Smithfield Foods Inc (SFD) 2005 Q1 法說會逐字稿

Thank you for holding and welcome to your conference call today with Jerry Hostetter. Today's call is being recorded for replay and transcription purposes. And in order to hear the replay, you would dial into 1-800-252-6030; they will ask for an identification number, and that number is 25-73-1456 and the replay will be available for one week. And also, we will be collecting questions throughout the conference. (OPERATOR INSTRUCTIONS). Thank you for using Sprint conference service. I'll turn the call over to you, Mr. Hostetter.

Thank you and good morning, everyone. Welcome to our conference call to discuss Smithfield Foods' fiscal year 2005 first-quarter results. We would like to caution you today 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 2004.

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 With. Luter III, Chairman and Chief Executive Officer. This is Jerry Hostetter, Head of Investor Relations. Larry Pope will begin our presentation this morning with a review of operations. Larry?

Thank you, Jerry. Good morning ladies and gentlemen. I am pleased this morning to report that Smithfield Foods is reporting another very strong quarter for the first quarter of fiscal 2005. This represents I believe five straight quarters where we have reported very significantly improved earnings compared to the same quarter in the prior year and we're very pleased with that. This represents a continuation of what we see as an overall improving environment for the industry and for Smithfield, in particular. As you look at some of the information we've given you in the press release, you will note that sales are up better than 30 percent between years. That represents the inclusion of Farmland Foods, which was acquired at the end of last October, early November, and that represents about 70 percent of that increase. The remainder represents sort of a price increase that has been affecting (ph) all of the pork products that are up year-over-year, so that's a couple hundred million dollars of that sales increase.

As well, our gross margins have improved from 8.9 percent last year to 9.7 this year. Importantly is the segment profits, which you see, and I will not go over that with you. You can see that our net income is reporting at 54.9 million versus 17.6 million from continuing operations last year. Just to remind you that discontinued operations represents the results of Schneider, which all of you know at this point, was sold in last quarter, so that is being reported separately as discontinued operations.

Our earnings per share for the quarter were 49 cents per share compared with 16 cents from continuing operations last year. The net income and the earnings-per-share numbers are both three times those of last year. And overall, we're very pleased with the results for this quarter.

As we look at the numbers, our hog production operations, which have been part of the drag on earnings for some time, are contributing very strongly to the earnings of this quarter. You are all aware of the increase in live hog markets that is out there -- 20 percent for the quarter resulted in us reporting a significant increase up to nearly $100 million in operating profit in hog production. The big difference in this year’s first quarter compared to previous years is the meat processing group. Traditionally, when hog prices are at these levels and the hog production operations are this strong, we anticipate that our meat processing operations will be very poor. In addition, the first quarter of our fiscal year is always or nearly always the weakest quarter in the year in the meat group as the demand for the meat is simply soft in the summertime. The combination of the summer months and these very high hog prices would traditionally lead us to believe that we would have very poor results in our first quarter. That was not the case this year and we're very pleased with that. We've been talking about for some time demand for pork, given the reduced supplies for beef and the overall demand for proteins, and these numbers are spelling out in spades how the demand is showing up, even in the weakest quarter of the year, and that gives us a lot of comfort. As we look forward into our second, third and fourth quarter, these demand situations continue to be quite good.

You will see through the numbers that our beef numbers are quite soft and just barely profitable at the operating profit level. Most of you are fully aware of the situation in the beef industry with the export markets closed and the Canadian border closed, and you're very much aware of the impact that is having on all of the domestic U.S. beef processors. Most everyone is unprofitable in the beef business. At some point, that situation will clear and we will return to what I consider more traditional and more historical levels, in terms of beef profitability. For the near-term, we are simply going to have to live with the situation as it exists, continue to wait for these markets to correct, and then I think our beef operations will be back on a steady-state there.

I have no concerns about the operating levels and the operations of our beef operations. We are quite competitive with anyone else in the industry. So I think we're not making any missteps from a management standpoint, we're simply living in an environment that we're having to deal with.

We made a few comments about our international operations. They did have a soft first quarter. I laid that out in the press release, so I won't go through that, except to tell you that we as a company continue to be very optimistic about what we see outside the U.S. borders, in terms of opportunities within our existing operations and even expansion of those operations. And so I believe going forward that's going to be an important part of this company's growth and an important part of the contributions to the bottom line of this company. I'm very excited about that.

I will talk just a minute, because I know that is the subject of the day, in terms of our hedging activities and our commodities positions. We traditionally have held very firmly that we do not want to get involved with quarter-to-quarter discussions of where we stand from a hedging standpoint and what we're doing in the commodities market. I want to be very clear in saying that we count that as an integral part of our business, particularly on the raising (ph) side of the business. We are routinely in those markets. It is part of our business strategy. This quarter, we tried to lay out in some significant detail for you, given the magnitude of the numbers and the fact that there was a lot of discussion when we outlined where that the fact that the earnings for the quarter were not equaling your expectations. In our pre-release, we felt that we should give you more detail in this press release, and we're doing that. And I hope this is helpful to you in understanding how our quarterly results -- how they were developed and why they differ from what you were projecting some several weeks back. But one thing I do want to be very clear about -- we are not setting a precedent here, in terms of outlining quarter-to-quarter how we are doing, because we consider that proprietary information and we do believe that it could compromise some of our activities and some of the benefits of our hedging activities and we do not want to get ourselves in a position where we're having to tell everyone, including our competitors, how we are positioning ourselves from a hedging standpoint. And we consider that very important to our operations. And as I have said to many people, you can judge us on the numbers. We count hedging as simply part of our operation and you judge us at the bottom line. Sometimes, we'll guess it correctly and sometimes we will make a mistake. And I stand pretty firmly for this quarter, while what the numbers are significant. I think the management decisions we made this February and March were based on very sound thought processes and very sound judgment, and I feel very comfortable with decisions we have made.

