Smithfield Foods Inc (SFD) 2004 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Smithfield Foods first-quarter earnings conference call. At this time, all participants are in a listen only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded and it will be available for replay after 1:00 PM today until August 28th at midnight. You may access the AT&T Executive Playback Service at any time by dialing 1-800-475-6701 and entering the access code of 696003. I would now like to turn the conference over to our host, Mr. Jerry Hostetter.

Good morning. Welcome to our conference call to discuss Smithfield Foods' fiscal year 2004 first-quarter results. We would like to caution you that in today's call, there may be forward-looking statements within the meaning of federal Securities laws. In light of the risks and uncertainties involved, we encourage you to read the forward-looking information section of the Smithfield Foods' Form 10-k for fiscal year 2003.

With us today are Dan Stevens, Chief Financial Officer, Richard Poulson, Executive Vice President and Senior Adviser to the Chairman, C. Larry Pope, President and Chief Operating Officer, and Joseph W. Luter III, Chairman and Chief Executive Officer. This is Jerry Hostetter, head of Investor Relations. Larry Pope will begin our presentation with a review of operations. Larry?

Good morning, ladies and gentlemen. I'd like to report this morning that Smithfield Foods is reporting net income of $22.1 million, or 2 cents per share, versus $11.8 million, or 11 cents per share, for the quarter ended July 27, 2003. Those earnings, while nearly double last year's first quarter, unfortunately were disappointing to the Company on an overall basis. As we started the first part of this quarter, we were anticipating earnings even stronger than those that we have reported this morning. Many of you know it was a tough quarter towards the end of June and into July, as the impact of the Canadian border closing collective to cow occurred an impact (ph) of the live hog markets and impacted live hogs coming into this country and impacted meat coming into this country; that had the effect of dampening livestock prices in this country, which we saw reacting to the continuing downturn in the breeding herds in this country and saw that hogs were returning to levels we thought they should be in terms of pricing. Those were moderated fairly significantly starting in June and into July.

If you go back and look at the Iowa Southern Minnesota markets in May and look at those in June and then again in July, you see that June, relative to May, goes up and then July comes right back down; that's the impact of those hogs crossing the border, both in the form of slaughter animals most recently but as well, there's been a significant increase in the number of feeder pigs coming across. This has impacted the live hog markets in a fairly significant way and reduced the overall profitability in the hog production that we were anticipating that would continue into the summer.

As well, there has been fresh pork crossing the border into the United States, which has been having an impact on fresh meat pricing and has moderated even those prices. Those were conditions on a situation we did not anticipate as we started with this quarter. So while we are reporting earnings nearly double last year, they are not as strong as we felt they would have been had you asked us just six weeks ago.

As you look at the numbers, our hog production operating profits are up about $40 million. Those are very much the result of the price of hogs and our raising costs, which are up somewhat as a result of grain prices year-over-year. Our pork results were off about $24 million, so what we saw was a pickup on the hog production side; a great deal of that was given back on the fresh meat side. The summer months, as all of you are fully aware, is generally the weakest period for the Company on the fresh pork side, and this was particularly weak, again, peace the last six to eight weeks because of these other influences.

Our beef numbers are quite good, and have been quite good for some time now, and we continue to see strong numbers. Hopefully, that will continue, although we did see the cattle prices rise yesterday. That has had an impact, depending on where (indiscernible) beef goes as a result of that.

On the international side, our numbers are about half what they were last year. We have had some seasonal influences in our European operations. I was just in Europe the week before last with both the presidents of our European operations, and I am very comfortable with where they are from running the business on that side. These numbers will write themselves right back up very, very quickly. I'm quite comfortable with that.

Our turkey businesses, which has been strong for now several years -- the turkey business, which we have a 49 percent interest in the fifth largest turkey operation, Carolina Turkeys, is off fairly significantly (sic). Those numbers look somewhat weak, but we will see where the turkey market goes as we go into to fall part of the year.

What is very encouraging to me as we continue into this quarter and look forward is our processed meats business. Our processed meats business continues to be very strong. As you may remember from reading our year-end report, our processed meats business on a (inaudible) volume standpoint was up eight percent last year and for this quarter, we are up another six percent over that prior year numbers. What's encouraging from that is it's occurring in virtually every area, from our foodservice business to our retail business and in our deli business; all of those numbers were up significantly, and that gives me an awful lot of comfort that we are using the raw materials we have out of our slaughter operations at our highest and best use and that we're growing the base of this business in a very solid way that's going to significantly benefit us, going forward.

