The Consolidated Financial Statements and notes and Financial Review should be read in conjunction with the Financial Summary.

Sara Lee Corporation and Subsidiaries      25

Financial Review

This Financial Review discusses the corporation’s results of operations, financial condition and liquidity, risk management activities, and significant accounting policies and critical estimates. This discussion should be read in conjunction with the Consolidated Financial Statements and related notes thereto contained elsewhere in this Annual Report. The corporation’s fiscal year ends on the Saturday closest to June 30. Fiscal year 2004 was a 53-week year, while fiscal years 2003 and 2002 were 52-week years. All reported results for fiscal 2004, unless otherwise indicated, include the impact of the additional week. Unless otherwise stated, references to years relate to fiscal years. The following is an outline of the analysis included herein:

Overview

2004 – During 2004, net sales rose 7.0%, reflecting the benefit from favorable foreign currency rates and the additional week in 2004. Changes in foreign currency exchange rates increased net sales by 4.9% during 2004. The corporation has significant operations in western and central Europe where approximately 35% of the sales in 2004 were generated. The change in the value of the European euro and British pound versus the U.S. dollar had the largest impact. The impact of the 53rd week in 2004 increased sales by 2.0%.

Operating income for the corporation increased by $41 million, or 2.4% in 2004, primarily as a result of the following:

Income before income taxes increased by $58 million, or 3.9%, as a result of the $41 million increase in operating income and lower interest expense. The decrease in interest expense was due to lower borrowing rates and reduced debt levels. During the year, the corporation used cash to reduce long- and short-term debt by $1,272 million.

Net income increased by $51 million, or 4.2% in 2004, as the effective tax rate declined slightly from the prior year. Diluted earnings per share increased 6.0% in 2004 and increased at a rate in excess of net income as a result of lower average shares outstanding. During 2004, the corporation used $350 million to repurchase 18 million shares of common stock.

The corporation’s cash flow from operations increased 11.9% in 2004, to $2,042 million, as compared to the prior year, primarily due to improved profitability, lower levels of cash taxes paid and a lower level of cash payments to employee benefit plans. The corporation used the cash from operations to repay $1,288 million of long-term debt, repurchase $350 million of the corporation’s common stock and increase the corporation’s common dividend.

In 2004, the corporation adopted a brand segmentation strategy to better concentrate investment and management attention on

26      Sara Lee Corporation and Subsidiaries

those brands that have the greatest potential for profitable long- term growth. Under the brand segmentation strategy, all of the corporation’s retail brands are assigned to one of four classifications – Strategic Investment, which receives the largest proportionate level of marketing spending, research and development, capital investment and management attention; Support and Grow; Sustain, and Manage for Cash, which will receive the least amount of market spending and other support.

Further information and details regarding the performance of the corporation and its business segments follows.

Description of the Business Segments

The corporation’s worldwide operations are managed in five business segments. The following is a description of each of these business segments.