Clearly, we did not anticipate the demand level to reach the point that it did this summer. We saw those higher numbers of hogs coming, as well as higher grains (ph), and we did have some concern about the profitability of our hog production and we saw an opportunity to put some significant money in the bank. And even given the losses we're reporting in this relates, I'm still very proud of the fact that we produced $100 million in operating profits in our hog production operations and our first quarter was nearly a record for this company. So, even giving those hedging activities that many have made comments about, we still produced a very strong first quarter. And I stand on our management decisions, in terms of our thought process and the decisions we made earlier this year.

In terms of the business, the first quarter is generally soft. Most of the information we gave you indicates that our business from a volume standpoint is flat, maybe 1 percent one way or the other. This is not the quarter when our business is really strong. The belly markets, certainly as high as bellies have gotten, may have had some impact at the retail level on sliced bacon. But our foodservice business continues to be flat to slightly up. Our deli business continues to move along from a volume standpoint very nicely and our export business, as everyone in the industry has experienced it, is very robust with our quarter and exports up 22 percent. Again, the rest of the industry is experiencing that and I think that export demand is helping all of us to report much better fresh pork results for the quarter.

In terms of our processed meats business, it's very solid. I would tell you that our margins quarter-to-quarter do not equal the margins we saw last year. It has simply been impossible from a business standpoint to keep our pricing -- keep our pricing levels moving at the pace at which these raw materials have increased. Even giving the level that these raw materials are routinely in the summertime, we have seen not only double-digit increases, but very significant double-digit increases in terms of -- probably just for the raw materials, whether that be hams, whether that be bellies, whether that be ribs or butts -- all of those commodities are up very significantly. And I think that you've probably heard from all of our competitors that there has been margin pressure in terms of trying to keep up with these rising raw material costs. With that being said, I think our organization has done a good job of continuing to be profitable in the processed meats side of the business in spite of all of that.

One point of note is that from a hog processing and slaughter level, we actually processed 3 percent less this quarter when adjusted for the farmland inclusion from last year, and that's part of a decision we made during this quarter to manage this business for margin. I think our numbers reflecting the fact that we have gone from an $18 million loss last year to a $22 million profit this year; I think that was a good decision. Others have indicated that they increased their slaughter levels; we did not increase our slaughter levels. And I think that benefited our sales and I think that has benefited this industry by our being disciplined. And I think that's part of our management strategy and I think it helped at the bottom line.

But from an overall business standpoint, the quarter was exceptionally good. The decisions that we've been making in terms of learning the business from my standpoint as I see them have been very solid. And I think we have a business that is in place, ready to capitalize once the beef business turns around. And I think our international business will be much stronger in the last nine months than it has been in the first three months. And as well -- I won't give you quite my forecast for the remaining three quarters until after Dan Stevens has gone through some of the more financial information I know you guys are all looking for. But I will come back to that and speak to it in terms of the nine-month look forward after that. Dan, let me at this point turn that to you.

Thanks, Larry. Good morning everyone. I'll just -- want to cover some of the key financial highlights that Larry didn't mention in his opening remarks.

Larry talked about the earnings-per-share increase as well, the sales increase. Sales obviously up the significantly over $670 million, most of that due to farmland, as he said. Our selling prices were also up in the pork segment and we also had some favorable currency impact in our international operations.

Our SG&A increased some 25 million, which you can see on the press release, and that's due to exclusively to farmland. Interest expense remained about the same as the first quarter of last year, and that's despite the fact that we do have higher debt levels than this year’s first quarter. It's really a function of two things. First, it's simply a higher proportion of floating-rate debt in this year’s first quarter with the paydown of our scheduled maturities of higher cost fixed-rate debt over the last year. And the second is lower pricing in our floating-rate debt this year. Most of our floating-rate debt is on a grid pricing basis. So as we improve our leverage and coverage ratios on the balance sheet, we're also improving our variable borrowing costs. As well, we're also continuing to see the favorable impact of the interest rate swaps that we did last year where we swapped fixed into floating-rate debt.

I would mention that shortly after the end of the quarter, we did close on a $400 million bond deal to take advantage of the favorable market conditions and to free up some liquidity. We used the proceeds from the offering to pay down the revolving credit facility, which at the time was close to the $600 million drawn (ph). In terms of an impact on interest expense going forward, the bond deal was priced at 7 percent. So given where today's short-term variable rates are, they will be close to 400 basis point increase and interest cost on the $400 million going forward.