I would tell you that our margins on processed meats are not where they were last year this time. We did have a situation last year of very cheap raw materials that helped our margins. Our margins this year are not at the level they were last year, but that being said, they are still at very satisfactory levels. I'm very pleased -- so that we're not in a situation of sacrificing margin and in pursuit of volume. We're not doing that. We do have a strategy in place to grow the volume; we do have a strategy in place to improve our margins in processed meats, and we're staying to that strategy and the volumes are coming to us even with some of our price integrity. Just for reference, the raw material costs for the raw materials that go into processed meats (indiscernible) dramatically between (indiscernible) with delis being up about 40 percent year-over-year and trimmings being up, which is the raw material for our sausage-based products, are up 35 percent, and hams are up 20 percent year-over-year. So with those kinds of raw material price increases are awfully difficult to push through in terms of our prices at the wholesale level, but our operating companies have done a fairly credible job there trying to stay abreast of these markets and keep their pricing in line with these increasing markets. I cannot tell you today that they have totally done that, but I will tell you that, in large measure, they have done that and they have done that while they were growing their volumes. That gives me an awful lot of comfort as we look forward to the future quarters and how this business will grow -- how these results will be once the fresh meat markets return to more normal -- what I call a more normal environment.

On the hog production side, the markets were significantly better this year than they were last year. As you know, we've been in nearly a year of markets being below the breakeven point. We did have markets this year -- I guess the ISM for the quarter must have been about $44, so we were in a profitable situation in our hog production business and we had very reasonably strong numbers, although moderated in the month of July. Our raising costs are up as a result of grain increases over the prior year, and so that serves to moderate those profits to some degree. I would tell you that we had some impact in terms of the overall efficiencies at the farms. As many of you may be aware, there has been, off and on, some issues with (indiscernible) in this industry and that has impacted our numbers to some degree, but in large measure, our farming operations are running smoothly. I do anticipate, as we look forward, that the grain -- the decline in grain prices that's been occurring will help our raising costs as we look forward for the next three, six and nine months. We will be looking at that -- while we don't comment on our hedging positions, we will use the futures' markets to control our raising costs as we see it makes sense.

Two things I think that I thought to comment on this morning -- I'm sure there are questions related to that -- deal with our situation with Farmland. As you probably know, we reached an agreement in July to acquire Farmland Foods for $363.5 million. Farmland Industries, as you know, is in bankruptcy, and Smithfield has been designated as the "stalking horse" bidder at this point. The deadline for overbids is September 12. If there are any qualifying bids received, an auction will be held probably in October. In any case, our closing should take place in November. Those all assume that we receive Hart-Scott-Rodino approval of the transaction. We have looked at a number of financing alternatives for the Farmland transaction. We have not, at this point, reached any decision in terms of how we will ultimately finance Farmland, although I will tell you that we are aware of the leverage on our balance sheet and that we realize that we need to consider that as we look at financing of this transaction, and we will consider that as we look at that. We are under a very strict confidentiality agreement with our creditor committees at this point, and so we're not in a position to elaborate, to any significant degree, in terms of Farmland at this point beyond those comments.

The second transaction that is pending that we have announced is the definitive agreement to acquire 90 percent of Cumberland Gap. Cumberland Gap, you may have read in our previous release, is primarily a smoked meat company in Millsboro (ph), Kentucky that has a strong brand name, at least regionally and with some major customers in the smoked ham and sausage business. The purchase price is approximately $56 million. Ray McGregor (ph) and his family, along with (indiscernible), are the shareholders in that entity. We will be acquiring 90 percent of the outstanding stock. The family has a very strong handle on that business and Ray McGregor, who is the Founder and Chief Executive Officer today, he will be running that business, going forward, for us. He has a lot of expertise in that business and has a very strong relationship with the customer base. He will be running that business; he and his family will be retaining and the remaining ten percent of the business, and so they do have a continuing vested interest in making sure this business runs forward profitably and will be operated -- will be operated as a division of John Morrell, and as well, it uses a substantial amount of fresh hams. We have been -- from time to time -- Smithfield Foods and its subs have been, from time to time, suppliers of raw material to Cumberland. This represents another avenue for our raw materials coming off of our slaughter plants to find a home ultimately in a value-added branded processed meats product. So we think Cumberland Gap will add very nicely to Smithfield's family of processed meats and as well, continue to serve our strategy of utilizing our raw materials in our own processing operations as opposed to selling out -- selling them out as green hams.

With that being said, before I make any comments looking forward, I'll turn it over to Dan Stevens and let him walk you through some of the other financial information that you might be interested in.

Thanks, Larry. I just want to point out a couple of numbers that aren't readily available from the information in the press release. First, in terms of our depreciation and capital expenditures for the quarter and over the last 12 months, our depreciation and amortization in the quarter was 43 million, compared to 41 million in last year's first quarter. Capital expenditures were 34.5 million in the quarter, compared to 45.5 million in last year's first quarter. As you know, after we completed some of our processed meats expansion projects in the first part of last year, we began to curb some of our capital expenditures because of the poor operating results of last year. Capital expenditures are continuing to attract low depreciation levels through the first part of the year. On a trailing 12 month basis, depreciation and amortization amortization was 175 million, and capital expenditures on a trailing twelve-month basis were 169 million.