·         Sara Lee Meats sells a variety of meat products, including hot dogs and corn dogs, breakfast sausages and sandwiches, smoked and dinner sausages, premium deli and luncheon meats, bacon, meat snacks, and cooked and dry hams. The primary raw materials for these meat products include pork, turkey, beef and chicken, which are purchased almost entirely from independent farmers and vendors. The corporation does not rely on any one vendor or small group of vendors for these raw materials, and prices fluctuate based on supply and demand in the marketplace. Sara Lee Meats primarily sells its products in the United States, western and central Europe and Mexico; 68% of the segment’s 2004 sales were generated in U.S. dollars, 27% were generated in euros and 5% were in Mexican pesos. Sales are made in both the retail channel to supermarkets, warehouse clubs and national chains, and in the foodservice channel to foodservice distributors and large operators. Sales are generally transacted through Sara Lee’s own sales force and outside brokers. The top 20 customers of the Sara Lee Meats business represent approximately 58% of the segment’s sales. The major brands that Sara Lee Meats sells its products under include Hillshire Farm, Ball Park, Jimmy Dean, Sara Lee, Bryan, State Fair, Kahn’s and Best’s Kosher in the United States; Nobre, Aoste, Stegeman, Justin Bridou and Cochonou in Europe; and Kir, Zwan and Duby in Mexico. Seasonality in the Sara Lee Meats segment is balanced by the diverse offering of products that tend to offset seasonal changes in demand. For example, sales of hot dogs and lunchmeat increase during the summer months and ham and breakfast sausage sales increase during the winter holiday periods. The meats business is highly competitive with an emphasis on product quality, innovation and price where new product innovations are a key component to success. The Sara Lee Meats segment competes with other international, national, regional and local companies in each of the product groups. The U.S. meats business is regulated by the U.S. Department of Agriculture, whose focus is on the quality, sanitation and safety of meat products. Sara Lee’s meat businesses in Europe and Mexico are regulated by local authorities in a similar fashion.

·         Sara Lee Bakery produces a wide variety of fresh and frozen baked products and specialty items, including bread, buns, bagels, rolls, muffins, specialty bread, refrigerated dough, frozen pies, cakes, cheesecakes and other desserts. The primary raw materials include wheat flour, sugar, corn syrup, butter, fruit, eggs and cooking oils, which are purchased from independent suppliers. The Sara Lee Bakery segment does not rely on any one vendor or small group of vendors for these raw materials, and prices fluctuate based upon supply and demand in the marketplace, weather and government price supports. The Sara Lee Bakery primarily sells its products in the United States, western and central Europe and Australia; 79% of the segment’s 2004 sales were generated in U.S. dollars, 18% were generated in euros and 3% were in Australian dollars. Sales are made in both the retail channel to supermarkets, warehouse clubs and national chains, and in the foodservice channel to foodservice distributors, restaurants and other institutions. Sales are generally made through Sara Lee’s sales force and independent wholesalers. The Sara Lee Bakery group offers delivery directly to retail customer stores and warehouses through its direct store delivery system, which maintains approximately 5,900 delivery routes. The top 20 customers of the Sara Lee Bakery business represent approximately 48% of the segment’s sales. The major brands that Sara Lee Bakery sells its products under include Sara Lee , Earth Grains , Grant’s Farm , Colonial, Rainbo , Holsum , IronKids , Mother’s , Sunbeam , Healthy Choice , Roman Meal and Chef Pierre in the United States; Bimbo , Ortiz and CroustiPate in Europe; and Sara Lee , Bon Gateaux and Universal Foods in Australia. Certain of the brands are used under licensing arrangements. Sales of products sold under these licensing arrangements represent less than 8% of total Sara Lee Bakery sales. Seasonality in the Sara Lee Bakery segment is balanced by the diverse offering of products that tend to offset the seasonal changes in demand. For example, sales of buns increase in the warm summer months, and sales of dough products, specialty cakes and pies increase for the winter holiday season. The bakery business is highly competitive, with an emphasis on product quality, innovation and value where new product innovations drive growth in this segment. The Sara Lee Bakery segment competes with other international, national, regional and local companies in each of the product groups. The bakery business is subject to the regulations of the Food and Drug Administration in the United States and by similar groups in foreign countries.

·         The Beverage segment produces coffee and tea products that are sold in major markets around the world including the United States, Europe, Australia and Brazil. The significant cost item in the production of coffee products is the price of green coffee beans that are purchased from farmers and coffee bean vendors in various countries in the world. The price of green coffee fluctuates based upon supply and demand, weather, the political climate in the producing nations, unilateral pricing policies of various nations and speculation in the commodities markets. Fifty percent of the segment’s 2004 sales were generated in euros, 31% were generated in

