the plan trustee to buy-out a section of the plan by calendar year 2024. The terms of the agreement require Sara Lee to make annual contributions of 1.6 million British pounds, certain additional contributions in calendar 2014 and 2019, and a final contribution as necessary to effect a buy-out of the section’s liability in 2024.

The other two sections of the plan are funded in accordance with local funding rules.

As of July 1, 2012, the total assets of the United Kingdom plan were 1,045 million British pounds. The plan had a total of 60 active participants, 7,247 deferred pensioners and 8,873 pensioners. As of July 1, 2012, the accumulated benefit obligations were 6 million British pounds for active participants, 402 million British pounds for deferred pensioners and 545 million British pounds for pensioners.

2012 Long-Term Incentive Share Plan

We adopted the 2012 Long-Term Incentive Share Plan. Our Chief Executive Officer, the members of our executive committee, highly compensated executives and, potentially, other key employees designated by the remuneration committee are eligible to participate in the 2012 Long-Term Incentive Share Plan. A performance share unit, which we refer to as a PSU, awarded under the 2012 Long-Term Incentive Share Plan is the participant’s right to receive a number of shares for no consideration subject to (1) the participant’s continued service with the Company or its affiliates and (2) a predetermined performance condition based on our relative total shareholder return, which we refer to as “TSR” (as defined in the 2012 Long-Term Incentive Share Plan).

Under the 2012 Long-Term Incentive Share Plan, PSUs will be earned only if the Company achieves certain specified levels of TSR relative to a comparator group generally over a three-year period commencing on the date of the award. Reflecting the transitional nature of the fiscal year 2012 award, the performance period will end on August 31, 2014. For PSU grants by D.E MASTER BLENDERS to our executive director an additional

 

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retention period applies until at least five years after the award date or, if earlier, until termination of their employment. The companies in the comparator group are set forth below.

 

Anheuser-Busch Inbev N.V.

   Chocoladefabriken Lindt & Sprungli AG

Heineken N.V.

   Nestlé S.A.

SABMiller plc

   Unilever plc

Diageo plc

   Henkel AG & Co. KGaA

Pernod-Ricard S.A.

   Procter & Gamble

Rémy Cointreau

   Reckitt Benckiser plc

Associated British Foods plc

   Beiersdorf AG

Groupe Danone S.A.

   L’Oreal S.A.

H.J. Heinz Company

   The Coca Cola Company

Kellogg Company

   PepsiCo Inc.

Depending on the ranking of the Company’s TSR against the TSR of the members of the comparator group, the number of earned PSUs can vary from 0% up to 200% of the number of PSUs granted. The TSR chart sets forth how the number of earned PSUs will be calculated based on the Company’s TSR against the TSRs of member companies in the comparator group. For any PSUs to be earned, the performance condition of the Company’s relative TSR over the performance period must be at least at the median of the TSRs of the members of the comparator group.

 

Rank of the Company’s TSR against the

TSR of the members of the Comparator

Group

  

Number of Earned PSUs expressed as a percentage of
the number of Awarded PSUs

Top 10% or above    200%
Between top 35% and top 10%    On a straight-line basis between 100% and 200% based on rankings plus interpolation between intermediate rankings
At top 35%    100%
Between median and top 35%    On a straight-line basis between 50% and 100% based on rankings plus interpolation between intermediate rankings
At median    50%
Below median    0%

In the event that a participant ceases active employment with the Company or an affiliate before the vesting date as specified in respect of any award in the relevant grant notice, some or all of the participant’s PSUs may be forfeited and the participant’s award(s) may or may not be settled (in shares or cash) as of the date of termination of employment, depending upon the reason for termination of employment.

Our board of directors may amend the 2012 Long-Term Incentive Share Plan at any time as it deems necessary and appropriate. If and to the extent that such amendment adversely affects the rights of any participants with awards outstanding at the time of such amendment, the amendment must be approved by at least 75% of the relevant participants. This does not limit or preclude in any way the right of the remuneration committee to amend the performance conditions if an event has occurred which causes the remuneration committee, acting fairly and reasonably, to consider that it would be appropriate to amend the performance conditions. In making any such amendment, the remuneration committee is required to use reasonable efforts to ensure that the amendment does not have a material adverse effect on the awards outstanding at the time of such amendment.