Our depreciation expense in the quarter was near $46 million compared to 38 million in last year's first quarter. Liquidity and amortization with operating profit of 111 million as we disclosed in the press release. Our EBITDA was 158 million for the quarter, compared to 93 million last year.

Taking a look at our balance sheet, our capital expenditures were 35 million for this year's first quarter, compared to about 30 million last year. Although our CapEx is continuing to run behind depreciation for the quarter, we do expect that trend to reverse here year later in the year with some of the capital projects relating to the bacon strategy and some other processed meat expansion and production improvement projects. Our debt level at the end of the first quarter increased to just under $2 billion, which is about $150 million up from the end of the fiscal year. Most of this increase is attributable to seasonal increase in working capital as well, the acquisition of Jean Caby in France and the timing of income tax payments and pension plan contributions.

Our debt to total capitalization actually increased slightly from 53 percent at the end of the year to 55 percent at the end of the quarter because of the increased debt levels and a reduction in other comprehensive income in the equity section of the balance sheet.

One of the reasons for the reduction in equity was our increased investment in Campofrio, which actually took place just after the end of the quarter. As most of you have probably seen from the press release, in early August, we increased our investment in Campofrio from just over 15 percent to just over 22 percent. Going forward, this benefits our P&L because we'll be picking up our share of the earnings of Campofrio where before, under the cost method, we were only recognizing our share of the dividends. It does, however, have a short-term negative impact on the balance sheet because changes in the share price of Campofrio were going through other comprehensive income in the balance sheet and not the P&L and these gains had to be reversed when we switched over to the equity method of accounting, which we did retroactively for the first quarter.

As well, we had the hedging losses that we talked about in the press release do have a short-term negative impact on the equity section of the balance sheet. And the bottom line is that, even though we had net income of over $50 million in the quarter, there was not a significant change in equity in the balance sheet for the quarter.

Finally, our liquidity after we closed on the $400 million bond deal stood at just under 600 million. And during the quarter, we did not have any further treasury share repurchases and the current share repurchase authorization still stands at 1.2 million shares. If you have any other questions on the financials, then we can cover those during the Q&A. And with that, I'll turn it back over to Larry.

Thanks, Dan. I will turn my attention at this point to our view relative to the remaining three quarters. We're certainly a little ways into our second quarter at this point. Traditionally, the fresh meat margins continue to improve as we come out of the summer months and into the fall months and early winter. We fully expect that to happen this year, although we are not a prognosticator and so often these numbers move around. The futures markets, as you can tell, have softened somewhat in the last several weeks, although they continue to indicate significant profitability in our live production operations. The live hog market today is about $53 and that continues to be very profitable on that side of the business. All of the meat cuts have softened this week, but they continued to be quite strong relative to historical levels. So as we go into the fall season, I am really quite bullish. Some of the trends that we were seeing from a negative side in the first quarter, in terms of our retail bacon business that had fallen off but with bellies reaching $1.20 a pound; those bellies have now fallen back into the low 90s and we're seeing very sharply renewed interest in the retail bacon business. And I think that business will be very, very strong. I think we have mentioned on a number of occasions that we have a strategy in place to use our fresh bellies and to produce bacon, rather than to sell bellies. I think we're going to have that opportunity again and again and again from both the retail and the foodservice side. And as these belly markets have moved to more normal levels, I see that emphasis really showing back up, and I think that's going to be very, very good for us.

I think it's going to be a good fall season for us. Freezer stocks are going in lighter. In terms of our raising operations, I don't want to get into so much detail, except to tell you that we continue to look at these grains which continue to be heading in the right direction. We will seize the opportunities to lock in our raising cost at levels equal to or below our raising costs today. And from this point forward, our raising costs should be going down, not up. So I think from a production side, we've seen the peak and I think that we will see improvement in that area. So I feel very comfortable on the raising side of the business that we have our cost under control. From an overall standpoint, I think that we are going into the better part of a year. I think that should benefit us well. We don't see the demand falling as some have indicated. We don't really see that happening. Although, it is anecdotal information, I don't believe there is any information out there that I've seen from any studies that says whether the Atkins diet or the protein and a low-carb situation is dead. So I think it all bodes very well for us. Most of the business parts this quarter that were not doing as well will certainly be improving. The exception to that that seems to be a wild-card is the beef business. And that is certainly not performing at the level of last year and not performing its historical levels. And that will go where it will go. And we will be part of the industry change as these borders change, although I guess it's not going to be, as I heard yesterday -- not going to be any changes in the Japanese markets now until after the first of the year.

With all of that said, I'm very optimistic from a business standpoint. I think we have everything running in the right direction and I think that we will benefit as we move into season and I see a very bright next three quarters for this Company. With that being said, we would be open to questions. Mr. Luter is on and will be available for any of your questions.

David Nelson.