Sara Lee Corporation and Subsidiaries      27

Financial Review

U.S. dollars, 5% were generated in Brazilian real and 3% in Australian dollars. Sales are made in both the retail channel to supermarkets, warehouse clubs and national chains, and in the foodservice channel to foodservice distributors. The Beverage segment also offers direct delivery to restaurants and warehouses through its direct delivery system. The top 20 customers of the Beverage business represent approximately 39% of the segment’s sales. In Europe, some of the more prominent brands are Douwe Egberts, Senseo, Maison du Café, Marcilla , Merrild and Pickwick . In the United States, brands include Chock full o’Nuts, Hills Bros., Chase and Sanborn and Superior , while in South America, significant brands include Café do Ponto, Café Caboclo, União and Café Pilão . Seasonal sales increases for Beverage products are experienced in the 2nd quarter due to higher consumer consumption in the winter months. The beverage business is highly competitive, with an emphasis on quality and value, and Sara Lee competes with other international and regional companies. Coffee consumption has increased in the world at a low single digit rate over the past 7 years. However, consumer preferences as to the blend or flavor and convenience of their purchase continues to change, with differing preferences in various countries and locations around the world. The Beverage segment continues to introduce new and innovative products to meet consumer’s needs.

·         Household Products produces and sells products in four primary product categories – body care, air care, shoe care and insecticides – and sells products directly to consumers in certain geographic areas via its direct selling division. Body care consists of soaps, shampoos, bath and shower products, deodorants, shaving creams, sunscreens and toothpastes that are sold primarily in Europe under brands such as Sanex, Duschdas, Radox, Monsavon, Delial and Prodent . Air care provides air fresheners under the Ambi Pur brand in the United States, Europe and certain Asian countries. Shoe care provides a variety of shoe care products, including polishes, cleaners and wax under the Kiwi and Meltonian brands in many countries around the world. Insecticides are sold primarily in Europe and Asia under brands such as Vapona, Catch, GoodKnight, Bloom and Ridsect . The direct selling division, which comprises less than 3% of the corporation’s sales and operating income, sells body care and air care products such as hair care, deodorants, moisturizers and fragrances as well as jewelry and cosmetics in Australia, Mexico, Argentina, Japan, the Philippines and South Africa. Forty percent of the segment’s 2004 sales were in euros; 10% were generated in British pounds; 9% were in Mexican pesos; 5% were in U.S. dollars; 4% were in South African rand; and the remaining 32% of the segment’s sales were primarily generated in the Asia-Pacific region and other portions of Europe. The top 20 customers of the Household Products business represent approximately 30% of the segment’s sales. The Household Products segment experiences higher sales in the second half of the fiscal year, as sales of both body care products and insecticides increase in anticipation of the warmer summer months. The household products business is highly competitive, with an emphasis on innovation, quality and value, and Sara Lee competes with other international and regional companies.