 

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The Compensation and Employee Benefits Committee of Sara Lee approved, and the remuneration committee of our board of directors has approved on June 28, 2012, an initial grant of PSUs under the 2012 Long-Term Incentive Share Plan to members of our senior management, which grants have the following values as of the date of grant: Messrs. Herkemij (€1.0 million), Cup (€500,000), Van Pelt (€333,334) and Snow (€280,667). These initial grants were made shortly after completion of the separation.

Annual Incentive Plan

Our executive director, the members of our executive committee and other key employees are eligible for annual bonuses under the AIP. Participants’ awards under the AIP are expressed as a percentage of their base salary and are based on the achievement of target performance measures. The performance measures under the AIP are based on the Company’s financial and operational targets that are measured over a one-year performance period.

The breakdown of performance measures under the AIP for fiscal year 2012 were:

 

   

Operating Income—40% of target bonus opportunity;

 

   

Net Sales—40% of target bonus opportunity;

 

   

Average Working Capital—20% of target bonus opportunity.

Specific financial goals within each of the performance measures were set by the Compensation and Employee Benefits Committee of Sara Lee prior to the separation. For fiscal year 2012, the maximum payout opportunity was 150% of a participant’s target bonus opportunity and threshold payout opportunity is 25% of target bonus opportunity. Payout percentages for performance between these performance levels is determined on a straight-line basis. The information in this document is the information available as per June 30, 2012. After June 30, 2012 the actual bonus pay-out over FY12 results was determined to be 98.42% of the target bonus.

Dutch Corporate Governance Code

The Dutch Corporate Governance Code, as revised, became effective on January 1, 2009, and applies to all Dutch companies listed on a government-recognized stock exchange, whether in the Netherlands or elsewhere. The Dutch Corporate Governance Code is based on a “comply or explain” principle. Accordingly, companies are required to disclose in their annual reports filed in the Netherlands whether or not they are complying with the various rules of the Dutch corporate governance code that are addressed to the board of directors and if they do not apply those provisions, to give the reasons for such non-application. The Dutch Corporate Governance Code contains principles and best practice provisions for the board of directors (executives and non-executives), shareholders and general meetings of shareholders, financial reporting, auditors, disclosure, compliance and enforcement standards.

We acknowledge the importance of good corporate governance. We have reviewed the Dutch Corporate Governance Code and support the best practice provisions thereof. Therefore, except as noted below or in the case of any future deviation, subject to explanation at such time, we comply with the applicable best practice provisions of the Dutch Corporate Governance Code.

Best practice provision II.1.5 prescribes that the board of directors declares regarding the financial reporting risks in the annual report that the internal risk management and control systems provide a reasonable assurance that the financial reporting does not contain any errors of material importance and that the risk management and control systems worked properly in the year under review. In connection with the accounting irregularities and certain other errors in Brazil, the board of directors cannot give such statement unconditionally.

Best practice provision II.2.8 states that remuneration in the event of dismissal may not exceed one year’s salary (the “fixed” remuneration component). It is our policy to set the level of severance pay for our directors at no more than one year’s salary, unless the board of directors, at the proposal of the remuneration committee,

 

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finds this manifestly unreasonable given the circumstances or unless dictated otherwise by applicable law. Considering our Chief Executive Officer’s severance entitlements prior to his engagement with our Company, we agreed to grant him a severance payment of 18 months under certain circumstances, including if his management service agreement is terminated due to D.E MASTER BLENDERS not being a listed separate company by December 31, 2012, or upon expiration of the term of his management service agreement. In addition, our Chief Executive Officer will be entitled to 2.5 times his base, bonus and pension compensation if his management services agreement terminates for certain reasons following a change in control and following a regular notice period. This is laid down in the addendum to Mr. Herkemij’s management services agreement and in line with the provisions of the Sara Lee Change in Control Plan that applied to Mr. Herkemij prior to the separation. We consider it manifestly unreasonable to take these entitlements away from him. It has been agreed with our Chief Executive Officer that if his management services agreement is renewed after four years his entitlement to severance in the event of a change in control will be reduced to one year base salary.

The full text of the Dutch Corporate Governance Code can be found on https://www.commissiecorporategovernance.nl.