The detail you provide is very helpful. I guess I would like to type into that. First, I want to understand what it means and make sure I avoid or know what it doesn't mean also. Because these markets are very dynamic moving targets. The October hog futures have just gone from 70 to 63 since the first of the month. And I want to understand what that 35 million of impact you're talking about in the release really is. Because you look at -- you talk about 47 million you left on the table in hog production, but that you had a 28 million positive on the grain side. And as I look at that 35 million that you left on the table for hogs for Q2, then I also see a 12 to 15 million positive on the grains side. So if 47 minus 28 and 35 minus 15 are 19 and 20 respectively, I know it's a long question -- sorry about that. Does that mean, does that imply in any way that you expect hog production and profits in Q2 to be anywhere roughly comparable therefore to Q1?

Let me see if I can answer it. From our standpoint, the first quarter -- and let's talk about hog production before we go to the grains. In terms of hog production, we essentially put commodity contracts in place and we have lifted those hedges. Those are not open positions, so our gain or loss on that has been realized. But according to the accounting rules, if you know those rules very well, and Dan might could explain it better than I could. But we have to assign -- at the point in time we take on a commodity contract, we have to assign the month and the period that the delivery of the hogs related to that contract applies. So by definition, regardless of when we lift our hedge, we have already assigned that profit or loss to a distinct period. And our hedging period we were looking at was mid-May to mid-September. And so, even though those contracts have been fully closed and realized, the actual gain and in this case, the loss on those commodities, will be spread over the period May 15 to September 15. And so we have taken part of those in that July 30 period, and the remainder of those will be reflected against the result of hog production to this point. At this point, we're realizing the actual cash markets on the live hog market. That's what's going through the P&L today with those "deferred losses" coming through the P&L through September.

I hope that -- I know that was a long answer. It was a long question, mine was a long answer. I just want to be clear, in terms of what that is. It is not open positions. In the case of grains, we don't know where the grain market is going to ultimately play out over that period, so we don't know where our hedge is going to be relative to the markets, if you know what I mean. That's why there is a little bit of iffiness in the grain side. So now you're asking the question -- are we going to make the same profit in the second quarter in hog production that we are going to make in the first quarter? Well, I don't know that I believe that the live hog market is going to equal $57, which is what it was for the first quarter. So from my standpoint, it's probably not going to be as strong a hog production P&L going into the second quarter. I don't know if that answers your question or not.

Larry, this is Joe Luter. Let me jump in for a second also. As you well know, David, usually the hog prices go down substantially in the fall and hen begin to rebound in late December going into the first part of the year. I think it's a good chance this year that is not going to happen for one reason. Because of the very, very high hog market this summer, people have marketed ahead, and certainly Smithfield has marketed ahead. And the average weights today are much less than they were in August of last year. And what we're trying to do is to eliminate some of the glut that traditionally takes place in October and November. The plan is to, when the glut comes in October or November, is to hold the hogs back and build the weights back up to 260, 65 pounds. Right now, we're marketing hogs in the 245 pound range. And so here, again, I cannot predict what hog prices are going to be. But I think you will see a fairly -- I don't think you will see the real peak in hog supply this fall that you have seen in previous falls. And this is one of the benefits that we have by having such large hog values and a number that we can try to level out the supply over the 12 months, rather than have any peaks and valleys, which really have not served this industry well historically.

If I could follow up on that hog weight question, then I want to move onto beef, please. Looking at the USDA livestock slaughter report from August 20, and this refers to the month of July, and that says the average live weight, at least on a national basis, was unchanged from the previous year at 262 pounds. Does that mean the Smithfield animals you're raising are 245? Is this the Company's specific issue you're talking about?

The hogs that we're raising, yes, we've dropped the weights down, but we're looking at our overall weight we buy. As you know, we buy approximately 50 percent of our hogs on the outside too, David, but we are seeing the hog weights lighter, even the hogs that we do not raise that we're buying on the open market.

USDA is not showing that, and I'm trying to understand why what you're saying is different than --.

I think it started in -- I can't answer government numbers. All I can tell you is that government numbers quite often are not correct.

Okay. If I could move onto beef, then. You cited the low cattle supplies as well as exports as an issue. But the beef herd supplies are probably going to stay down for quite awhile, but there are some signs of dairy herd rebuilding and obviously you have packer land in Wisconsin. If the dairy herd rebuilds faster than the beef herd, would that be a positive for your beef operation?

Yes, it would. And if Rich Vester (ph) was on this call -- and Rich, you know, he runs our beef division -- he would tell you that, normally, when you have short cattle supplies on fed cattle, you don't want to get the same impact on the dairy herds that you have on the fed cattle herd. So I think it is correct that we expect the dairy -- the profitability on the dairy herd business should be better than the fed cattle during this low slaughter level, David. And that has always been true in the past. Keep the mind, though, we do process fed cattle also.

I will follow up more afterwards. Thank you very much.

Christina McCracken.

Good morning. Following on Dave's question relative to beef, obviously, you commented, Larry, on the markets to Japan remaining closed. Have you heard anything on Canada and what that might mean? What's built into your expectation I guess for the balance of the year, relative to supplies of Canadian cattle coming into the market?

Christine, I have not heard anything on the Canadian markets of late. Dick Poulson, you're on the phone. Dick, have you heard anything?

No, I have not Larry -- just what we all read in the, press which is sort of nothing at this point.