EBITDA for the quarter was 106 million this year, compared to 84 million last year. The increase reflects the $15 million of additional pretax income, higher interest expense of $4 million and slightly higher depreciation and amortization. On a trailing twelve-month basis, EBITDA is 327 million, compared to just over 300 million for the 12 months ended April. Interest expense was up in the quarter as result of a couple of things. One, our average borrowings are up over the same quarter last year. Secondly, in May, as most of you know, we issued 350 million of senior unsecured Notes at 7.75. We used the proceeds to pay down our short-term borrowings, which we were borrowing at about 3.25 percent.

To take a look at some of our balance sheet changes during the quarter, our debt increased by just over 100 million to just over 1.8 billion at the end of July. This includes our normal seasonal working capital increase, as well as it includes a fairly significant increase due to the foreign exchange impact of our Canadian dollar and Polish (indiscernible) Euro-denominated debt. Our debt to total capitalization moved up to about 58 percent at the end of the quarter. As we discussed last quarter, part of this increase was in a -- debt to total cap -- is due to the $100 million pension liability that we recorded as a reduction in equity in our fiscal fourth quarter. The financing that we did in May did give us some additional liquidity. Today, we have over $550 million of available liquidity with the availability and our U.S. and international revolving credit facilities. Lastly, there were no share repurchases during the quarter, so that keeps our share repurchase authorization at 1.2 million shares. Larry?

Thank you, Dan. I think you can see from some of Dan's comments and some of the information he gave you that we have moderated our capital spending rate and have had that in place now for I guess close to nine months. Isn't that about right, Dan?

It started second quarter last year.

When one our earnings turned downward, we were in a position to significantly impact capital expenditures. Now, there is a lag on that once capital projects are approved; it's difficult to stop a capital project in the middle, and we wouldn't want to do that. As well, I would tell you that we are not passing any capital projects that have fairly rapid payback periods, nor are we passing on capital expenditures that impact the growth of the base of this business, or meet the necessity of some customer demand that improves our relationship with the customers. So, I don't think that we are negatively impacting this business, going forward; we're just acting prudently while these earnings are at less than levels we would like for them to be. We're managing our capital expenditures and will continue to manage those until those earnings return to levels we're very comfortable with.

From a borrowing standpoint, we are continuing to manage the balance sheet. We did see a situation where we could opportunistically go out there, term out some of this short-term debt into long-term debt, give ourselves a significant amount of liquidity, which Dan just laid out to you is over $500 million. So, the Company, from a financial standpoint and a liquidity standpoint, is very solid, and I'm very comfortable with that. Certainly, we're not comfortable with a 58 percent debt to total capitalization level, realizing that that is, to a fair degree, impacted by the pension calculation. It's not that we've taken on an awful lot more debt; it's the way the accounting for the hedging liability is accounted for that drives that number to a fair degree.

With that being said, looking forward to the fall, generally, fresh pork improves as we move past Labor Day and into the fall and winter part of the year. It's generally the very strong time of the year, certainly for the fresh meat side and as well seasonally for processed meats, and we see nothing that necessarily should change that, particularly on the processed meats side as we look at the fall. Fresh pork should improve as we go forward.

On the hog production side, as you look at the futures and the October futures and the December futures, they are significantly above where they were last year. It looks like they are closing in on the $40 mark. So while it doesn't look like thee will be a big, big profit on hog production, we certainly don't anticipate the losses that we've had last year in that second and into the third quarter. It doesn't look like that's going to be the case this year; hog prices look to be stronger. As well, the impact of declining grain markets should favorably impact our raising costs in the latter three to six months, so we should see declining costs and an improving situation on that side.

Processed meats business continues to be very, very good. We have an awful lot of opportunities out there in fun of us. As I said, I've been doing a great deal of traveling and visiting with our people and I'm very encouraged by what I see on that side of the business. There is some seasonal weakness as a result of some of these raw materials today, but those are very much just short-term issues. The baseline business is very good, and our international business -- I am very comfortable will return to -- not only return but we will surpass where we have been in the past. So, if the people running those businesses for us have a handle on it that I think they do, there's nothing fundamentally wrong with those businesses at all. In fact, they are on a strong note, not a weak note. With that being said, Dan and Mr. Luter -- or Mr. Poulson and myself would be glad to take any questions you guys might have about the quarter.

Operator, we are ready to take questions please.

Thank you. (OPERATOR INSTRUCTIONS). One moment for the first question. Our first question comes from the line of John McMillan from Prudential.