Employees

Our total headcount (measured on the basis of full-time equivalent (“fte”)) was 7,788 as of July 3, 2010, 7,508 as of July 2, 2011 and 7,619 as of June 30, 2012. As of June 30, 2012, we had 2,685 employees in sales and marketing, 3,850 in operations and support and 1,084 in general and administration, and 979 in the Retail—Western Europe segment, 2,547 in the Retail—Rest of World segment, 1,930 in the Out of Home segment and 2,163 in Other.

Works Council

Koninklijke Douwe Egberts B.V., one of D.E MASTER BLENDERS’ subsidiaries has a works council. In addition, we have a European works council. A works council is a body consisting of employee representatives who have been elected by the employees.

Under Dutch law, a works council has a right to render its advice or, in certain areas, approval on resolutions concerning important matters within the scope of its authority such as intended acquisitions or divestitures, seeking credit facilities or making capital investments. Failure by us to follow-up the advice opens the possibility for a works council to appeal to the Enterprise Chamber within one month of written notification of our decision. During this one month period we must suspend the implementation of the decision.

Shareholdings by directors and senior management

The following tables set forth information with respect to the ownership of D.E MASTER BLENDERS’ equity as of June 30, 2012 and as of October 10, 2012 for each of our directors and members of our senior management, and our directors and senior management collectively. See also “Item 4—Information on the Company—Treatment of Equity-Based Compensation at Separation”.

Beneficial ownership is determined in accordance with rules of the SEC and generally includes any shares over which a person exercises sole or shared voting and/or investment power. Ordinary shares subject to options and warrants currently exercisable or exercisable within 60 days or that vest in connection with the separation are deemed outstanding for computing the percentage ownership of the person holding the options but are not deemed outstanding for computing the percentage ownership of any other person. Except as otherwise indicated, we believe the beneficial owners of the ordinary shares listed below, based on information furnished by them, have sole voting and investment power with respect to the number of shares listed opposite their names. None of the directors or members of senior management that hold our ordinary shares has any different voting rights than the other holders of our ordinary shares.

 

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Board of directors as per June 30, 2012

 

Name Directors1

   Number of Shares
Owned
     Performance Stock
Units2 3
     Restricted
Stock  Units4
     Approximate
Percentage of
Class
 

Jan Bennink5

     235,650         0         0         *   

Michiel J. Herkemij

     0         0         0         *   

Maria Mercedes M. Corrales

     0         0         0         *   

Andrea Illy

     0         0         0         *   

Cornelis J.A. van Lede

     0         0         0         *   

Norman R. Sorensen

     20,562         0         0         *   

Sandra E. Taylor

     0         0         0         *   

 

* Less than 1% of the outstanding ordinary shares

 

1. The address of each of our directors is c/o D.E MASTER BLENDERS, Oosterdoksstraat 80, 1011 DK Amsterdam, the Netherlands.

 

2. On January 26, 2012, Sara Lee performance stock units (“PSUs”) were granted under Sara Lee’s Plans to Messrs. Bennink (136,933 Sara Lee PSUs) and Herkemij (35,204 Sara Lee PSUs). The number of PSUs was originally in Sara Lee stock and the PSUs have been converted into shares of D.E MASTER BLENDERS. The conversion ratio was based on the Sara Lee stock price on June 27 and 28, 2012 and the D.E MASTER BLENDERS stock price on June 29, 2012 and July 2, 2012. The number of Sara Lee PSUs that will vest can vary from 25% to 150%. Conversion took place after the end of fiscal 2012. The PSUs granted to Mr. Herkemij will vest on August 31, 2014 if, and to the extent, predetermined performance goals are met. Of the Sara Lee PSUs granted to Mr. Bennink, one-half vested upon completion of the separation (based on the agreed conversion ratio (see also “Item 4—Treatment of Equity-Based Compensation in Separation”) and was calculated after the end of fiscal 2012) and vesting was subject to achievement of predetermined performance goals. After June 30, 2012, it was determined that the performance goal was achieved for 80.06%. In addition, the Compensation and Employee Benefits Committee of Sara Lee approved, and our remuneration committee approved an initial fiscal year 2012 grant of PSUs under the 2012 Long-Term Incentive Share Plan to Mr. Herkemij (€1,000,000). The number of PSUs to vest pursuant to this initial grant can vary from 0% to 200% and PSUs will vest on August 31, 2014 if, and to the extent, predetermined performance goals, as described under 2012 Long-Term Incentive Share Plan, are achieved. Finally, the Corporate Governance, Nominating and Policy Committee of Sara Lee approved, and our remuneration committee approved a one-time grant of PSUs to Mr. Bennink (€1,750,000). The number of PSUs to vest pursuant to this one-time grant can vary from 0% to 200% and PSUs will vest on August 31, 2015. Although this one-time award grant was made by Sara Lee, the applicable terms are similar to the terms of the 2012 Long-Term Incentive Share Plan, described above.