That is right. And so I point to that Christine. That's why we have -- in terms of what I call the one wild-card in our earnings is that we cannot control these industry issues affecting the beef side of the business. We simply cannot do that. And at this point, it doesn't look like this Canadian border is opening soon, but I don't have any more intelligence on that than you do.

But technically, things should not get any worse at this point, given kind of steady-state supplies of cattle?

I guess I would say that is right, Christine. I guess I would say that is right.

And then just on the hog production side. Obviously, there's a lot of hogs out there. You've talked about the market's ability to absorb that, those pounds. I guess I'm interested in knowing some of your, or one of your competitors just this week talked about somewhat softer protein demand -- I'm talking about weaker foodservice trends, maybe tied to economic weakness and maybe even some softening in the protein diet trends. I'm wondering -- you kind of commented I guess somewhat to the contrary -- still seeing very strong demand. Can you talk about that a little? Have you seen any softer trends and do you expect the market to continue to be able to absorb those pounds?

Presently, the hog slaughter numbers are running 395 to 396, 397,000 hogs per day, Christine. This is here in the third week of August. And these are very, very high slaughter levels for any time of the year, particularly August. And the product is moving out extremely well and there has been very, very little sales resistance to these high volumes. Now primarily, I think it is due to two factors. One is the export demand and the second is, there is a lot last beef in the country. And when people not eating beef, they switch to poultry and to pork. Why we think in the pork sector that our earnings are going to be very good for the next 12 months, perhaps 18, 24 months is without question, you will have a lot less cattle coming to market.

If you talk to the people in the feedlot business today, they are marketing these cattle at heavy weights. They are not rushing the cattle through and there's not many cattle behind them. So we do see shortages of cattle for an extended period of time. Now while this will hurt our beef operations, it will certainly help our pork operations and help our turkey operations. But there is no question that I think you're going to have shortages of beef. You've already seen one packer -- here again, this was a co-op packer in Iowa that went out of business just last week -- and you have a couple of other vulnerable players that will be -- there is no question in my mind -- that beef earnings domestically are going to be under pressure. The people that have the plants in Canada are doing extremely well right now because the live cattle market is substantially below the live cattle market in the U.S. That is a long answer, but that is that is as we see it.

So beef obviously is going to -- the supplies of beef are going to stay low. But export demand technically with Japan putting on that (technical difficulty) will maybe be a little bit softer through the balance of this calendar year.

Larry, you want to comment?

Christine, were you speaking to beef at that point?

No, sorry, on pork. And there are a few things keeping pork demand strong. Obviously, low supplies of beef, but also a strong export demand now with this safeguard tariff. It seems like a little bit of that export demand is going to be weaker.

I guess I would say that there's some truth to that, Christine, but some of the things that we -- a lot of the product that we sell into Japan is the higher-value product. And so while the safeguards are there, and they're going to protect the lower valued items because many of the cuts that we saw are the loin-based products. And those are at a price that are above the safeguard tariff, so we're okay. I think our Japanese business is going to be okay. I don't think it's going to be what you would call robust. The big difference in exports, and I'm sure you've heard that from everyone, is not Japan. It is Mexico and eastern Europe. That's where we're saying the big expansion, in terms of export opportunities. I mean, Mexico, I think the January through June numbers are more than triple last year, closing in on four times last year. And eastern Europe as well continue to be a big opportunity as well. So I don't think that most of us are saying that the export opportunities are in Japan; they are not. They are really in Mexico and eastern Europe.

That's good to hear. Thanks.

John McMillan.

Good morning, everybody. Actually, I have a comment and then a question. And my only comment, Larry, is that if you quantify big net hedging losses -- going forward, you're really obligated in my mind to quantify big hedging net gains, like when you locked in corn early last year. I think if we want to get normalized earnings, and I'm all for information, you have to go both ways. That's just a comment -- you can respond to it or not. But as for my question, it just deals with -- what happened in the market in July? I guess the export demand for pork is good, but it seemed like the entire business slowed down or your business slowed down in July. Was it just a case of higher pricing, just kind of rationing demand?

Business slowed down in July, John?

I think when you preannounced --.

John, ran we preannounced for one reason, and that was we had the $400 million debt offering. That is the only reason we preannounced. We were required to by the attorneys.

Okay. I was not made aware of it that; I am now. But your business didn't -- was barely even in the quarter?

I would say yes. It always blips up and down in various products segments and months. But no, I think, if we look at all three months in the quarter and there is a -- they're pretty steady numbers. Do you concur, Larry?

Yes, Joe.

I just had some discussions with Jerry. I don't mean to broaden here -- that just suggested your business (indiscernible). I will kind of work it out with him. There's a lot of moving parts here and I'm struggling to figure out whether opening orders is good or bad or a little of both. But if the Japanese were to open their borders to our beef, would that take some of the top spin off of the pork industry?

Perhaps, yes, John. But here again, as Larry has mentioned, while our exports to Japan are up, they are not dramatically up.

Okay, thanks a lot.

But John, here again, I'm going to repeat this. I know you've heard it from me a thousand times. But, yes, there are a lot of moving parts in this industry and that is the nature of the industry and that's going to never change.

It seems like now, there's with export markets and with extremely volatile -- I guess pork bellies are noted for their volatility -- but it just seems a little bit more volatile than normal, I guess.