Good morning, everybody.

Good morning, John.

Joe, to the extent -- were your beef operations helped by the ban in the quarter?

I couldn't understand you John.

Can you hear me now? Were your beef operations helped by the Canadian ban during the quarter?

I think so. I don't think there's any question about that. I think it's helped all the beef processes in the United States.

So to the extent that ban is -- there's so many moving parts right now. I don't -- (indiscernible due to multiple speakers).

That's precisely the point. I mean, the ban has probably helped our beef operations. There's no doubt they've hurt our pork operations, but to what degree they balance out, they're many different opinions.

Just -- because I'm trying -- what were your (indiscernible)-ready sales in the quarter? Do you have that, Jerry?

I've got it, John. Why don't you go ahead with your next question. I'll come back as soon as I --.

Just on a genetic basis, I know your hogs used to have smaller bellies, but to the extent you quoted that bellies were up 40 percent, do you feel like you've made those genetic improvements over the last year to kind of -- I think you talked about breeding in -- do you feel like you've made those genetic improvements?

First of all, John, yes. When we put the NPD (ph) hogs in about twelve years ago, bellies were trading roughly where trimmings were; things have dramatically changed in the belly market because of the foodservice producing (indiscernible) over the last decade, and what we thought would be an advantage really turned out to be a disadvantage. Having said that, we have made a valid major change in our genetics, which I don't want to go into to any great degree at all for obvious reasons -- to help correct that, and we believe these genetic changes (inaudible) help us in that area include meat quality. Larry, anything else you want to add to that?

Yes. The primary reason for changing the genetics -- and Joe is right, John; we don't want to disclose what we consider trade information, trade secrets. We have what I believe is improved the genetics for our NPD (ph) hog. We have changed some of that and that will have some impact on the belly, but it's a meat quality issue overall.

In terms of 40 percent, you do understand I was talking about the pure pricing of belly? We have that we have been a seller, we have been a seller of green bellies, and that's number one. Number two, as I know you know, John, sliced bacon -- sliced bacon trades off of the belly market, so what I was -- really was the fact that we've had to keep our wholesale prices of bellies, or bacon, up dramatically in reaction to a 40 percent increase in the raw material for bacon. Again, I think our operating people have done a terrific job. They've just not been able to get all of that 40 percent through in wholesale prices. That was the point I was making.

Okay, and just what you see in the last week since this ban was lifted or changed?

I don't think we've seen any dramatic change at this point. You know, the live cattle market has gone up in the last several days and hog prices did fall last week but they seem to be showing a little bit of strength today. These are -- this is the (indiscernible) John. I keep repeating over and over and over again, this is the nature of the business. It is cyclical and it is affected by many factors and exports and imports do affect this entire industry. That's why you do have some degree of unpredictability in earnings, but I keep going back to the same point; if you look at our earnings in four-year segments, they are just as predictable and steady as can be, but we do have unexpected swings, and that's the nature of the business. I think we all focus in too much on what's going to happen the next three months and not enough of what's going to happen in the next one, two, three years.

Thanks a lot.

The next question comes from the line of David Nelson from Credit Suisse First Boston.

Good morning. Let's start with interest expense. Maybe, Dan, that came in a little higher than I was looking for. Do you expect it to be near this level for the balance of the year, or is some of this seasonal? (indiscernible due to multiple speakers) -- I guess that depends on how you finance Farmland also. Sorry to interrupt.

That's right. Absent those two acquisitions, I would expect it will come down over time just because, as you know, we've got a seasonal buildup until January and February. The other thing that impacts it, of course, are the exchange rates, and we would expect that the dollar would probably strengthen over time against those currencies, so I would expect that that number will come down a little bit.

And you have higher hog prices, David, which -- (indiscernible due to multiple speakers) -- increase your working capital needs.

Okay. On the forecasting side, I guess that was a disappointment to me -- and some of that is clearly related to processed meat, as Larry was talking about, with the trimmings and the bellies going up. But the IDP results were actually slightly into the black, and I realize your quarters are quite the same. You do more of a (indiscernible) in June (indiscernible) April (inaudible) July, which was not a good trade for you.

No, it was not!

Do you think everything is going okay in packing here with margins like this?

David, if you look back over the last twenty years, probably we have lost money in pork operations, I would just guess, 14 out of the last twenty summers, and these things happen. Normally, when you have a poor summer, you have a fairly strong fall. That's not to say it's going to happen this year, but you know, the pork operations were disappointing but that's just -- I think they would not have been disappointing absent the Canadian situation, but that will correct itself.

I'm sorry, Joe. Go ahead.