 

3. After June 30, 2012, the remuneration committee granted Mr. Herkemij his annual PSU award (€1,500,000). The number of PSUs to vest pursuant to these grants can vary from 0% to 200% and will vest on August 31, 2015 if, and to the extent, predetermined performance goals, as described under 2012 Long-Term Incentive Share Plan, are achieved.

 

4.

Under Sara Lee’s 1998 Long-Term Incentive Stock Plan, the 2002 Long-Term Incentive Stock Plan and the Employee Matters Agreement 2012 restricted stock units (“RSUs”) were granted to Messrs. Bennink (136,933 RSUs) and Herkemij (35,204 RSUs). The number of RSUs is in Sara Lee stock and the RSUs has been converted in shares of D.E MASTER BLENDERS. The conversion ratio was based on the Sara Lee stock price on June 27 and 28, 2012 and the D.E MASTER BLENDERS stock price on June 29, 2012 and July 2, 2012. Conversion took place after the end of fiscal 2012. All of the RSUs granted to Mr. Herkemij and one-half of the RSUs granted to Mr. Bennink, vested upon completion of the separation. See also “Item 4—Treatment of Equity-Based Compensation in Separation”. In addition, under Sara Lee’s 1998 Long-Term Incentive Stock Plan, the 2002 Long-Term Incentive Stock Plan and the Employee Matters Agreement 2012 RSUs were granted to Messrs. Van Lede (60,441 Sara Lee RSUs) and Sorensen (45,918 Sara Lee

 

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  RSUs). To compensate them for the decrease in value as a result of the Separation, an additional RSU grant was made by D.E MASTER BLENDERS upon the Separation. The conversion ratio was based on the Sara Lee stock price on June 27 and 28, 2012 and the D.E MASTER BLENDERS stock price on June 29, 2012 and July 2, 2012. This additional grant was made after the end of fiscal 2012. The RSUs will vest six months after termination of their memberships of the Sara Lee board.

 

5. Does not include 1,700 shares of common stock held by Mr. Bennink for the benefit of his minor children.

Senior management as per June 30, 2012

 

Name directors and senior managers6

   Number of Shares
Owned
     Performance
Stock

Units7,8
     Restricted
Stock Units
     Approximate
Percentage of
Class
 

Michel M.G. Cup

     0         0         0         *   

Eugenio Minvielle

     0         0         0         *   

Harm-Jan van Pelt

     38,666         0         0         *   

Nick J. Snow

     1,247         0         0         *   

Board of directors and senior management collectively as per June 30, 2012

 

Directors and senior management as a group (11 people)

     296,125         0         0         *   

 

6. The address of each of the members of senior management is c/o D.E MASTER BLENDERS, Oosterdoksstraat 80, 1011 DK Amsterdam, the Netherlands.

 

7. On November 4, 2011, Sara Lee performance stock units (PSUs) were granted under Sara Lee’s Plans to Messrs. Van Pelt (12,412 Sara Lee PSUs) and Snow (10,451 Sara Lee PSUs—after June 30, 2012 this grant was adjusted downwards, see table below). On January 26, 2012, Sara Lee PSUs were granted under Sara Lee’s Plans to Mr. Cup (17,602 Sara Lee PSUs). The number of PSUs was originally in Sara Lee stock and the PSUs have been converted into shares of D.E MASTER BLENDERS. The conversion ratio was based on the Sara Lee stock price on June 27 and June 28, 2012 and the D.E MASTER BLENDERS stock price on June 29, 2012 and July 2, 2012. The number of Sara Lee PSUs that will vest can vary from 25% to 150%. Conversion took place after the end of fiscal 2012. All PSUs will vest on August 31, 2014 if, and to the extent, the predetermined performance goals are met. After June 30, 2012, the performance goal was achieved for 80.06%. In addition, the Compensation and Employee Benefits Committee of Sara Lee approved, and our remuneration committee approved an initial grant of PSUs under the 2012 Long-Term Incentive Share Plan to Messrs. Cup (€500,000), Van Pelt (€333,334) and Snow (€280,667; after June 30, 2012 this grant was cancelled due to the termination of his employment). The number of PSUs to vest pursuant to these initial grants can vary from 0% to 200% and PSUs will vest on August 31, 2014 if, and to the extent, predetermined performance goals, as described under 2012 Long-Term Incentive Share Plan, are achieved.