·         Branded Apparel, the corporation’s business segment previously referred to as Intimates and Underwear, has been renamed to better reflect the range of products offered by these businesses. Branded Apparel sources, manufactures and markets basic branded “innerwear” products under the three categories of intimate apparel, underwear/activewear and legwear. The primary raw materials used in the production of these branded apparel products include various natural and synthetic fabrics and fibers, including those made from cotton, nylon, spandex and certain elastics that are purchased from various independent suppliers. The corporation relies on a small group of suppliers to provide sewing services and certain textiles and yarns that are used in production. The largest of these specific suppliers provides approximately 15% of estimated manufacturing needs. Alternative sources of supply exist for each of these products, services and the other raw materials that are used in production. Prices for raw materials fluctuate based upon supply and demand in the marketplace. Branded Apparel primarily sells its products in the United States and Europe; 67% of the segment’s 2004 sales were generated in U.S. dollars, 17% were in euros and 9% were in British pounds. The top 20 customers of the Branded Apparel segment represent approximately 58% of the segment’s sales. Approximately 22% of this segment’s sales are to Wal-Mart stores. Principal brands include Hanes, Hanes Her Way, Champion, Playtex, L’eggs, barely there, Bali, Just My Size and Wonderbra in the United States and Dim, Playtex, Unno, Nur Die, Lovable and Wonderbra in Europe. Distribution channels range from department and specialty stores for premium brands to warehouse clubs and mass-merchandise outlets for certain value-priced brands. Sales are transacted through Sara Lee’s sales force. On a constant currency basis, sales are typically higher in the first two quarters of each year. Socks, hosiery and fleece products generally have higher sales in this period as a result of the cooler weather and back-to-school shopping. Sales levels in a period are also impacted by retailers’ decisions to increase or decrease inventory levels in response to anticipated consumer demand. The Branded Apparel business is highly competitive, with an emphasis on product value and quality. While many products such as white underwear, athletic socks, basic fleece products and T-shirts are not subject to significant change year-to-year, other products such as intimate apparel and sheer hosiery have a heavier emphasis on style and innovation. The corporation’s products in this segment compete against those of other national and international manufacturers. In addition, the consolidation of the retail trade has resulted in certain customers developing their own brands and sourcing product needs from third-party manufacturers.

28      Sara Lee Corporation and Subsidiaries

On January 1, 2005, the World Trade Organization will complete a 10-year plan to phase out import quotas that limit the number of apparel products that can be imported into the U.S. and other countries from certain countries in the world. Of the approximately 180 countries that ship apparel products to the U.S., there are currently 46 countries where U.S. import quotas exist. These include China, India, Vietnam, Pakistan and Sri Lanka as examples. These quotas establish a maximum number of garments that can be shipped into the U.S. per year. Once these quotas are completely phased out, these limits will no longer exist. The corporation sources products from a number of countries in the world and is continually evaluating its sourcing options. In evaluating these alternatives, the corporation considers factors such as quality, style, delivery times and manufacturing flexibility, in addition to the cost of manufacturing the apparel products and compliance with specific operating standards. The corporation will continue to evaluate its product sourcing strategies, given these changes, including the ability to relocate production sourcing to lower cost locations that previously may not have been available due to the import quotas. The phase out of import quotas also could potentially allow new competitors to enter the apparel business. This includes both new domestic as well as foreign competitors who could establish manufacturing sites in these foreign locations. The corporation, under its numerous brands, designs, sources, produces, markets and delivers apparel products in this highly competitive business and will continue to evaluate sourcing and marketing options. It is unclear what the long-term implications will be from the elimination of these quotas.

The corporation also has initiated a strategic review of options for its European apparel business as part of a larger review of the corporation’s brand portfolio. No decision regarding available options has been or is expected to be made regarding this business until the second half of fiscal 2005.

Sara Lee Corporation and Subsidiaries      29

Financial Review

Review of Consolidated Results of Operations – 2004 Compared With 2003

Net Sales   Consolidated net sales increased $1,275 million, or 7.0%, in 2004 over 2003, to $19,566 million. The strengthening of foreign currencies, particularly the euro, increased reported net sales by 4.9%, or $881 million. In addition, the 2004 fiscal year included 53 weeks, while the 2003 fiscal year included 52 weeks. The impact of the extra week in 2004 increased net sales by $373 million, or 2.0%. Net sales in 2003 includes $53 million from businesses that have been disposed of subsequent to the start of 2003. During 2004, the corporation adopted new accounting standard FASB Interpretation No. 46, “Consolidation of Variable Interest Entities.” Upon the adoption, the corporation began to consolidate a joint venture investment and, as a result, has included net sales of $16 million in 2004 as a result of this consolidation. This is more fully described in the “Summary of Significant Accounting Policies” contained in Note 2 to the Consolidated Financial Statements. The dispositions and the change in the accounting rule decreased net sales between the years by $37 million, or 0.2%. The remaining net sales increase of $58 million, or 0.3%, was primarily attributable to net sales increases in Sara Lee Meats and Beverage, due to higher raw material costs that are partially passed on to customers and an improved product mix, and by sales increases for body care and insecticide products from the corporation’s Household Products segment. Partially offsetting this increase is a net sales decline in the Sara Lee Bakery segment, primarily due to a decline in unit volumes, and in the Branded Apparel segment, due to changes in product mix and lower average selling prices.