I don't -- I think they are higher prices than normal, but the bellies have always been volatile and I think they always will be. But I don't think we have seen any volatility that's particularly unusual. We have just seen steady price increases above levels that we anticipated, and it's coming from strong demand domestically and internationally, and less beef on the market. And I think -- and that is the reason for what I think -- if you had beef numbers up where they were a year or two years ago, there is no question you would have a much sharper and lower hog market today. So you keep in mind that we are competing against all proteins.

Joe, I want to follow-up with one point, John, this issue of moving parts. I think that is almost a positive as opposed to a negative from Smithfield. We have said the growth of this Company over the last three or four or five years is the fact that we have broadened that base. And the fact that we have today -- our beef profitability is down. And offset to that is our pork profitability is up. And so as well, the fact that we have raising operations combined with processing operations; when raising is down, processing is up and vice versa. As well, we have the opportunity when there may be the situation, while it's as strong in the U.S., we've got the international operations that as well, they are a much more minor piece of our business. But I think over time, they're going to become a more significant part of us. The one thing that we have focused on from a management standpoint, and I guess I would pass on to you guys as you look at the business. Smithfield is probably at any point in time going forward, going to have one segment of the business that is not performing. It's simply the fact that these businesses are interacting with each other. Some of them are counter to the other one. When one's up, the other is down. So it is virtually impossible for us to show every segment of the business being up. It is the nature of the business that we're in and the fact that we have these offsetting both geography and businesses. I think it's very much a strength for the fact that our beef operations that we're producing a 49 cent profit when we have no profitability coming out of the beef side of the business. Again, the big positive for this first quarter was the fact that where we saw these $57 hogs, and that is the ISM (ph), we were really paying $60 for hogs.

John, if you go back five years before we got into hog production in any significant numbers and before we got into beef and before we got into turkey -- if we broke even the first quarter, we patted ourselves on the back because we always lost money -- not always -- but we've lost money more time than not in the first quarter. And we have eliminated that volatility. So I think that, because Smithfield today, there is no question that you will have a more consistent stream of earnings the way Smithfield is structured today, compared to the way it was structured five years ago.

And a follow-up, one final point. As (indiscernible) beating a dead horse here. But even you guys have looked forward where you would have traditionally put us at a very, very weak in the first quarter and very strong in the third quarter, I think you guys as you look at our second, third and fourth quarters, you're looking at relatively stable earnings across all of the four quarters with a little bit improving in the third and the fourth quarter. But you have shown it, even in the way you guys are projecting the quarterly numbers.

Thank you for all of this, I am learning. Thank you.

John, we all continue to learn in this business because every year is a little different than the previous year.

Leonard Teitelbaum.

Yes, I think I kind of forgot what it was during the discussion here. Look, maybe it's me, but I think this thing has turned out to be a relatively good quarter. And maybe I'm just not doing my numbers right. But with the section of beef, you guys did pretty well. I thought I understood -- back to Dave's question -- about what works out to me to be the difference between cash and book profit on your hedge positions. And I know you can't close them until you have said it, which is the middle of September. So on an operating basis, if you take out that closed position, why wouldn't we expect, Larry, and I think you were talking about reported earnings -- wouldn't we expect operating profit in the hog -- in the raising area, to come in around $250 million this year? You've done 100. I think adjusting for the hedge, you could do 90 in this quarter and you're only halfway through. Why would that be such a bad estimate, just on industry conditions?

It would not be, Leonard, but it is impossible to project what hog prices are going to be. And that is why we are always a very guarded. Keep in mind that I don't know of one company in this industry that accurately predicted the hog market in the last six months -- not one. And not just anyone in the industry; I don't think that there is anyone that predicted it. Right today as we sit right now, Larry said, you have a $53 hog market. But when you add the premiums because of the quality of the hogs, we have around a 55, $55.5 hog market with, say, a $43 cost -- 12, 24 -- we're making around $30 a head and where we're raising 15 billion head a year. So the arithmetic is very, very simple. And, yes, we do have a hedging loss that we will realize in the month of August and a little part of September. But we expect these hogs to be, as I told you, we expect these hogs to be higher this fall, a lot higher than they were last fall, and we expect them maybe not to drop off as much because of some of these weights. Keep in mind -- just a 2 or 3 percent difference in supply sometimes has 10, 12, 15 cents impact upon price, and that is the nature of the business. But we feel very confident that our earnings in the hog production segment is going to be very strong for the next nine months.

If I could just move on to a couple of other things here. Larry, one of the things that I took away from here that I was very fairly encouraged about, and I did not going to the call feeling this way, is that given your percentage in the industry, if you are moderating your production, and I can think a long time ago, we talked about there were just too many hogs being slaughtered for the market to absorb. That may have changed. But if you're reducing your production and we don't see anybody else picking up the slack, why shouldn't that not be kind of a buffer to a significant drop in hogs, given the demands that we see right now?