 

8. After June 30, 2012, the remuneration committee has granted their annual PSU award to Messrs. Cup (€1,000,000), Van Pelt (€500,000) and Minvielle (€500,000 plus a one-time sign-on grant of €500,000). The number of PSUs to vest pursuant to these grants can vary from 0% to 200% and will vest on August 31, 2015.

 

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Board of directors as per October 10, 2012

This table shows the numbers of D.E MASTER BLENDERS equity held by the members of the board of directors as filed with the AFM register at the date of this Annual Report.

 

Name Directors

   Number of Shares
Owned as a result
of the separation
    Number of Shares
purchased until
October 10, 2012
     Performance
Stock

Units  granted by
Sara Lee
    Performance
Stock

Units  granted by
D.E MASTER
BLENDERS
    Restricted
Stock  Units9
 

Jan Bennink

     357,143 10      262,956         377,650 11      0        0   

Michiel J. Herkemij

     37,685 12      0         259,597        323,700 13      0   

Maria Mercedes M. Corrales

     0        0         0        0        0   

Andrea Illy

     0        0         0        0        0   

Cornelis J.A. van Lede

     0        0         0        0        70,258   

Norman R. Sorensen

     20,562 14      4,000         0        0        53,376   

Sandra E. Taylor

     0           0        0        0   

 

9. Reference is made to footnote 4 above.

 

10. Includes the 235,650 ordinary shares held at June 30, 2012 and the Sara Lee PSUs and RSUs (after taxes) that vested as a result of the separation (121,493). Reference is made to footnote 2 above.

 

11. The number in the table is the maximum number of PSUs (200%) following the one-time grant by the Corporate Governance, Nominating and Policy Committee of Sara Lee which was documented at the completion of the spin-off. The terms of the 2012 Long-Term Incentive Share Plan apply to this award. Reference is made to footnote 2 above.

 

12. Sara Lee RSUs (after taxes) that vested as a result of the separation. Reference is made to footnote 4 above.

 

13. The number in the table is the maximum number of PSUs (200%) of the annual D.E MASTER BLENDERS PSU award relating to the September 2012 grant. The terms of the 2012 Long-Term Incentive Share Plan apply to this award. Reference is made to footnote 3 above.

 

14. Ordinary shares held at June 30, 2012.

Senior management as per October 10, 2012

This table shows the numbers of D.E MASTER BLENDERS equity held by senior management as filed with the AFM register at the date of this Annual Report.

 

Name Directors

   Number of Shares
Owned as a result
of the separation
     Number of Shares
purchased until
October 10, 2012
     Performance Stock
Units  granted by
Sara Lee15
     Performance Stock
Units  granted by
D.E MASTER
BLENDERS
    Restricted
Stock Units
 

Michel M.G. Cup

     0         10,000         106,078         215,800 16      0   

Eugenio Minvielle

     0         0         0         215,800 16,17      0   

Harm-Jan van Pelt

     38,666         0         70,718         107,900 16      0   

Nick J. Snow

     1,247         0         0         0        0   

 

15. Not including the Sara Lee PSU grant to Messrs. Cup, Van Pelt, and Snow (see footnote 7 above). After conversion of the Sara Lee PSUs into D.E MASTER BLENDERS PSUs and adjustment for the achievement of performance conditions the following numbers of PSUs are held: Cup (23,719), Van Pelt (16,725) and Snow (5,798—this represents the downward adjustment made after June 30, 2012).

 

16. The numbers in the table are the maximum number of PSUs (200%) achievable under the annual D.E MASTER BLENDERS PSU award relating to the September 2012 grant. The terms of the 2012 Long-Term Incentive Share Plan apply to these awards.