Gross Margin Percent   The gross margin percent decreased from 39.6% in 2003 to 38.6% in 2004. Raw material commodity costs in Sara Lee Meats, Beverage and Branded Apparel all increased during the year, and these businesses were unable to recover all of these cost increases from the customer. The Household Products gross margin percent fell as a result of a competitive marketplace, and the Sara Lee Bakery gross margin percent increased slightly due to a favorable product mix during the year and benefits from restructuring actions.

Selling, General and Administrative Expenses   Total selling, general and administrative (“SG&A”) expenses increased $329 million, or 5.9%, in 2004. SG&A expenses increased primarily due to the strengthening of foreign currencies, particularly the euro, versus the U.S. dollar as the impact of these changes in foreign currency increased selling, general and administrative expenses by $275 million. Additionally, the corporation experienced increased expenses associated with pension and medical plans and other employee benefit costs, and higher levels of software and trademark amortization, offset in part by lower advertising and promotion costs. When measured as a percentage of sales, SG&A expenses decreased by 0.3%, from 30.4% of sales in 2003 to 30.1% in 2004. SG&A expenses, measured as a percent of sales, increased in the Branded Apparel segment and declined in the Sara Lee Meats, Sara Lee Bakery, Beverage and Household Products segments.

Charges for (Income from) Exit Activities and Business Dispositions   The reported results for 2004 and 2003 reflect amounts recognized for exit and disposal actions, including the impact of certain activities that were completed for amounts more favorable than previously estimated. The objective of the actions taken was to improve the competitive structure of the corporation by exiting certain high-cost manufacturing, distribution and administrative activities and disposing of both certain businesses in which the corporation had a minority ownership position and other components of business investments. The following table illustrates where the costs (income) associated with all exit and disposal activities are recognized in the Consolidated Statements of Income of the corporation.

During 2004, the corporation recognized charges for approved actions to reduce the cost structure of each of the corporation’s business segments including Sara Lee Meats, Sara Lee Bakery, Beverage, Household Products, Branded Apparel and the corporate office, and to dispose of certain businesses, including the impact of certain business dispositions that were completed for amounts that were more favorable than originally estimated. The net impact of these actions was to reduce pretax income, net income and diluted earnings per share by $54 million, $36 million and $0.05 per share, respectively. The total charge consists of $63 million of net costs related to exit activities and $9 million of net gains associated with the disposal of certain investments. The $63 million net charge for exit activities consists of the following components: a $70 million charge associated with terminating 6,222 employees, a $6 million charge for anticipated losses on assets held for sale, a $5 million charge for accelerated depreciation expense related to the assets to be disposed, a $1 million charge for accelerated amortization related to the cost to abandon certain Sara Lee Bakery trademarks and a $19 million credit related to the disposal of assets and the settlement of lease and employee termination obligations for amounts more favorable than originally estimated. The $9 million net gain recognized from management’s approved actions to

30      Sara Lee Corporation and Subsidiaries

dispose of certain businesses consists of a $13 million gain recognized on the disposal of a minority ownership position in Johnsonville Foods. Offsetting this gain is a net $4 million charge related to the disposal of an Italian hosiery business and the favorable settlement of amounts associated with prior dispositions.