You know, Canadian hogs -- one trend that we're beginning to see is -- and a lot of this goes to country of origin and labor -- and that looks like it's going to come in next year. But Canadian hogs now are selling at pretty severe discounts to the live hog market in this country, which has not been the case in the past. I think country of origin (inaudible) this will continue to do so. You know, that's as I see it.

Sure. But with more hogs, capacity utilization has been higher at your --.

Well, what's happened, I think, David, is that it used to be, when you had a tremendous number of hogs, you have a lot higher profitability in the packing segment because the plants were running close to 100 percent. What we have now, yes, they're running close to 100 percent but you've got a glut of too much of every protein out there. Despite the fact that plants are running at 100 percent, we're putting out more meat, beef, pork and and poultry -- (technical difficulty) -- than there is demand for. We are beginning to see some reductions in beef and poultry and pork. These things tend to correct themselves because people exit the business when they incur losses. You know, we've talked mostly in negatives, negatives, negatives this morning, but I think the key point is that we have been -- we have been probable for the quarter; our earnings are up; most of our competitors' earnings are down, and several of our major competitors are experiencing losses. You know, in light of industry conditions, I think we've done very well, but that still doesn't excuse the fact that the earnings are disappointing. But there again, that's the nature of the business and we are confident that once this cycle is over with, that earnings will get back to historical levels.

We are just trying to understand the dynamics. Excluding the Canadian hog import increase, hasn't there been -- at least some people have talked about -- more U.S. hogs coming to market that was expected. Are you a believer of that. If so, why do you think that's been the case?

Well, I think there have been less hogs absent the Canadian hogs (inaudible). If you subtract the Canadian hogs, there's no question there's been a reduction. I mean, I think that reduction is continuing because I do believe that we have an awful lot of people still out there that (indiscernible) cost in the 43, 44 cent range, which is below breakeven -- which is above -- well, it's below breakeven.

You're raising costs here in the quarter. Larry mentioned $44 (indiscernible) what you got for your hogs back. (indiscernible) I get a little higher than 37. How much do you think that might go down over the coming you're, looking at beef costs?

It will depend upon the grains and you know, the grains got down, (indiscernible) corn got down to around 221, I believe. Now, it's -- the last time I looked, I think it was back up around 240, but I do believe that the government report is long and we're going to have a very abundant crop this year, and these grains should get cheaper. Whether they do or not, it's never any certainty to it, but I think we expect cheaper corn going into next year than we had the previous year. That will reduce our costs. (indiscernible due to multiple speakers). We are still confident -- what gives us confidence during these downturns is we still firmly believe that we've got reduction costs that are lower than the vast majority of the industry. That being the case and the industry not having extremely deep pockets, that by being a low-cost operator, when we come out of the downcycle, we usually emerge stronger than we were before the down cycle, you know, started. So, this may sound strange but we have a $35 hog market for six months and (indiscernible) six months but quite frankly, I think (inaudible) help us in the next four years; it's just the nature of the beast!

Great, thank you.

David, I'd at least comment on a point or to there. Hog raising costs -- I don't want you to leave this call believing that our raising costs are $37. When I said the $44 mark, that's the Iowa/southern Minnesota, and I was just checking while Mr. Luter was speaking, and I think it was 44.40 or something like that. In fact, as you're probably aware with grade meal, you sell hogs at a premium to that. So, the market in terms of the sales price for the animals we sell is more like 46.5. Our raising costs are not $37; in fact, they are $40 and even a little above that. So, I don't want you to -- and that's got some -- (technical difficulty) -- you do have some hedging that impacts that number both ways, both up and down. But I don't want you to leave this call leaving that our raising costs are $37, because they're not. We did receive more than $44 for the (inaudible).

I got you. Thank you!

Christine McCracken from Midwest Research.

Good morning! A couple of things -- one follow-up. Is it your view that with the situation in Canada that there's been any contraction in production up there with the very poor returns that they are seen?

I don't have any information, Christine. Mr. Luter might.

You're talking beef or pork, Christine?

Sorry, on pork.

On pork? We haven't seen it yet. I think you are going to definitely see it in beef. Canada has the same problem; there's one reason that we decided to exit to some degree in the fresh meat business in Canada. I remember when we sold a fresh meat plant several years ago, and while we've not been very active in acquiring anything in Brazil -- and that is, anytime you have an industry that is very, very dependent upon the export market and with food safety issues and politicians being politicians, it can turn into a disaster when a big percentage of your production is dependent upon the export market. That's what Canada is going through right now and that's what the poultry industry went through when Russia put the ban on (indiscernible) poultry (indiscernible) a year or so ago. That's just -- that's just the weight is, and that's one reason that we have never invested a lot of dollars in any any business that is heavily dependent upon the export market to survive.

Is it possible too, with this situation, that in fact U.S. producers might wait to expand their herds? Certainly we've seen the drop in -- (indiscernible due to multiple speakers).