 

17. Including a one-time sign-on grant.

 

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ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

7A Major shareholders

The following table sets forth the total number of ordinary shares owned by each shareholder whose ownership of ordinary shares exceeds 5 percent of the ordinary shares issued and outstanding as of July 9, 2012. July 9, 2012 was the first day of official trading in our ordinary shares on Euronext Amsterdam. Accordingly, to identify major shareholders for our first Annual Report, we have used this date rather than the date of the end of the reporting period. The information set out below is solely based on public filings with the Netherlands Authority for the Financial Markets (Stichting Autoriteit Financiële Markten, the “AFM”) as of July 9, 2012.

 

Greater than 5% Shareholders

   Date of notification     Number of Shares Owned     Approximate Percentage  

Parentes Holding SE

Rooseveltplatz 4-5 / Top 10,

A-1090 Vienna, Austria

     June 29, 2012 1      0        12.19 %* 

Donata Holding SE

Rooseveltplatz 4-5 / Top 10,

A-1090 Vienna, Austria

     June 29, 2012 2      72,515,572     12.19

Morgan Stanley Investment

Management Inc.

     July 4, 2012        31,290,384        5.26

 

* Voting interest based on a voting rights agreement.

 

1. Notification was made for an indirect actual ownership of 12.19% of the voting rights in D.E MASTER BLENDERS.

 

2. Notification was made for an indirect actual ownership of 72,515,572 D.E MASTER BLENDERS’ ordinary shares.

From February 27, 2012, the date of our incorporation, until June 28, 2012, the date of the separation, Sara Lee held 100% of our issued and outstanding ordinary shares.

Our major shareholders do not have voting rights different from other shareholders.

On October 5, 2012, our shareholders’ register contained 53,725 holders of record resident in the United States, representing approximately 5.00% of our outstanding shares. Due to the nature of the Dutch central securities depository system through which our shares are settled in the Netherlands, we are unable to verify the residence of the holders of our outstanding shares, except for the shares held by Donata Holding SE and Morgan Stanley Investment Management Inc. which have notified their holdings to the AFM.

We are not aware of any arrangement that may, at a subsequent date, result in a change of control.

7B Related party transactions

Agreements with Sara Lee Corporation

As part of the separation, we entered into a master separation agreement and several other agreements to effect the separation and provide a framework for our relationship with Sara Lee going forward. These agreements provide for the allocation between us and Sara Lee of the assets, liabilities and obligations of Sara Lee and its subsidiaries, and govern the relationship between us and Sara Lee since the separation.

 

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In addition to the master separation agreement, the other principal agreements we entered into with Sara Lee include:

 

   

a merger agreement;

 

   

a transition services agreement;

 

   

a tax sharing agreement;

 

   

an employee matters agreement; and

 

   

an intellectual property separation agreement.

In the discussion that follows, we have described the material provisions of these agreements with Sara Lee. The summaries of these agreements are qualified in their entirety by reference to the full text of the applicable agreements, which are included as exhibits to this Annual Report. We encourage you to read the full text of those agreements. We entered into these agreements prior to the completion of the separation in the context of our current relationship with Sara Lee. Some of the terms of those agreements may not be the same as those we could obtain in arm’s-length negotiations with unaffiliated third parties.

Master Separation Agreement

The master separation agreement contains the key provisions relating to the separation, including provisions relating to the principal intercompany transactions required to effect the separation, the conditions to the separation and provisions governing the relationships between Sara Lee and us going forward.

Transfer of Assets and Assumption of Liabilities. The master separation agreement identifies assets and rights to be transferred, liabilities to be assumed and contracts to be assigned between us and Sara Lee as part of the separation.

The Distribution. The master separation agreement governs the rights and obligations of the parties regarding the distribution. Prior to the distribution, the number of shares of DE US, Inc. common stock held by Sara Lee was increased to the number of our ordinary shares distributable pursuant to the merger of DE US, Inc. with one of our wholly owned U.S. subsidiaries. Sara Lee then caused its agents to distribute all of the issued and outstanding shares of DE US, Inc. common stock to the exchange agent who held the shares on behalf of the Sara Lee shareholders who hold Sara Lee shares as of the record date.

Releases, Allocation of Liabilities and Indemnification. The master separation agreement provides for a full and complete release and discharge of all liabilities existing or arising from or based on facts existing prior to the separation, between or among us, DE US, Inc. or any of our affiliates, and Sara Lee or any of its affiliates (other than DE US, Inc.), except as set forth in the master separation agreement.