During 2003, the corporation recognized a charge of $39 million for exit activities in the Sara Lee Bakery and Beverage segments and recognized income of $37 million after completing certain previously announced exit activities and business dispositions for amounts more favorable than originally estimated. The net impact of these exit activities and business dispositions was to reduce pretax income by $2 million and increase net income by $3 million, which had no impact on diluted earnings per share. The $39 million charge consisted of the following components: a $15 million charge associated with terminating a number of employees, a $13 million charge to dispose of certain manufacturing and distribution assets, a $6 million charge for the abandonment of certain trademarks and a $5 million charge for the cost to exit certain lease obligations.

The costs (income) of the above actions on the corporation’s business segments are summarized as follows:

These actions are more fully explained in Note 16 to the Consolidated Financial Statements titled “Exit and Disposal Activities.” As a result of the exit activities taken, the corporation’s cost structure was reduced and efficiency improved. It is estimated that income before income taxes in 2004 included $59 million of incremental benefits over those realized in the prior year. The total annual savings generated from restructuring efforts initiated since 2001 was $274 million in 2004.

Receipt of Contingent Sale Proceeds   The corporation sold its European cut tobacco business in 1999. Under the terms of that agree ment, the corporation received a cash payment of 95 million euros from the buyer in January 2004. If tobacco continues to be a legal product in the Netherlands, Germany and Belgium, additional annual cash payments of 95 million euros can be received through 2010. If tobacco ceases to be a legal product at any time during this period, the corporation forfeits the receipt of all future amounts. The contingent payment of these amounts is based on the legal status of the product in each country, with the Netherlands accounting for 67% of the total, Germany 22% and Belgium 11%. If the contingencies on these amounts pass, the amounts will be recognized in income upon receipt. In 2004, the contingencies associated with the first payment passed, and the corporation received a cash payment of 95 million euros. This was equivalent to $119 million, or $0.15 per diluted share, based upon exchange rates in effect on the date of receipt.

Net Interest Expense   Net interest expense decreased by $17 million in 2004, to $181 million, primarily as a result of lower average borrowings and interest rates.

Income Tax Expense   The effective tax rate decreased from 17.7% in 2003 to 17.5% in 2004. The fiscal 2004 tax expense was impacted by a number of significant items which are set out in a reconciliation of the corporation’s effective tax rate to the U.S. statutory rate in Note 21 to the Consolidated Financial Statements. The most significant of these items was the finalization of certain tax reviews and audits for $207 million less than originally anticipated. In addition, the corporation recognized a tax charge of $140 million in connection with the remittance of current year foreign earnings to the U.S.

Consolidated Net Income and Diluted Earnings Per Share (“EPS”) As a result of the factors discussed above, consolidated net income of $1,272 million in 2004 was $51 million, or 4.2% higher than the prior year. Diluted EPS increased from $1.50 in 2003 to $1.59 in 2004, an increase of 6.0%. Diluted EPS increased at a higher rate than net income primarily as a result of the corporation purchasing shares of its outstanding common stock which reduced the average shares outstanding.

A discussion of each business segment’s sales and operating segment income is presented below.

The intangible amortization in the table above relates to trademarks and customer relationships. Software amortization is recognized in the earnings of the segments. The amortization related to trademarks and customer relationships increased in 2004 due to the impact of foreign currency exchange rates, and the decision in the second quarter of the year to begin amortizing certain trademarks that were previously determined to have an indefinite life. In addition, amortization in 2003 included the impact of the accelerated amortization of various Bakery trademarks which were abandoned and fully written off at the end of 2003.

General corporate expenses increased primarily as a result of higher pension and other employee benefit plan costs, the centralization of certain finance and marketing functions in the corporate office and expenses associated with hedging certain transactions.

(1) Excludes the impact of dispositions

Unit volumes for processed meats in the Sara Lee Meats segment, including the 53rd week and excluding the impact of dispositions, increased 1% as compared to 2003 levels. Unit volumes were up 1% in the U.S. and Europe, which were partially offset by a decline of 4% in Mexico. In the U.S., unit volumes in the deli channel increased 9% from a combination of increased distribution and new products, retail channel volumes increased 1% as increased new product sales were partially offset by volume declines in smoked and dinner sausage and foodservice unit volumes declined by 1% due to reduced low margin sales.