Yes, I think (indiscernible) liquidation is continuing and you know, as I said just a couple of minutes ago, Christine, if you do continue to have weak prices where it will hurt us in the short-term, I think it will help us in the long-term, but I don't see anyone in the United States expanding production. We're certainly not, and we have told everyone that's interested that we do not plan to increase hog production in the United States. We may buy some existing assets, but we're not going to add capacity when we think there's already too much capacity out there.

Excellent.

What we're going through right now is no different than what we've gone through every four years for the last 100 years.

Well, it is different to the extent that Canadian (indiscernible) certainly depressing (indiscernible).

That's right, but I've told you that are discounting these Canadian hogs to the point where they are raising these hogs on a loss. You've got the same economics coming into play as coming in the United States. I guess the key question is, are you going to have the Canadian government to bail out agriculture in Canada? Again, politicians are politicians, but here again, you get into all kinds of trade issues if that begins to take place. I will say that this country of origin labeling, although the vast majority of the industry in this country would like to see that requirement go away and philosophically, I disagree with it also, because I do believe in free trade. But Canada has had country of origin labeling for many, many years and the result has been we've not been able to ship fresh pork into Canada because it has to be labeled as imported rather than Product of Canada, and -- (technical difficulty) -- Canadian consumer -- (technical difficulty) -- discriminates against product that does not come from Canada.

So you know, the position of Smithfield Foods, which is different from most of the industry, is that we think country of origin labeling in the United States should stay in because the Canadians have had it for a number of years, as I just said, and there's no question in my mind it will help hog prices in this country. So, having said -- as I said earlier, philosophically, I'm against it but for purely selfish reasons (indiscernible) Smithfield Foods Country of Origin labeling would be very, very good for Smithfield and all hog producers in the United States. (indiscernible due to multiple speakers) -- except the ones that are totally dependent upon the feeder pigs coming in from Canada.

Separately, Larry, you had mentioned, on your international operations, that you had some seasonality issues with Europe. Are you referring to France, Poland? In the release, you actually highlighted Canada and Poland as being weak. Can you go into a little more detail there?

Quite honestly, Christine, it was Canada and Poland, and France is down a little bit, but that's a rounding.

Let me just jump in, Christine. Keep in mind that the cattle market, in my understanding, has gotten down as cheap as $20 a hundredweight because of the glut of cattle. Obviously, all of the retailers have jumped on these very, very cheap beef prices in Canada at the expense of all the other proteins, and so that has hurt pork sales in Canada very, very significantly.

So that's in Poland specifically that we would actually turn the corner there. (Indiscernible due to multiple speakers).

Well, we have turned a corner, but here again, you can turn the corner and have seasonal downs at the same time, Christine. (indiscernible due to multiple speakers). We expect -- I mean, I can't speak for Larry, but Larry was in Poland a couple of weeks ago and he came back and yes, (indiscernible) down in Poland so far this year, but the management over there has assured us that their earnings will in fact be up with the year despite the current weakness.

Thank you.

Our next question comes from the line of Jonathan Feeney (ph) from Wachovia.

Good morning! A quick question for you, Joe -- you alluded earlier to the value, the long-term value of actually having down parts of the cycle and then being able to indicate the potential strength (indiscernible) market -- (technical difficulty). I gather that's what you were talking about. If you -- (technical difficulty) -- 97 or 98 or so hog cycles in the past 30 years, how does this one -- you know, assuming we come out of this Canada situation in the next couple months and kind of resume a (inaudible) upward, how does this hog -- this kind of bottoming of a hog cycle compare with others you've been through?

I think this cycle is pretty close to the ones we've had in the past except for 1998. 1998 was a severe cycle where hogs got down to roughly $10 a hundredweight. But in that situation, you ran out of shackle space, which caused that. But this cycle I think that we've gone through this past year resembles the cycles of '94 and '90 and '86, and '82 more than '98. You know, you see what happened in '98; it was very down, but look what happened in 2000 and 2001. We had tremendous profits in hog production. I don't have the numbers right at my fingertips. Larry, you might have it, but we bought several of the large hog producing companies after the '98 cycle. We pretty well paid for half of the purchase price in the next 2.5 years. Am I correct, Larry?

That's right, Joe.

In fact, we believe we are looking at some additional assets now. As I said, not new production, but people that have got high costs and they are in the business but are not in it as efficiently as they should -- as they could be. We bought some assets despite the fact of apparent losses in that segment of that business. (indiscernible) in the West is an example of what we did three or four months ago.

One question on Farmland -- clearly, animal prices have come back much more quickly than wholesale and retail are kind of willing to accept. Do you think that the rationalization -- (technical difficulty) -- into the hands of a rational players of preferably Smithfield (inaudible) going to have a positive impact on the ability to take wholesale pricing and kind of restore those margins? Or do you view this kind of correction (indiscernible) narrowing of margins year-over-year in processing as getting back to business as usual?