You're addressing it to Larry? I think it should be -- one component that you have to keep in mind, Leonard, is the Canadian feeder pigs (ph) crossing the border. But generally speaking, we are not seeing expansion. Banks are extremely reluctant to lend money for expansion. We have bought a couple of companies last year when their hog production was unprofitable, which is what we like to do, Leonard. We've always felt that there is more opportunity in bad times than good times. But yes, we are seeing discipline. The numbers are up to some degree because the weather conditions have been ideal and the death rate and the average daily gain in the feed conversions are very good from what we see right now. And our cost to raise hogs will be less next year than they were this year. The corn I think is going to be a little bit cheaper than last year. Plus right now, our productivity is substantially better than it was last year, but a lot of it is because the herds are not affected by (indiscernible) to the same degree and we have had ideal growing conditions because we had a relatively cool summer.

I would add to that, Leonard, just some anecdotal information. I spoke at a port conference here, I don't know, six weeks ago, and as part of my comments (indiscernible) comments back (ph). I don't know if there's a lot of people out there thinking much about expansion and our livestock tide (ph) just came in this morning. He and I were just talking at 7:30 this morning. He just spent three days out in the Midwest and came back and said, Larry, I said Jeff, what did they say about expansion? And he said -- no one, no one is talking about expanding their herds at this point.

We're hearing the same thing. Dan, do you have a projection on interest costs for the year, given the reset on -- with the bond issue?

Yes, Larry. The incremental, as I mentioned in my opening remarks, the incremental margin is going to be about $16 million a year on an annualized basis. So you can add about $4 million a quarter to the 27 that we reported for the quarter. It should be somewhere in the plus-$30 million range going forward.

Do you have projections for free cash flow?

I don't Leonard.

Rats. Thank you.

Tim Jones (ph).

Good morning, thank you. Just following up on the pork supply situation, it sounds good that no one is talking about expansion and the weights are a little lower than usual. So that bodes well going forward. But what are we seeing out of Canada, Joe, in terms of feeder pigs? It seems like there's been a slowdown of imports. Is that accurate?

Yes, there has been a slowdown. Larry, you may be a little bit closer to the exact amount of the slowdown in the last 30 days than I am.

I think I have that literally almost right in front of me, Joe. The last I guess I would count back 1, 2, 3, 4, 5, 6, 7, 8, 9, 10 -- 12 weeks, only one or two of those -- three or four of those weeks have a double-digit in them. They are increased, but they've come down dramatically from the levels they were before into -- I guess I would say the last 10 or 12 weeks, the number has been a high-single digit 8 percent or so. And that is down substantially from what we were seeing, as you may well remember, some six months ago. So the feeder pig numbers have really dropped down. The other side of it that you didn't ask but that could have been the other question is that the market hogs coming across -- has also dropped pretty dramatically. That's even more. In fact, they're down close to zero and may go into negative territory with Maple Leaf killing more hogs. I think there's another little plant that has opened up as well. So there's an even sharper drop, in terms of market animals coming across.

Okay and so hypothetically, if and when the borders reopen for U.S. beef and we begin to export beef to Japan, that may reduce the U.S. pork exports. But at the same time, we should see the Canadian protein glut kind of work itself off. And therefore, would you expect to see even less feeder and market hog imports into the U.S.? So net-net, the supply-demand balance should remain fairly steady in the U.S.?

The answer is yes. You're seeing the pork being pushed down into the U.S. because you have a tremendous surplus of very cheap beef in Canada. The cattle market I think in Canada today is around $60, I believe. And the cattle market in the United States is approaching $85 or $90 today. So there is no question because of the real glut of beef in Canada, because they have not been able to export to the United States or Japan or other world markets, it has pushed more pork out of Canada. And this is just another example of what Larry said just a minute or two ago. All of these proteins, they are all interrelated and n what happens in one protein has an effect upon the other proteins.

Great. So therefore, you mentioned last quarter that with the cattle cycle turning and disciplined hog production going forward, which we seem to continue to have today, that that could lead to a longer and higher hog cycle than typical. So you still feel that is possible today?

I think it's probable today. As Larry has comments and I think my comments, we are very bullish about the business in the next 12 to 18 months from what we see out there. And primarily is because we don't have the tremendous glut of total protein that we had a year or two ago. I mean, you have a lot less beef. You don't have the hog or the poultry expansion that you saw just a few years ago. And there just seems to be a little that more discipline in the industry. And the demand we see going up with what is happening in China. We see China historically has exported quite a bit of pork into Russia. We don't think they're going to be in the position to do that because of the dramatic growth that has taken place in China today. And then that opens up the Russian market and we're putting quite a bit of product. We haven't talk about Russia today, but Russia is importing quite a bit of meat today. So we're really -- it's really a world economy that we're dealing with today, to a much greater degree than just a few years ago. That's because of the exports are a higher and higher percentage of the total production in this country.

Great, thank you very much.

We have time for one more question, please.

(indiscernible)

Good morning. On the beef side, do you expect margins to generally kind of model along with the next three or four months, the balance of this calendar year at the levels you saw in the first quarter? I'm not asking for exact percentages. I'm just saying, is this environment going to generally persist, or do you expect some rebound?