We are liable for and have agreed to perform all liabilities with respect to our business, which we refer to as the DE US, Inc. liabilities. Those liabilities include, with certain exceptions, (1) all liabilities of DE US, Inc. and D.E MASTER BLENDERS to the extent based upon or arising out of the DE US, Inc. business and its assets, (2) all liabilities of Sara Lee to the extent based upon or arising out of the DE US, Inc. business and its assets, (3) all liabilities based upon or arising out of financial instruments of DE US, Inc., (4) all outstanding liabilities included on the DE US, Inc. balance sheet or in the notes thereto and all other liabilities that are of a nature or type that would have resulted in such liabilities being included as liabilities on a combined balance sheet of DE US, Inc., or the notes thereto, as of the distribution date (were such balance sheet and notes to be prepared) on a basis consistent with the determination of the nature and type of liabilities included on the DE US, Inc. balance sheet and (5) certain other designated liabilities.

Sara Lee is liable for and agreed to perform all liabilities other than DE US, Inc. liabilities, which we refer to as the Sara Lee liabilities.

 

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In addition, the master separation agreement provides for cross-indemnities principally designed to place financial responsibility for the obligations and liabilities of our business and geographic focus with us and financial responsibility for the obligations and liabilities of the Sara Lee retained businesses and its geographic focus with Sara Lee. Specifically, subject to certain exceptions set forth in the master separation agreement, we assumed liability for, and to indemnify and hold harmless Sara Lee, its affiliates (other than DE US, Inc.) and its directors, officers and employees against, certain liabilities relating to our business and the separation, including all liabilities relating to, arising out of or resulting from:

 

   

the failure by D.E MASTER BLENDERS, DE US, Inc. and its subsidiaries or any other person to pay, perform or otherwise promptly discharge any DE US, Inc. liability;

 

   

any DE US, Inc. liability;

 

   

the performance or breach of any DE US, Inc. contracts or certain designated DE US, Inc. agreements;

 

   

the current or former business and operations of D.E MASTER BLENDERS and DE US, Inc. and its subsidiaries;

 

   

except for certain Sara Lee-provided information, any claim that the information included in our registration statement on Form F-1, this Annual Report or our European Union Listing Prospectus, is or was false or misleading with respect to any material fact or omits or omitted to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading; and

 

   

the breach by us or DE US, Inc. and its subsidiaries of any covenant or agreement set forth in any agreement entered into in connection with the separation.

Sara Lee agreed to indemnify and hold harmless us, our affiliates and our directors, officers and employees from and against all liabilities relating to, arising out of or resulting from:

 

   

the failure by Sara Lee and its subsidiaries or any other person to pay, perform or otherwise promptly discharge any Sara Lee liability;

 

   

any Sara Lee liability;

 

   

the performance or breach of certain designated Sara Lee agreements;

 

   

the current or former business or operations of Sara Lee and its subsidiaries;

 

   

solely with respect to certain information supplied by or the responsibility of Sara Lee, any claim that the information included in our registration statement on Form F-1, this Annual Report or our European Union Listing Prospectus, is or was false or misleading with respect to any material fact or omits or omitted to state any material fact required to be stated therein or necessary in order to make the statements therein, in light of the circumstances under which they were made, not misleading; and

 

   

the breach by Sara Lee or its subsidiaries of any covenant or agreement set forth in any agreement entered into in connection with the separation.

The master separation agreement also establishes procedures with respect to claims subject to indemnification and related matters. Indemnification with respect to taxes and tax matters is governed by the tax sharing agreement and, to a limited extent, the transition services agreement.

Access to Information. The master separation agreement provides that the parties will exchange certain information reasonably required to comply with requirements imposed on the requesting party by a government authority, for use in any proceeding or to satisfy audit, accounting or similar requirements, for use in compensation, benefit or welfare plan administration or other bona fide business purposes, or to comply with its obligations under the master separation agreement or any ancillary agreement. In addition, the parties will use

 

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commercially reasonable efforts to make available to each other past and present directors, officers, other employees and agents as witnesses in any legal, administrative or other proceeding in which the other party may become involved.