Well, I think that there will be -- as you become bigger and you are a player, there tends to be more discipline that takes place. We've seen that in the beef segment, and I think that would be true also in the pork segment.

Do you think the effect on the industry as a whole will be --?

I think it will be positive. I think it will be positive, and I think it will be positive for the hog producer and I think it will be positive for the meatpacker -- absolutely. I think anytime that you bring more discipline to an industry, I think it's good for all concerned.

Okay. Well, thanks very much!

Our next question comes from the line of [Tim Rainee] from D.A. Davidson.

Good morning. I just wanted to follow up on the percentage of product in your processed meats area that you now market under your own brands and how much you are able to sort of forward integrate? That's been a continual focus of yours and the Cumberland Gap acquisition certainly plays to that.

we've got -- from our standpoint, if you look at the -- Dan may have that very handy -- if you look at our 10-K -- (technical difficulty) -- beginning of that how much of that goes into -- how much of our business is now processed meats versus how much of it is fresh pork; there's a nice chart -- (technical difficulty).

I guess I was just hoping for an update.

From that standpoint, I don't know that we have done that number for this quarter, but I will give you a reference point and then make a comment. We were 51 percent processed meats, 46 percent fresh pork at the end of the fiscal year. Our processed meat business is up six percent, and our fresh pork numbers -- are the off, Dan, five percent?

No, they're down about one percent.

Some of that fresh pork, volume being down, is fresh pork being diverted into processed meat, so it's the proper mix that continues. That 51/46 and the last three percentage is byproducts, but that 51/46 processed meats continues to trend upwards, if that answers your question.

Great. Then, with regard to your capital expenditures, you mentioned that you are not reinvesting in any new capacity for hog-growing. Can you talk about two things? One, the impact of the tax -- the accelerated depreciation for small farmers, and whether you're seeing small farmers investing? Second, you know, kind of a quick outline of where that 170 million was going if it wasn't going into hog farms?

I guess -- let's start. Let me make a comment or two and then Dan and Mr. Luther can both have their comments. Let me make one comment from a Smithfield side. We aren't making CapEx decisions based on tax law; we make decisions based on business decisions. I want to say that fundamentally.

Returned of investment.

That's right.

That's the only criteria we really use unless we see a big opportunity in the sales area, but we make capital expenditure decisions based on what is going to be our return on that invested -- additional invested capital.

That being said, what are small farmers doing out there? We are not interesting in growing (indiscernible) in this country, so we are not investing in new (indiscernible) production in this country. I don't know -- certainly, every indication from pig crop report is that the rest of the industry is not investing in it either. So, I don't think I have any indication from our standpoint. Joe, you may have better information --.

No. There's no question; the small people are not -- (indiscernible due to multiple speakers) -- growing in that area. There's no question about that.

That being said, now your question is where the $170 million of CapEx that we spent go. The largest single one that comes to mind very quickly is our investment in our (indiscernible) bacon operations in Milwaukee, Wisconsin, which has been a growth end of the business for now a number of years. We continue to invest fairly heavily in that end of the business because the opportunities for margin are very strong and the opportunities for the customers to migrate from raw bacon to pre-cooked bacon, particularly on the institutional and foodservice side, is very strong. We continue to put substantial dollars into that end of the business and will as long as the opportunities still are there. They are continuing to be there. Dan, I don't know if you can address it better than that?

Well, I guess the other thing we have in there -- when you are talking about 179, that's on a trailing 12 basis, but that would include some pre-cooked (indiscernible) capital expansion; we've got our capacity expansion. We have put some money into hog production in Poland, not here in the U.S. but we have in Poland. As well, we've also increased some bacon capacity, so those are kind of major products.

Thanks for your help.

Our last question is from the line of Andy Wolf from BB&T Capital Markets.

Andy Wolf. Thank you. I joined the call a little late. Could you folks comment on your outlook -- obviously, provisional as it is -- on when you think the USDA might lift the ban on Canadian cattle into the U.S.?

We did not make comment, Andy, I will say that and I'll let Joe respond, but I'm not going to begin to quite speculate on that. (Indiscernible due to multiple speakers) -- read everything and I don't have an opinion. Joe, maybe you do?

My opinion is worth nothing on that. You start trying to predict what the government's going to do, you're on very soft ground!

Yes. Folks in Washington who you might say something to (inaudible) option -- I mean, obviously I think it's a very critical question -- (indiscernible due to multiple speakers) -- the earning stream this year. Anything you have to add would be very useful.