We expect that beef will be modestly profitable for the next 12 months. It will not be as bad as the previous three or four or five months. But we do not expect it to be robust or as good as what it was prior to the -- we expect the beef margins to be weaker in the next 12 months than they have been for, say, the past 36 months. And that is strictly coming out of -- we expect the herds to be substantially less, unless cattle come into market in the next 12 months and would have come in 12 month periods.

And Joe, that outlook excludes any possibility of either the export markets opening or the U.S. border to Canada, right?

I did not catch the question.

You are assuming that neither the Asian export markets or the U.S. border to Canada will open in the next 12 months?

No, I'm not assuming that. Here again, I don't have any better feel for it than any of you. My guess is Canada is not going to open up until after the elections. Japan is not going to open up until some time after the first of the year. And they may not open then. But because of the beef herd being down, the beef is being consumed in this country, but we don't have a glut. I think we would have a glut if we had the same number of cattle coming to market today as would come into market 12 to 18 months ago, I think we would have a problem. But, fortunately, the herds are down when the export demand is down at the same time.

On the port processing front, I recognize the business is strengthening on a seasonal basis the next four months. But generally speaking, do you see improving margins in the next three or four months, excluding the seasonality factor as hog prices come down?

Generally when hogs prices come down, profit margin on processed meats go up, and vice versa. That is generally the case. Keep in mind, we sell out front quite a bit. The Wal-Marts and the Costcos of the world, they like to buy out front where they know where their costs are going to be a month or two out. And so that's just the nature of the business.

Your pork processing margins on a year-over-year basis for the second quarter and the third quarter are not too tough, are they?

No.

Fair enough. And, given the hedging losses and the mark-to-market and so forth, offset by the gains, it was not clear to me -- and I don't know if you can answer this -- but is the consensus EPS estimate for the second quarter, is that appropriate, too high, too low? Can you comment on that?

The consensus for the second quarter?

Yes.

Quite frankly, I don't know what that is consensus is. Larry, you may know. I don't know.

I'm not sure I know where it is at. Dan or Jerry, I thought we were about 59 cents or 60 -- 53.

We have never commented on estimates and I don't think we're going to begin today. Okay?

That's fine. And then you touched on Europe and pursuing opportunities there. Does that mean acquisitions, joint ventures -- what does that mean?

I think that means both. I think it means both. We do believe that the meat industry in Europe is in the wrong part of Europe, and although we have bought a couple of processed -- we did buy a processed ham plant in France, our focus is going to be on Eastern Europe because we are -- we believe with confidence that Eastern Europe is the midwest of the United States and the industry should be located there. And the only reason it is not located there was that we have had an iron curtain in Europe for the last 50 years that has now come down. But we believe that the meat industry 20, 30 years from today, it will be located in Eastern Europe for the most part, rather than Western Europe.

And then Dan, do you have an estimate for CapEx for the year?

As I mentioned, I think looking forward, we're probably going to be spending much closer to depreciation levels, so I think that's going to put us in the $165 to $170 million on an annualized basis, versus what we saw in the first quarter.

And cash on the balance sheet at the end of August, at the end of your quarter, sorry?

At the end of July?

Yes, exactly.

It will be about the same, Riza (ph). That just represents the cash float and some small cash positions that we keep for various reasons. But it will be in the $65 to $70 million range.

Got it. Thank you very much.

Joe, have you got some closing remarks?

I think anything I would say, Jerry, would be a repeat. I would say that we're very happy with the first quarter. It would have been a blowout quarter for us if we had not have taken the position on the hog futures, and I assume full responsibility. It was my decision. But as I said in the press release, given the same set of facts, I would make the same decision again. It's the first time in my entire business career that I have seen hog slaughter numbers go up and prices go up substantially at the same time. That has never happened before. It did happen this year and it adversely affected us. But the business decision was sound and that is not going to deter us from running the business we have always run it.

I am very optimistic about this year. I do believe that the next nine months, and quite frankly the next 18 months, will be very, very good. And I'm saying that at the same time as I've always said that this is a business where things can change dramatically and very, very quickly. Last November and December, for instance, beef earnings were excellent. Thirty days layer, they were red because of one cow with BSE in the United States. So that is the nature of the industry that we're in. But because we're in different proteins and when one is under distress, it usually helps the other. And we are very, very -- we continue to be very, very optimistic. And if you -- I will repeat one more time -- if you look at Smithfield Foods, for the last 30 years, we have had roughly a 26 percent return to our investors over a 30-year period. And I don't see that changing in the next four or five years. We have an awful lot of good things going for us. We're going to dramatically increase our processed meat business, we're going to get out of the commodity fresh beef business in the next year or two. We have plans on the drawing boards to accomplish that in bellies and hams and we continue to be very, very optimistic.

I will say that we will be much more internationalized in the next five years than we have been in the previous five years. And there are lots of trading opportunities between countries because of wide variances in price on the same commodity from country to country. And moving into the international arena, that is going to give us a big opportunity in my judgment. We are shipping a lot of fresh hams into Europe today that we were not doing just a few years ago, or even a year and a half ago. But we remain very, very optimistic and we think this year’s going to be a great year.

Thank you, Joe.

If not a record year, and I think it will probably be a record year. But here again, there's no certainty.

Thank you Joe, and thanks to everyone for joining us today.