Net sales in the Sara Lee Meats segment increased by $425 million, or 11.3%, to $4,171 million in 2004 from $3,746 million in 2003. During the year, the strengthening of the euro, partially offset by the weakening of the Mexican peso, increased reported net sales by $117 million, or 3.4%. The 2004 fiscal year included 53 weeks, while the 2003 fiscal year included 52 weeks. The impact of the 53rd week in 2004 increased net sales by $83 million, or 2.2%. 2003 includes net sales of $4 million from a business that was disposed of subsequent to the beginning of 2003. The remaining net sales increase of $229 million, or 5.9%, was primarily due to higher net product prices and reduced promotion spending in connection

32      Sara Lee Corporation and Subsidiaries

with higher raw material costs, plus the impact of a favorable product mix and higher unit volumes during the year.

The Sara Lee Meats gross margin percentage decreased from 31.0% in 2003 to 29.7% in 2004, primarily as a result of increases in commodity meat prices, including pork, which could not be passed along to customers in their entirety. The impact of higher commodity costs was partially offset by an improved product mix and manufacturing cost savings.

Operating segment income in Sara Lee Meats increased by $40 million, or 10.7%, from $375 million in 2003 to $415 million in 2004. Changes in foreign currency, particularly the euro, increased reported operating segment income by $14 million, or 4.0%. The impact from the extra week of operating results in 2004 increased operating segment income by $7 million, or 1.9%. Dispositions completed subsequent to the beginning of 2003 did not have a significant impact on operating segment income during the year. Income from exit activities and business dispositions of $3 million was recognized in 2004, as compared to $6 million in 2003. The difference in income from exit activities and business dispositions of $3 million decreased reported operating segment income by 1.0%. The remaining operating segment income increase of $22 million, or 5.6% as compared to the prior year, is the result of improved sales performance from a favorable product mix, manufacturing and distribution efficiencies and lower spending on media advertising and promotion, partially offset by higher administrative costs.

Unit volumes in the Sara Lee Bakery segment, including the 53rd week, declined 1% during 2004 as volume decreased for fresh bread in the U.S., primarily regional and store brands, due to a category decline for white breads. These declines were partially offset by unit volume increases in frozen bakery products in the U.S. and Australia and increases in fresh bread in Europe. Unit volumes for refrigerated dough products were unchanged between the years.

Net sales in the Sara Lee Bakery segment increased $139 million, or 4.2%, in 2004 as compared to 2003. Changes in foreign currency exchange rates increased reported net sales by $88 million, or 2.7%. The impact of the extra week in 2004 increased reported net sales by $69 million, or 2.0%. There were no acquisitions or dispositions that impacted the Sara Lee Bakery segment during the year. The remaining net sales decline of $18 million, or 0.5%, was primarily a result of a decline in unit volumes in the U.S. white bread category that were partially offset by increased unit volumes of health-oriented fresh breads in the U.S., crustless breads in Europe and more favorable promotional pricing practices during the year.

The gross margin percentage in the Sara Lee Bakery segment increased 0.8%, from 41.0% in 2003 to 41.8% in 2004, as a result

Sara Lee Corporation and Subsidiaries      33

Financial Review

of a favorable product mix and benefits from restructuring actions, which offset higher costs for certain key ingredients, wages and employee benefits and the impact of lower unit volumes.

Operating segment income in the Sara Lee Bakery segment increased by $58 million, or 59.2%, from $98 million in 2003 to $156 million in 2004. Changes in foreign currency, particularly the euro, increased reported operating segment income by $8 million, or 8.4%. The impact of the extra week in 2004 increased operating segment income by $7 million, or 5.0%. Charges for exit activities and business dispositions, including the cost of accelerated depreciation on facilities to be sold, decreased operating segment income by $19 million in 2004 as compared to $27 million in 2003. The $8 million difference between these two amounts increased operating segment income by 20.2%. The remaining operating segment income increase of $35 million, or 25.6% during the year, was attributable to an improved product mix plus lower employee costs as a result of restructuring actions taken in the prior year.