(Indiscernible due to multiple speakers) -- here again, I just don't -- you know, you talked to different people, you get five different opinions. Obviously, (indiscernible) then no telling what would happen, so when you have a situation where you can have one cow can have this kind of impact, only an idiot would make a prediction of what's going to happen in the next twelve months. I mean, I hate to not answer your question, but I don't think there's an answer to your question.

That's fine. I agree that there's a lot of variability as to what the outcome might be. The other question I had on the Canadian situation -- you mentioned, in your release, that you had an influx of fresh pork. We track the hog side of it, so we see what's going on there. We assume it's more from the hog side, but is fresh pork now coming in from Canada at an accelerating pace -- (indiscernible due to multiple speakers)?

I'm glad you asked because as I mentioned earlier, all the retailers in Canada are emphasizing beef because they are buying beef so cheap, compared to what they had bought it for in the past. There's just a glut of Canadian beef and they are able to buy it very, very cheap and make extremely long margins on it. Here again, these are the Canadian retailers. Of course, that comes into the expense of all the other proteins. (inaudible) only eat so much meat, regardless of whether it's poultry or beef or pork. (indiscernible due to multiple speakers).

I think the key thing -- I think we are dwelling on too many negative situations. This will correct itself. It has obviously helped our beef side; it has hurt our port side, but these are temporary things, in my judgment -- and I've been in this industry a long, long time and I guess that's why I'm still alive, because I learned to accept these changes that take place in the industry. But there's no question, it will correct itself. The big advantage you have in Smithfield is that we are in beef; we are in pork; we are in hog production; we are in international. Despite the fact of a disappointing quarter, our earnings are almost double last year and very few people can say that. Yes, it's all on the hog production side, but here again, that was the big problem last year. It's not so much of a problem this year and there's no question that in the next two or three years, even this year that we are in, that we will see, in my opinion, dramatic improvements in hog production profits. We will probably see this conversation six months from now. We will probably seek beef earnings come down; we will see pork earnings go up; we will see international earnings go up, and we will see hog production go up. That's probably what we will be talking about six months from today. You know, but you have -- you have certain things that can happen that can change all of that, such as one diseased cow in Canada, which is totally unpredictable. But this is an industry that, despite its cyclicality, it's an industry that does have very, very predictable earnings. If you look at longer periods of time, people do eat, and there is not going to be any new technology that's going to come out to hurt this industry. (indiscernible).

We agree. Obviously, until late in the quarter, I think what you're saying is what we will be talking about in six months or so was already occurring, so hopefully this Canadian situation gets cleared up soon.

I think we will be talking about completely different ups and downs in six months from now, but that's the industry.

Lastly, on the average unit selling pricing, the pressure you saw there -- I guess I was little surprised. It sounds like from your press release, it was as severe in processed meat as in fresh. Could you give us a little color on that?

I think that's true; I think that's true with everyone in the industry. In fact, while I've been sitting here during this conference call, I just got a fax (indiscernible) results, which are down for the quarter, and it's predictable because of the problems in the turkey industry and because you've got higher raw material. So, I think anytime you have higher raw material costs, usually you have margins that come under pressure for the short-term until the adjustments take place.

I think a little bit of that is the function of how we calculate that average unit selling price. What we do is because we don't have a good breakout of sales by fresh and processed that at the time of the press release, we just calculate an average selling price based on total fresh and processed sales. So, if it says that the increase was only half of the increase in raw materials for both fresh and processed, it's because the calculation itself is based on total fresh and processed sales dollars (inaudible). That's not the same necessarily (indiscernible) it was attributable to (indiscernible) fresh and processed. I would tell you that we did improve our product mix and our customer mix in the processed meats, so it's probably much more heavily weighted towards the fresh meats.

For John McMillan, just coming back to his question, the (indiscernible) volumes are off a little bit; they were 14 million pounds, down about four percent from last year's first quarter.

As the hour has come to a close here, Joe, we would like to offer you the opportunity to make some closing remarks, if you'd like to?

I don't know if I can make any closing remarks that would be any different than what I've expressed in the last hour. That is that you have to always keep in mind when you invest in this industry that you have to have the discipline to look at long-term trends and not short-term trends. That's the way we run the business and that's the way we think is the correct way to run the business; it has served us well in the past and I think it's going to serve us well in the future. If you look at what Smithfield has been able to do in the last 25 years, it's well above the S&P 500; it's well above the industry. Despite glitches -- temporary glitches that happen in one segment of that business, we're not going to deviate because of short-term phenomena such as one diseased cow in Canada. You know, we will get over it and we will survive and we will prosper and I think we'll do as well in the future as we've done in the past.

Thanks, Joe. Thanks, everyone, for joining us today. Good bye.

Ladies and gentlemen, that does conclude our conference for today. Thanks for your participation and for using AT&T Executive Teleconference. You may now disconnect.