Expenses. Except as expressly set forth in the master separation agreement or in any related transaction agreement, all third party fees, costs and expenses of Sara Lee, DE US, Inc. or D.E MASTER BLENDERS in connection with the separation were allocated between Sara Lee, DE US, Inc. and D.E MASTER BLENDERS by Sara Lee, in its sole discretion. Each of Sara Lee and D.E MASTER BLENDERS will generally pay its own costs and expenses incurred after the distribution date.

Merger Agreement

The merger agreement governed the merger of DE US, Inc. with and into a wholly owned U.S. subsidiary of D.E MASTER BLENDERS.

Transition Services Agreement

We entered into a transition services agreement with Sara Lee, which provides for the provision of certain transitional services principally by Sara Lee to us. The services include the provision of certain application maintenance, application development and infrastructure maintenance services. For these services, the transition services agreement generally provides for a term of up to six months, which term may be extended for up to an additional six months. The transition services agreement also provides for the provision of certain tax support services over the course of up to four years, which may be extended with the parties’ consent.

Tax Sharing Agreement

Before the separation, DE US, Inc. entered into a tax sharing agreement with Sara Lee. In general, under the tax sharing agreement, DE US, Inc. is responsible for and must indemnify Sara Lee against (1) all non-U.S. income taxes attributable to a member of the DE US, Inc. group for all taxable periods, (2) all taxes of the DE US, Inc. business following the distribution and (3) tax liability or contractual liability for indemnity obligations relating to taxes in respect of certain dispositions identified in the tax sharing agreement. In general, Sara Lee is responsible for and must indemnify DE US, Inc. against (1) all U.S. federal income taxes relating to Sara Lee and its affiliates (including members of the DE US, Inc. group) prior to the distribution, (2) all non-U.S. income taxes attributable to a member of the Sara Lee group (as determined following the distribution) for all taxable periods, (3) all state and local income taxes relating to Sara Lee and its affiliates (including members of the DE US, Inc. group) prior to the distribution, (4) all taxes of the Sara Lee group (as determined following the distribution) following the distribution and (5) tax liability or contractual liability for indemnity obligations relating to taxes in respect of certain dispositions identified in the tax sharing agreement.

The tax sharing agreement also separately allocates among the parties any tax liability arising as a result of any failure of the separation to qualify as a tax-free transaction to Sara Lee and DE US, Inc.. Under the tax sharing agreement, DE US, Inc. is required to indemnify Sara Lee and its affiliates against all tax-related liabilities caused by the failure of the distribution to qualify as tax-free (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 any of its affiliates, including the Company, 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 the Company, concerning a party’s plan or intention with respect to actions or operations after the distribution date. In addition, DE US, Inc. is responsible for 50% of any taxes resulting from the failure of the distribution and certain related transactions, including the debt exchange, to qualify as tax-free, which failure is (1) not due to the actions, misrepresentations or omission of Sara Lee or DE US, Inc. or their respective affiliates or (2) 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 party’s plan or intention with respect to actions or operations after the distribution date.

 

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Employee Matters Agreement

We entered into an employee matters agreement with Sara Lee providing for our respective obligations to employees and former employees who are or were associated with DE US, Inc. and its subsidiaries (including those employees who transfer employment from Sara Lee to DE US, Inc. and its subsidiaries in connection with the separation) and for other employment and employee benefits matters.

The treatment of outstanding Sara Lee equity awards in connection with the distribution is set forth in the employee matters agreement and is described above in “Treatment of Equity-Based Compensation” under Item 4.

In addition, the employee matters agreement sets forth the following:

 

   

Following the distribution, DE US, Inc. Employees are generally only eligible to participate in DE US, Inc. benefit plans and DE US, Inc. has no liability under any Sara Lee benefit plan. DE US, Inc. and Sara Lee will take all actions necessary or appropriate to ensure that DE US, Inc. will not have any liability under any Sara Lee benefit plan. DE US, Inc. will assume, pay, perform and fulfill all liabilities relating to past, current or future employment with the DE US, Inc. business.

 

   

Following the distribution, Remaining Employees are generally only eligible to participate in Sara Lee benefit plans and Sara Lee has no liability under any DE US, Inc. benefit plan. DE US, Inc. and Sara Lee will take all actions necessary or appropriate to ensure that Sara Lee will not have any liability under any Sara Lee benefit plan. Sara Lee will assume, pay, perform and fulfill all liabilities relating to past, current or future employment with the Sara Lee business.

Intellectual Property Separation Agreement

We entered into an intell