Beverage

Net unit volumes in the Beverage segment, including the impact of the 53rd week, increased 3% in 2004 as strong shipments in the Brazilian and U.S. retail markets were partially offset by declines in U.S. foodservice markets due to a competitive marketplace.

Net sales in the Beverage segment increased by $401 million, or 14.6%, to $3,157 million in 2004, reflecting the impact of changes in foreign currency, higher unit selling prices which are related to increased green coffee commodity prices, an improved product mix and improved sales performance in the Brazilian and U.S. retail markets. The impact of foreign currency changes, particularly in the euro, increased reported net sales by $242 million, or 9.3%. The impact of the 53rd week in 2004 increased reported net sales by $61 million, or 2.0%. There were no acquisitions or dispositions that impacted the Beverage segment during the period. The remaining net sales increase of $98 million, or 3.3% compared to the prior year, was primarily due to higher raw material costs that were passed along in part to customers, as well as an improved product mix, plus the impact of improved sales performance in the U.S. and Brazilian retail markets.

The gross margin percent in the Beverage segment decreased 1.6%, from 45.5% in 2003 to 43.9% in 2004, primarily as a result of the combination of increased price competition and the fact that not all raw material price increases could be passed along to the customer.

Operating segment income for the Beverage segment increased $63 million, or 14.7%, to $492 million in 2004 from $429 million in 2003. The strengthening of foreign currencies versus the U.S. dollar increased operating segment income by $49 million, or 11.7%. The impact of the extra week in 2004 increased operating segment income by $10 million, or 2.0%. The remaining operating segment income increase was $1 million, or 0.3%, resulting from higher unit volumes and lower media advertising and promotion that were mostly offset by lower gross margins and higher employee pension expense.

34      Sara Lee Corporation and Subsidiaries

Unit volumes for the Household Products segment’s four core categories – body care, air care, shoe care and insecticides – increased 1% in 2004, including the impact of the 53rd week. Unit volumes increased in the body care and insecticide categories primarily due to improved sales performance in Asia and Europe from new product introductions, market share increases and category growth during the year which benefited from favorably warm weather. Partially offsetting this increase was a unit volume decline in the shoe care and air care categories due to a competitive marketplace.

Net sales increased by $263 million, or 12.4%, from $2,118 million in 2003 to $2,381 million in 2004. The impact of changes in foreign currency exchange rates increased reported net sales by $207 million, or 10.1%, as the strengthening of currencies in Europe, Australia, the United Kingdom and South Africa more than offset a weakening of the currency in Mexico. The impact of the 53rd week increased reported net sales by $55 million, or 2.4%. Net sales in 2003 include $7 million from a business that was disposed subsequent to the beginning of 2003. As a result, the remaining net sales increase of $8 million, or 0.3%, was primarily due to increases in unit volume in the body care and insecticide categories plus sales growth in the direct selling business in Mexico, the Philippines, South Africa and Australia, partially offset by weaknesses in the shoe care and air care categories.

The gross margin percentage in the Household Products segment decreased 0.8%, from 56.6% in 2003 to 55.8% in 2004, primarily from competitive pricing in the marketplace.

Operating segment income increased $45 million, or 12.0% to $414 million in 2004. Changes in foreign exchange rates increased operating segment income by $35 million, or 9.7%. The impact of the 53rd week increased reported operating segment income by $10 million, or 2.4%. The remaining operating segment income decreased by less than $1 million as the impact of higher unit volumes in body care and insecticides and sales growth in the direct selling business was offset by lower margins, higher pension charges and increased information technology-related expenses.

Branded Apparel